In re KLEIN. DOUGHERTY v. FIRST NAT. BANK OF CANTON, OHIO, 197 F. 241

SATER, District Judge (after stating the facts as above). The case is here both on appeal and on a petition for review. As no objection is made touching the remedies so chosen to bring the matters in controversy into this court, we need not .concern ourselves with any question of remedy or jurisdiction. Re Martin, 193 Eed. 841 (C. C. A. 6). ' The trustee in bankruptcy, to maintain his contention that the bank’s mortgage is invalid as against him as the representative of the bankrupt’s creditors, advances the following propositions:

(1) The chattel mortgage transferred to the bank the whole of Klein’s property when he was insolvent and! when the bank had reasonable cause to believe that a preference was thereby intended to be given to it, in consequence of which the bank, if the mortgage be upheld, will receive, in the order of priorities prescribed by the bankruptcy statute, a greater percentage of its claim than other creditors of the same class. The mortgage, therefore, constitutes a preference whether the date of the transfer be considered as of the date of the execution or of the filing of the mortgage. '

(2) The bank is conclusively estopped from claiming against him under such mortgage, because the mortgage, in pursuance of a concerted plan and positive agreement, was withheld from record for almost a year, on account of which others were disposed to give and did give Klein credit between the date of the execution and of the filing of such instrument.

(3) The bank’s mortgage, considered in conjunction with that of ■Clayson and the William Edwards Company, which was given at the same time, and with its withholding from record in pm;suance of an agreement which contemplated the effect such withholding would have on the debtor’s financial standing, was taken for the purpose and with the intent of hindering and delaying his other creditors. These propositions are all controverted by the bank not only as to the conclusions of fact adduced from the evidence, but as to the law applicable to the case.

The transactions involved occurred when sections 60a and 60b of the Bankruptcy Act (Act July 1, 1898, c. 541, 30 Stat. 562 [U. S. Comp. St. 1901, p. 3447]), as amended February 5, 1903 (Act Feb. 5, 1903, c. 487, 32 Stat. 799 [U. S. Comp. St. Supp. 1911, p. 1506]), were in fofce. Whether the mortgage to the bank constituted a preference or not at the time it was given must be determined by the facts and circumstances then existing.

The situation was such as to beget confidence in Klein and in his ability to pay his creditors in full. - As the bank was not urging payment of its original $10,000 loan, and as it from the first considered favorably his application for an increased accommodation, it must be presumed that his business relations with it for the preceding year had been satisfactory. There is no suggestion in the record that he had'ever been untruthful in his dealings, or had practiced deception, or had done aught to éxcite distrust.

His apparent frankness in submitting for. inspection his invoices, bills .of cost, and a statement of assets and liabilities was such as to ¡induce reliance on his representations.

In the light of subsequent events, it appears that he magnified his investment and his monthly profits, if, indeed, there were any at all, and overstated his liabilities by $2,100 in favor of his father-in-law, Clavson, but the valuation for the test of solvency or insolvency under {he issue made must relate to the conditions affecting the hotel as a going concern when the mortgage was given, and not at its value as dead property after bankruptcy intervened. Butler Paper Co. v. Goembel, 143 Fed. 295, 74 C. C. A. 433 (C. C. A. 7); Loveland, Bank. (4th Ed.) 303.

The trustee, on whom is cast the burden of proof that the mortgage constituted a preference, concedes that the cost of the_hofel equipment for which Klein specifically accounted reaches $35,500, but he did not pretend to account for all of it.

Although Klein’s evidence beyond that amount is xmcertain, nevertheless, notwithstanding his valuation of assets as scheduled in the bankruptcy proceeding, considering, the aggregate of his expenditures, as evidenced by his cost bills, and of the funds which had been at his disposal for investment in his business, none of which appear to have been otherwise expended, the expense other than for mere furnishings incident to the launching of an enterprise of the magnitude of his hotel venture, wc are not prepared to say that his assets did not exceed his liabilities, or that he was insolvent, or that he did not in good faith believe he could pay his debts in full, and have a substantial sum remaining.

