McGill v. Commercial Credit Co.

• Decision Date: 17 June 1917
• Citation: 243 F. 637
• Parties: McGILL v. COMMERCIAL CREDIT CO.
• Court: U.S. Court of Appeals — Fourth Circuit

243 F. 637

McGILL v. COMMERCIAL CREDIT CO.

United States District Court, D. Maryland.

June 17, 1917

[Copyrighted Material Omitted] [Copyrighted Material Omitted]

Rosenberg Levis & Ball, of New York City, Sykes & Nyburg, of Baltimore, Md., and Robert P. Levis, of New York City, for plaintiff.

Leo Oppenheimer, of New York City, and Sylvan Hayes Lauchheimer, of Baltimore, Md., for defendant.

ROSE District Judge.

William H. Rich & Son, Inc., is, or was, a New York corporation. In the borough of Brooklyn, in the county of Kings, in that state, it was for some years extensively engaged in making and selling umbrellas and similar articles. Upon its own petition filed on the 15th of May, 1915, it was adjudicated a bankrupt by the United States District Court for the Eastern District of New York. It will be called the bankrupt. In due course the plaintiff, Charles H. McGill became its trustee, and will be so styled. The defendant is the Commercial Credit Company. It has a Delaware charter, but its business is carried on in or from Baltimore, in which, or in the suburbs of which, all its principal officers reside. It has waived objection to being sued here.

On the 17th of February, 1915, it was an unsecured creditor of the bankrupt for upwards of $55,000. To pay or secure this sum the bankrupt, between the date named and the 5th of the succeeding April, assigned to the defendant outstanding accounts due it by various customers, to the aggregate amount of something over $71,000. From these the defendant has paid itself in full. The trustee seeks to recover what the defendant thus received. He rests his case upon three distinct grounds. They will be stated here, not in the order in which they appear in his bill of complaint, but in that in which it will be most convenient to discuss them. They are:

First. The bankrupt and the defendant conspired to defraud the other creditors of the former.

Second. The assignment was a preference voidable under the Bankrupt Act.

Third. It was a preference voidable under the Corporation Law of New York.

Of these in their order:

The Alleged Conspiracy to Defraud.

Defendant furnishes, at a price, cash to merchants and manufacturers upon the security of the accounts due them for their wares. This business has in late years reached large proportions. It flourishes because it enables the seller of goods, so soon as he has shipped them, to turn into money a larger percentage of their price than it would be ordinarily possible for him otherwise so promptly to do. Under the trade usage of some countries, buyers of goods, upon receipt of bill of lading, accept drafts for the price, payable at an agreed time after sight. Where this is done, there is no demand for the special form of banking in which the defendant is engaged. The seller simply discounts his draft at a bank. The latter does not have to take expensive precautions to prevent the seller from collecting it when due or from applying the proceeds to his own use. It therefore can afford to discount such paper at its usual rate. Where the maximum legal rate of interest is 6 per cent. the cost to the bank's customers for such an accommodation will not reach 8 per cent., even taking into consideration the balance which under such circumstances a bank would expect its customers to maintain. Such discounting of commercial bills impairs no one's credit. He who does it is not anxious to conceal the fact. It so happens in this country that in most lines of business it is unusual for buyers to accept drafts, and it is rather uncommon for those who are prompt pay to give notes for their purchases. But here, as elsewhere, men always want to make and sell all the goods for which they can find a profitable market, and sometimes, in order to tide over what they persuade themselves are fleeting embarrassments, they are willing to make large sales at or even below cost. They need the use of more money than they have or can borrow upon their personal credit alone. They seek to use as security the sums due them by their customers. In America these are ordinarily in the form of open accounts and in that form alone. Such an account is by no means as good a security as a customer's note or bill, and it necessarily costs more to discount. All defenses available as against the seller of goods may be made against it in whomsoever's hands it may come, whether they be breach of warranty, failure in quantity or quality, set-off, or what not. Such drawbacks to the availability of open accounts are inherent. There are others which are imposed by the present point of view of many bank and credit men, who question the wisdom of doing business with those who sell their accounts. They say that one who does so has freed himself from one of the most effective checks upon overtrading; that such sales make it exceedingly difficult, if not impossible, for any one dealing with him to be sure what unpledged assets, if any, he has; and that he is handicapping himself by paying more than the ordinary bank rate for money. Most men who sell their accounts are anxious to keep the fact secret. That cannot be done if notification of the sale be given to the customer whose account has been sold. Yet the withholding of such notice still further reduces the security value of the account, and compels the purchaser to take various expensive and troublesome precautions, for which in the long run the seller must pay. The debtors of the seller make their payments to him. The buyer keeps a staff of auditors, clerks, and perhaps other agents, busy in trying to make sure that he gets all the money which the seller receives from a sold account. In spite of all this watchfulness, he not infrequently fails to do so. In this as in other forms of collateral banking, there is a tendency to look more to the security than to either the moral or financial worth of the borrower. It was Bagehot, I believe, who years ago acutely observed that, in the long run, lending on the commercial credit of the maker of negotiable paper was safer than lending on collateral of any kind.

