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3 F.(2d) 38

property to the Kirby Petroleum Company to the values at the time of the transfer to with intent to hinder, delay, or defraud its the Kirby Petroleum Company coincided creditors. The evidence on the facts is with- nearly with the facts of value, and that the out dispute; the evidence of opinion pre- statements made to the agencies did not sents widely variant views. represent their real views, but were gross and inexcusable misstatements.

The evidence on the facts is that this company, a canal company, which had been for many years engaged in planting rice, which had had some very prosperous years, but which for the last three years of its existence had had one failure after another, until its losses reached the staggering total of $400,000, placed a mortgage upon practically its entire property in favor of the Kirby Petroleum Company, in the principal sum of $ -; that it defaulted on its interest, which for a year had gone unpaid, and that after many demands for payment, and expressions of determination to foreclose, it was arranged that the Old River Company, in satisfaction of the mortgage debt, which at that time, with interest and attorney's fees, amounted to $ should convey to the Kirby Petroleum Company the property covered by the mortgage, which was substantially the entire property of the company.

There was the evidence of Mr. Kittrell, a former director of the company, that in his opinion the assets of the company were worth in excess of $750,000. There was testimony of others that they were worth no more than the amount of the debt. The officers of the company, who on the stand testified that the value of the property at the time of the transfer was not more than the amount of the debt, were confronted with statements issued by them prior to the transfer, showing assets in excess of $1,000,000, and, unless conditions have arisen since the giving out of the statements which change the basis of the opinions, the opinions of these officers are undoubtedly of little value, and furnish little guide to go by.

It is clear that the company, having suffered such tremendous losses during the past three years as put it out of active operation, and being in December, 1923, under the hammer of the mortgage in the congealing state of a moribund, if not entirely dead, estate, its value had shrunk tremendously during the three years of adverse times. I am of the opinion, however, that the changes in condition between the times of the statements issued by one of the officers and the transfer under the mortgage did not justify such a difference in valuation, and that the values given in these statements were recklessly and unwarrantably, if not fraudulently, stated; and I am further of the opinion that the views of the officers as

Mr. Kittrell's testimony was to the effect that, as a director, he knew there was no value for the stockholders unless oil might be discovered, but that he did think there was an equity for the unsecured creditors, and that he had opposed the transfer of the property for these reasons. There was testimony that the officers of the Kirby Petroleum Company had stated to one of the unsecured creditors that, if they could receive their debt, they would be glad to release the property.

In my opinion, the property, if it had been in free hands, which were not forced by the pressure of an overdue mortgage of enormous size, would have been, in December, 1923, worth more than the mortgage. Just how much I cannot say with accuracy, as value is entirely a question of opinion, and value, where it is connected with a plant, is so largely dependent upon the going qualities of that plant. Taking the land as acreage, apart from its value incident to an operating rice canal, it is my opinion that the value placed by some of the witnesses of $25 an acre is ample, if not too high. It is very difficult to state what value the plant, in its present condition, adds to the land. From some aspects it might become a white elephant. bought the lands and the plant, with the necessity to operate at a heavy loss, the existence of the plant would be a detriment, rather than a benefit.

If one

However that may be, I am of the opinion that, taking it as it stands, it did not have a value in bulk, which is the way, because of the mortgage, it must be treated, of much more than the mortgage, and in the light of the broken state of the property, the pressing character and overwhelming size of the debt, the property could not be said to have any value greatly in excess of the debt.

[1] I do not agree with the contention of the defendant that, actual fraud, in the sense of a gross and corrupt motive to profit those who are acting, must be shown in order to justify adjudication. I think it sufficient if the effect of the transfer is to give one creditor such an unreasonable advantage over the others as that no reasonable explanation appears other than actual or constructive fraud.

[2] On the other hand, I do not agree

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3 FEDERAL REPORTER, 2d SERIES

with the contention of the plaintiffs that it is sufficient to show that more property was transferred than the debt amounted to. I think the true rule is that there must be fraud, actual or constructive. This fraud

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In re SMITH.

PAYNTER v. SLATOR et al.

(District Court, S. D. Texas, at Laredo. December 3, 1924.)

No. 13.