The record does not disclose the terms on which his liabilities other than for rent and not secured by the mortgages were incurred, but the inference to be drawn is that some of them had matured. There is, however, no suggestion in the evidence that he contemplated a cessation of business, if the additional loan were not granted, nor any fact disclosed that the necessity for an increased loan to meet his obligations was due to any circumstance other than his recent embarking in a new but reported growing and prosperous enterprise in which he had made an investment in excess of what his capital warranted.

He had not stopped the payment of any of his paper, nor had any of it gone to protest, nor had he been sued or threatened with suit for any debt, nor were there rumors that he was financially embarrassed, nor were any creditors, save the William Edwards Company, pressing for payment or security.

He proposed, it is true, to mortgage the whole of his property and did not intend to pay from the additional loan his arrearage of rent, about which there was a dispute, or the whole of his floating debt, but, if his investment was as much as Loichot, as cashier acting for the bank, found it to be from the submitted partial list of bills of cost, or as Klein represented it to Eoichot to be, his equity in the mortgaged property was from two to four times the amount of his remaining unsecured debt, and this he could easily pay, as he agreed to do, out of his earnings, if they were as represented.

The trustee seeks to draw an inference prejudicial to Klein and the bank from the withholding of the wife’s property from the mortgage, but the argument is without merit. The law didi not cast on her the duty of subjecting her property to liability for her husband’s debts, and under the facts then known it did noi appear that any necessity for her so doing existed. The property mortgaged, excepting a small amount intended for consumption, was not of the character of a stock of goods, subject to. sale and requiring replacement.

It was more in the nature of a permanent investment and akin to that of a manufacturing plant, which is replaced only when worn out. Its incumbrance would not.necessarily cause a stoppage of his business. Loichot was not an expert on the value of hotel equipments, and did not cause an appraisement to be made, nor did he conduct an exhaustive examination into Klein’s, affairs, but he verified his statement as to liabilities, and found it, as submitted, to be correct, and as to assets he examined far enough to learn that Klein’s equity in the property was substantial.

He thus entitled himself to the benefit of the rule that reasonable cause to believe that a transfer and the effect of its enforcement will operate as a preference does not exist where the creditor examines the debtor’s books, which do not reveal insolvency. Loveland, Bank. (4th Ed.) 1006,1007. It now appears that his finding as to liabilities, but through no fault of his, was excessive to the amount of $2,100.

He found the pressure for security from the William Edwards Company, the largest merchandise creditor, so slight that, acting with deliberation and after it had availed itself of the advice of counsel regarding its claim, that company was content to take a second mortgage, defer payment and pro rate, if need be, with Clayson’s large claim.

Clayson, although not able for want of ready funds to advance a part of the desired new loan, expressed his confidence in Klein’s financial strength, not only by his ready acceptance of a second mortgage, but by his indorsement of Klein’s note to the bank for a sum equal to what he would have personally loaned, had he been in funds. The presumption is strong that the bank would not have increased its loan had it not felt itself entirely secure in so doing. Loichot, in the performance of his part of the transaction, did what a reasonable and prudent man would ordinarily have done under like circumstances.

He believed in the accuracy of Klein’s statements, as to the extent of his investment, his liabilities and profits, and his personal investigation tended to confirm their truthfulness. But knowledge of or belief in Klein’s insolvency is not the criterion of proof. The true inquiry is, Did he have reasonable cause to believe? Merchants’ Nat. Bank v. Cook, 95 U. S. 342, 346, 24 L. Ed. 412; Loveland, Bank. (4th Ed.) 911, note; Re McDonald & Son (D. C.) 178 Fed. 487, 492; Collier, Bank. (8th Ed.) 666.

In view of the evidence submitted, we are constrained to hold that he did not have such knowledge of facts as wouldl induce in the ‘mind of an ordinarily prudent man reasonable belief that Klein was insolvent, or that the intrinsic value of his assets was not largely in excess of his debts, or that he intended to give the bank a preference by the execution and delivery of the mortgage to it, nor did he accept it for that purpose. Excepting as to the hotel and saloon supplies intended for consumption, the bank’s mortgage at his inception and execution was free from .infirmity.

