Whitfield v. Kern

• Decision Date: 30 April 1937
• Docket Number: No. 220.,220.
• Citation: 192 A. 48
• Parties: WHITFIELD v. KERN et al.
• Court: New Jersey Supreme Court

192 A. 48

WHITFIELD

v. KERN et al.

No. 220.

Court of Errors and Appeals of New Jersey.

April 30, 1937.

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The CHIEF JUSTICE, PARKER and BODINE, Justices, and HETFIELD, Judge, dissenting.

Appeal from Court of Chancery.

Suit by Nathan A. Whitfield, trustee in bankruptcy of E. C. & J. B. Kern, Incorporated, against Edward C. Kern and others. From a decree of the Court of Chancery (120 N.J.Eq. 115, 184 A. 333), in favor of the complainant, the defendants appeal.

Reversed, and cause remanded.

Abraham M. Herman, of Orange, for appellants. Jacob Lipman, of Newark (George H. Rosenstein, of Newark, of counsel), for respondent.

HEHER, Justice.

Appellants Edward C. Kern and John B. Kern were severally adjudged guilty of "misappropriations" of the moneys of E. C. & J. B. Kern, Inc., now a bankrupt corporation, prior to the adjudication in bankruptcy; and they and Fannie R. Kern, who constituted the board of directors of the corporation during the period of the claimed peculations, were found to have been guilty of "gross negligence" in the directorial management of the corporate affairs and business, and personal liability for the moneys so "misappropriated" was decreed. The decree differentiates the respective liabilities, based upon what was conceived to be "the greater and lesser degrees of culpability." As between themselves, John B. was held primarily liable for the entire amount necessary to liquidate the claims of creditors at the time of the adjudication, plus the administrative expenses and costs of this suit. A secondary liability was imposed upon Edward C., with "recourse over against John B. Kern as to any payment made" by him, while Fannie R. was adjudged "thirdly liable," with "recourse over against John B. Kern and Edward C. Kern and either of them, as to any payments made" by her.

The corporation was organized on February 26, 1920, and was adjudged bankrupt on May 31, 1932. It was engaged in the combined optical and retail jewelry business. It was a "family corporation"— "close corporation," in the popular rather than the technical sense, is a term more definitely descriptive. The business had been founded by Edward C. some thirty-one years prior to the incorporation; and it concededly was in a prosperous state at the latter time. Fannie R. is his wife. John B. is his son. The original capital fund was $16,400, divided into 164 shares of the par value of $100 each. Edward C. held the majority of the issued stock, while his wife and son owned the remainder. Within two years after the incorporation, the earned surplus was used to increase the capital fund to $24,600. Thus these surplus moneys, like the original subscriptions to the capital stock, were dedicated to capital. These stockholders constituted the corporate body's board of directors from the time of its organization until the adjudication in bankruptcy; and they all took an active part in the conduct of the business until February 23, 1927, when Edward C, because of ill health, sold and assigned all his stock, then 224 shares, to John B., and assumed a mere advisory role in relation to corporate management. From then until the adjudication John B. held all but 2 of the outstanding shares of the capital stock. His father and mother had one share each to qualify them for membership in the board of directors.

The business continued to prosper. There is evidence to show that its surplus increased from $1,330.90, at the close of the year 1926, to $7,113.92 at the end of the year 1929; and that its net worth increased during the same period from $25,990.90 to $31,713.92. In 1930 the annual net profit was reduced to $557.18, while a loss was suffered in the year 1931. The claims proved in bankruptcy totalled $20,747.92. The additional moneys needed to satisfy these claims, with interest, after the liquidation of the estate, amounted to approximately $21,000; and this sum the appellants were decreed to pay to the trustee. The decline in fortune was attributed by appellants to the current trade depression.

