Susquehanna Chemical Corp. v. Producers Bank & Tr. Co.

• Decision Date: 27 April 1949
• Docket Number: No. 9824.,9824.
• Parties: SUSQUEHANNA CHEMICAL CORPORATION v. PRODUCERS BANK & TRUST CO., BRADFORD, PA.
• Court: U.S. Court of Appeals — Third Circuit

174 F.2d 783 (1949)

SUSQUEHANNA CHEMICAL CORPORATION v. PRODUCERS BANK & TRUST CO., BRADFORD, PA.

No. 9824.

United States Court of Appeals Third Circuit.

Argued April 5, 1949.

Decided April 27, 1949.

Frank B. Quinn, Erie, Pa. (James D. Wolfe, Bradford, Pa., on the brief), for appellant.

Henry A. MacDonald, Erie, Pa. (Gifford, Graham, MacDonald & Illig, Erie, Pa., on the brief), for appellee.

Before MARIS, GOODRICH, and KALODNER, Circuit Judges.

GOODRICH, Circuit Judge.

This case is a contest between the trustees in reorganization for the Susquehanna Chemical Corporation and the bank with which the corporation had, on July 30, 1948, checking accounts. The debtor owed the bank an amount greater than its checking accounts upon a demand note containing the usual Pennsylvania confession of judgment clause. Petition for reorganization under Chapter X, 11 U.S.C.A. § 501 et seq., was filed and trustees appointed on July 30, 1948. The bank thereafter refused to honor checks drawn on the checking accounts of the debtor corporation and claimed that under Pennsylvania law it was entitled to apply these accounts to the payment of its own debt. The trustees sought, in reorganization court, a judgment that the bank be directed to pay the amount of the deposits to the trustees. The District Court rendered such judgment and the bank appeals.

The first question is a procedural one which the Court raises sua sponte. We have been concerned with the question whether the equivalent to a turnover order may be applied to a claim against a bank, because the relation between the bank and depositor is, as all lawyers know, a debtor-creditor matter and the bank has no specific property belonging to the depositor. However, it appears to be undisputed that this difficulty is one which may be waived by the parties and is waived by no one objecting to it. Resort need not be had to plenary proceedings in such a case if nobody objects to the matter being handled in the reorganization court.¹

The next question to be answered is whether the rights of the parties with regard to this matter of set-off are to be determined by state law or federal law. This will make a difference. The answer to the question is that federal law controls. The authority of the United States in this field grows from the bankruptcy power which, in turn, is directly given to the Federal Government by the Constitution. The reorganization court is one dealing with the process authorized and directed by Congress and based on a grant of constitutional power to that body. We are, therefore, dealing with federal law in all matters concerning the conduct of reorganization proceedings, although, of course, a reorganization court, like a bankruptcy court, takes the property situation as it finds it, and property rights will have been determined by state law prior to bankruptcy or reorganization proceedings.

The application of federal law to reorganization proceedings seems to be settled beyond doubt by the decisions of the Supreme Court and other federal courts.² It is likewise recognized by state decisions where questions involving the application of state law in bankruptcy matters have come up.³

Before we leave this matter of state or federal law there is one other point which should be disposed of. The appellant argues that under the Pennsylvania statute⁴ a bank depositor who owes his bank money has only a claim against the bank for the difference between his "deposit" and the bank's claim against him. Language from some Pennsylvania decisions is cited to indicate that where a depositor does owe the bank, the latter's honoring of the depositor's checks is a matter of courtesy or accommodation if the bank's claim is bigger than the customer's account. The rule of property with regard to the situation presents a point of considerable difficulty. The reorganization court can handle the disposition of the debtor's assets and liabilities, but it cannot make an asset out of an alleged bank account if, in fact, there is no bank account. We think, however, the appellant's own argument shows the weakness in the position it suggests. The customer's lack of claim against the bank is conditioned by the circumstance that "the right of defalcation is claimed." But when one talks about claiming such a right, we get the equivalent of set-off or counter-claim called by another name. And then we get to the place of considering set-off, counter-claim, etc. and we are, as already indicated, away from the state law and governed by the federal law upon the subject.⁵ We pass, then, from the consideration of state statute to federal statute upon the subject-matter involved.

