In re Terens

175 F. 495, 1910 U.S. Dist. LEXIS 428

• Court: District Court, E.D. Wisconsin
• Decided: January 13, 1910
• Status: Published

Opinion

QUARLES, District Judge

(after stating the facts as above). The doctrine known as “marshaling assets” has long been familiar in equity jurisprudence. Cord Romilly, 1M. R., in Re Professional Eife Insurance, 3 E. R. Eq. 668, defines the doctrine as follows:

"If. is a settled principle that when there are two classes of creditors and two funds, and one class of creditors can only go against one fund, while the other class of creditors can go against both, the court will marshal the assets, restricting the creditors who have a double security from touching the fund applicable to the pavment of the first class of creditors until they are paid in Ml.”

Congress has borrowed this doctrine from the court of equity and has incorporated it into the present bankruptcy act, section 5f of which reads as follows:

“The net proceeds of the partnership- property shall he appropriated to the payment of the partnership debts, and the net proceeds of the individual estate of each partner to the .payment of his individual debts. Should any surplus remain of the propony of any partner after paying ids individual debts, such surplus shall be added to the partnership assets- and be applied to the payment of the partnership debts. Should any surplus of the partnership property remain after paying the partnership debts, such stir]tins shall be added to the assets of the individual partners in the proportion of their respective interests in the partnership.”

, The contention of the petitioner is that we have here a proper case for the application of the doctrine, there being two funds and two classes of creditors, within the meaning- of the rule. On the other hand, it is contended, and the referee ruled, that by virtue of the dissolution agreement of December loth Terens became the sole owner, and that there is now no partnership fund to be administered. It is apparent, therefore, at the outset, that this dispute hinges largely upon the construction to be imposed upon this dissolution agreement, and to that subject we may first give our attention.

It is important in the first instance to consider the situation of the parties at the túne this contract was entered into. It is conceded on all hands that the firm of Terens & Oswald was hopelessly insolvent on the 15th clay of December, 1908, and that it had been 'insolvent for several years, although from the slack business methods pursued and crude books kept the real situation had never been presented so as to amount to demonstration. Terens swears that he never would have assumed the debts of the firm if he had not supposed that he was getting- assets sufficient to liquidate the firm debts. Oswald was without assets and quite heavily involved on his own account. Terens, although he had some individual property, was heavily incumbered and insolvent. The firm had not been meeting its obligations promptly, was hard pressed for ready money, and had been sued by firm creditors. It appears from the evidence that, while neither partner believed that the firm was insolvent, it must have been understood by all parties concerned that a crisis was approaching. Conferences were held with the bankers who held their paper, and with lawyers, and the dissolution was hit upon as a prudential step to meet the difficulties with which they were confronted.

This written agreement of December 15th is to be read in connection with a further oral agreement whereby an inventory of assets and liabilities was to be prepared, and the consideration moving to Oswald for his transfer to Terens was to be measured by the surplus shown by such inventory of assets over and above the firm liabilities. The making of this inventory was undertaken shortly after the agreement of December 15th, and a few days of investigation convinced Oswald that there was no surplus of assets over liabilities, and that he really had nothing to transfer, and that all the benefit that he could expect to derive from the contract was an “exoneration” from his liability as partner—-that is, that Terens would make the firm assets pay the firm debts, and thus allow him to step out and escape his liability in solido. Terens continued the preparation of the inventory for several days longer, until Mr. Craite, his attorney, convinced him that he had over-estimated the assets, and that there was nothing left but bankruptcy. Terens swears that it was the understanding that he was to pay the firm debts out of the firm assets transferred to him by his partner; but he adds on cross-examination that he had some individual property from which he hoped to raise a loan which would enable him to swing the business.

Terens, after the advice of Craite, summoned Oswald to a conference, and as a result on the 10th day of January Terens and his attorney began the preparation of schedules looking to a voluntary petition in bankruptcy, and on the 12th day of January such petition was filed, and Terens was adjudicated. Under these circumstances, what was the legal effect of the dissolution agreement? What did Oswald sell? It was not specific articles of personal property. It was not a transfer of the corpus of the estate, but of only such interest in the surplus after the firm debts had been provided for. At the outset the distinction must be sharply drawn between such a transfer by one insolvent partner to another, and a sale by both partners of certain specific property to a third party. In the latter case the entire title passes by the transfer, and it has been repeatedly held that the legal right of either or both partners to sell the firm assets and transfer good title thereto is not impaired by the fact of insolvency.

