US SUPREME COURT DECISIONS

The right of an insolvent debtor to prefer one creditor to another, exists in the Illinois to its fullest extent, and the giving of judgment notes is recognized as a legitimate method of preference.

In the absence of national bankrupt laws, if a remedy is sought in a court of equity against fraudulent preferences, it must be on allegation and proof of a design to defraud and to delay the complaining creditor.

While the policy of the law permits preferences, and such preferences as are necessarily unknown to others than those concerned, it does not permit any device which prevents the debtor from giving a like advantage to his other creditors, if he so wishes, unless such device is put in the form of a mortgage or other instrument perpetually open to public inspection upon the public record.

The present case is one in which the fundamental rule that equality is equity may properly be applied.

On September 11, 1896, the American Oak Leather Company, a corporation of the State of Ohio, filed in the Circuit Court of the United States for the Northern District of Illinois a bill of complaint against C. H. Fargo & Company, a corporation of the State of Illinois; the United States Rubber Company, a corporation of the State of New Jersey; L. Candee & Company, chanrobles.com-red

Page 181 U. S. 435

a corporation of the State of Connecticut; John W. Arnold, United States Marshal for the Northern District of Illinois, and the Metropolitan National Bank, a national banking association.

The bill alleged that the complainant was a judgment creditor of C. H. Fargo & Company, an insolvent corporation; that judgments by confession against said C. H. Fargo & Company had been entered in the circuit court of the United States on August 6, 1896, for large amounts in favor of the United States Rubber Company and L. Candee & Company; that, on the same day, an assignment was made by C. H. Fargo & Company of all its book accounts to said rubber companies; that a judgment by confession had been entered on August 6, 1896, for a large amount, in favor of the Metropolitan National Bank, and on the same day deeds to said bank had been executed by Fargo & Company conveying its factory at Dixon, Illinois; that executions had been issued on said judgments and levied upon all the tangible assets of C. H. Fargo & Company; that said judgments were illegal because given and taken with intent to defraud the complainant and other creditors of C. H. Fargo & Company. The bill prayed that the said judgments, executions, assignment, and deeds should be set aside, and that the assets of C. H. Fargo & Company should be applied, through a receiver, to the payment of its bona fide creditors.

Subsequently other creditors to a large amount filed intervening petitions and joined in the complainant's prayer for relief. Answers were filed by the several defendants, denying the allegations of fraud, and thereupon the court referred the case to Henry W. Bishop, as a master in chancery, "to take proofs herein and report the same, together with his conclusions thereon, as to the facts only." An order was also entered appointing a receiver, and upon appeal to the Circuit Court of Appeals for the Seventh Circuit, this order was affirmed. 82 F.2d 8.

On April 17, 1899, after taking a large amount of testimony, and a protracted hearing, the master filed a report, of which the important portions were as follows:

"There was due January 6, 1896, to Candee & Company, upon the notes of C. H. Fargo & Company (given in settlement in November, 1895), the sum of $44,900, and on the same

Page 181 U. S. 436

date there was due from the Fargo Company to the United States Rubber Company on open account for proceeds of sale of consigned goods the sum of $141,537.13."

"It is shown by the testimony, and I so find, that about January 2, 1896, the C. H. Fargo Company, anticipating difficulty in meeting its regular obligations maturing during that month, applied to one Charles L. Johnson, who represented both the Candee Company and the United States Rubber Company, for a loan of $50,000, representing that the Fargo Company was perfectly solvent, and that this accommodation would relieve it from its temporary embarrassments and enable it to go on with its business."

"This application was granted, and on January 6, 1896, Johnson agreed, acting for L. Candee Company, to lend the Fargo Company the sum of $50,000 for six months, upon the understanding that this loan and the indebtedness of $44,900 upon the notes previously given as aforesaid, and the balance due the United States Rubber Company, and which might become due it, should be secured in such way as might be satisfactory to their counsel, Mr. Beale, of the law firm of Isham, Lincoln & Beale."

"The proposition was accepted on the 6th day of January, 1896, and it was agreed and was arranged between the parties as follows:"

"First. That the $50,000 should be advanced by the Fargo Company by L. Candee & Company, partly on that date and during the succeeding two weeks."

"Second. That the Fargo Company should that day execute and deliver its three judgment notes, one for $45,000, payable on demand to the order of L. Candee & Company, to secure that company with respect to its liability as endorser or guarantor upon the notes for $44,900 given previous to January, 1896; one for $51,500, payable on demand to L. Candee & Company, as collateral security to plain notes of the Fargo Company, which were given as evidence of the advance of $50,000 then to be made, and one for $140,000, payable on demand to the order of the United States Rubber Company, as collateral security to the then existing and to any future indebtedness

Page 181 U. S. 437

of the Fargo Company to the United States Rubber Company as aforesaid."

