308 U.S. 295 (1939), 39, Pepper v. Litton

Docket Nº:No. 39
Citation:308 U.S. 295, 60 S.Ct. 238, 84 L.Ed. 281
Party Name:Pepper v. Litton
Case Date:December 04, 1939
Court:United States Supreme Court

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308 U.S. 295 (1939)

60 S.Ct. 238, 84 L.Ed. 281




No. 39

United States Supreme Court

Dec. 4, 1939

Argued November 9, 10, 1939




1. The overruling by a state court of a motion made by the trustee of a bankrupt corporation to set aside a judgment against the corporation, where such motion was based exclusively upon the ground that the state practice governing confession of judgments was not followed in obtaining the judgment, and upon the ground that the agent purporting to act for the corporation in the matter was not authorized, does not bar the trustee, acting in the bankruptcy court on behalf of other creditors, from attacking the validity or priority of the claim underlying the judgment, matters which were not in issue and could not have been decided in the state court proceeding. P. 302.

2. Courts of bankruptcy, in passing upon the validity and priority of claims, exercise equity powers, and have not only the power, but the duty, to disallow or subordinate claims if equity and fairness so require. That power and duty are especially clear where the claim seeking allowance accrues to the benefit of an officer, director, or stockholder of the bankrupt. P. 303.

3. Merger of a claim in a judgment does not change its nature insofar as provability in bankruptcy is concerned; the court of bankruptcy may look behind the judgment to the essence of the liability. P. 305.

4. A dominant and controlling stockholder has a fiduciary duty to creditors in dealing with the corporation and with them, and, when his transactions are challenged, must prove the good faith of the transactions and their inherent fairness from the viewpoint of the corporation and those interested therein. This obligation is enforceable by the trustee in bankruptcy of the corporation. P. 306.

5. A dominant or controlling stockholder or group of stockholders are fiduciaries, as are directors. Their powers are powers in trust. P. 306.

6. The dominant and controlling stockholder of a corporation, scheming to defraud one of its creditors, sued the corporation on accumulated unpaid salary claims, the amounts of which were fixed by himself, and which he sought to collect only when the corporation was in financial difficulties; caused the corporation to confess

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judgment; used the judgment to delay the other creditor; levied on part of the corporate property and bought it in at sheriff's sale for much less than his judgment or the other claim; transferred the property to a second "one-man" corporation for six times what it cost him at the sale, payable in stock; caused the first corporation to go into voluntary bankruptcy for the sole purpose of avoiding payment of the other creditor's claim; bought up other debts, and presented his judgment as a claim, preferred in part, against the remaining assets of the bankrupt.

Held, that the judgment claim was properly disallowed by the court of bankruptcy either as a secured or as an unsecured claim. P. 310.

7. The fact that the judgment lien was perfected more than four months preceding bankruptcy cannot affect the result. P. 312.

100 F.2d 830, reversed.

Certiorari, 307 U.S. 620, to review the reversal of a judgment disallowing a claim in bankruptcy.

DOUGLAS, J., lead opinion

MR. JUSTICE DOUGLAS, delivered the opinion of the Court.

This case presents the question of the power of the bankruptcy court to disallow either as a secured or as a general or unsecured claim a judgment obtained by the dominant and controlling stockholder of the bankrupt corporation on alleged salary claims. The judgment of the District Court disallowing the claim was reversed by the Circuit Court of Appeals, 100 F.2d 830. We granted certiorari because of an apparent restriction imposed by that decision on the power of the bankruptcy court to disallow or to subordinate such claims in exercise of its broad equitable powers. 307 U.S. 620.

The findings of the District Court, amply supported by the evidence, reveal a scheme to defraud creditors reminiscent of some of the evils with which 13 Eliz. c. 5 was designed to cope. But for the use of a so-called

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"one-man" or family corporation, Dixie Splint Coal Company, of which respondent was the dominant and controlling stockholder, that scheme followed an ancient pattern.

