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short cut-off date. To that extent, a very minor extent, it is an impingement on the State law.
Mr. HOBBs. The other question I had in mind is in regard to our chairman's bill, if we voted it out of this committee. Section 13a of H. R. 5693 relates to the same subject matter. Is there any objection from any of your clients or agencies which you represent to that section of that bill?
Mr. KUPFER. Judge Reed was good enough to discuss that with me before the hearing this morning. I am not a legislative draftsman and I think it is more a matter of legislative draftsmanship than otherwise.
Section 13 makes a very minor conforming amendment in section 60a. Of itself, there is no objection to it.
But our objection to section 60a goes deeper. It is substantial. So, I suggested to Judge Reed that it would be very bad if H. R. 5693 went through after H. R. 2412, or after your bill, because then it would restore section 60 in effect to its present form.
So, I suggested to him that one of two things should be done, and I think to this we all agree. Either that section 13 should be taken out of H. R. 5693, so that this matter we have before us this morning might be determined on the merits or, alternatively, that you make sure that Mr. Reed's bill or your bill is passed after the bill that contains merely the conforming amendment.
My own feeling would be, without being at all expert on the subject, and there are legislative draftsmen here who know more about it than I do, that the cleanest amputation would be to eliminate section 13 from H. R. 5693, and then the main matter can be determined on its merits.
Mr. Hobbs. I think the subcommittee is at one on this proposition. We have no idea of bypassing neither Judge Reed's bill nor mine and we are going to plump for prompt passage.
But our idea was, in supporting the two, that there was nothing controversial in H. R. 5693 and if we could get that through it would cure a large part of the disease in section 60. Then, we could quarrel over the details of the two bills that would go further and whatever is determined we would have the benefit of H. R. 5693. That may be wrong.
Mr. KUPFER. It is a matter of draftsmanship. My own idea would be that as long as section 60 has to be amended in the manner that Judge Reed's bill (H. R. 2412) or your bill (H. R. 5834) prescribes, and will be so amended, I suggest you take section 13 out of H. R. 5693 altogether because you might get into the curious situation that the omnibus bill (H. R. 5693) passes after one of your two bills, and that is what I am worrying about.
Mr. Hobbs. The omnibus bill to which you refer is H. R. 5693?
Mr. Hobbs. It would be just the reverse as we conceive it. But I am glad to have your idea on it.
Mr. KUPFER. That is purely a matter of legislative timing, of course.
(Statements and resolutions referred to by Mr. Kupfer are follows:)
STATEMENT OF THE AMERICAN BAR ASSOCIATION IN SUPPORT OF IDENTICAL S.
826 (SENATOR FERGUSON) AND H. R. 2412 (REPRESENTATIVE CHAUNCEY W. REED)—To AMEND SECTION 60A OF THE BANKRUPTCY ACT-SUBMITTED ON BEHALF OF THE AMERICAN BAR AssociATION
Officers: Tappan Gregory, president, Chicago, Ill.; Howard L. Barkdull, chairman, House of Delegates, Cleveland, Ohio; Benjamin Wham, chairman, section of corporation, banking, and mercantile law, Chicago, Ill.
Special committee on the revision of section 60a of the Bankruptcy Act: John Hanna, professor, School of Law, Columbia University, N. Y.; J. Francis Ireton, Baltimore, Md.: Homer J. Livingston, vice-president, First National Bank of Chicago, Ill.; James A. MacLachlan, professor, Law School of Harvard University, Cambridge, Mass.; Milton P. Kupfer, New York, chairman.
I. INTRODUCTORY NOTE
These identical bills were introduced at the request of, and are sponsored by, the American Bar Association, consequent upon a 2-year study made by a special committee created by its section of corporation, banking, and mercantile law to deal with their subject matter.
As appointed in 1945, this committee consisted of Homer J. Livingston, vice president of the First National Bank of Chicago, and chairman of the Bankruptcy Committee of the American Bankers Association, as chairman; Prof. John Hanna of the Columbia University Law School; J. Francis Ireton, of the Baltimore bar; Milton P. Kupfer of the New York bar; and W. Leslie Miller of the Detroit_bar. Its personnel has remained unchanged except that, during its second year, Prof. James A. MacLachlan, of the Harvard Law School, replaced Mr. Miller. Mr. Livingston and Mr. Kupfer have been the successive chairmen of the committee.
IJ. HISTORICAL BACKGROUND OF SECTION 60A
Traditionally, it is the primary office of the Bankruptcy Act to protect creditors, both secured and unsecured; to marshal the bankrupt's assets; and to distribute them among this creditors, equitable and equally, in accordance with their respective rights and interests. The trustee is the statutory instrumentality charged with the performance of these duties.