"Third. That in case the Fargo Company should at any time find it necessary to suspend business it would assign as additional security all its accounts and bills receivable; that it should not give any judgment notes to other creditors which would impair the security to the Rubber Companies, and that the $50,000 advance should be used by the Fargo Company in reduction of its general indebtedness as it matured; and"

"Fourth. That the four employees of the Fargo Company who were on the board of directors, and also E. A. Fargo, should retire from the board and there should be elected in their places by the stockholders of the company five persons, to be nominated by said Beale, in whom he had confidence, one of whom should become secretary and treasurer, and that the directors so to be elected at Beal's nomination should not hamper or interfere with the proper carrying on of the ordinary business of the company."

"* * * *"

"I find that the attention of the general creditors was never called to this arrangement, and they had no knowledge of it. The Metropolitan National Bank first learned of it at or about the time a judgment note was given it to secure the payment of its claim of $50,000 as hereinafter stated."

"I find that, in pursuance of this arrangement, and on January 6, 1896, a meeting of the board of directors of the C. H. Fargo & Company was had before any change in said board, when a resolution was passed authorizing the borrowing of the $50,000, the giving of judgment notes, as in said agreement provided for, and assignment of the accounts, bills, and choses in action upon the contingencies agreed upon, and upon the same day the three judgment notes referred to were executed and delivered by Charles E. Fargo, president of the company, Frank M. Fargo, vice-president and treasurer, and E. A. Fargo, secretary, and the loan of $50,000 was perfected, $10,000 being advanced at the time and the balance of $50,000 during the succeeding two weeks."

"This action was ratified on the 8th day of January, 1896,

Page 181 U. S. 438

by the unanimous vote of the stockholders of C. H. Fargo & Company, all the shares being represented."

"I find that, in pursuance also of said arrangement and as a part of it, at a meeting of the stockholders of C. H. Fargo & Company, held January 9, 1896, George C. Madison, Tiffany Blake, Buell McKeever, Frederick B. Fuller, Gilbert E. Porter, Charles E. Fargo, and F. M. Fargo were duly elected directors for the ensuing year."

"The first five, except Blake, were employees in the office of William G. Beale, and said Blake was assistant corporation counsel of the City of Chicago, of which William G. Beale was then corporation counsel, and all five were elected by the stockholders at the suggestion of said Beale. Subsequently, at a meeting of the newly constituted board at which Charles E. Fargo was reelected president of the company, Frank M. Fargo was reelected vice-president of the company, and Buell McKeever was elected secretary and treasurer of the company, the bylaws of the company were amended, providing against the giving of judgment notes or preferential security without special authorization of the board of directors."

"I also find that the change of the board of directors and officers, and the changes of the bylaws of said company, and the resolution thereof authorizing judgment notes and assignments of accounts if necessary, were all for the purpose of giving preferential security to the rubber companies, and the matter was kept secret in order to allow the Fargo Company an opportunity of getting through embarrassments apparently temporary, but not with a fraudulent intent as to the other creditors of the company. The only purpose and object of changing the board of directors as aforesaid and of amending the bylaws was to protect the rubber companies against the giving by the Fargo Company of preferential security or judgment notes to other of its creditors which should be superior to the security of the rubber companies."

"I further find that the arrangement as made was carried out in good faith by the parties, and that the directors elected at the suggestion of said Beale took no part in the active management of the Fargo Company after their election, and that

Page 181 U. S. 439

no stockholders' or directors' meetings of the Fargo Company were held after January 9, 1896, until August 5, 1896."

"I find that, on January 9, 1896, which was the date of the meeting of the new directors, the authorized capital stock of the said corporation of C. H. Fargo & Company was $400,000 and the debts of the corporation on January 6, 1896, as follows:"

Amount owing United States Rubber Company . . $141,537.13

Amount owing Candee & Company . . . . . . . . 44,900.00

Amount owing Metropolitan National Bank . . . 50,000.00

Amount owing other creditors. . . . . . . . . 210,216.20

-----------

Total . . . . . . . . . . . . . . . . . . $446,653.33

"I find that the value of the assets of C. H. Fargo & Company at that time had not been definitely ascertained, but I find, as a matter of fact, as the results of efforts since made in collecting the same in liquidation and from other sources of information disclosed by the testimony, that, on the 6th day of January, 1896, the assets of said company were not sufficient to discharge its indebtedness, of which fact the defendants, the rubber companies, are shown to have been ignorant, relying upon the representation of the Fargos that there was a large excess of assets over liabilities. The fact that Johnson, representing the rubber companies, made no detailed examination of the assets of the company, but consented to advance the money which was applied for, is evidence to my mind that he believed in the assurances which were given him by the Fargos of the condition of their company."