In 1931, Pepper, the petitioner, brought suit in a state court in Virginia against Dixie Splint Coal Company and Litton, the respondent, for an accounting of royalties due Pepper under a lease.1 While this suit was pending, and in anticipation that Pepper would recover, Litton caused Dixie Splint Coal Company to confess a judgment in Litton's favor in the amount of $33,468.89, representing alleged accumulated salary claims dating back at least five years. This was done by P. H. Smith, secretary and treasurer of Dixie Splint Coal Company, who, according to the District Court, was "an employee of Litton and subservient to the latter's will." This was on June 2, 1933. Execution was issued on this judgment the same day, but no return was made thereon, Litton waiting "quietly until the outcome of the Pepper suit was definitely known." On February 19, 1934, Pepper obtained a judgment against Dixie Splint Coal Company for $9,000. On motion of the company, execution on the judgment was suspended for ninety [60 S.Ct. 241] days to permit an appeal. But defendant in that suit did not appeal.2 Instead, on March 19, 1934, while execution on the Pepper judgment was suspended, Litton caused an execution to issue on his confessed judgment and levy to be made thereunder. Yet Litton "had no intention of trying to satisfy his confessed judgment" against his corporation "unless and until it became necessary to do so;" he was using it "only as a shield against the Pepper debt." Thus, when execution and levy were made March 19, 1934, no steps were

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taken for over two months towards a sale of the property on which levy had been made. On May 31, 1934, Pepper caused an execution to issue on her judgment, and levy was made June 2, 1934. On this latter date, the sheriff "who seems to have been cooperating with Litton," advertised the property for sale under the Litton levy made in the previous March. On June 14, 1934, the sale was held, and Litton became the purchaser of the property sold at the sum of $3,200.

The next step in the "planned and fraudulent scheme" was the formation by Litton of "another of his one-man corporations," Dixie Beaver Coal Company, to which Litton transferred the property he had acquired at the execution sale at a valuation of $20,135.36 to be paid for in stock of the new company.3

On September 4, 1934, the third step in Litton's scheme was taken. On that date, Dixie Splint Coal Company, pursuant to a resolution of the board of directors, passed June 16, 1934, (two days after the Litton execution sale) filed a voluntary petition in bankruptcy. This step, according to the findings below, was "plainly for the sole purpose of avoiding payment of the Pepper debt." The bankrupt at that time had $4,500 on bank deposit and $12,000 in accounts receivable, most of which was good. The cash on deposit was then more than sufficient to pay all creditors with the exception of Pepper. And Litton caused the voluntary petition to be filed "feeling confident that his confessed judgment would cover and consume" the remaining assets. Adjudication followed on September 7, 1934.

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Litton's next step in his scheme to defeat the Pepper claim was to purchase wage claims against the bankrupt and to cause "in some manner" other claims to be withdrawn. This was done, according to the District Court, so that Pepper might be made to appear as the only general creditor -- a situation designed to give Litton a decided technical advantage, as we shall see.

On June 13, 1934, Pepper had instituted suit in the Virginia state court to have the Litton judgment declared void. On June 15, 1934, the day following the sale under the Litton execution, the sheriff instituted an interpleader action joining Litton, Pepper, and the Clinchfield Coal Corporation and alleging, inter alia, that that corporation had a prior lien on all the property sold for a debt of $2,153. Litton and Pepper both answered admitting the prior lien of the corporation, Pepper answering "without prejudice to her rights" asserted in the chancery cause to have the Litton judgment set aside. On July 18, 1934, an order in the interpleader suit was entered directing payment of $2,153.00 to the Clinchfield Coal Corporation.

Thereafter the trustee, with the authority of the bankruptcy court, moved in the state court to set aside the judgment and to quash the execution thereof on the ground that the judgment was void, since it had not been confessed in the manner required by the Virginia statute.4

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The court concluded that the Litton judgment was void, but denied the motion on the [60 S.Ct. 242] grounds that the trustee was estopped to challenge it. The court held that Pepper, in the interpleader suit, had treated the fund derived from the execution sale under the Litton judgment as valid, and consequently had elected to recognize the validity of the judgment. Since Litton had acquired, or caused to have withdrawn, all the remaining claims against the

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estate, the trustee in this suit was representing only Pepper. Therefore, since Pepper was estopped, so was the trustee. On appeal, that judgment was affirmed on those grounds. Smith v. Litton, 167 Va. 263, 188 S.E. 214.

Thereafter, the question of the allowance of the Litton judgment came before the bankruptcy court on exceptions previously made by Pepper. That court concluded that the decision by the state court that the trustee was estopped to attack the Litton judgment there did not prevent the bankruptcy court from considering its...

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