In re General Steel Tank Company, Inc.

• Decision Date: 04 May 1973
• Docket Number: No. 72-2279.,72-2279.
• Citation: 478 F.2d 294
• Parties: In the Matter of GENERAL STEEL TANK COMPANY, INC., Bankrupt. MERRITT-HOLLAND WELDING SUPLIES, INC., et al., Appellants, v. GENERAL STEEL TANK COMPANY, INC., Appellee.
• Court: U.S. Court of Appeals — Fourth Circuit

478 F.2d 294 (1973)

In the Matter of GENERAL STEEL TANK COMPANY, INC., Bankrupt.

MERRITT-HOLLAND WELDING SUPLIES, INC., et al., Appellants, v. GENERAL STEEL TANK COMPANY, INC., Appellee.

No. 72-2279.

United States Court of Appeals, Fourth Circuit.

Argued February 7, 1973.

Decided May 4, 1973.

L. Patten Mason, Beaufort, N. C., Ellis L. Aycock, Wilmington, N. C., and John A. Mraz, Charlotte, N. C. (Wheatly & Mason, Beaufort, N. C., Stevens, Mc-Ghee, Aycock, Morgan & Lennon, Wilmington, N. C., and Mraz, Aycock & Casstevens, Charlotte, N. C., on brief), for appellants.

Hubert Humphrey, Greensboro, N. C. (McLendon, Brim, Brooks, Pierce & Daniels, Greensboro, N. C., on brief), for General Steel Tank Co., Inc.

Larry B. Sitton, Greensboro, N. C. (Smith, Moore, Smith, Schell & Hunter, Greensboro, N. C., on brief), for Fidelity and Deposit Co. of Md.

Before HAYNSWORTH, Chief Judge, BUTZNER, Circuit Judge, and BRYAN, District Judge.

BUTZNER, Circuit Judge:

This appeal concerns the right of attaching creditors to seek recovery against an unindemnified surety on bonds given to release an insolvent debtor's property that had been attached within four months before the filing of an arrangement under Chapter XI of the Bankruptcy Act.¹ The district court, affirming the referee, held that § 67(a) of the Act rendered the bonds null and void, and it restrained the attaching creditors from continuing state court suits to recover from the surety the accounts owed by the debtor. Because we hold that the Act does not discharge the liability of an unindemnified surety, we vacate the judgment of the district court and remand the case for modification of the referee's order.

Creditors of General Steel Tank Co., Inc., alleging that the company was removing its property from North Carolina, attached the property through proceedings filed in state courts. The attachments were discharged when General Steel posted bonds conditioned on its paying any judgments that might be obtained by attaching creditors but limiting liability on the bonds to the value of the property attached. Fidelity & Deposit Company of Maryland was the surety on the bonds. Within four months, General Steel filed a petition for an arrangement.

The referee found that General Steel was insolvent when the creditors secured the attachments. He declared the attachment liens and the bonds null and void, and he enjoined the attaching creditors from continuing their state court suits to subject the surety to liability.

The attaching creditors, reserving their rights against the surety, participated in the arrangement, but they also sought permission to continue their state court actions so they could establish General Steel's liability as principal and pursue their remedies against the surety. They acknowledge that any judgments awarded by the state courts can be executed only against the surety, not against General Steel, and they are willing to have this restriction expressed in the referee's order.

General Steel and its surety challenge the attaching creditors' right to obtain judgments in the state courts against General Steel even for the limited purpose of subjecting the surety to liability on the bond. The Bankruptcy Act, however, does not support their contention. Continuation of state court actions to impose liability on the debtor's surety is a recognized procedure,² and the attaching creditors' participation in the arrangement and receipt of a fraction of the indebtedness does not bar this relief.³

Section 16 of the Act provides that the discharge of a debtor shall not alter the liability of his surety.⁴ This provision rests on the premises that a discharge is personal and that it results from operation of the law, not the consent of the creditor.⁵ These principles form the background for interpreting the specific provisions of § 67(a), which pertain to a surety's liability on a bond given to release an attachment lien. The purpose of § 67(a) is to foster the equitable distribution of the debtor's property by preventing the creation of preferences by judicial liens, either directly, or indirectly through the interposition of a surety. Under § 67(a) (1), a lien obtained by attachment within four months before the filing of a petition for arrangement is deemed null and void if the debtor was insolvent at the time the lien was obtained.⁶ If a lien deemed null and void under § 67(a) (1) has been dissolved by a releasing bond, the transfer of property, or the creation of a lien, for the indemnification of the surety is deemed null and void under § 67(a) (2).⁷ As a corollary to the preceding provisions, § 67(a) (3) renders property and liens affected by §§ 67(a)(1) and (2) available for the benefit of the debtor's estate.⁸ Finally, when § 67(a) (2) nullifies the protection a surety has obtained through indemnification, § 67(a) (5) discharges the surety of his liability to the extent the indemnifying property or lien enhances the debtor's estate.⁹