"I further find that between January 6, 1896, and August 6, 1896, the new liabilities incurred by said corporation to creditors other than the rubber companies and the bank were $246,660.54 (of which there was due and unpaid on August 6, 1896, $142,690.95), and that, during the same period, the Fargo Company paid out more than $300,000 to its general creditors in the regular course of business, paying substantially all of the indebtedness of January 6, 1896, which was largely to the same persons who are now creditors. "

Page 181 U. S. 440

"I further find that between January 6 and August 6, 1896, the Fargo Company continued its business as before, reducing its general indebtedness to a considerable extent with its general creditors; that, during said time, it paid Candee & Company $44,900, the amount of its indebtedness prior to January 6, 1896, and $13,470 on account of the advance of $50,000 as aforesaid; that, during said time, it paid to the United States Rubber Company $15,000 on account of the indebtedness to that company existing January 6, but it also sold consigned goods of that company to the amount of $24,534.04, of which it remitted only $5,495.40, and that, on August 6, 1896, there was due to the United States Rubber Company the sum of $142,424,81, and to L. Candee & Company the sum of $36,530."

"I further find from the testimony that the indebtedness of the Fargo Company, which was incurred after January 9, 1896, up to the time of the entry of judgment upon the judgment notes referred to, was incurred in ignorance of the giving of the judgment notes and the change of directors, and of the change of officers, and of the arrangement existing between the rubber companies and the Fargo Company, and that the amount of the claims that were thus contracted and is still unpaid exceeded $110,000."

"I find that, while Johnson and Sadler, representing the rubber companies, were here from January 2 to January 6, 1896, that it was then agreed that separate books showing sales of consigned goods should be kept, and the proceeds of the sales thereof should be kept in a separate bank account, which was done."

"I find that the advance of $50,000 on January 6, 1896, and the giving of the judgment notes and security referred to, was the result of an evident feeling upon the part of all the parties to the transaction, and was in the belief and expectation on their part that, through the assistance which was in this way afforded the Fargo Company, it would be enabled to continue its business successfully and become ultimately relieved of its financial embarrassment, and that said arrangement was entered into in good faith and without any fraudulent intent."

"I find that the testimony does not show that the parties

Page 181 U. S. 441

were influenced in making the arrangement aforesaid upon a belief of the insolvency of the Fargo Company at that time, and the conduct of the corporation afterwards and until about the time of the entering up of the judgment notes, in my judgment, clearly indicated the hope and expectation that the Fargo Company would be finally relieved of its troubles."

"In support of this conclusion, I find that, in the meantime and between January 6, 1896, and August, 1896, in the regular course of its business, the Fargo Company reduced to a large extent the indebtedness which existed January 1, 1896, increasing the capacity of their manufacturing business, reducing its stock, and discharging, to a large extent, its general liabilities, except with the United States Rubber Company and the Metropolitan National Bank, with an evident purpose and expectation of continuing its business, during which time nothing is shown to have occurred with these parties inconsistent with this theory."

"I find that, during this period, the general creditors were substantially the same as before, with the exception of the Eagle Tanning Works of Chicago, whose claim of $2,500.24 has been established, for the goods purchased on credit between April 1, 1896, and July 15, 1896, and Wilder & Company, and the Pfister & Vogel Leather Company, hereinafter mentioned."

"* * * *"

"And I also find that, during this time, upon the letter heads of the C. H. Fargo Company, the printed names of the Fargos, treasurer and secretary, appeared as before, without anything to show any change in the construction or management of said corporation, nor were such changes in any way mentioned, or their real condition disclosed."

"* * * *"

"I further find that, during many years prior to January 6, 1896, the C. H. Fargo Company had been doing business with the Metropolitan National Bank of this city, its banker, resulting in the creation from time to time of a large indebtedness to said bank, which was finally reduced, in the usual course of business, so that, on the fifth day of August, 1896, said indebtedness amounted to the sum of $40,000. "

Page 181 U. S. 442

"That the Metropolitan National Bank, during the summer of 1896, applied to C. H. Fargo & Company to reduce its indebtedness to it and to finally discharge it by the month of November following."

"I further find that, at the same time, said bank gave the C. H. Fargo Company said notice, and down to about the 3d or 4th day of August, A.D. 1896, it had no knowledge of any transactions which occurred between it and the rubber companies in the previous month of January, and that it did not know of the change in the board of directors of said C. H. Fargo & Company, or that it had given the rubber companies judgment notes for an indebtedness owing by it to said rubber companies, or of the agreement which had been entered into in respect to the same between it and the rubber companies, or of the action which had been taken by the newly constituted board in pursuance of this agreement."

"I further find that, on or about Monday, the 3d day of August, A.D. 1896, Charles E. Fargo, president of the said C. H. Fargo & Company, called at the Metropolitan National Bank, and while there applied to the bank for an additional loan of $10,000."