I. Bankruptcy 213-Value of mortgaged property to be determined in view of its mortgaged condition.

must be deduced from a motive to oppress some of the creditors in favor of others, or to advantage the transferror, or from some facts which furnish the basis for a finding of corrupt motive, or, a corrupt motive being absent, the act must be so egregious, must equity in mortgaged property, it must be valued

appear so unnecessary for a reasonable man to perform, unless he intends to defraud, as that from the act no reasonable inference, except intent to deceive, can be drawn. [3] In this case I think it clear that no actual fraud was intended. I think it further clear that the parties to the transaction believed that what they were doing was the only reasonable and correct way to dispose of the transaction; that they felt sure that if the property was put up at foreclosure it could not bring the debt, and that it was an unreasonable and an ungracious thing to compel a creditor to go through the expense and trouble of a sale, when the property, which they had represented to him was of good value in order to get his loan, was not, in the opinion of all parties concerned, substantially above that value, and certainly would not at a sale bring more than the mortgage.

Counsel for the petitioner denies that the fact of the mortgage and its threatened foreclosure can be taken into consideration in determining whether the transfer was or was not fraudulent within the statute. They say that the value of the property in free hands is the controlling question. With this position I do not agree. As I have tried to indicate above, the question in its last analysis is one of intent, this intent to be either directly proven or inferred from the facts. How can it be said that persons knowing that their property was about to be sold under a mortgage which they could not possibly protect it from, who took the shortest and best way out by transferring the property without a dollar of return to themselves, they themselves being unsecured creditors of the company, were guilty of an act of fraud? Certainly I cannot say it, nor do I believe that the small margin between the value of this incumbered property in a free state and its mortgage, is sufficient to justify any court in holding, under these facts, that the transfer was other than bona fide, or that any element of intent to defraud was present in it.

In determining whether a bankrupt has an

in its actual condition, subject to the mortgage and its conditions, and not at the value it might have, if free of incumbrance.

2. Bankruptcy 101-Adjudication brings into custody of the court only property of which bankrupt has possession.

An adjudication in bankruptcy operates as a universal caveat, and brings in custodia legis all property of the bankrupt of which he has possession at the time, but not property to which he may have title, but of which he is not in possession, until it is reduced to possession by plenary suit.

3. Bankruptcy

213-Possession of mortgaged property under foreclosure does not pass to bankruptcy court.

Where property of a bankrupt is subject to a valid mortgage, which is unaffected by the

Bankruptcy Act (Comp. St. §§ 9585-9656), and which is in process of foreclosure in a state court at the time of adjudication, custody of the property remains in the state court, and does not pass to the court of bankruptcy.

4. Bankruptcy 213-Sale by mortgagee under power of sale held valid as against the trustee of mortgagor.

Where under the state law, as in Texas, a power of sale in a mortgage or trust deed gives a contract right to pass title to the property as against the mortgagor and all junior lienholdprior to the filing of a petition in bankruptcy ers, the posting of notice of sale thereunder against the mortgagor is a constructive taking of possession by the mortgagee, which possession is not affected by the subsequent adjudication, and a sale pursuant to such notice, though after adjudication, is valid as against

the trustee.

In Equity. Suit by Hollie D. Paynter, trustee in bankruptcy of L. C. Smith, against M. D. Slator and others. Decree for

defendants.

Asher R. Smith, of Laredo, Tex., Henry A. Bundschu, of Kansas City, Mo., for plaintiff.

White, Wilcox, Graves & Taylor, of Austin, Tex., and F. Stevens, of San Antonio, Tex., for defendants.

HUTCHESON, District Judge. This is a suit by Hollie D. Paynter, as trustee in bankruptcy of the estate of L. C. Smith, in The petition for bankruptcy will there- which it is sought to set aside a sale made. fere be denied. under the power contained in a deed of trust

3 F.(2d) 40

executed on the 31st day of October, 1913, and renewed from time to time by M. D. Slator and L. C. Smith, who were joint owners of a tract of land of 17,500 acres in Webb and Zapata counties, Tex.

The facts are undisputed, except as to the value of the land in dispute. They are, briefly: That Slator lives in Texas, and L. C. Smith, the bankrupt, lives in Missouri. That, the principal note of $35,000 and one of the interest notes being in default, H. P. Drought, in accordance with the terms of the deed of trust, did on November 12, 1923, post three notices of sale in Webb and Zapata counties, and that, pursuant to said notices, the property was sold at public sale on the 4th day of December, 1923, and at said sale was bought by the defendant, H. P. Drought. Thereafter, on the 8th day of December, 1923, the land was sold by Drought to Slator for $38,433.14. That at the date of the sale of said land under the deed of trust there was due $41,916.15. That now, if the sale should be avoided, there would be due on the debt, up to October 20, 1924, the sum of $45,576.30. That neither Drought nor Stevens, the substitute trustee, had any notice of the bankruptcy proceedings until after the land had been sold under trustee's sale, and in turn conveyed to Slator. That an involuntary petition in bankruptcy was filed against L. C. Smith, bankrupt, in the District Court of the United States for the Western Division of Missouri, at Kansas City, on November 17, that he was adjudicated bankrupt on November 20, 1923. That Hollie D. Paynter was appointed receiver of the bankrupt's estate on November 27, 1923. That a copy of the order of adjudication of the bankrupt was recorded in Zapata county, Tex., on the 17th day of December, 1923, and in Webb county on the 7th day of December. That the schedules in bankruptcy were filed on the 6th day of February, 1924, and that the receiver, Paynter, was elected trustee on 25th day of February, 1924, and that neither as receiver nor trustee did he have any notice of the foreclosure proceedings, until January, 1924. That the trustee had never at any time offered to pay any interest, or bear any of the burdens incident to the indebted

