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In re Sparta Canning Co.

November 20, 1934


Appeal from the District Court of the United States for the Western District of Wisconsin.

Author: Sparks

Before EVANS, SPARKS, and FITZHENRY, Circuit Judges.

SPARKS, Circuit Judge.

This appeal involves the question as to the right of appellants, who were directors of a corporation which subsequently suspended business and filed a voluntary petition in bankruptcy, to preferences in the assets of the corporation. Appellee, the trustee for the Sparta Canning Company, filed a petition praying that the Referee in Bankruptcy order appellants to show cause why certain chattel mortgages alleged to constitute fraudulent preferences should not be cancelled and set aside, and appellants required to account for the proceeds received from the sale of the property covered by the mortgages. He based his claim on the ground that the mortgages were executed:

(1) To secure the officers and directors of a corporation

(2) for a pre-existing debt

(3) after the corporation became insolvent.

Appellants in their answer claimed that on the contrary, the mortgages were to secure them for contemporaneous loans, and that at the time of their execution the corporation was a solvent, going concern.

The two mortgages in question had been executed on July 6, and September 4, 1931, to secure the payment of certain notes to appellants aggregating $24,360.90, dated from March 4, to June 24, 1931. They were duly recorded at once upon their execution. Foreclosure proceedings were had on May 7, 1932, at which time the mortgagees bid in the mortgaged property for the amount due on the notes, plus costs and attorneys fees, a total of $25,109.12. On October 6, 1932, the company was adjudicated a bankrupt upon its voluntary petition.

The evidence showed that the bankrupt company was organized in 1924 and began doing business in 1925, but that at no time had it ever made any profits or paid any dividends. In April 1931, the stockholders at a regular meeting discussed the general condition of the company and the advisability of continuing operations for the ensuing packing season. The stockholders themselves failed to respond to the suggestion that they help finance the pack, but voted to authorize the directors to borrow for that purpose, and to mortgage any or all of the assets of the corporation as security for the loans. Thereafter appellants made advances amounting to over $24,000, part of which was used to pay certain indebtedness to a bank, and the balance to finance the 1931 pack. The last note given to one of the directors was dated June 24, 1931, for $4,329. The pack consisted of two parts, the first of peas, and the other of beans, and the evidence showed that as soon as each was completed it was mortgaged under the two mortgages herein involved. At that time the corporation owed the growers of the two 1931 crops about $7,000.

The referee found that at the time the advancements were made the corporation was a going concern, but that it was insolvent at the time the mortgages were executed. He also found that the advances were made in order to enable the corporation to continue in business, and that part of the money was used to pay an old indebtedness. He concluded as a matter of law that the mortgages were valid as against the corporation and its creditors, basing this conclusion upon the proposition, as stated in his memorandum, that, "In Wisconsin an insolvent person, including a corporation, has a right to prefer a creditor, whether that creditor is an agent of an individual or an agent or officer of a corporation. But when a corporation is no longer a going concern, -- or the equivalent thereof, a suspension of business is contemplated, or the state of affairs is such that the officers know or ought to have known that suspension was about to occur, -- the property of a corporation becomes a trust fund for creditors and all creditors must be treated alike and no one has any right to more than his share and it makes no difference whether the creditor is an officer of the corporation or not." He also concluded that it made no difference whether the liability was considered as a pre-existing debt or not, because a creditor had the right to take security or receive pay for a pre-existing debt where a corporation was insolvent but still a going concern.

The appellants filed exceptions to the referee's report as to the finding that part of the money was used for the payment of an old debt of the company, and that at the time of the execution of the mortgages the corporation was insolvent. Appellee filed a petition to review the report in that it held the mortgages valid as against the creditors and trustee of the bankrupt.

Upon review, the District Court amended the findings of the referee by adding the following:

"That at the time of the execution of said mortgage the financial situation and condition of the Sparta Canning Company was such that the directors knew or ought to have known ...

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