Wie do not attach importance to the nonproduction by the bank of the list of assets andl liabilities submitted to it by Klein prior to the execution and delivery of the mortgage. No formal demand was made for it. by the trustee, nor does it appear that such list was left in Loichot’s possession, or that any search was made for it by any party to this proceeding. If it remained with Klein, the duty of producing it or of accounting for its absence rested on the trustee rather than on Loichot. The evidence as to its submission and as to what it showed is convincing.

There is nothing in the record derogatory to the credibility of Loichot as -a witness. The agreement that the mortgage should be withheld! from the files pending negotiations for the sale of the mortgaged property was not in contemplation at or prior to the time of the giving of the mortgages, but had its origin after they had been executed and delivered. That intending purchasers will ordinarily take advantage of a seller’s financial burdens, if their existence be known, to minimize the price to be paid for the

article offered, is a well-known fact. The purpose of the agreement was meritorious, in that it sought to avoid such a situation and to realize the greatest sum possible for the mortgagor and his creditors, and not to enable him to obtain a fictitious credit or to continue business. Its design was to benefit, and not to injure, creditors.

Loichot’s information at the time the mortgages were filed was that Klein’s financial standing was better than when the mortgages were given, and that no new liability had been incurred, unless the vague statement of the landlord’s representative to Loichot is susceptible of the strained construction that the arrearage for rent was other than or in excess of that which existed when the mortgages were given.

The landlord knew of Klein’s debt to the bank, but Loichot did not communicate to the landlord the existence of the mortgages, nor was he called upon by anything that occurred in such conversation to make any disclosure regarding them. Klein, however, at the time the mortgages were filed, had incurred liabilities largely in excess of those which he had satisfied, to persons ignorant of the existence of the mortgages, and was insolvent, and it is therefore urged that the bank is conclusively estopped from claiming under its mortgage as against the unsecured creditors.

The withholding of the mortgages from record in pursuance of an agreement is a fact to be considered in connection with all the other facts and circumstances in determining whether the transaction was fraudulent or not. It is doubtless true that the failure to file the mortgages gave Klein better credit than he otherwise would have had and enabled him to continue business longer than he otherwise could have. clone, and yet the average amount of credit per month obtained by him was seemingly as great after they were-filed as it was before. This may have been due to his decreased ability to pay.

There is, however, no affirmative evidence that any one gave Klein credit in reliance on his apparently unincumbered property, nor did the bank have knowledge of an intent on his part to deal with others as the owner of property of that character. It did not misrepresent its interest in the property, or withhold the mortgage from an actual fraudulent motive, or know or believe that the mortgagor was insolvent. Actual fraud did not exist. The law of Ohio is controlling upon federal courts in questions arising upon the validity of chattel mortgages given and filed in that state upon property located therein.

Re Shirley, 112 Fed. 301, 50 C. C. A. 252; Etheridge v. Sperry, 139 U. S. 266, 11 Sup. Ct. 565, 35. L. Ed.

Section 4150, Revised Statutes of Ohio, regulating the filing of chattel mortgages, provides: “A mortgage, or conveyance, intended to operate as a mortgage of goods and chattels, which is not accompanied by an immediate delivery, and followed by an actual and continued change of possession of the things mortgaged, shall be absolutely void as against the creditors of the mortgagor, subsequent purchasers, and mortgagees in good faith, unless the mortgage, or a true copy thereof, be forthwith deposited as directed in the next section.”

Section 4151 provides that chattel mortgages shall be deposited with the county recorder of the county in which the mortgagor resides, and they may, when filed, be recorded, if their respective owners desire.

Section 4153. Under the state law, the bank’s mortgage conveyed the property therein described to the bank, the title passing to it as general owner with the right of immediate possession on breach of condition. Robinson v. Fitch, 26 Ohio St. 659, 663; Lindemann v. Ingham, 36 Ohio St. 1, 9; Bates v. Wiles, 1 Handy (Ohio) 532. It was valid under the Ohio rule, as between the bank and Klein, whether it was filed or not (Francisco v. Ryan, 54 Ohio St. 307, 43 N. E. 1045, 56 Am. St. Rep. 711; Boyer v. Knowlton Co., 85 Ohio St. 104, 97 N.