It is also well settled that while each partner has the right to require the partnership property to be applied to the payment of partnership debts in preference to the debts of the individual partner, to the end that he be not required to pay the former out of his individual estate, still the right of the creditor of the partnership to payment out of the partnership property in preference to the individual creditor is derivative in nature, and is worked out by subrogation to the existing right of one of the partners to assert this equitable principle. Until the assets have been brought under the custody of the law, each partner has plenary power at any time to release or waive this right. If no partner retains this right, then no creditor of the partnership has it. Case v. Beauregard, 99 U. S. 125, 25 L. Ed. 370; Fitzpatrick v. Flannagan, 106 U. S. 648, 654, 1 Sup. Ct. 369, 27 L. Ed. 211; Huiskamp v. Moline Wagon Co., 121 U. S. 310, 7 Sup. Ct. 899, 30 L. Ed. 971.

It is strenuously insisted in argument that these authorities are decisive of the instant case. But it will be observed that in each of the cases cited certain of the firm assets had been sold by consent of all partners to third parties, so that a complete legal title to the specific items of personal property passed to the purchaser and amounted to a complete waiver of this equitable right, and constituted a release of such assets from firm liabilities. In the instant case there has been no such disposition. The status of the firm assets was precisely the same on the 12th of January that it was on the 15th of December. The only change wrought by the dissolution agreement was in the attitude of Oswald, who by virtue thereof became a surety for the firm obligations. Brandt on Suretyship and Guaranty, § 36. I cannot see that this change in the legal attitude amounts to a waiver on the part of Oswald which would defeat the equity of the firm creditors.

Sargent v. Blake, 160 Fed. 57, 87 C. C. A. 213, 17 L. R. A. (N. S.) 1040, is cited as conclusively ruling this case. The learned judge who wrote the opinion announces two rules of law which at different times control the distribution of firm assets: First. The partners own and may in good faith dispose of the partnership property. They may apply it to their individual debts in preference to partnership debts, and may make such honest disposition of the same as they deem proper. Second. In the administration of partnership property in the courts, the creditors of the partnership have the right to the application of the partnership property to the payment of the partnership debts in preference to individual debts of the respective partners. The first he calls a rule of operation; the second, a rule of administration. Sargent v. Blake was held to fall within the first rule by reason of its peculiar facts. It seems to me that this case clearly falls within the second rule, unless Oswald has in some way waived the right, which he so strenuously insisted upon, of securing exoneration by the application of firm assets to the liquidation of firm debts.

The exact question here involved was considered in a learned and elaborate opinion by Marshall, J., in Thayer v. Humphrey, 91 Wis. 276, 289, 61 N. W. 1007, 30 L. R. A. 549, 51 Am. St. Rep. 887, where many authorities are reviewed. The conclusion reached by the court is that such a dissolution agreement, between partners who were insolvent, regarding the assets of an insolvent firm, will not release the partnership assets. A great diversity of ruling will be found in the opinions of the state and lower federal courts; and one is reminded of the terse statement by Westbury, L. C., in his opinion in Ex parte Mayou, 34 E. J. 25, in a case almost identical with the instant case:

“I take it that the principle of all the decisions is that which is shortly stated by Lord EMon in the case of Er parte Williams, .11 Tes. 3, in which he very concisely stales that every one of these transactions must depend entirely upon the bona fides, and, without considering the question of fraudulent "intent, he held that there was no bona fides in the transaction, that the assignment by one insolvent partner to the other was fraudulent in nature; that it did not operate as a conversion of the bankrupt’s property into the separate estate of Wood, the surviving partner; that it must be still considered as joint property, and distributed as Such among joint creditors.”

