This section is from the book "American Commercial Law Series ", by Alfred W. Bays. Also available from Amazon: American commercial law series.
Property held by bankrupt in trust does not pass to the trustee.
(1) In general.
The property to which the bankrupt has title as trustee, does not pass to the trustee in bankruptcy. We are now speaking, not of those cases of property held by the bankrupt but belonging to another, but to those cases in which the bankrupt has legal title to property, but charged with a trust in favor of another. Such property so owned in trust does not pass to the trustee in bankruptcy, for, though he owns the legal title, the beneficial, equitable or real ownership is in another.
We may make a division of such cases into those which we may term express trusts, and those in which the trust is an implication from the circumstances.
(2) Express trusts.
The trustee in bankruptcy gets no title to property held upon express trust. Thus where a bankrupt held
118. Bankr. Act 1898, SEC. 70, d, 5 under a will devising him property in trust for others, this does not become a part of the bankrupt estate.119
(3) Implied trusts.
Property that by reason of the circumstances becomes impressed with the character of a trust, does not become a part of the estate to become administered in bankruptcy, but may be reclaimed by the beneficial owners.
Thus it has been held that where a corporation declared a dividend, and set the fund aside for the payment of the dividend, and thereafter went in bankruptcy before the dividend was paid, the fund was impressed with a trust, and was payable in full to the stockholders entitled thereto.120
(4) Identification of trust fund.
It is necessary in such cases that the fund claimed be one that can be identified. If the identity becomes lost by its intermixture generally with the bankrupt's other funds, there is no right to assert the trust against the general funds. The trust property must be traced and identified.121
While this is the general rule, it has also been held that where the trust moneys have been deposited in a general account, and this account does not fall below the amount held in trust, the trust money will be presumed to be a part of this larger fund, and may be reclaimed in full by the beneficiaries.122
119. City National Bank v. Slocumb, (C. C. A. 6th Cir.) 272. Fed. 11.)
120. In re Interborough Consol. Corp. (D. C. N. Y.) 276 Fed. 914.
121. Schuyler v. Littlefield, 35 A. B. R. 209.
122. So. Cotton Oil Co. v. Elliotte, (C. C. A. 6th Cir.) 33 A. B. R. 375.
And it has been held that where a stockbroker who goes into bankruptcy has had stock on hand belonging to a customer, and has upon his bankruptcy certificates for that stock, not belonging to someone else although not the identical certificates delivered by or bought for the customer, they are reclaimable by the customer as his property and do not constitute a part of the general estate. This is upon the theory that the property owned by the stockholder is stock of the corporation and the certificates are but the evidence thereof.123
Where property is transferred or money paid by the bankrupt within four months preceding the filing of the petition in bankruptcy, and the recipient knew or had reasonable cause to know that a preference was intended, the transaction may be set aside by the trustee.
Inasmuch as a main object of the bankruptcy law is to secure an equal distribution of the bankrupt's estate among his creditors, it follows that this object could be easily defeated if we should allow the bankrupt upon becoming insolvent to make a payment or a transfer of property to one or several of his creditors which would stand against the trustee when appointed. Consequently, the law provides that payments which amount to preferences within a period of four months prior to the time the petition is filed shall be set aside upon suit by the trustee for that purpose, provided the creditor to whom such preference was made knew or had reasonable cause to know that a preference was intended.124 He does have reasonable cause to believe that
123. In re Solomon & Co. (C. C. A. 2nd Cir.) 268 Fed. 108.
124. Bankr. Act, 1898, SEC. 60b.; First National Bank v. Gal-braith, (C. C. A. 8th Cir.) 271 Fed. 687.
a preference was intended whenever he knows that the debtor is insolvent.125 We do not inquire as to preferences made before the four months period because there being nothing illegal or immoral about a preference, it would tend to unsettle business too much to allow payments to be inquired into except as made in reference to the bankrupt's present financial condition and therefore the law limits the inquiry to the short period of four months prior to the time a petition is filed.
Any conveyance made which would amount to giving the creditor a preference over the others, whether made in direct satisfaction of the debt or to secure it is voidable, if the creditors know or should know that a preference is intended.
As we have seen there cannot be a preference unless there is a creditor to whom it is made. Cash transactions cannot be disturbed. Thus D is insolvent, but not yet bankrupt. He buys property from A, paying A cash. A is never a creditor and the payment is not a preference. From B he borrows money giving B at the time the loan is made, a mortgage as security. The mortage cannot be disturbed. Had D bought the property from A on credit, and then paid for it the payment would be a preference because it would be a payment to a creditor. Or if B had loaned the money without security, and then had afterwards prevailed on D to secure him, that would be a preference.126 If a mortgage is given to secure a past indebtedness and also a present indebtedness, it will be upheld to the extent of the present consideration only, provided, of course, proceedings are begun within four months. As it has been stated before in this text (in connection with Acts of Bankruptcy) there cannot be a preference unless there is a diminution in the value of the estate.127 And within this rule there is no preference merely because the bankrupt in his exigency may sell at a low price.
125. Coder v. Arts, (C. C. A. 8th Cir.) 152 Fed. 943 s. c. 213 U. S. 223; Benjamin v. Buell, (C. C. A. 7th Cir.) 268 Fed. 792; Lowell v. Ash ton (D. C. Mass.) 272 Fed. 536.
126. Feilbach v. Russell, (C. C. A. 6th Cir.) 233 Fed. 412.
And it has been held that there is no diminution of the estate to make the act a preference where there are payments on running account, followed by new purchases, the net result of which is to increase the value of the estate. 128