Prudence-Bonds Corp. v. State Street Trust Co.

• Decision Date: 05 December 1951
• Docket Number: Docket 22138.,No. 77,77
• Parties: PRUDENCE-BONDS CORP. et al. v. STATE STREET TRUST CO. et al.
• Court: U.S. Court of Appeals — Second Circuit

202 F.2d 555 (1953)

PRUDENCE-BONDS CORP. et al. v. STATE STREET TRUST CO. et al.

No. 77, Docket 22138.

United States Court of Appeals Second Circuit.

Argued November 9, 1951.

Decided December 5, 1951.

Reargued April 15, 1952.

Decided March 3, 1953.

Charles M. McCarty, New York City, George C. Wildermuth, Samuel Silbiger, Brooklyn, N. Y., and Nemerov & Shapiro, New York City, (Aaron Schwartz, New York City, of counsel), for appellants.

Peabody, Arnold, Batchelder & Luther, Boston, Mass., Milbank, Tweed, Hope & Hadley, New York City (Willard B. Luther, Boston, Mass., A. Donald MacKinnon, New York City, John S. Whipple, Boston, Mass., and William E. Jackson, New York City, of counsel), for appellees.

Before SWAN, Chief Judge, FRANK, Circuit Judge, and COXE, District Judge.

FRANK, Circuit Judge.

1. We assume, arguendo (1) that, to give the bankruptcy court jurisdiction, it was not necessary that the guaranty (or the proceeds of its enforcement) be part of the debtor's assets,¹ and (2) that, in fact, the guaranty constituted part of the mortgaged property.² Even so, we think the court, as a bankruptcy court, lacked jurisdiction on the facts here because (a) that jurisdiction could exist only if the suit were a representative action³ for restoration of the trust fund, and (b) under pertinent New York decisions, such a representative action cannot rest upon the indenture trustee's breach where that breach consists merely of inaction — here the failure to enforce the guaranty. Those New York decisions control us, although, as we once pointed out, they may lead to most undesirable results.⁴ Our discussions in earlier cases⁵ render it unnecessary here to canvass in detail Smith v. Continental Bank, 292 N.Y. 275, 54 N.E. 2d 823, and related decisions. Suffice it to say that, if the inaction of the trustee in the Smith case could give rise to personal suits only, i. e., not a representative suit for restoration of the fund, then surely the same must be true of the trustee's inaction here. Appellant urges that the Smith case dealt solely with an individual bondholder's suit at law for his personal loss, and that, for the trustee's misconduct alleged in that suit, a representative action for restoration of the fund could also have been maintained against the trustee. We do not agree. The New York courts, as we understand them, hold (a) that such inaction does not amount to a "release or surrender" of any mortgaged property, and that, without a "release or surrender," personal, individual suits only — not a representative suit for "restoration of the fund" — may be maintained; and also (b) that any such individual suits must be brought by those who held bonds at the time of the trustee's breach, not by subsequent transferees of the bonds (absent express assignments to them of the individual claims against the trustees). We think that (b) results from (a), not vice versa. Accordingly, nothing in the recent New York statute, Personal Property Law, McK.Consol.Laws, c. 41, § 41 (1950), wiping out (b) as to transfers made after September 1, 1950, would affect our decision, even if that statute were retroactive.⁶

2. We agree with the master and the district judge that there is no merit in appellant's objection to the trustee's surrender of $10,000 in cash for cancelled bonds. The trust agreement did not require, as a condition of such a surrender, compliance with conditions contained in the agreement but applicable to other types of releases.⁷

Affirmed.

On Rehearing

Before SWAN, Chief Judge, L. HAND and FRANK, Circuit Judges.