In Black’s Appeal, 44 Pa. 503, it is held that, when the condition of the firm at the time of the transfer is such as to warrant the partner in supposing that a necessity for marshaling assets is likely shortly to arise, it is under such circumstances a fraud in the partners to make a transfer or division of the assets and thus attempt to deprive firm crecí - itors of their preference. In many cases, under varying circumstances, transfers by one insolvent partner to another have been held mala fides without proof of actual fraudulent intent. In re Cook, 3 Biss. 122, Fed. Cas. No. 3,150; In re Sauthoff, 8 Biss. 35, Fed. Cas. No. 12,380; Roop v. Herron, 15 Neb. 73, 17 N. W. 353; Bulger v. Rosa, 119 N. Y. 465, 24 N. E. 853; Nordinger v. Anderson, 123 N. Y. 544, 25 N. E. 992; Peyser v. Myers, 135 N. Y. 599, 32 N. E. 699; Darby v. Gilligan, 33 W. Va. 246, 10 S. E. 400, 6 L. R. A. 740; Conroy v. Woods, 13 Cal. 626, 73 Am. Dec. 605; Olson v. Morrison, 29 Mich. 395; Phelps v. McNeely, 66 Mo. 554, 27 Am. Rep. 378; In re Worth (D. C.) 130 Fed. 927, 930; Tenney v. Johnson, 43 N. H. 144; Collins v. Hood, 4 McLean, 186, Fed. Cas. No. 3,015; Sedam v. Williams, 4 McLean, 57, Fed. Cas. No. 12,609; Marsh v. Bennett, 5 McLean, 117, Fed. Cas. No. 9,110; In re Byrne, Fed. Cas. No. 2,270. Many other cases to the same effect might be cited.

The Circuit Court of Appeals of the Seventh Circuit have just handed down an opinion in Re Filmar (No. 1,592 of the October Term) 177 Fed. 170. After discussing the provisions of sections 5a, 5f, and 5g, they hold:

“These provisions^ we think, indicate very clearly that Congress intended that' the bankruptcy courts should have full equitable powers in dealing with partnership matters. With the property in custody and all parties present, and no rights of innocent purchasers or transferees having intervened, a court of general equity powers would concededly -award priority to IApincott (the partnership creditor), because there had been ho application of the property with the consent of the partners to the payment of individual debts (Sargent v. Blake, 160 Fed. 57, 87 C. C. A. 213, 17 L. R. A. [N. S.] 1040), because Ilipincott in his own right as a partnership creditor would be entitled to equity’s rule of distribution, and because Swigert (the retiring partner) for his own-protection would have the right to ask -that Lipincott be first paid.”

It is insisted that the petitioning bank is disingenuous in posing as a partnership creditor, when its real purpose is to insist upon its right also to share in the individual assets of Terens by reason of his guaranty on the notes. In view of the- fact that the Circuit Court of Appeals of the Seventh Circuit have distinctly held that a creditor so situated may have recourse to both funds (Re McCoy, 150 Fed. 106, 80 C. C. A. 60), I am unable to appreciate the force of this criticism. In Re Head (D. C.) 114 Fed. 489, it is held that such a dissolution by insolvent partners within four months must be treated as mala fides, because it works a preference in favor of individual creditors and against the joint creditors, and is violative of the spirit of the bankruptcy act. Re Worth (D. C.) 130 Fed. 927, 930.

It remains to consider and construe section 5g, which is in pari materias, which throws much light on the amplitude of the equitable jurisdiction conferred upon the court. It allows proof of the partnership estate against the individual estate, and vice versa. It expressly suggests the doctrine of marshaling assets to prevent preferences and to secure the equitable distribution among the several estates. The preferences supposed to interfere with a just and equitable distribution may result from the action of partners calculated to convert partnership property into individual assets, thus giving undue advantage to individual creditors. Properly construed, this subdivision meets the very case we have in hand. Re Wilcox (D. C.) 94 Fed. 107; Re Jones (D. C.) 100 Fed. 781; Re Head (D. C.) 114 Fed. 489. Re Denning (D. C.) 111 Fed. 219, 221, was similar in its facts to the instant case, and the court concludes:

‘'Moreover, section 5g of the bankruptcy act was ini ended to clear up the whole matter, and to permit the court to deal with conversions of this kind so as not only to prevent preferences in the technical meaning of that word, but also so as'to secure the equitable distribution of the property of the several esi ates.”

In my judgment the dissolution agreement, under the peculiar circumstances of this case, did not work a liberation of the firm assets and convert the same into the individual assets of Terens, hut that, when the property came to the custody of the court, Oswald still retained the right to insist- upon the payment of the firm debts out o f the firm assets, as he does by his consent to the administration by the court, and that by subrogation or derivation the firm creditors are justified in insisting upon such a marshaling of assets as is provided for in the bankruptcy act.

For these reasons, the finding of the learned referee is reversed, and the cause is remanded for further proceedings in accordance with this opinion.