This section is from the book "American Commercial Law Series ", by Alfred W. Bays. Also available from Amazon: American commercial law series.
In an involuntary petition it is necessary for the creditors to allege some act of bankruptcy. What shall constitute an act of bankruptcy is set out specifically by the law.
Our National Bankruptcy Law provides that a debtor may be made an involuntary bankrupt when an act of bankruptcy has been committed by him. It is not enough that a debtor be unable to pay his debts. An act of bankruptcy may be considered as the indication to the world that the bankrupt is a fit subject for the bankruptcy courts.
The acts of bankruptcy are here enumerated. The law provides:74 "Acts of bankruptcy by a person shall consist of his having
(1) Conveyed, transferred, concealed or removed, or permitted to be concealed or removed, any part of his property with intent to hinder, delay or defraud his creditors, or any of them; or
(2) Transferred, while insolvent, any portion of his property to one or more of his creditors with intent to prefer such creditors over his other creditors; or
(3) Suffered or permitted, while insolvent, any creditor to obtain a preference through legal proceedings, and not having at least five days before a sale or final disposition of any property affected by such preference, vacated or discharged such preference; or
74. Id., SEC. 3.
(4) Made a general assignment for the benefit of his creditors, or, being insolvent, applied for a receiver or trustee for his property or because of insolvency, a receiver or trustee has been put in charge of his property under the laws of a state, or of the United States; or
(5) Admitted in writing his inability to pay his debts and his willingness to be adjudged a bankrupt on that ground.
We will consider these "acts of bankruptcy" seriatim.
Usually an act of bankruptcy involves a transaction which may be set aside, but whether it may be avoided is an entirely different question from whether it is an act of bankruptcy.
Insolvency is defined by the Bankruptcy Law, in the quotation, below. It usually exists whenever any act of bankruptcy is committed and is an essential element in most acts of bankruptcy.
(1) Definition and importance of insolvency.
We have heretofore noticed the difference between insolvency and bankruptcy - that the former term denotes a financial condition, through which by the indulgence of creditors one can often come successfully without having his business life, his property or his debts in any way affected, while the latter signifies judicial proceedings for the purpose of dividing among his creditors the property of one, insolvent, whose debts thereupon become discharged. Bankruptcy is, in fact, the relief offered to the creditors of an insolvent debtor and to the debtor himself.
It is sufficient to notice here in reference to insolvency as an element of bankruptcy that it is usually essential. Why it might be held unessential is considered hereafter when we consider the act of bankruptcy in detail.
Insolvency is defined by the bankruptcy law to be as follows:
"A person shall be deemed insolvent within the provisions of this act whenever the aggregate of his property, exclusive of any property which he may have conveyed, transferred, concealed or removed, or permitted to be concealed or removed, with intent to defraud, hinder or delay his creditors, shall not, at a fair valuation, be sufficient in amount to pay his debts."75
Under our former bankruptcy law in force 1867-1879, one was insolvent when he stopped payments in the ordinary course of trade. In fact, this has been the test of all bankruptcy laws until the present.
(2) How valuation arrived at to determine insolvency.
To determine whether a person is insolvent, we inquire whether all his property, including his exemptions, exclusive of property fraudulently conveyed by him, when taken at a fair valuation, before bankruptcy proceedings were begun, is not of sufficient value to pay his debts.
Exemptions of bankrupt. We have noticed, and will note more particularly hereafter that a bankrupt is entitled to the exemptions that are allowed to him by the local law of his state. In determining whether a person is insolvent these exemptions must be included as a part of his assets, even though the result is not enough unexempt property to satisfy the liabilities.
75. Bankr. Act 1898, SEC. I, par. 15.
Property fraudulently conveyed. In the determination of solvency, property that the bankrupt may have conveyed, transferred, concealed or removed, or permitted to be concealed or removed, with intent to defraud, hinder or delay his creditors, is to be excluded. The bankruptcy act so provides, and the reason is apparent. By that means a debtor has accomplished his own insolvency so far as his visible assets are concerned, unless the creditors can set aside the transfers or uncover the concealments. It may be a question whether the transfers are fraudulent, or whether the concealments have been made, and if they have, whether they can be set aside or recovered. The debtor has temporarily, at least, removed these assets out of the way of his creditors, and hence they ought not be considered even though their recovery may mean more than enough to pay the debts in full.
Assets to be appraised at their fair value. The definition of insolvency requires that the assets are to be taken at a "fair valuation." It has been held that "fair valuation" means a value that can be made promptly effective by the owner of the property to pay debts. "Such a price as a capable and diligent business man could presently obtain for the property after conferring with those accustomed to buy such property."76
This "fair valuation" requires the business to be taken as a "going concern" when the act of bankruptcy was committed. "The valuation for the test of solvency or insolvency under the issue must relate to the conditions, as a going concern, when the alleged preference was given, and not to the mere dead matter of the plant after bankruptcy intervened."77
76. Stern v. Paper, (D. C. N. D.) 183 Fed. 228; In re Sedalia Farmer's Co-Op. Packing & Produce., (D. C. Mo.) 268 Fed. 898.
But this assumes that the business was in fact a going concern.78
(3) Defense that debtor is not insolvent.
If a debtor would defend against bankruptcy proceedings on the ground he is not an insolvent he must definitely and affirmatively put in the defense; if he does not deny it in the manner set out by the law he will be taken to have admitted it. If he does deny he may demand a jury to try the issues.
A petition in involuntary bankruptcy must allege an act of bankruptcy committed within four months of the filing of the petition.
An act of bankruptcy may be considered as an outward expression of one's financial condition entitling creditors to proceed in bankruptcy. The bankruptcy proceeding is to afford relief from a presently existing financial embarrassment. Obviously the law must set a limit within which the act of bankruptcy must be done and the petition in bankruptcy filed in order to join them in an existing state of affairs. This limit has been determined by providing that the act of bankruptcy will subject the debtor to bankruptcy proceedings only if the petition is filed within four months thereafter.
The petition must allege an act of bankruptcy and is defective unless it does so. It may be amended, but the amended petition must show an act of bankruptcy within four months of the filing of the amendment.79
77. Butler Paper Co. v. Goembel, (C. C. A. 7th Cir.) 143 Fed. 295.
78. In re Jones, (C. C. A. 7th Cir.) 268 Fed. 818.