"I find that, during this interview or shortly thereafter, the said Charles E. Fargo informed the president of said bank that the said C. H. Fargo & Company had given the rubber companies judgment notes for the amount of its indebtedness to them, and while said C. E. Fargo insisted that the assets of his company were at that time largely in excess of its indebtedness and ample to meet the entire amount thereof, that, owing to the difficulty in making its collections as rapidly as its outstanding paper matured, his company would be obliged to fail unless it received some assistance."

"I find that, at the time of said interviews, the said C. E. Fargo represented to the president of said bank that the said C. H. Fargo & Company was indebted to him and his brothers for money exceeding $10,000 which they had borrowed upon their notes for the benefit of the company, and which they had paid over to the company for use in its business, and that said Fargo brothers had put up some bank stock that they owned as collateral

Page 181 U. S. 443

to said notes, and C. F. Fargo thereupon proposed to said bank that, if it would loan said C. H. Fargo & Company $10,000 in addition to its then existing loan, so that said company could reimburse him and his brothers and enable them to take up said notes, he would procure from the said C. H. Fargo & Company judgment notes for said bank, both for said sum so advanced as aforesaid and also for notes then remaining due said bank to the amount of $40,000."

"I further find that said bank acceded to said proposition, and loaned said C. H. Fargo & Company said additional sum of $10,000, receiving two judgment notes of the Fargo Company for the sum of $25,000 each, crediting to the account of said C. H. Fargo & Company in said bank said sum of $10,000."

"I further find that, at the time of the completion of this arrangement with said bank, neither the bank nor its officers nor attorneys had any knowledge of the change of the board of directors of the said C. H. Fargo & Company, or of its bylaws, but the bank did know that the rubber companies, as a part of the final arrangements made, were entitled equally with themselves to enter judgment upon the judgment notes which had been given."

"I further find that neither the complainants herein nor any of the other creditors of the said C. H. Fargo & Company were led to give credit to said company by reason of the transactions had between it and the bank, nor did any of the said parties sell any goods to said C. H. Fargo & Company subsequent to the time when said bank made said $10,000 loan aforesaid to C. H. Fargo & Company, nor did the said bank in any way participate in or have any knowledge of the change in the bylaws of said C. H. Fargo & Company as aforesaid."

"I further find that, from about the time when the said judgment notes were given to said bank as aforesaid, the said bank entered into a stipulation with the rubber companies by which it was agreed that they should unite their efforts to collect their respective claims against the said C. H. Fargo Fargo & Company and should share pro rata in whatever proceeds should be derived therefrom."

"* * * *"

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Page 181 U. S. 444

"I further find upon the testimony submitted to and taken before me in connection with this branch of the case that the defendant, the Metropolitan National Bank, is not shown to have been guilty of any actual fraud as against the complainants or the other creditors of C. H. Fargo & Company by reason of any of its transactions with the said defendants, C. H. Fargo & Company or the said rubber companies."

"I further find that August 6, 1896, before entry of the judgment in favor of the rubber companies as set forth in the pleadings, C. E. Fargo & Company, by its president, C. E. Fargo, duly assigned to the United States rubber company all the accounts and bills receivable of the Fargo Company as further security for the indebtedness to the rubber companies, pursuant to and in accordance with the agreement made in January, 1896."

"I find nothing in the testimony which has been taken before me upon this reference which so changes the record which was before the court upon the hearing of the application for the appointment of a receiver as to lead me to a conclusion different from that announced by the court at that time; indeed, the effect of the testimony, in my judgment, is to explain and strengthen the conclusion then expressed by the court that there was no fraud in fact or want of good faith shown in the conduct of any of the defendants in respect to the transactions complained of, and upon a careful examination of the whole record and testimony I so find and report."

Exceptions filed by the respondents were overruled, and the report was in all respects confirmed.

On May 4, 1899, the circuit court, per Circuit Judge Grosscup, entered a decree setting aside the preferences complained of in the bill, as

"fraudulent in law (although not at the time believed by the parties to be such, but, on the contrary, believed to have been within their rights) as against the other creditors of C. H. Fargo & Company,"

and directing the assets in the hands of the receiver, amounting to about $111,000, to be distributed pro rata among the creditors, including the defendants. An appeal and a cross-appeal were taken to the circuit court of appeals, and that court, on October 3, 1899, reversed the decree of the circuit court insofar as it permitted chanrobles.com-red

Page 181 U. S. 445

the rubber companies and bank, defendants, to share equally with other creditors in the fund to be distributed.

Thereupon this Court upon the petition of the rubber companies and the Metropolitan National Bank, and the cross-petition of the complaining creditors, allowed a writ of certiorari to the circuit court of appeals of the Seventh Circuit.