ness.

Upon the testimony of value I find that, while at the time of the making of the deed of trust and its various extensions the property was worth in excess of the debt, at the time of the sale, on account of the great depression which existed in the cattle business, lands for grazing, which is the use to

which this land was adapted, had become, practically unsalable, and their rentals had been enormously reduced, so that at the time of the sale the property was worth far less than it was at the time of the giving of the mortgage. I find that had the property been in free hands-that is, unincumbered by past due mortgage, and in a condition to be held until a purchaser could be discovered for it—it would have been worth somewhat more than the mortgage, just how much more upon the evidence I find it very difficult to say. But in the condition it was in, incumbered by mortgage to very near its entire value, the whole property, and therefore the half interest in the bankrupt, was not worth in excess of the mortgage debt, and there was no equity for the bankrupt.

Could the property be treated as in free hands, it is my opinion that the property was probably worth $3 an acre, with an equity, therefore, in the bankrupt at this time of something like $4,000 or $5,000. The debt, and its validity and amount, are conceded. The whole contention on the foregoing facts is that, on account of the bankruptcy of the Smith estate prior to the sale under the deed of trust, the property had passed into the custody of the bankruptcy court, which custody preserved the status, and prevented any effective sale under the power, at least until in due process of administration, the bankruptcy court could elect either to surrender the property as burdensome, or by administration, realize the bankrupt's equity out of it.

[1] Plaintiff concedes that, if there was no equity for the bankrupt, the sale must stand, but contends that the finding of the court that the property must be valued in its mortgage condition is incorrect, and that upon the finding that there was an equity, had the property been free and unincumbered, prima facie right on the part of the plaintiff to have the sale set aside is established. With this contention I do not agree, because the administration of an equity in bankruptcy is a practical, not a theoretical, proposition, and it is unsound to say that property can be valued for the purpose of determining the beneficial interest of the bankrupt in it from any other standpoint than that which its actual condition presents. Mente & Co. et al. v. Old River Company (D. C.) 3 F.(2d) 38.

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equity for the bankrupt, I have concluded to dispose of the matter, not from the standpoint of the want of equity of the bankrupt in the property, but from that of want of equity in the bill, having concluded that the adjudication of the bankrupt was not effective to suspend or prevent the sale under the power, and that that sale was valid and effectual to pass the title to the property. The reasons which support this conclusion will be briefly stated.

[2] Notwithstanding the difficulty inhering in the application of the doctrine of custodia legis to real property situated in a jurisdiction other than that of the adjudication, which view has been ably pressed by defendant, and which finds support in Jones on Mortgages, § 1234, citing Whitridge v. Taylor, 66 N. C. 273, I agree with plaintiff's contention, in view of the amendment of the Bankruptcy Act (Comp. St. § 9585-9656), which gives general ancillary jurisdiction to all bankruptcy courts (Collett v. Adams, 249 U. S. 545, 39 S. Ct. 372, 63 L. Ed. 764; Knauth, Nachod & Kuhne v. Latham, 242 U. S. 427, 37 S. Ct. 139, 61 L. Ed. 404; Lazarus v. Prentice, 234 U. S. 263, 34 S. Ct. 851, 58 L. Ed. 1305) that the adjudication in bankruptcy of Smith in the Western district of Missouri operated as a universal caveat, and brought in custodia legis, not only the property of the bankrupt in that jurisdiction, but the property of the bankrupt in his possession at the time of the bankruptcy wherever situated (Acme Harvester v. Beekman, 222 U. S. 301, 32 S. Ct. 96, 56 L. Ed. 208).

This caveat, however, does not extend to all property to which the bankrupt has title, but only to that of which he has possession also, as to which property the summary jurisdiction of the bankruptcy court is complete. As to all property of the bankrupt not in his possession at the time of bankruptcy, the doctrine of custodia legis does not extend, until by plenary suit it has been reduced to possession.