E. 137), but void as against contesting creditors, who, between the time of its execution and filing, had acquired rights or liens upon it by attachment, execution, or other appropriate legal steps for the payment of their debts (Wilson v. Leslie, 20 Ohio, 161; Brown v. Webb, 20 Ohio, 389; York Mfg. Co. v. Cassell, 201 U. S. 344, 26 Sup. Ct. 481, 50 L. Ed. 782; Re Shirley, supra). Therefore, when it was filed, it became operative as against all of Klein’s other creditors, because none of them had fastened a valid right or lien upon the mortgaged property before its filing.

In the Shirley Case Judge Day, speaking for this court, said: “We reach the conclusion that under the Ohio statutes, as interpreted by the highest courts of the state, a chattel mortgage being wholly void as against certain creditors until filed, mere withholding it from record does not necessarily work a fraud upon the other creditors. Such withholding with the intent. to defraud others undoubtedly invalidates the security.

It is claimed that the mortgagee is estopped to assert his security as against others who dealt with the mortgagor on the faith of the property after the execution of the mortgage and before its record. But there can be no estoppel, in the absence of fraud, if the mortgagee simply held a security void until filed as against creditors who were at full liberty to assert their rights against the property. The mortgagor had an undoubted right to prefer creditors by giving to one a security denied to others. When the chattel mortgage is filed it becomes such preference only from the. date of filing.

Until filed, it is void as to ‘creditors.’ While this term is used without limitation in the statute, as construed by the Ohio Supreme Court, it means such creditors as have fastened upon the property before the filing of the mortgage. All other creditors must assail the security for fraud in order to defeat the preference.” It is clear from what has been said that the bank’s mortgage was not given or taken with intent to hinder,. delay, or defraud) Klein’s creditors, or any of them, and that the bank is not estopped to claim, under it unless such result flows from the amendment of February 5, 1903, to

section 60a of the Bankruptcy Act. Although the barnk’s chattel mortgage, which was given to secure an additional loan as well as an antecedent debt, was executed and delivered in good faith when Klein, for aught that appears, was solvent, and was not fraudulently withheld! from record, and the whole transaction relating to it was had in good faith, nevertheless, did the filing of it within four months of the institution of bankruptcy proceedings bring it within the disabilities of

section 60a ? The answer must be in the negative, if we concur in the views announced in Re Sturtevant, 188 Fed. 196, 110 C. C. A. 68 (C. C. A. 7), Meyer Bros. Drug Co. v. Pipkin Drug Co., 136 Fed. 396, 69 C. C. A. 240 (C. C. A. 5), Re Sayed (D. C.) 185 Fed. 962, and Debus v. Yates (D. C.) 193 Fed. 427, or if we adopt the necessarily logical conclusion flowing from Re Doran, 154 Fed. 467, 83 C. C. A. 265, decided by this court. Under the bankrupt law as originally enacted, a transfer dated as of the time it was actually made without regard to the date of filing or recording.

Cases consequently arose in which preferential transfers, though fraudulent and constituting acts of bankruptcy, could not be successfully assailed, even though the instruments evidencing them were filed or recorded:, as the case might be, within four months of the filing of the petition in bankruptcy, because the transfers were made prior to the beginning of the four months’ period. The withholding of such transfers from .the files or record thus operated to defeat the benefit contemplated by the establishment of such period.

To correct this defect in the law, the amendment of February 5, 1903, was made, whereby the words “within four months before the filing of the petition, or, after the filing of the petition and before adjudication,” were eliminated from

section 60b and inserted in

section 60a, and also the words, “where the preference consists of a transfer, such period of four months shall not expire until four months after the date of recording or registering the transfer, if by law such recording or registering is required,” were added at the end of

section 60a. The purpose of

section 60a, as originally enacted, was to define what judgments and what transfers are preferential, and it still performs that office. The added! sentence prolonging the four months’ period until four months after the date of recording or registering the transfer applies only to cases “where the preference consists in a transfer,” and the conditional clause, “if by law such recording or registering is required,” we interpret to mean, if by the law of the state by which the validity of the mortgage against contesting creditors is determined, such recording or registering is required.