The withdrawals of corporate funds at issue are classable under three heads, viz.: (1) $3,000 paid to Edward C. in the year 1928, and a like amount paid to him in the year 1929. It was claimed that these disbursements were made as compensation for services rendered to the corporation by Edward C, but the learned Vice Chancellor found that, while there was some evidence of services "in an advisory capacity" furnished by him during those years, the sums in question were received as payments on the principal of a mortgage given to secure the purchase price of the corporate stock sold by him to John B. in 1927; (2) $8,000 drawn by John B. as compensation for services rendered to the corporation in excess of what the Vice Chancellor found was the reasonable value of the services; i. e., $5,200 per year. The total annual withdrawals were as follows; $5,733.69 in 1927, $9,670.52 in 1928, $6,755.89 in 1929, $6,047.92 in 1930, and $5,698.66 in 1931. John B. possessed the technical skill and training requisite for the proper conduct of the business, and he devoted his entire time to it. At the time of the purchase of his father's stock, he was a graduate ophthalmologist, and also a graduate optometrist, admitted to practice in this state. He had been trained in the business under the tutelage of his father. His general management included the examination of eyes, the grinding and fitting of lenses, the repair of jewelry, the selling of goods, and the keeping of books; and (3) $19,000 claimed to have been taken in various amounts by John B., who was the corporate treasurer, during the period commencing in January, 1931, and ending with the date of the adjudication in bankruptcy. There is no contention that these sums represent withdrawals of profits. John B. maintains that they were not appropriated to his own use, but "were either in exchange or most likely were notes that were discounted or renewed," and points in demonstration of this to what he terms "unexplained" deposits corresponding respectively in date and amount to the sums withdrawn.

In respect of classes (1) and (2), there was plainly no embezzlement nor misappropriation of corporate funds by an officer or director without claim of right thereto. Bad faith is not charged. The evidence tends to show that the moneys so taken represent withdrawals by the owner of all but two of the outstanding shares of capital stock, either as profits or as compensation for services rendered. Although the bill alleged the making of these disbursements and the conduct of the business while the corporation was insolvent, there was no finding of insolvency at the times of these respective withdrawals; and the decree does not proceed upon the theory that the rights of creditors occupying that status at the time of the adjudication in bankruptcy were thereby impaired. As a matter of fact, their claims arose subsequent to the withdrawals, with the possible exception of some of the salary payments made in the latter part of the year 1931. The ratio decidendi of the decree under review is that they were rendered illegal because not sanctioned by corporate action, or ratified thereafter, and that the directors are also liable in the premises as for "gross negligence," in "failing to exercise supervision and control over the acts of the said John B. Kern and Edward C. Kern, and over the business, affairs and transactions of the said E. C. & J. B. Kern, Inc." Conceding that these payments could have been authorized or ratified, if thereby the capital fund was not impaired, the lack of appropriate corporate action is held to be fatal; and the loss thus occasioned is the sole basis of the liability fastened upon the directors.

A trustee in bankruptcy is the representative of the corporation, and of the creditors as well, where there has been infringement of the latter's rights as a class, as distinguished from a direct, tortious, individual injury. His is a comprehensive title.

The Bankruptcy Act (section 70, as amended). in terms, invests the trustee, by operation of law, with the title of the bankrupt and his rights and remedies as of the date of the adjudication in bankruptcy. 11 U.S.C.A. § 110. But this and cognate sections have been interpreted as evincing a purpose to vest in the trustee the title to such property "as it was at the time of the filing of the petition." Isaacs v. Hobbs Tie & Timber Company, 282 U.S. 734, 51 S.Ct. 270, 75 L.Ed. 645: Everett v. Judson, 228 U.S. 474, 33 S.Ct. 568, 57 L.Ed. 927, 46 L.R.A.(N.S.) 154, Acme Harvester Co. v. Beekman Lumber Co., 222 U.S. 300, 32 S.Ct. 96, 56 L.Ed. 208.

And he is possessed also of certain special rights and remedies conferred upon creditors by the state law and by this and related sections of the Bankruptcy Act, designed to secure the preservation of the insolvent estate as a fund for the benefit of all the creditors. He is vested with title to property transferred by the bankrupt in fraud of his creditors, and property which, prior to the filing of the petition, he could by any means have transferred or which might have been levied upon and sold tinder judicial process against him. Bankr. Act § 70a, subds. (4,5) 11 U.S.C.A. § 110 (a), subds. (4) and (5). He may avoid any transfer of property by the bankrupt which any of his creditors might have avoided, and recover the property so transferred, or its value, from the person to whom it was transferred, unless he was a bona fide holder for value prior to the date of the adjudication. Section 70e, as amended, 11 U.S.C.A. § 110 (e). Section 47a, subdivision (2), of the Bankruptcy Act (as amended), endows the trustee with all the rights, remedies, and powers of a creditor "armed with process." 11 U.S.C. A. § 75 (a) (2). The rights thus conferred are primary and not derivative. By this section the trustee is vested, as the representative of the...