L. HAND, Circuit Judge.

This is an appeal by Prudence-Bonds Corporation (which we shall call the New Company), from the order of a court of bankruptcy in a proceeding under § 77B, Bankr.Act, 11 U.S.C.A. § 207, passing the account of the State Street Trust Company (which we shall call the Trustee), as trustee of three mortgages, pledged to secure the "Tenth Series" of negotiable bonds, issued by the original Prudence-Bonds Corporation (which we shall call the Debtor). On December 5, 1951, we dismissed the appeal on the ground that we had no jurisdiction over an attempted surcharge by the New Company of the account of the Trustee; the New Company has asked for a rehearing and the appeal has been reheard both by argument and briefs. Although Judge Inch's opinion in the District Court, 101 F.Supp. 729 states the facts in detail, it will make our discussion clearer, if we give a renewed outline of them. Prudence Company, Inc. (which we shall call the Guarantor) owned a large number of real estate mortgages, and sold them to the Debtor in exchange for ten or more "series" of negotiable bonds to be issued by the Debtor. As security for the tenth of these "series" the Debtor and the Trustee entered into a contract (which we shall call the Indenture), by which the Debtor assigned to the Trustee three of these mortgages, which with other property constituted a trust res. The Guarantor was not a party to the Indenture, but at the same time it executed a collateral agreement with the Trustee (which we shall call the Primary Guaranty), guaranteeing payment of the "Tenth Series" bonds, principal and interest, as they fell due. It was one of the Debtor's covenants in the Indenture that the Guarantor would also deposit a guaranty with the Trustee that the principal of any mortgages assigned to it by the Debtor should be paid by the mortgagors within eighteen months after it fell due, and that the interest should be paid when due. The Indenture, including the Primary Guaranty was executed on May 1, 1927; and on the 27th of July, 1928, the Guarantor deposited with the Trustee a guaranty (which we shall call the Secondary Guaranty) of the payment, as aforesaid, of any mortgages held as security. The mortgagors in one of the three mortgages that were part of the res, defaulted in the payment of its principal, and the default continued for more than eighteen months, during which period the Guarantor was solvent and could have performed the Secondary Guaranty. The Trustee filed its account in the reorganization proceeding at bar and prayed the court to settle the account and discharge it from further liability. The New Company which had succeeded to all the rights of a reorganization trustee, surcharged the account with the loss on the defaulted mortgage, the Guarantor having itself become insolvent shortly after the Debtor. Two questions arise: (1) Whether the New Company has any standing to enforce the Secondary Guaranty against the Trustee; and (2) if it has, whether its claim against the Trustee is good on the merits. In the decision that we are now rehearing, we assumed that the standing of the New Company to sue upon the claim must be determined under the law of New York, and that the courts of that state had held that, in situations like this, arising out of the neglect of a trustee to protect the res, as contrasted with a surrender or release of it, there arise only individual and separate claims of which the bondholders are severally the obligees, and which a reorganization trustee has no standing to assert. For that reason we dismissed the appeal, and had not occasion to consider the merits of the surcharge.

We have concluded that we were mistaken in assuming that the New Company had no such standing. The bondholders did of course have a direct claim against the Debtor by virtue of its promise to pay their bonds, just as they had a claim against the Guarantor upon the Primary Guaranty; but on this appeal we are concerned with neither. In addition they had claims against the Trustee under the Indenture; but these were only as beneficiaries of the trust, except as the Trustee made any express covenants in addition to its obligation as trustee. The Secondary Guaranty was a part of the res, as we shall show when we come to consider the merits; it was in substance an insurance by the Guarantor of performance of their promises by the mortgagors of the three mortgages — a sort of credit insurance. When the Trustee after notice of default upon one of these three mortgages — with which alone this appeal is concerned — failed to take any steps to enforce the Secondary Guaranty of which it was the obligee, it defaulted in its duty as trustee and became liable to the bondholders for any loss that resulted, except as the exculpatory clauses of the Indenture excused it; and, since the result turns upon the meaning of those clauses, our jurisdiction depends upon whether the New Corporation has any standing to press the claims of the bondholders for this breach. The Trustee says that the New Company has no such standing because by the law of New York, which controls the rights of the parties, the breach was at most a failure properly to protect a part of the res — i. e., to compel the Guarantor to perform the Secondary Guaranty — and not a "surrender or release." We agree that it was not. The Trustee next argues that the Court of Appeals of New York has several times decided that at the time of the events here in suit a bondholder's claim for such a breach did not pass with a transfer of the bond, but remained with the transferrer; and, further, that the claim even of those bondholders, who may not have bought their bonds after the breach, is personal to them severally, on which they must sue as primary obligees and which a trustee in reorganization under § 77B of the Bankruptcy Act may not assert on their behalf. Hence the District Court was without jurisdiction over the New Company's surcharge.

There can be no doubt that, until it was changed by statute, it was the settled doctrine of New York that in such situations a claim against a trustee for breach of his duty to protect the res, did not pass by transfer of the bond but remained the property of the transferrer;¹ and the same doctrine was applied to transfers of "participation certificates" which did not secure a debt, but were direct and beneficial interests...