In this case no party claims that General Steel transferred any property, or created any lien, for the indemnification of the surety. Nevertheless, the referee held, and the district court affirmed, that the policy of the Bankruptcy Act would be subverted by allowing the attaching creditors to recover a greater portion of their debts than other creditors even though the surety, not the debtor, would pay the difference. This conclusion, however, conflicts with § 16, which recognizes the legitimacy of a creditor's recovery against a surety despite the principal's discharge in bankruptcy.¹⁰ When § 67(a) is read in the light of § 16, it is apparent that allowing attaching creditors to recover a portion of their claims against a surety on a releasing bond does not contravene the policy of the Bankruptcy Act. The loss suffered by the attaching creditors is simply transferred to the surety with-out affecting the debtor's estate or his other creditors.¹¹

The referee and the district court also ruled that under North Carolina law the bonds given to release the attachment were statutory forthcoming bonds that stood as a substitute for the attached property, and not payment bonds for the satisfaction of any judgments that might be obtained by the attaching creditors. They held that the Act's nullification of the attachment liens also dissolved the bonds and discharged the liability of the surety.

The bankruptcy court's ruling does not, we believe, give appropriate consideration to the legislative history of § 67(a). Prior to 1934, the predecessor to § 67(a)¹² contained no provision governing the surety's liability when an attachment lien was discharged by a bond. Most cases held that bankruptcy did not relieve the surety of his liability,¹³ although a minority ruled that the surety was released.¹⁴ In 1934, Congress amended the Act to incorporate the minority view by expressly providing that the bond given to dissolve an attachment lien was null and void.¹⁵ Congress again amended the section in 1938, this time to substantially its present form.¹⁶ The 1938 amendment abolished the 1934 clause that voided all bonds when the liens underlying them were invalidated, and it replaced the clause with § 67(a) (5), which discharged only those sureties whose indemnifying transfers had been voided under § 67(a) (2). The amendment makes no reference to the distinction between forthcoming bonds and payment bonds. It classifies both types as "releasing bonds." The intention to expand surety liability seems obvious, for otherwise there would have been no need to alter the 1934 statutory framework.

The congressional intent is made even clearer by the legislative history of the 1938 amendment. The House committee report recognized that under the amendment the surety could remain liable even when § 67(a) (1) voided the underlying lien. However, the committee noted that the credit for the value of the indemnifying property allowed by § 67(a) (5) prevents injustice to the surety.¹⁷ The emphasis in the House committee report on the limited nature of release granted to sureties by § 67(a) (5) provides additional support for our interpretation of § 67(a). According to the report, the provision discharging the liability of a surety applies only to "the case where a lien has been released by the furnishing of a bond, the surety of which has been indemnified."¹⁸ The narrow scope of § 67(a) (5) indicates that Congress intended only a limited exception to the general rule of continued surety liability.

In sum, we conclude that the Bankruptcy Act does not discharge the liability of an unindemnified surety on a bond given to release the property of an insolvent debtor that was attached within four months before a petition for arrangement.¹⁹ But this holding is not to be read as conclusively imposing liability on the surety. The bankruptcy court's adjudication of the surety's liability ends after it determines when the attachments were given, whether the debtor was insolvent at that time, what transfers of property and liens are deemed null and void, and to what extent the liability of the surety must be discharged under the Act because of the indemnifying property and liens he must surrender for the benefit of the debtor's estate. The surety's liability ultimately must be decided in a forum other than the bankruptcy court, where the validity of the attachment and the effect of state law on the surety's undertaking can be litigated. Nothing that we have written reflects on these issues. We hold only that the Bankruptcy Act did not discharge the unindemnified surety.

Accordingly, the judgment of the district court is vacated, and the case is remanded so the referee's order may be modified to delete the declaration that the bonds are null and void and that no recourse may be had against the surety. The injunction should be modified to permit the attaching creditors to pursue their state court actions and to bar them from executing any judgments...