It follows from these broad general principles, as well as from the basic provisions of the Bankruptcy Act itself, that
(a) A trustee occupies the position of a universal judgment-creditor with all such a creditor's remedies, and
(6) Except as may be necessary to avoid preferences or fraudulent transfers, he takes the bankrupt’s assets subject to all valid liens and encumbrances thereon, as conferred by applicable State law. (See, illustratively, secs. 57 (e) and (h), 67 (b), and 70 (a) of the act.)
To put it another way, a trustee in bankruptcy had never been doctrinally placed upon the level of a bona fide purchaser, actual or potential, of any portion of the debtor's assets. Since it is the office of the Bankruptcy Act to protect creditors, this, of course, is as it should be, and such has been the holding of our courts ever since a bankruptcy statute first came into our law.
This consistent pattern would probably never have been disturbed but for a series of unfortunate decisions, of which two are illustrative, of the United States Supreme Court, in the earlier decades of this century.
In Sexton v. Kessler (225 U. S. 90), a loan was made, upon the security of stocks and bonds, more than 4 months prior to the borrower's bankruptcy. However, the lender permitted the borrower to remain in possession and control of the Security, and reduced the subject matter of the pledge to his (the lender's ) possession virtually on the eve of bankruptcy. Despite good argument that was made to the contrary, the Supreme Court held that this death-bed reduction to possession related back to the date of the original loan, and refused to declare the transfer preferential. The doctrine of the Sexton case, accordingly, became known as the "relation back" doctrine.
Another equally unfortunate result was reached in Carey v. Donohue (240 U. S. 430). In that case, the creditor took a deed to Ohio real estate, and did not record it at all. The recording statutes of Ohio invalidated an unrecorded deed against a bona fide purchaser for value, but not as against a judgment-creditor.
For that reason, the Supreme Court held that the trustee had no right to attack the grantee's title, and the doctrine of this Carey case, accordingly, came to be known as the “pocket lien" doctrine.
Other cases to substantially the effect of one or the other of these two are Bailey v. Baker Ice Machine Co. (239 U. S. 268), Martin v. The Commercial Bank (245 U. S. 513), and Bunch v. Maloney (246 U. S. 658).
III. THE PRESENT LANGUAGE OF SECTION 60A
The "pocket lien" and "relation back” doctrines were obviously pernicious, and required correction in the interests of unsecured creditors, resulting in the amendment, in 1938, of section 60a to its present form.
As the principal draftsmen of the amendment have freely admitted, it was felt necessary, in view of the then conservative attitude of the Supreme Court as manifested by the foregoing cases, to use strong language in order to be sure of obtaining even moderate results. Availing oneself of the benefit of hindsight in view of the change in the personnel of the Court, it may be observed in passing that this precaution was, perhaps, unnecessary.
In any event, what was done was not only to place a trustee in bankruptcy upon the level of a bona fide purchaser for value so far as determining the time of a preference was concerned, but, even further, to place the trustee for that purpose in the position not merely of an actual but of a potential bona fide purchaser for value. This was accomplished in 1938 by amending the second sentence of section 60a so as to read:
For the purposes of subdivisions (a) and (b) of this section, a transfer (to a secured creditor) shall have been deemed to have been made at the time when it became so far perfected that no bona fide purchaser from the debtor and no creditor could thereafter have acquired any rights in property so transferred, superior to the rights of the transferee therein, and if such transfer is not so perfected prior to the filing of the petition in bankruptcy
it shall have been deemed to hav been made immediately before bankruptcy. [Italics supplied.)
As has also been frankly admitted, the present language of the amendment has also brought in its train entirely unanticipated results, equally unfair to secured creditors. In brief, as so frequently happens, the pendulum was swung too far to the other side. The object of the present bills is to retain the basic objectives of the 1938 amendment, and restore the proper balance.
IV. THE KLAUDER AND VARDAMAN CASES
(a) Their practical hardships
It did not take long for the basic injustices of the 1938 amendment to become apparent, and its unanticipated results to be realized.