The poorer or the more troublesome the security, the more the borrower must pay for the loan. One of defendant's witnesses said that the money received by the seller of accounts cost him on an average from 15 to 16 per cent. That fact makes the seller all the more unwilling that any one should suspect that he sells his accounts. Defendant seeks, as it must, to meet the seller's wishes. In many cases it thinks it necessary to insist that the very checks with which the seller's customers pay his account should be turned over to it. If it passes such checks through its own bank in the ordinary way, its indorsement may tell the story to the drawer of the check. To prevent such a possibility, the defendant, in pursuance of a formal resolution of its board of directors, agrees with its banks that the number '54' stamped on the back of checks shall constitute its indorsement. The checks of the bankrupt's customers which came to defendant were so indorsed. It wanted to supervise the bankrupt's dealings with its customers without giving any of them reason to suspect that there was any relation between it and the bankrupt. For that purpose the bankrupt was required to rent a post office box in its own name, but to turn the key over to defendant's agents. The latter, calling themselves for the purpose the Eastern Audit Company, requested statements from some of the bankrupt's customers.

In the absence of statute to the contrary, the purchaser of accounts is not required to notify the debtor. If he does not, he takes the risk that the latter may pay the seller, but as against third persons he acquires good title to the account. Such a buyer is therefore under no legal obligation to tell any one he has bought an account, and, unless the circumstances are peculiar, it is not easy to argue that he is under any ethical call to do so. But defendant was not content with merely keeping its business to itself. It went further in this, and, as it says, in many other cases. For the sole purpose of preventing some people from suspecting the truth, it did what it otherwise would not have done, and it continued to do these things after it knew the bankrupt's creditors, or some of them, had become exercised over a report that the bankrupt was selling accounts, and after it had reason at least to suspect that the bankrupt was not making truthful answers to the questions which on this subject its creditors were putting to it.

It was on September 4, 1912, that the defendant began the purchase of the bankrupt's accounts, and within the next two years it bought them to the aggregate amount of over a million dollars. In March, 1914, some rumors that the bankrupt was selling its accounts reached some of its creditors, and they spoke to its president on the subject. He was much exercised, and on the 21st of that month wrote Mr. Duncan then president of defendant:

'It was reported to me yesterday that a house in New York makes the assertion that we sell our accounts receivable. * * * I thought it advisable to write you personally to have you investigate the possibility of a leak on the part of any of your staff. In this office we naturally do all we can to keep this private, and I believe that we succeed. * * * I shall be glad to have you consider this strictly confidential, and give me your views regarding the matter as early as possible.'

Mr. Duncan answered that he was surprised, and added:

'We do everything possible to keep the names of all of our customers strictly confidential. * * * We would do all but fire any clerk that gave out such confidential information about any of our customers. I regret very much indeed that any one should have heard of this

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