The purpose of the amendment was, we think, as stated in Re Sturtevant, to prevent preferential fraudulent transfers from escaping the four months’ provision, unless they were filed or recorded!, as the case may be, before that period began to run. It did not change the date as to which such transfers .are to be judged in determining their voidable,character. As was said in Debus v. Yates (D. C.) 193 Fed, 447, in speaking of the amendment of 1903: “It simply prolonged the time in which, by the filing of a petition in bankruptcy, a recorded preferential transfer might be deemed to be a voidable preference.

It had nothing whatever to do with changing the date as to which it was to be judged in determining whether all the elements of a voidable preference-were present.” This view finds support in the fact that the amendment did not abrogate the well-settled rule that, to make a transfer preferential, the transferee’s reasonable cause to believe that the debtor intended to give him a preference over other creditors must concur with the debtor’s intent to give a preference. Re First Nat. Bank of Louisville, 155 Fed. 100, 84 C. C. A. 16 (C. C. A. 6); Re Leech, 171 Fed. 622, 96 C. C. A. 424 (C. C. A. 6); Hardy v.

Gray, 144 Fed. 922, 75 C. C. A. 562 (C. C. A. 2); Curtiss v. Kingman, 159 Fed. 880, 87 C. C. A. 60 (C. C. A. 1); Tumlin v. Bryan, 165 Fed. 166, 91 C. C. A. 200, 21 L. R. A., (N. S.) 960 (C. C. A. 5). The debtor performs his

part in reference to a transfer when it is made. The time at which the transfer instrument shall be filed and recorded is ordinarily determined wholly by the transferee. There may be, as in the present case, a transfer wholly free from preferential and) fraudulent taint, a withholding for a laudable purpose as regards unsecured creditors and for a period wholly within the discretion of the transferee, and yet, if the preferential character of the instrument must be judged.as of the date of its filing, the transfer then becomes preferential in the absence of any intent in that behalf on the part of the debtor.

If this be the correct view of the statute, it then, not only postpones the time within which a transfer may be successfully assailed, but also materially alters the essential character of the transaction. To avoid such a result and the creation by construction of a transaction different from the actual one, the court in Re Jackson Brick '& Tile Co. (D.

C.) 189 Fed. 636, refused! to apply the rule, which we are asked to adopt, to a transfer based on a present consideration; but if it has no application to a transfer based on a present consideration,' which is not preferential, we see no reason why it should apply to a transfer which is not preferential, though based on a pre-existing debt, unless the state law, unlike that of Ohio, is such that the conveyance has no force and validity whatever as to creditors until filed or recorded. Speaking to this point, it was ruled in Re Sayed (D.

C.) 185 Fed. 965: “We find that tbe intent to give a preference * * * must exist on the part of the giver of the security at the time it is given, and the receiver must then have cause to believe that the giver has such intent. * * * The intent on the part of the transferrer must exist at the critical moment.

If that moment be the instant of recording, how can it be said that the transferrer then has that intent, when he perhaps gave and delivered the instrument two years before, while he was perfectly solvent, and had continuously supposed that it was recorded, as might well be the case if the lack of recording had been from the carelessness of the secured creditor?” The contention is not without merit that, because the amendment did not provide that transfers shall be judged as to validity as of the date of filing and without regard to their execution,

section 60b was so amended June 25, 1910 (Act June 25, 1910, c. 412, § 11, 36 Stat. 842), as to eliminate from preferential transfers the intent of the debtor and make them, when recordable and recorded, speak as of the date of recording. The action of Congress, it is true, in thus amending the statute is not necessarily such an admission of imperfection in the previous enactment of 1903 as to prevent judicial

interpretation from giving it the same effect as the amendment imparts (School District v. Kelley, 120 Iowa, 119, 94 N. W. 284), but ordinarily such an amendment may be taken as indicating an intention to make some change in the previously existing law (Mosle v. Bidwell, 130 Fed. 334, 65 C. C. A. 533 [C. C. A. 2]). By necessary implication the same result as is obtained here was reached by this court in Re Doran, 154 Fed. 467, 83 C. C. A. 265. The case arose under the statutes of Kentucky, which, as regards the subject-matter under consideration, are not dissimilar from those of Ohio.

