Fellows, J.
(after stating the facts). We have recently had occasion to consider a case brought for the same purpose as is the instant case, and in which some of the questions here involved were determined. Grand Rapids Trust Co. v. Nichols, 199 Mich. 126; we shall have occasion to refer to that case as we proceed.
It is insisted that the order of the referee above mentioned, having been made without personal service on defendant, is void and of no effect as to this defendant, and for that reason this or any other suit has not been validly authorized and may not be maintained. The authorities upon this question are not in harmony; the United States circuit court of appeals of this circuit having, set aside a somewhat similar order made upon similar notice by mail, in a direct proceeding for that purpose. In re Haley, 158 Fed. 74. We are impressed, however, from an examination of the authorities, that the making of such an order by the referee in a case of this character without personal service is recognized as the proper practice; that it is determinative of the amount of the indebtedness of the bankrupt and of the amount necessary, in addition to the other assets, to liquidate such indebtedness, but that it is not res adjudicata of any defenses personal to the defendant; that while it authorizes the bringing of a suit in the proper forum, it does not foreclose the defendant from such defenses as he may see fit to make.
The statute of limitations is pleaded, although not strenuously insisted upon. It is not available. The [390]*390statute did not begin to run until the order of the referee. Scovill v. Thayer, 105 U. S. 143.
Before proceeding further it is well that wé consider the character of this litigation, the theory upon which the case was tried, and the theory under which defendant may be called upon to respond. This is necessary in order that we determine what rights the trustee in bankruptcy possesses, and under which provision of the bankruptcy law he seeks to exercise such rights, in order that we may determine the proper forum under our system of procedure in which such rights may be enforced. His powers and rights are prescribed by the act of congress and are very broad. He has the rights of the bankrupt; in addition he has the right not possessed by the bankrupt, that of pursuing property conveyed by the bankrupt in fraud of creditors, and by the recent amendment he has the rights of a creditor armed with process. In order to determine the proper forum in which he may exercise these respective rights, it is important that we understand which of these rights he is here seeking to enforce.' For that purpose we must consider the nature of the rights here asserted in order to judge the remedy adaptable.
This is not a suit to recover on a statutory liability, nor, strictly speaking, is it an action to recover an unpaid subscription; nor is it an action brought to recover property conveyed by the bankrupt in fraud of creditors and which conveyance of necessity operates as a fraud upon all creditors, and the recovery inures to the benefit of nil creditors. As we shall presently see, the recovery here does not inure to the benefit of all the creditors but only to those who have extended credit in reliance upon the capital stock of the corporation. The case was tried and submitted to the jury in the court -below upon the claim of the plaintiff that the Groveland Mining Company, acting [391]*391through its officers and promoters, in fraud of the rights of creditors, had disposed of the property of the corporation, i. e., its shares of stock, at a grossly inadequate price, or without consideration; and that under such circumstances the contract for sale and sale of such stock was void, rendering the stockholders liable for the stock fraudulently obtained by them. Where creditors’ and' other stockholders’ rights are not invaded, a corporation, at the time this corporation was organized and before Act No. 46, Pub. Acts 1915. (3 Comp. Laws 1915, § 11945 et seq.), was passed, might dispose of its stock at such figure or for such property as it and the prospective stockholder might agree upon. Young v. Erie Iron Co., 65 Mich. 111; Rickerson Roller Mill Co. v. Machine Co., 75 Fed. 554; Old Dominion Copper Co. v. Lewisohn, 210 U. S. 206; Coit v. Gold Amalgamating Co., 119 U. S. 343. In the last cited case the court recognized the right of creditors, who had extended credit in the belief that the stock was fully paid, to proceed against the stockholders in case property was fraudulently exchanged for stock, but at the same time pointed out the distinction between such a case and one brought for unpaid. subscriptions, the court saying:
“The case is very different from that in which subscriptions to stock are payable in cash, and where only a part of the installments has been paid. In that case there is still a debt due to the corporation, which, if it become insolvent, may be sequestered in equity by the creditors, as a trust fund liable to the payment of their debts. But where full paid stock is issued for property received, there must be actual fraud in the transaction to enable creditors of the corporation to call the stockholders to account. A gross and obvious overvaluation of property would be strong evidence of fraud.”
