In re New Haven Clock & Watch Company

• Citation: 253 F.2d 577
• Decision Date: 28 March 1958
• Docket Number: Docket 24767.,No. 158,158
• Court: United States Courts of Appeals. United States Court of Appeals (2nd Circuit)
• Parties: Matter of The NEW HAVEN CLOCK & WATCH COMPANY, Debtor. The FIRST NATIONAL BANK OF CHICAGO, Petitioner-Appellee-Appellant, v. Arthur B. O'KEEFE, Jr., Trustee, Appellant, and The United States of America, Appellant.

253 F.2d 577 (1958)

Matter of The NEW HAVEN CLOCK & WATCH COMPANY, Debtor.

The FIRST NATIONAL BANK OF CHICAGO, Petitioner-Appellee-Appellant, v. Arthur B. O'KEEFE, Jr., Trustee, Appellant, and The United States of America, Appellant.

No. 158, Docket 24767.

United States Court of Appeals Second Circuit.

Argued January 15, 1958.

Decided March 28, 1958.

Schwartz & Knight, New Haven, Conn. (J. Stephen Knight, New Haven, Conn., of counsel, and Charles D. Issac, on the brief, New Haven, Conn.), for petitioner-appellee-appellant.

Curtiss K. Thompson, New Haven, Conn., for appellant Arthur B. O'Keefe, Jr., Trustee.

Charles K. Rice, Asst. Atty. Gen., Lee A. Jackson and I. Henry Kutz, Attorneys, Washington, D. C. (Marvin W. Weinstein, Department of Justice, Washington, D. C., Attorney, of counsel), Simon S. Cohen, U. S. Atty., for District of Connecticut, Hartford, Conn., and W. Paul Flynn, Asst. U. S. Atty., New Haven, Conn., for appellant United States of America.

Before MEDINA and MOORE, Circuit Judges, and GALSTON, District Judge.

MEDINA, Circuit Judge.

The New Haven Clock & Watch Company, a debtor which on December 7, 1956 filed a petition for reorganization under Chapter X of the Bankruptcy Act, 11 U.S.C.A. § 501 et seq., had, since 1947, been borrowing large sums of money from The First National Bank of Chicago. This debt was secured by the assignment to the Bank of accounts receivable owing to the Clock Company. The principal issues on this appeal from the order below directing the Trustee to pay to the Bank the amount of the Clock Company's debt involve the validity and priority of the Bank's security upheld by the court below, under the financing arrangement used by the Bank in lending large sums to the Clock Company.

The United States, a substantial creditor of the Clock Company, asserts that the assignment of the accounts receivable to the Bank was fraudulent in law because the Clock Company allegedly reserved the right to dispose of the proceeds of the accounts, and thus the transfers to the Bank were void under Section 70, sub. e of the Bankruptcy Act.¹ The principle that the "reservation of dominion" by the debtor over property transferred to secure a loan voids the creditor's security interest in that property was applied by the Supreme Court to financing by the assignment of accounts receivable in Benedict v. Ratner, 268 U.S. 353, 45 S.Ct. 566, 569, 69 L.Ed. 991.

It is against the rule set forth by the Supreme Court in Benedict v. Ratner, requiring the creditor so to "police" the assigned accounts that the debtor does not reserve dominion over them, that we must test the validity of the Bank's security. Assuming arguendo, as the Government contends, that this rule is applicable to every security transaction involving the assignment of accounts regardless of state law relating specifically to such assignments, it is nevertheless clear that, since, in the case at bar, the Bank effectively "policed" the receivables assigned to it, the transfers to the Bank were not fraudulent and thus not void under the Bankruptcy Act.

The financing agreement entered into by the Bank and the Clock Company, and the control over the assigned accounts exercised by the Bank acting pursuant thereto, are readily distinguishable from the security transaction involved in Benedict v. Ratner. In that case the only tangible evidence of the assignment was a list of the assigned accounts sent by the debtor to the creditor. Although the creditor was given the right to demand that these accounts be used in repayment of the loan, he did not do so, but rather "the company (debtor) was not required to apply any of the collections to the repayment of (the) loan. It was not required to replace accounts collected by other collateral of equal value. It was not required to account in any way to (the creditor). It was at liberty to use the proceeds of all accounts collected as it might see fit. * * * The business was to be conducted as (before the loan had been negotiated). Indebtedness was to be incurred, as usual, for the purchase of merchandise and otherwise in the ordinary course of business." 268 U.S. at page 360, 45 S.Ct. at page 567. Thus, the security transaction in Benedict v. Ratner was an assignment of accounts in name only, while, in the case at bar, the actual conduct of the Bank in controlling the receivables assigned to it was the precise opposite of what occurred in Benedict v. Ratner, and shows beyond doubt that the debtor did not, in fact, reserve dominion over the assigned accounts.

