
    (Eighth Circuit—Cuyahoga Co., O., Circuit Court
    Jan. Term, 1899.)
    Before Hale, Marvin and Caldwell, JJ.
    SIMPSON L. FORD, Receiver, etc., v. ISAAC P. LAMSON et al. L. PHILILLI v. THE AMMON-STEVENS CO.
    
      Conversion of insolvent partnership into a corporation — Assets of .corporation given for stock subscriptions, not payment—
    (1). 'Where the members of an insolvent partnership convert their business into a corporation, turning over to the corporation all the assets of the partnership in payment for their stock subscriptions, but the corporation also assuming all the liabilities of the partnership. Held, that nothing whatever should be counted as a payment of the stocK subscriptions, and the subscribers to such stock remain liable to the creditors of the corporation for their subscriptions to the stock.
    
      Corporation insolvent in fact, but going concern — Bight to pay creditors by way of preference—
    (2). Where a corporation which is actually insolvent, but still carrying on its business, transfers practically the whole of its assets to one of its creditors, who is not aware of the condition of the corporation and there being no collusion, such transfer will be upheld.
    
      Cognovit note to creditor by corporation insolvent in fact, but going concern—
    (3). A creditor of a corporation which is still carrying on its business, although insolvent in fact, of which such creditor is not aware, may take a cognovit note from such corporation, and take judgment thereon, and his levy of an execution upon such judgment, on the assets of the corporation will be upheld.
    
      Insolvent corporation can not pay claims of directors by way of preference—
    
    
      i). An insolvent corporation with no expectation of being able to continue its business, can not rightfully secure or pay debts owing to its directors.
    
      Insolvent corporation — Attachment by creditor—
    (5). An attachment and levy by a creditor on the assets of a corporation carrying on its business although in fact insolvent, will give a valid lien on the assets levied upon.
   Hale, J.

These cases are here on appeal, They have been tiled together, involving substantially the same transaction. I will endeavor to indicate sufficiently to enable counsel to-draw the decree.

The controversy arises between the unsecured creditors of the Ammon-Stevens Company, an insolvent corporation, and certain creditors who are claiming preference.

On the first of January, 1893, the Ammon-Stevens Company was incorporated with a capital stock of $40,000 to prosecute a wholesale millinery business in the city of Cleveland. Of this stock F. G. Ammon subscribed $20,000; A. J. Stevens $10,000; J. P. Lamson $9,800; N. S. Calhoun $100, and Mr. Jennings $100, the latter two being .given one share each in order to qualify as directors of the ■company.

The first issue made arises out of the claim made by creditors averring that the several subscriptions to the capital ■stock have not bean paid; that the same are still due and .should now be paid to the receiver to be distributed to the ■creditors of the corporation pro rata.

Prior to the organization of this corporation the first 'three subscribers had been prosecuting the business under a partnership agreement from the first of January, 1890, to the first of December, 1892, when, by its terms, the partnership agreement expired,

The subscription to the stock was attempted to be paid by the transfer of all the partnership assets to the corporation, the corporation assuming all the liabilities of the partnership, and the claim is that the partnership was insolvent at that time, and, in the transfer made, actually transferred nothing to the corporation;

. And we find and hold that the partnership at the time of this transfer was insolvent, even after the cancellation of 'an indebtedness of $26,000, due from the partnership to Mr, Lamson.

Soon after the formation of the partnership, $10,000 of the accounts was pharged off, and although the corporation did business for a period of nearly eighteen months, at the end of that time $33,000 of the accounts, transferred to make up the $40,000 of the assets that was claimed to exist and were transferred to the corporation in payment of the stock, were yet uncollected, and nothing has ever been realized from them. The partnership had been doing business for three years, and necessarily there must have been a considerable depreciation of the -tangible property then on hand by the partnership.

And we hold that nothing whatever that should be counted as a payment of the stock subscriptions, was transferred ,by the partnership to the corporation.

Some time in January or in February, 1894, Mr. Lamson sold to Mr. Ammon,who was at that time insolvent, $5,000 of his stock' — sold it as paid-up stock, and we do not think as against creditors that that sho.uld release him of his liability to pay his subscription; so that the. subscribers to, that stock are still liable to pay, for the benefit of the creditors, to the receiver, the subscriptions made to the stock.