In the recent case of Decke v. Baker, 201 Mich. 608, Decke, a stockholder, sought to liave set aside an issue [392]*392of stock to Baker for Ms services; the company was made a defendant and filed a cross-bill also seeking to set aside such issue of stock to Baker. Mr. Justice Stone, speaking for the court, said:
“If the facts were conceded to be as claimed by the cross-plaintiff, Baker Clay Company, there would be no ground for equitable relief as to it, but the parties would be left in the position in which they have placed themselves. Walhier v. Weber, 142 Mich. 322, 325; Benson v. Bawden, 149 Mich. 584; 4 Thompson on Corporations (2d Ed.), § 3916; 9 Cyc. p. 546.”
The trustee in bankruptcy, suing in right of the bankrupt, and not basing his right upon a fraudulent disposition of property, which right could be exercised only for the benefit, of creditors, and not basing his right on the amendment to the bankruptcy law in 1910 referred to in the Nichols Case, is bound by the contracts of the bankrupt, and could not recover in right of the bankrupt, unless the bankrupt could recover. Wasey v. Whitcomb, 167 Mich. 58; Marine Savings Bank v. Norton, 160 Mich. 614; York Manfg. Co. v. Cassell, 201 U. S. 344; Zartman v. National Bank, 216 U. S. 134. The contract of the bankrupt must be gotten rid of, set aside, before the trustee can call upon the stockholder for anything other than his contract with the bankrupt required. This may be done in case of fraud upon the rights of creditors in a proceeding suitable for that purpose.
Free access — add to your briefcase to read the full text and ask questions with AI
Fellows, J.
(after stating the facts). We have recently had occasion to consider a case brought for the same purpose as is the instant case, and in which some of the questions here involved were determined. Grand Rapids Trust Co. v. Nichols, 199 Mich. 126; we shall have occasion to refer to that case as we proceed.
It is insisted that the order of the referee above mentioned, having been made without personal service on defendant, is void and of no effect as to this defendant, and for that reason this or any other suit has not been validly authorized and may not be maintained. The authorities upon this question are not in harmony; the United States circuit court of appeals of this circuit having, set aside a somewhat similar order made upon similar notice by mail, in a direct proceeding for that purpose. In re Haley, 158 Fed. 74. We are impressed, however, from an examination of the authorities, that the making of such an order by the referee in a case of this character without personal service is recognized as the proper practice; that it is determinative of the amount of the indebtedness of the bankrupt and of the amount necessary, in addition to the other assets, to liquidate such indebtedness, but that it is not res adjudicata of any defenses personal to the defendant; that while it authorizes the bringing of a suit in the proper forum, it does not foreclose the defendant from such defenses as he may see fit to make.
The statute of limitations is pleaded, although not strenuously insisted upon. It is not available. The [390]*390statute did not begin to run until the order of the referee. Scovill v. Thayer, 105 U. S. 143.
Before proceeding further it is well that wé consider the character of this litigation, the theory upon which the case was tried, and the theory under which defendant may be called upon to respond. This is necessary in order that we determine what rights the trustee in bankruptcy possesses, and under which provision of the bankruptcy law he seeks to exercise such rights, in order that we may determine the proper forum under our system of procedure in which such rights may be enforced. His powers and rights are prescribed by the act of congress and are very broad. He has the rights of the bankrupt; in addition he has the right not possessed by the bankrupt, that of pursuing property conveyed by the bankrupt in fraud of creditors, and by the recent amendment he has the rights of a creditor armed with process. In order to determine the proper forum in which he may exercise these respective rights, it is important that we understand which of these rights he is here seeking to enforce.' For that purpose we must consider the nature of the rights here asserted in order to judge the remedy adaptable.
