Arnold v. Phillips

• Decision Date: 08 March 1941
• Docket Number: No. 9660.,9660.
• Citation: 117 F.2d 497
• Parties: ARNOLD v. PHILLIPS. In re SOUTHERN BREWING CO.
• Court: U.S. Court of Appeals — Fifth Circuit

117 F.2d 497 (1941)

ARNOLD v. PHILLIPS. In re SOUTHERN BREWING CO.

No. 9660.

Circuit Court of Appeals, Fifth Circuit.

February 4, 1941.

Rehearing Denied March 8, 1941.

COPYRIGHT MATERIAL OMITTED

Leon Jaworski, of Houston, Tex., for appellant.

J. C. Hutcheson, III., of Houston, Tex., for appellee.

Before FOSTER, SIBLEY, and McCORD, Circuit Judges.

SIBLEY, Circuit Judge.

In a bankruptcy case the district court on the trustee's petition set aside a duly recorded deed of trust against the bankrupt corporation's entire plant, made over four years before bankruptcy to its then President and dominating and practically sole stockholder to secure advances of money to the corporation. A foreclosure of it by sale under power six months before bankruptcy was also cancelled, the deed being unrecorded at bankruptcy, and the bankrupt adjudged to be the owner of the property free of this incumbrance. The appeal is from this judgment.

The legal theory of the decision stated by the district judge is that the original capitalization of $50,000 in 1933 was then known to be inadequate; that on September 5, 1934, when the deed of trust was made to secure past advances of $75,500 and interest, and contemplated future advances, the stockholder was seeking to protect himself not from the corporation, but against its then and future creditors, which was inequitable under the decisions in Taylor v. Standard Gas & Electric Company, 306 U.S. 307, 59 S.Ct. 543, 83 L.Ed. 669, and Pepper v. Litton, 308 U.S. 295, 60 S.Ct. 238, 84 L.Ed. 281, and that the advances are to be treated not as debts but stock subscriptions. The trustee puts forward an additional theory that the corporation was but the agency or instrumentality of the stockholder and that its corporate entity is to be wholly disregarded, and the view taken that the stockholder cannot have a debt against himself, nor a deed of trust against his own property.

The appealing stockholder, A. M. Arnold, contends that the matter is controlled by Texas law, and under that law the debt and security, though to an officer and sole stockholder, are valid; but if not, because the deed of trust was recorded before any of the creditors now represented by the trustee gave credit to the corporation, none of them can question it, and the trustee cannot. Also, that the failure to record the foreclosure deed before the bankruptcy did not avoid it, because Arnold, who bought in the property, at once leased it to the bankrupt, whose possession as Arnold's tenant was notice of Arnold's title and equivalent to record.

The important facts are in brief these: Arnold was and is in the building and contracting business. With the cessation of national prohibition in 1933 he thought money could be made in the beer brewing business. He interested a brewer, Souza, and in July, 1933, obtained a Texas charter for Southern Brewing Company, the bankrupt, by which he, his son-in-law Otto, and Souza were named directors for the first year, and the capital stock was fixed at $50,000, all paid in cash by Arnold, to whom 498 shares were issued, and one share each to the other directors. While the brewery was building, it was decided to enlarge it to include a bottling plant. By the end of the year Arnold had advanced, on demand notes, about $70,000 in addition to the $50,000 capital, and the plant had cost approximately $115,000. Additional advances were made to begin operations, Arnold guaranteeing some of the accounts for supplies. At the end of the fiscal year, June 30, 1934, a demand note for the $75,500 of advances and interest at 8% was made. On September 5, 1934, a substitute note was given for $79,729, due September 5, 1937, with interest at 6%, and secured by a deed of trust on the entire plant, in which Arnold's daughter, Mrs. Otto, was trustee. The deed stated that it was to secure also future contemplated indebtedness, and was duly recorded. For two years thereafter the business prospered, a salary to Arnold ranging from $15,000 to $25,000 per year was set up on the books, but by no formal action of the directors, and was paid, totalling $45,000. Interest was also paid on Arnold's note to an amount of $19,000, and a credit on principal of $27,400, so that the note stood at $52,392 on October 31, 1936. In the corporation's financial statement of that date, after all these payments to Arnold a surplus was shown of about $97,000. The business then began to lose money. The salary credited to Arnold during the next year he had charged off the books. He collected no interest, and in February, 1937, he began making further advances which by May, 1938, amounted to about $47,000. On May 4, 1938, he gave his son-in-law Otto all his stock, and Otto took over the management, though Arnold still helped him. Otto also began making some advances and got Arnold to furnish yet more, so that in the fall of 1938 Arnold's advances stood at $99,379, including the $52,392 balance of the initial advances. He decided in October, 1938, to foreclose on the plant; the daughter as trustee sold it at public outcry under the power in the deed. Arnold made the only bid, the amount of his debt, and obtained a deed but did not record it. The same day he leased the plant to the corporation, which continued to operate there without any apparent difference. Bankruptcy occurred six months later. The unsecured indebtedness is about $66,000. Assets besides the plant have proven of little value, and are not sufficient to pay these creditors. Arnold has since his purchase of the plant refused $200,000 for it. Its cost according to the books was $238,000, and its book value as depreciated is $147,000. There is no pleading, no evidence and no finding of any intentional fraud, or of mismanagement other than is implied in what has been stated. The apparent loss in dealing through Monte Carlo Distributing Company is adverted to below.

The parties differ radically as to what system of law controls. We are of opinion that in a bankruptcy case the ownership of property depends ordinarily on the State law, and so does the existence of a debt and the validity of the security for it. The enquiry begins in State law, but does not end there. Whether when bankruptcy supervenes a title acquired by one creditor is good against other creditors, and what are the relative rights and standing of creditors as against each other, and what the propriety of recognizing and enforcing secured debts under varying circumstances, are questions so related to the bankruptcy power as to be regulable by Congress; they are of the essence of bankruptcy law. There necessarily arises also a body of judicial interpretation having the effect of law, which overrides the interpretations of the State courts on similar questions. The "equity" administered in the bankruptcy courts may not be exactly that of the State courts. We think in this case we ought to give the more earnest heed to the federal conceptions of the equities of creditor and stockholder relationships where corporations are involved.

The district court properly looked behind the title Arnold acquired at the sale held by his own daughter six months before bankruptcy. Neither the deed he got nor the lease he made was recorded; the occupancy appeared afterwards to be just what it had always been. Only himself, his daughter and his son-in-law participated. The son-in-law,...