The amendment of 1903 was then in force. The mortgage, which was valid at its inception, was not recorded for more than fourteen months after its execution, or until within less than four months prior to the filing of the petition in bankruptcy.

Debts were created between the date of the giving and the filing of the mortgage, but, as none of the creditors had fastened upon the mortgaged property before the mortgage was filed, it was sustained excepting as to the stock of goods from which sales were made by the mortgagor in the course of trade; the evidence failing to show what part, if any, of such stock passed into the hands of the trustee. The validity of the mortgage was necessarily measured as of the date of its execution and delivery. Crucible Steel Co. v. Holt, 174 Fed. 127, 98 C. C.

A. 101, decided by this court in 1909, involved the rights of a vendor who had made a conditional sale of goods under an agreement, which was not recorded, that the title was to remain in him until payment of the purchase price. Under the law of Kentucky, where the transaction occurred, such a sale amounts to a sale and a chattel mortgage back to the vendor, and is controlled by the provisions of the state statute concerning the recording of chattel mortgages.

After the execution and delivery of the contract, but before the filing of the petition in bankruptcy, the bankrupt became indebted to certain parties, in whose behalf the trustee in bankruptcy contested the claim of the vendor as to the title to and right of possession of the goods sold. The vendor asked for the enforcement of a lien thereon and asserted priority over general creditors in the proceeds of their sale. The case differed from the Doran Case, in that in the latter the chattel mortgage had been filed.

The difference, however, was not regarded as important, and we refused to disturb the ruling of the Doran Case and upheld the vendor’s lien upon the goods in question for the unpaid purchase money. The Supreme Court, to which the case was appealed, in its opinion (Holt v. Crucible Steel Co., 224 U. S. 262, 32 Sup. Ct. 414, 56 L. Ed. 756), announced! April 1, 1912, affirming this court, treated the instrument of sale as a valid unrecorded chattel mortgage. It affirmed its holdings in York Mfg. Co. v. Cassell, 201 U. S. 344, 26 Sup. Ct. 481, 50 L. Ed. 782, and Thomas v. Taggart, 209 U. S. 385, 28 Sup.

Ct. 519, 52 L. Ed. 845, that the effect to be given to an unrecorded chattel mortgage must be determined by the recording law of the state. The result obtained is in harmony with the conclusion reached in the Doran Case and does not consist with the contention here made by the trustee. Loeser v. Savings Deposit Bank & Trust Co., 148 Red. 975, 78 C. C. A. 597, 18 L. R. A. (N. S.) 1233 (C. C. A. 6), does not militate against the conclusion here reached.

That case was decided with reference to the express stipulation that the bankrupt at the time of the execution and delivery of the mortgage was insolvent, and that the mortgagee had reasonable cause to believe at that time that she was insolvent, which condition existed at the time the mortgage was filed, apd that the effect of efiforcing' the mortgage, if held valid, would be 'to enable the mortgagee to obtain a greater percentage of its debt than any other of the bankrupt’s creditors of the same class.

The question as to whether the validity of the mortgage should be determined as of the date of the making or of the recording was not involved. We are not unmindful that there are reported cases which hold contrary to the foregoing, but the views above expressed are believed to be the better and are in accord with those heretofore entertained by this court. As the validity of the bank’s mortgage must be judged as of thedate of its execution, and as under the Ohio law it was neither preferential nor fraudulent, and therefore not within the disabilities of

section 60a, it must be sustained, excepting as to the stock of goods designed for consumption in the hotel and saloon. The District Court is affirmed.