The first intimations came with Klauder v. Corn Exchange National Bank & Trust Co. ((1943), 318 U. S. 434, 63 S. Ct. 679, 87 L. Ed. 884.) In that case, the Corn Exchange Bank & Trust Co. made advances to the Quaker City Sheet Metal Co. upon the security of specific assignments of certain of its accounts receivable. Concededly, the advances were made and the assignments were taken long prior to the beginning of the 4 months' period, not only in good faith and for full value, but at the very request of the overwhelming majority of Quaker City's unsecured creditors. Much more than 4 months later, Quaker City was petitioned into bankruptcy. The Supreme Court, applied the present language of section 60a, and struck down the assignment on the sole ground that, under the Pennsylvania law (which, itself, had not been too certainly declared by its own courts), a bona fide purchaser of the accounts could have prevailed against the assignee, solely because notice of the assignments had not been given to the respective accountdebtors.
If the impact of this decision had been solely on accounts receivable, and if it had not been extended even in that field, the situation might have been borne. But, in the first place, it immediately became clear that the same rule might well be held to apply to all manner of security, on both tangibles and intangibles, where a potential bona fide purchaser of its subject-matter could acquire rights superior to the grantor or assignee, even though the security is given for a present consideration and in good faith, and the transaction is good against creditors.
This would be true in any case where the applicable State law, in order to facilitate the conduct of industry and trade, and in furtherance of common justice, permits the borrower to sell and pass good title to the mortgaged property to an innocent purchaser for value. Illustratively, such a situation exists under the factors' lien acts in force in a number of States; trust receipts under the Uniform
Trust Receipts Act; conditional sales agreements for resale; chattel mortgages on merchandise stocks; and many other situations. The constricting effect both upon the wholesale and retail financing of automobiles; cattle loans; oil leases; airplane equipment loans; and other situations too numerous to mention, is obvious.
The legislatures of some 29 States have attempted to mitigate the effect of the present interpretation of section 60a upon accounts receivable, by passing statutes prescribing various methods for the perfection of title to the assignment of such accounts. Unfortunately, because of the present language of section 60a, similar action cannot be taken with respect to the lender's interests, enumerated in the last preceding paragraph, on tangible personal property which is offered for sale to the general public in the normal course of business. And, of course, it is common knowledge that most of the wholesale financing of automobiles and domestic appliances (such as radios, washing machines, vacuum cleaners, etc.) is done by the dealers on trust receipts, conditional sales, or chattel mortgages. Therefore, only an amendment to section 60a can cure the difficulty with respect to that type of security which, for the reasons stated, covers what is probably the most important area in our whole economy.
Furthermore, it has even been contended-and not without reason—that under the present language of the section, all loans must be closed at the courthouse door, because, in no other way, can the acquisition of the intended security possess that attribute of simultaneity with the advance that the statutory language seems to require if the lien is not to be struck down. Of course, in ordinary every-day transactions, this is a manifest impossibility. Yet, under the present wording of section 60a, if there is any lapse of time between (1) the date upon which a loan is made and the security therefor taken, and (2) the date on which the transfer of the security is fully perfected against bona fide purchasers, the lender's security, taken in good faith and for full value, is vulnerable to attack as a preference whenever a petition in bankruptcy is filed against the borrower at any time within 4 months after the date on which the transfer is so perfected. Illustrative of this common type of situation are ordinary real estate and chattel mortgage transactions, where recording or filing is required to perfect the lender's lien against bona fide purchasers.
The whole situation works unnecessary hardship; has greatly impeded all forms of secured commercial financing (whether conducted by banks, factors, finance companies, or anybody else); and has principally prejudiced the smaller, borrowing businessman. The matter has come to a pass where the authors (Prof. Arthur John Keeffe, and Messrs. John J. Kelly, Jr. and Myron S. Lewis) of an article on the subject, entitled “Sick Sixty,” in the September 1947 issue of the Cornell Law Quarterly, were prompted to begin it with the following paragraph:
“Think of the effect on business if the headlines of the Wall Street Journal this morning proclaimed: Supreme Court voids all security devices as bankruptcy preferences. While such a catastrophe is not yet upon us, its probability has been foreshadowed by the wording of section 60a of the Bankruptcy Act and the logical implications of Corn Exchange National Bank & Trust Co. v. Klauder."
While experience with judicial precedent would indicate that the voiding of all security-devices can hardly be regarded as probable, and while, as one of the undersigned has endeavored to show in law review articles, such an implication from the Klauder case is not necessarily logical, the fact that responsible authors express opinions such as that quoted goes to emphasize the existing uncertainty, which casts doubt on desirable security transactions. (6) Resulting confusion
But the matter did not stop even there, because it became increasingly confused when, as is most usually the case, the transaction crosses State lines. This occurs whenever the lender is located in one State; the borrower, in another; the physical property in a third; and the account-debtors and/or "potential" bona fide purchaser in a fourth or fifth. Then, the impacts of conflicts of law questions become superimposed upon the doctrine of the Klauder case and confusion becomes worse confounded.