The corporation continued to prosecute its business for which it was incorporated until the second of June, 1894, at which date its liabilities exceeded the value of its assets by more than $50,000,and at least $100,000 more than can be realized from the assets in the manner in which the concern is being closed out,

The acts of the board of directors on that date prior and subsequent thereto are made the basis of several actions by the plaintiffs and cross-petitioners.

The evidence establishes the following facts:

The business of the corporation was carried on at a loss from the start, of which the directors had knowledge; that-very large purchases were made for the spring trade of 1894; that prior to April 14, 1894, the business had been conducted under the chief management of Mr. Ammon. At that last named date the board of directors resolved that checks should be issued for the payment of bills owing by the corporation, only on the approval of Mr. Calhoun, one of the directors, after which a large proportion of the receipts were paid on claims upon which Mr. Lamson was surety or in some way responsible, On this date the corporation was indebted to The Bristol National Bank of Connecticut and the Hartford Bank, in the aggregate $31,000, upon which Mr. Lamson was surety.

The corporation was also indebted to the Union National Bank of this city in the sum of $32,000, for which Mr. Lamson was surety, and to Caskey & Calhoun in the sum of $13,000 upon which Mr. Lamson was not an indorser. On the second of June, 1894, the corporation, by its trustees, resolved to transfer accounts of the face value of $55,000 to Mr. Lamson for the sum of $45,000 for the express purpose of paying the Union National Bank and Caskey & Calhoun. Mr. Lamson had just returned from Connecticut where he had arranged with Mr. Sessions, his brother-in-law, to take up the claims of the Connecticut Banks and advance $1,000 for the corporation, for which he was to receive a cognovit note of the corporation due on demand. Whether the latter part of that agreement was definitely arranged between Sessions and Lamson does not definitely appear, but ultimately it took that form-. The debts to the Connecticut Banks were not due at the time payment was made to the banks. The note with power of attorney to confess judgment was authorized by the directors at this meeting, was executed, and forwarded to Mr. Sessions, The arrangements authorized by this resolution were carried out; the accounts were transferred to Lamson, $45,000 paid by him; $32,000 was paid to the Union National Bank, and $13,000 to Caskey & Calhoun, and these debts were cancelled.

The cognovit note was sent to Mr. Sessions who paid the two banks in Connecticut; he also sent to the corporation, the Ammon-Stevens Company, $1,000; this note was not endorsed by Mr. Lamson; it was made on the second of June, immediately forwarded to Mr. Sessions, received by him on the fourth of June, andón the same day sent to Mr. Bourne, cashier of the Union-National Bank of this city, for collection.

In this way Mr. Lamson was relieved from his endorsement or liability on $63,000 of the company’s paper, and substantially all the good accounts withdrawn from the assets of the corporation and from the reach of unsecured creditors. On the thirteenth of June, judgment was entered upon this note in the court of common pleas of Lake county, with the knowledge of at least one of the directors of the corporation; execution was issued upon that judgment, and' on the fourteenth day of June, levy was made upon all tangible property of the corporation, which ended any further prosecution of the business by the corporation.

' About the time the accounts were transferred to Lamson, the company, by its directors — -not we think, in the usual course of business, sold merchandise to O. D. Myers and Taylor Sons & Company, of this city, aggregating about $7,000, which was likewise used to pay debts secured by Mr. Lamson.

It is not disputed that at the time of the transaction above indicated, the liabilities of the company exceeded largely the value of the assets; that the corporation was, in fact, insolvent.

It seems equally olear to us that the directors, at the time these acts were done, knew or should have known that the corporation was grossly insolvent..

We are of the opinion also that the action taken by the directors of this insolvent corporation practically incapacitated it from further prosecution o,f its business with any reasonable prospect of success, and this, too, we think the directors ought to have known. We do not think or believe that the directors, who testified that they hoped to bring the company out of its trouble and yet make it a success, had any such expectation; but we can only say that there was no reasonable basis for such hope. The corporation had been kept afloat by the aid of Mr. Lamson in making advances to the company and in endorsing its paper, When this support was withdrawn, there was no alternative but failure. The adoption of the resolution of June 2nd, and the carrying out of the transactions therein provided for, put the affairs of the corporation in such condition, that there was practically no alternative but failure.