This is not a suit to recover on a statutory liability, nor, strictly speaking, is it an action to recover an unpaid subscription; nor is it an action brought to recover property conveyed by the bankrupt in fraud of creditors and which conveyance of necessity operates as a fraud upon all creditors, and the recovery inures to the benefit of nil creditors. As we shall presently see, the recovery here does not inure to the benefit of all the creditors but only to those who have extended credit in reliance upon the capital stock of the corporation. The case was tried and submitted to the jury in the court -below upon the claim of the plaintiff that the Groveland Mining Company, acting [391]*391through its officers and promoters, in fraud of the rights of creditors, had disposed of the property of the corporation, i. e., its shares of stock, at a grossly inadequate price, or without consideration; and that under such circumstances the contract for sale and sale of such stock was void, rendering the stockholders liable for the stock fraudulently obtained by them. Where creditors’ and' other stockholders’ rights are not invaded, a corporation, at the time this corporation was organized and before Act No. 46, Pub. Acts 1915. (3 Comp. Laws 1915, § 11945 et seq.), was passed, might dispose of its stock at such figure or for such property as it and the prospective stockholder might agree upon. Young v. Erie Iron Co., 65 Mich. 111; Rickerson Roller Mill Co. v. Machine Co., 75 Fed. 554; Old Dominion Copper Co. v. Lewisohn, 210 U. S. 206; Coit v. Gold Amalgamating Co., 119 U. S. 343. In the last cited case the court recognized the right of creditors, who had extended credit in the belief that the stock was fully paid, to proceed against the stockholders in case property was fraudulently exchanged for stock, but at the same time pointed out the distinction between such a case and one brought for unpaid. subscriptions, the court saying:
“The case is very different from that in which subscriptions to stock are payable in cash, and where only a part of the installments has been paid. In that case there is still a debt due to the corporation, which, if it become insolvent, may be sequestered in equity by the creditors, as a trust fund liable to the payment of their debts. But where full paid stock is issued for property received, there must be actual fraud in the transaction to enable creditors of the corporation to call the stockholders to account. A gross and obvious overvaluation of property would be strong evidence of fraud.”
In the recent case of Decke v. Baker, 201 Mich. 608, Decke, a stockholder, sought to liave set aside an issue [392]*392of stock to Baker for Ms services; the company was made a defendant and filed a cross-bill also seeking to set aside such issue of stock to Baker. Mr. Justice Stone, speaking for the court, said:
“If the facts were conceded to be as claimed by the cross-plaintiff, Baker Clay Company, there would be no ground for equitable relief as to it, but the parties would be left in the position in which they have placed themselves. Walhier v. Weber, 142 Mich. 322, 325; Benson v. Bawden, 149 Mich. 584; 4 Thompson on Corporations (2d Ed.), § 3916; 9 Cyc. p. 546.”
The trustee in bankruptcy, suing in right of the bankrupt, and not basing his right upon a fraudulent disposition of property, which right could be exercised only for the benefit, of creditors, and not basing his right on the amendment to the bankruptcy law in 1910 referred to in the Nichols Case, is bound by the contracts of the bankrupt, and could not recover in right of the bankrupt, unless the bankrupt could recover. Wasey v. Whitcomb, 167 Mich. 58; Marine Savings Bank v. Norton, 160 Mich. 614; York Manfg. Co. v. Cassell, 201 U. S. 344; Zartman v. National Bank, 216 U. S. 134. The contract of the bankrupt must be gotten rid of, set aside, before the trustee can call upon the stockholder for anything other than his contract with the bankrupt required. This may be done in case of fraud upon the rights of creditors in a proceeding suitable for that purpose.
The theory upon which the action may be maintained by a trustee in bankruptcy against a stockholder who has paid an agreed price for stock in a corporation, is that the capital stock of a corporation is a trust fund for the benefit of its creditors, and its officers may not fraudulently convey it away, and that, if so fraudulently conveyed away, the fraudulent contract may be vacated and the property, i. e., the capital stock, may be recovered for. In a proceeding [393]*393of this character the plaintiff’s (trustee’s) right to recover is and must be based on the following premises: (1) That the capital stock of a corporation is the property of the corporation, a trust fund for the benefit of the corporation and its creditors; (2) that creditors have a right to rely and do rely on such capital stock in extending credit to the corporation; and (3) that in disregard of the rights of such creditors the corporation has disposed of its capital stock either in actual fraud, or for such an inadequate con-' sideration as to work a constructive fraud.
If an individual creditor were seeking relief in the courts of the State upon the theory here advanced by the plaintiff, he would be required to proceed by creditors’ bills, having taken the necessary preliminary steps.
As stated, the theory upon which this suit may be maintained must be the trust fund theory; it must be that a trust fund existed, and that the trustee in bankruptcy is pursuing that trust fund for the benefit of such creditors (not necessarily all creditors) as may establish their right to participate. In pursuing this trust fund, therefore, the trustee’s right must come from the amendment to the bankruptcy law, to which we shall now refer, rather than his right under the original act.