The third point is the applicability of the set-off section of the Bankruptcy Act. Section 68, 11 U.S.C.A. § 108, states the right of set-off in rather broad terms. It says "In all cases of mutual debts or mutual credits between the estate of a bankrupt and a creditor the account shall be stated and one debt shall be set off against the other, and the balance only shall be allowed or paid. * * *" Added to that sweeping rule we have the provision in Chapter X that the law applicable in bankruptcy proceedings is to be applied in reorganization "where not inconsistent with the provisions of this chapter * * *." 11 U.S.C.A. § 600.

In considering whether the application of a set-off provision is inconsistent with the purpose of the reorganization chapter it must be kept in mind that there is a sharp difference between straight bankruptcy proceedings and those for reorganization. In bankruptcy the object is to liquidate the assets of the bankrupt, to pay off his creditors as quickly and inexpensively as possible and to free the bankrupt from the burden of accumulated debt so that he may begin his business life anew. But the purpose of reorganization is not liquidation at all. If reorganization is successful the debtor corporation will continue to function, to pay its creditors, and carry on its business. The purpose of reorganization is to save a sick business, not to bury it and divide up its belongings.

It is quite evident that the application of the unqualified right of set-off might be enough, without more, to defeat the purpose of reorganization. As Finletter says on the subject: "It is not appropriate to use the same rule of set-off as is applied in a liquidation. To do so may deprive the debtor, for no equitable reason, of all or a large part of its current assets at a time when it needs them most and may frustrate the purpose of the Act."⁶

Recognition of the important differences between straight bankruptcy and reorganization has led both the courts and textbooks writers to say that the compulsory application of Section 68 to all reorganization cases would not be consistent with provisions of the chapter.⁷ In other words, sometimes the set-off rule of Section 68 is to be applicable; at other times it is not. Whether it is or not depends upon the equities of the situation. To support this conclusion we have not only the textbook writers, but also the Supreme Court in Lowden v. Northwestern National Bank, 1936, 298 U.S. 160, 56 S.Ct. 696, 80 L.Ed. 1114. We think that this decision plus the other authorities cited in the footnote show beyond doubt that the reorganization court is not bound to apply, willy-nilly, the set-off rule of Section 68 of the Bankruptcy Act. The criteria to be applied are given by the Supreme Court in the Lowden case. They include the value of the assets, the temporary or permanent duration of the debtor's inability to pay its debts as they mature, the superior liens, if any, to that of the creditor seeking set-off, and any understanding between the parties that the deposits were to be used to cancel the debtor's obligation.

This brings us, then, to the final problem in the case. Did the District Judge, sitting in the capacity of what would have been called, in former days, a Chancellor, exercise his discretion reasonably when he, in effect, denied the bank its set-off? On this point the situation of the debtor corporation at the time of the reorganization is pertinent for consideration. Here was a small but active company. The value of its real estate and equipment was over $1,000,000. The value of personal property, other than equipment, was valued at over $50,000. The only lien of record against it was a judgment note of which there was a balance of $2250 due on July 30, 1948. No execution had been threatened or issued against it. The bank had not entered judgment on its note. There was no understanding between the parties concerning set-off. The unpaid balance on the note was about $27,000 and the deposit accounts with the bank were about $20,000. Quite evidently this company was a going concern and its only difficulty was a shortage of liquid working capital. It was, in common parlance, land poor. What its creditor bank did, at the beginning of reorganization, was the thing most calculated to throw a monkey wrench into the whole machinery of reorganization. The bank seized its cash. Fortunately, the trustees were able to raise some money elsewhere so that the reorganization did not collapse. They promptly got authority from the reorganization court to borrow up to $200,000 on trustees' certificates and almost immediately raised $75,000 by that means.

We think the District Court was right in concluding that the application of the equities in this...