That is exactly what happened in In re Vardaman Shoe Co. (E. D. Mo. 1943), 52 Fed. Supp. 562, a decision which, unfortunately, was not appealed. In that case, two banks in East St. Louis, III., acting again in good faith, and paying full value, advanced money to the Vardaman Shoe Co., a Missouri corporation, upon the security of its accounts. Again, the transactions occurred before the commencement of the 4-month period. When the Vardaman company was subsequently petitioned into bankruptcy, the court was first faced with the problem of whether the law of Missouri or Illinois applied, and, if so, whether the law of
either required notification to the account debtors-a rule which, incidentally, is the minority rule of this country.
The court "solved” the problem with a crude simplicity that was alike arresting and, in the view of all students of the problem, most unfortunate. It simply held first, that it made no difference which law applied, and secondly, even on the assumption that the applicable rule was the non-notification one, the provisions of section 173 of the restatement of the law of contracts required the nullification of the bank's security. This, for the reason that section 173 permits in certain highly restricted situations, a second assignee to obtain title to the proceeds of assigned accounts, even in a non-notification state. Few students of the problem believe that the Klauder case required the holding in Vardaman, but it cannot be said that, under the present language of section 60a, the conclusion was altogether without basis, and there is always the hazard of similar holdings as long as section 60a remains in its present form. (c) And conflicts
True it is that there is one case on the subject (Matter of Rosen (1946), 157 Fed. (2d) 997 (certiorari denied 330 U. S. 835)) in which the court, while necessarily following the Klauder doctrine, has, at leas inferentially, disapproved its extension in the Vardaman case. Even here, the original holding of the Referee followed Vardaman. Moreover, well-reasoned as is the ultimate opinion in the Rosen case, it did not purport to repudiate the Vardaman case. Even giving it full effect, it merely sets up one case against another, and there are eight circuits still to be heard from. Obviously, businessmen and credit-extension agencies cannot conduct their affairs with lawyers constantly at their elbows, and the lawyers themselves are unable, under the present language of section 60a to tell them what the law is. And all of this is particularly grievous at a juncture in our economic life when the flow of credit must be kept free.
V. THE BAR ASSOCIATION'S STUDY, AND THE OBJECTIVES OF THE PRESENT BILLS
Naturally, the situation with which the industrial business and banking communities were thus faced came to the attention of the American Bar Association, not only by direct representations made by a number of businessmen and lawyers, but also as the result of an independent consideration of the matter made by its instrumentality charged with these matters—its section of corporation, banking and mercantile law.
Accordingly, at the first postwar convention of the association held in Cincinnati in December 1945, the section created a committee, manned as above stated, to deal with it.
In the ensuing months, this committee proceeded with its work; consulted a number of outside experts; and reported to the council of the section at its meeting in New York on May 24, 1946. The following action, as set forth in its minutes, was accordingly taken:
“Professor John Hanna reported, in the absence of Homer J. Livingston, Chicago, chairman for the committee on the revision of section 60a of the Bankruptcy Act, outlining, in detail, its activities and the draft of a proposed amendment that had been worked out in correspondence and conferences among the committee members, the last of which had been held at the New York office of the American Bankers Association on May 8, 1946. He further outlined the difficulties that had arisen under the Chandler Act amendment to section 60a, and stated that after considering all aspects of the problem, the committee had determined to draft a proposed amendment along the following lines:
"(a) to eliminate from the section the so-called hypothetical bona fide purchaser test and substitute therefor the judgment creditor test, as determinative of the existence of a preference; and
“(b) to provide that no transfer, made in good faith for a present consideration, shall constitute a preference if the provisions of applicable State law governing such transfer are complied with.
“A round-table discussion of Professor Hanna's report then ensued, participated in, among others, by Referee Olney, Mr. Bartlett, Mr. Gerdes, Mr. Kearns, and Mr. Kupfer. In the course of this discussion, it was pointed out that the section had been giving continuous consideration to this matter for more than 3 years, since the decision of the United States Supreme Court in the Klauder case (Corn Exchange National Bank & Trust Co. v. Klauder, 318 U. S. 434, 87 Law Ed. 484, 63 Sup. Ct. 440), and had kept current with the opinions of the lower Federal courts that had followed it. At the conclusion of this discussion, Mr. Gerdes moved (1) that the council record its approval of the amendment of section 60a of the Bankruptcy Act in the sense proposed by Professor Hanna, namely