The bill in the case of Grand Rapids Trust Co. v. Nichols, supra, was framed upon the theory here discussed, and we there sustained the right of the trustee to file such a bill on the ground that the amendment of 1910 to section 47 of the bankruptcy law (36 U. S. Stat. 838, 840), gave to the trustee all the rights, remedies, and power of a judgment creditor holding an execution duly returned unsatisfied; that he had the right to pursue property transferred by the bankrupt in fraud of his creditors; that he had the rights of a creditor “armed with process”; and that when [394]*394pursuing such rights he could maintain a bill in the nature of a creditor’s bill. It will be noted that the amendment above- referred to not only gives to the trustee the rights of a creditor “armed with process,” but also gives him the 'remedies of such a creditor.
When this plaintiff sought to have set aside the contract between the company and the defendant, by which the option was- transferred to the company in consideration of the issuance of stock, upon the ground that such transaction was in fraud of creditors and their rights, and that he had the right to follow the trust fund, he was exercising a right given him by the amendment above referred to, the right of a judgment creditor with an execution returned unsatisfied, the right under our practice to file a creditor’s bill. We so held in the Nichols Case and- we are not persuaded that an incorrect result was there reached. We there pointed out that in an equitable proceeding the court may carefully guard the interests of each and every party. It was admitted in that case that some of the creditors would not be entitled to participate. It is quite probable that such is the case here, and that it will always be the case where the trustee is proceeding against stockholders who have exchanged property for stock. Under the broad power of a court of equity, what creditors, if any, are entitled to participate may be determined; what persons, if any, are liable to account may be decreed; sufficient to liquidate the claims of those entitled to participate, and no more, may be awarded against such persons, as may be liable. While the number of original stockholders here are few, cases will arise where they are numerous; a multiplicity of suits should be avoided. One bill in which all are made parties will suffice to determine the rights and liabilities of all.
We repeat that we are not here dealing with the collection of an unpaid stock subscription, strictly [395]*395speaking; nor with the enforcement of a stockholder’s statutory liability; nor with a proceeding where the recovery of necessity inures to the benefit of all creditors; but considering solely the case before us, that of a bankrupt corporation, the theory upon which it was tried and the only theory upon'which recovery may be had, we hold that in such a proceeding the trustee is exercising the rights given him under the amendment to section 47, may pursue the remedies provided in our system of procedure incident to such rights, that the relief under our practice must be had in equity, and that this suit on the law side of the court may not be maintained.
As we have concluded that the case should be remanded for transfer to the equity side of the court to be there disposed of, it becomes necessary to consider one further assignment of error. We have adverted to the fact that only those creditors who extend credit in reliance upon the capital stock are entitled to relief in proceedings of this character. On the trial defendant sought to show knowledge of the Lake Erie Ore Company of the transaction. This he was not permitted to do. In this there was error. Those creditors who participate in a transaction involving the transfer of corporate property at fraudulent valuation, who deal with the company with actual knowledge of what its assets are, and who extend credit knowing fully that the capital stock has been exchanged for property, and know for what property it was exchanged, cannot, when the venture proves disastrous, call upon stockholders upon the theory that they extended credit in reliance upon the capital stock and its being fully paid. Ten Eyck v. Railroad Co., 114 Mich. 494; Rickerson Roller-Mills Co. v. Machine Co., supra. In the last cited case it was said by Judge Lurton:
“When credit is extended to a corporation with full knowledge of special arrangements between the cor[396]*396poration and purchasers of the stock whereby non-assessable stock has been issued for less than its par value, it cannot be said that such credit has been extended in reliance that the stock has been fully paid, or is subject to further calls by the corporation.”
It will be competent for the defendant to show the relation, dealings, and knowledge of this creditor with the affairs- of the bankrupt company in order that the court may determine whether this creditor dealt with and extended credit to the company in reliance upon the capital stock. This will, of course, be true of other creditors; indeed, the burden will be upon such creditors to prove their right to call upon the stockholders.
It follows from what has-been said that the judgment must be reversed and the case remanded with instructions to transfer it to the equity side of the court, pursuant to section 2, chapter 11, Act No. '314, Pub. Acts 1915 (3 Comp. Laws 1915, § 12351). Defendant will recover costs of this court.
Bird, Moore, Brooke, and Stone, JJ., concurred with Fellows, J.