By these essential facts of the case the rights of the parties are to be determined. First, it is claimed by the receiver, that the money paid to the Union National Bank should be refunded to him, that it may be distributed to the general creditors of the corporation pro rata,

Upon this claim we hold with the bank.

The evidence shows no collusion between the bank and directors of the corporation. It is not shown that the bank had knowledge of the situation. The company, at the time this payment was made to the bank, was in the actual possession of its property and engaged, in a way, in the prosecution of its business; nor do we think the affairs of the corporation had reached a condition when the doctrine of the Rouse v. Bank case, 46 Ohio St., applies.

Again, it is sought to have declared void the levy of the execution issued on the Sessions’ judgment. The evidence in the case does not authorise the finding that Mr. Sessions knew of the condition of the corporation, or colluded with or aided the directors in defrauding the general creditors of the corporation, or in carrying out a purpose by the directors to prefer themselves.

If we are right in our holding as to the bank, Mr. Sessions can not be deprived of his advantage by the doctrine of. the Rouse case.

Sessions actually advanced to and for the corporation at the time he received the note, the full sum for which he took the company’s note. The transaction was not illegal, and he held his note by good title. While the company was in possession of its property, and apparently, so far as known to outsiders, was engaged in the prosecution of its business, we are of the opinion that a creditor might lawfully enforce his claim against the company by any remedy provided by law. We, therefore, decide this . issue in favor of Mr. Sessions, not without some doubts and misgivings. Much might be said against this holding' — the fact that the claim was not due; that Mr. Sessions was a brother-in-law of Mr. Lamson, and other circumstances connected with it' tend quite strongly to show that there might have been some collusion between Lamson and Sessions to bring about the result that was accomplished, but we hold as I have stated.

Again, what are the rights and liabilities of Mr. Lam-son ?

We have found that the corporation at the time of the transfer of the accounts to him — to Mr. Lamson — was insolvent, of which fact he (Lamson) had knowledge; that the board of directors could have had no reasonable expectation of continuing for any considerable time the business of the corporation; that after the acts of June 2nd, and those immediately following, the only alternative was failure which was then eminent.

We must find also under the evidence, that one of the objects of the board was to relieve Mr. Lamson from his liability, and, if we are to hold the board to have intended the natural legitimate results of the acts done, that it was the-intention of the directors to prefer him and relieve him from his liability as surety.

The authorities are not entirely uniform upon the subject of preference by an insolvent corporation of its directors.

In Connecticut and two or three other states, the courts have sustained preference to directors under circumstances similar to those found in this case; but the decided weight of the authority is against the proposition. As indicating the general tendency of the authorities,! read a sentence or two from the case of Alney v. The Connecticut Land Company, 16 R. I., 597.

“The directors of an insolvent corporation are by virtue of their position, debarred from preferring debts of the corporation due to themselves. The directors of a corporation are trustees for its stockholders. When the corporation becomes insolvent, the' directors become trustees for the corporation creditors.’’

In the discussion of the case the reasons are briefly given for this holding.

“The vital question is, whether a director of an insolvent corporation is to be regarded as a trustee for its creditor. If he is so, the duty of a trustee to a cestui que trust is plain. For a trustee to collect his own debts, to the detriment of that of his cestui, is a clear breach of fidelity. When, one accepts the trust of caring for . another’s interest, he accepts the attendant duty. It must be admitted that directors of a corporation are not technical trustees. They do not have in themselves the title to property which they hold for the benefit of others; and certainly, as to creditors, they are under no express trust. The corporation is a legal being, distinct from its officers and stockholders. It may deal with them as individuals and may owe them debts. It holds its own property, and has the capacity and responsibility of acting for itself. Nevertheless, the conduct of its affairs must, of necessity, be entrusted to officers in whom confidence is reposed, to whom large powers are given, and by whom its property is managed for the common benefit.