It was the practice of the Bank to lend to the Clock Company in exchange for demand collateral notes in the amount of each loan no more than seventy-five per cent of the face amount of the accounts assigned to it to secure the loan, and this ratio of debt to collateral was continuously maintained by the Bank in its dealings with the Clock Company. Along with each schedule of accounts assigned to the Bank there was an assignment contract which obligated the Clock Company to: (1) transmit to the Bank all proceeds received on the assigned accounts, so endorsed that the Bank could collect on them; (2) keep the proceeds of the assigned accounts separate from its own funds and expressly in trust for the Bank; (3) record on all of its pertinent records and books of account a notation showing that these accounts were assigned; (4) allow the Bank to examine and make extracts from its records; (5) notify the Bank immediately in case of the return of merchandise by the debtor of an assigned account, segregate and label the returned goods, and within ten days forward new accounts to cover the value of the returns. The assignment contract also provided that all funds collected or received by the Bank from the debtors of the assigned receivables were to be deposited in a special account in the Bank. This account was to be held by the Bank as collateral security for the payment of any indebtedness to it, and the Clock Company had no control over, nor could it withdraw any money from this account.

This special collateral account was opened and maintained by the Bank as provided in the agreement, and most of the other provisions of the assignment contract were also carried out by the parties. In addition, the Bank, acting pursuant to another provision in the contract, appointed an employee of the Clock Company as its special agent, who received in its behalf all payments from the debtors of assigned accounts and transmitted them to the Bank, and this employee was subject exclusively to orders from the Bank in the handling of these receipts.

Additional evidence of the exercise by the Bank of control over the assigned receivables is afforded by other records of these assignments kept up to date by the Clock Company. For each account assigned the Clock Company prepared an electronic punch card and an invoice in duplicate. Each of these invoices was stamped on the back directing the account debtor to pay the amount due thereon to the Bank, without inquiry, in full satisfaction of the Clock Company's interest in that account. The Clock Company retained one of these stamped invoices along with the electronic punch card for that account and sent the duplicate invoice to the Bank. Thus, in the Clock Company's office, the records of the assigned accounts consisted of the punch cards, the stamped invoices and the customers' ledger card which was stamped to indicate the assignment.

Against this background of the Bank's control and "policing" of the assigned receivables, the Government argues that the Clock Company actually reserved dominion over the accounts because it was allowed by the Bank to substitute new accounts for some of those previously assigned. However, this contention is untenable because the value of these substituted accounts was less than two per cent of the amount of money loaned, and also because there were sound financial reasons for these substitutions. Some assigned accounts had deteriorated in collateral value, and the Bank on at least one occasion notified the Company that if the deterioration of assigned receivables continued the Bank would require a greater ratio of collateral to secure the loans. Fresh accounts were also substituted when an assigned account had become stale or uncollectible, or when the account debtor returned merchandise or received a credit. Likewise, the Government's attack on the security transactions because of the Clock Company's failure to segregate and label returned merchandise is without merit since new receivables were assigned by the Company to cover those accounts against which merchandise had been returned.

Thus, although the Clock Company often substituted, without the Bank's direction, fresh accounts for old ones which had previously been assigned, and the Clock Company's customers' ledger was not always stamped up to date as the Company was required by the terms of the agreement to do, we hold that the continuous maintenance by the Bank of the four-to-three collateral to debt ratio in the form of assigned receivables and/or money in the collateral account, the Bank's hiring of its own agent in the Clock Company to handle and forward to it collections on the assigned accounts, and the keeping of an up-to-date record of the assignments on a set of electronic punch cards and duplicate invoices, all show sufficient "policing" to sustain the validity of the Bank's security interest. In other words, on the basis of the facts in the case at bar there is no ground for the imputation of fraud in the security transaction as there was in Benedict v. Ratner, where, in spite of the assignment of the receivables, business was conducted, and indebtedness incurred, by the debtor as though the assignment had not been made.

Although the Bank's control over its security interest thus adequately fulfilled the "policing" requirements under the rule of Benedict v. Ratner, an alternative ground for rejecting the...