“As corporations have multiplied and have become so greatly concerned in business affairs in recent years, the obligations arising from such a relation have become correspondingly prominent.
“While the decisions in regard to this relation are not harmonious, it has been generally agreed that directors are trustees for stockholders. This being established, we think it follows naturally that, when the corporation becomes insolvent and the stockholders have no longer a substantial interest in the property of the corporation, directors should be regarded as trustees of the creditors to"whom the property of the corporation must go.”

Denying a preference that was made to the trustees.

Now, in this state, of course, the trust doctrine is carried to its furthest extent, and goes quite as far as it is carried in any other state.

' We hold, then, that an insolvent corporation with no expectation of continuing its business, can not rightfully secure or pay debts to its directors,nor debts upon which such directors are collaterally liable, and thus relieve such director from his collateral liability. These accounts were not sold to Mr, Lamson, in the usual course of business. He took the accounts under the stipulation that the money paid by him should be applied in payment, or a large proportion of it, upon debts upon which he was collaterally liable. He was under obligation before this transaction, to pay the debts which were actually paid, and the transaction is not different from what it would have been, had he paid the debts and withdrawn from the corporation assets, accounts sufficient to indemnify himself for the payment thus made. In this state at least, directors occupy a position of trust towards the creditors of an insolvent corporation, and can not, under the circumstances of this case, violate that trust by transferring the assets of the corporation to themselves, either in payments of debts due to themselves, or to relieve themselves from collateral liability. The relation which directors bear to the corporation as trustees of its assets, is such that they can not rightfully prefer debts due to themselves from the corporation, or prefer debts in the payment of which they have a personal interest. The rule forbids, not only preference by directors of their own debts, but also of all debts in which they are interested and from which they could reap a personal advantage by the preference. It follows, then, that the accounts were wrongfully transferred to Mr. Lamson, and that he must account to the receiver for the proceeds realized by them, and that the money now held by the bank should be paid over to the receiver to be distributed pro rata among the creditors.

As to Caskey & Calhoun, the logic of what we have said would require either that they refund the $13,000 received, or require Mr. Lamson to account for the entire accounts transferred to him, And, as we hold, the withdrawal of these accounts from the assets of the corporation was wrongfully done, with the knowledge of Mr. Lamson and Mr. Calhoun. Those accounts — those assets may be, accounted for entirely by Mr. Lamson,and the controversy between him and Caskey & Calhoun settled between them. If the general creditors — the unsecured creditors, get advantage of all the assets which the corporation had, they get all they are entitled to, and they get that by having the benefit of all those accounts.

Now, disconnected with this transaction is the claim of Menke against this corporation. He commenced an attachment proceeding, and levied upon the book accounts of the corporation. The levy of this attachment was made on the 13th of June. On the 14th a receiver was appointed of this corporation, Mr. Ford, in the second case that I named. The question here arises between this attaching creditor and the general creditors. He claims a preference by virtue of his attachment, and it is insisted by the receiver that he gets no such preference.

The majority of-the Court hold that by the levy of the attachment on the 13th on the book adounts, the attaching creditor obtained a lien; that the provisions of the statute relating to the appointment of a receiver to collect those accounts and apply them to the debt of the attaching creditor, are provisions of the statute enacted for the purpose of enabling the attaching creditor to realize the benefits of the attachment; and, inasmuch as a receiver was appointed on the day following the levy of this attachment, who was ordered to take possession of all the books, accounts and property of the insolvent corporation, that it would have been a useless thing to appoint a receiver at the instance of the attaching creditor to work out his rights under a levy; that all of that could properly be done under the receiver who was appointed for the benefit of the general creditors.

One of my associates, Judge Caldwell, is very sure that we are wrong in this proposition, and very likely we are, but that is what we hold.

Mr. Caskey: You have not passed upon the major point — • upon the value of the property levied on the cognovit note, and the liability. You said Sessions was not chargeable, but you did not say anything as to Lamson.

Judge Hale: There, again, a majority of the court do not think that Mr. Lamson ought to beheld upon that levy; in other words, we allow Mr. Sessions the benefit of his, levy,and do not require Mr. Lamscn to make good to his creditors the amount of property withdrawn by that levy.

Gilbert & Hills, for Plaintiffs.

Caskey & Calhoun, A. A, Stearns, for Defendants.

Judge Marvin: I can not understand how Mr. Lamsom is to be excused from liability therein  