[3] Bankruptcy Act, § 67d (Comp. St. 9651), provides that valid, bona fide liens are not affected by the act, and it has been affirmatively settled by the authorities that, as to all liens where foreclosure has been commenced prior to the bankruptcy, the property covered thereby is not drawn into the bankruptcy court, but remains in the custody of the court of foreclosure. Griffin et al. v. Lenhart et al. (C. C. A.) 266 F. 671; Brown Shoe Co. v. Wynne (C. C. A.) 281 F. 807. Had Drought, therefore, commenced foreclosure proceedings in the state

court, instead of beginning trustee's sale by posting notices, there can be no doubt that the bankruptcy could not in any manner have affected the proceedings, and the state court could and should have proceeded to judgment and sale.

[4] This much is conceded by the parties. The rub comes where the contention of the plaintiff that, adjudication having taken place before the sale, the sale constituted an unwarranted interference with the custody of the bankruptcy court, under the analogy of a suit of foreclosure commenced after bankruptcy, meets the contention of the defendant that this analogy is false, and that the true analogy is found in cases where possessory rights under contract are asserted against the bankrupt, such as under conditional sales (York Mfg. Co. v. Cassell, 201 U. S. 350, 26 S. Ct. 481, 50 L. Ed. 782), or sales under powers (Hiscock v. Varick Bank, 206 U. S. 28, 27 S. Ct. 681, 51 L. Ed. 945).

In support of their contentions both parties cite authorities in point. For the plaintiff is In re Hasie, 206 F. 789, opinion by District Judge Meek, Northern district of Texas, holding flatly that a sale under a deed of trust is void, Cohen v. Nixon, 236 F. 407 (D. C. Georgia), to the same effect, and Pugh v. Loisel, 219 F. 417, 135 C. C. A. 221, a case of foreclosure, but one whose general expressions give him comfort. On the point that a sale under a deed of trust is valid, Bray v. Aikin, 60 Tex. 688; Hall v. Bliss, 118 Mass. 554, 19 Am. Rep. 476, and McGready v. Harris, 54 Mo. 137, which cases flatly support defendant's contention, and, in addition, defendant argues that In re Hasie misinterpreted and misunderstood the status of powers of sale in Texas, and therefore cannot be followed as authority.

In this particular defendants are correct, for it is the rule in Texas that a power of sale granted in a deed of trust is not a mere remedy, but it is a contract right, effective to pass full title, foreclosing, not only the maker, but all junior lienholders. Hampshire v. Greeves, 104 Tex. 620, 143 S. W. 147. Nor can this right be taken away by retroactive law. International Bldg. & Loan Ass'n v. Hardy, 86 Tex. 610, 26 S. W. 497, 24 L. R. A. 284, 40 Am. St. Rep. 870. It is also clear that Judge Meek misinterpreted the Texas authorities as to the effect of death on the power of sale, it being the law in Texas that death does not affect the power. Wiener v. Zwieb, 105 Tex. 262, 141 S. W. 771, 147 S. W. 867.

Plaintiff concedes that, if this were a sale

3 F.(2d) 40

by a pledgee of property in his possession, attempt by any of its provisions to deprive the sale would be valid under the authority a lienor of any remedy which the law of of Hiscock v. Bank. He contends, however, the state vested him with; on the other that the property was never in the posses- hand, it provided (section 67d): 'Liens sion of the trustee in the deed of trust, but given or accepted in good faith was in the possession of the bankrupt, and shall not be affected by this act.'" that In re Eppstein, 156 F. 42, 84 C. C. A. 208, 17 L. R. A. (N. S.) 465, Stanard v. Dayton, 220 F. 442, 137 C. C. A. 35, and Dayton v. Pueblo Co., 241 U. S. 589, 36 S. Ct. 695, 60 L. Ed. 1190, control.

I agree with plaintiff that, whatever inconsistencies and vagaries appear in the application given by the courts to the doctrine of custodia legis, this one thing is fixed: That property which is actually in custodia legis cannot be put up at forced sale, or by any sort of vis major have its title affected adversely to the bankrupt, without the consent of the court of its custody, and I also agree with plaintiff that the Eppstein Case and the Dayton Case furnish very strong analogies. In those cases, however, it will be noted that the sale, while not through court process, was a forced sale, and that the possession and right to possession was in the bankrupt when adjudication occurred; whereas, here the sale was under a contract right given by the bankrupt, and the trustee had, under the terms of the contract, taken constructive possession, at least, of the property in order to exercise his power before adjudication.

To such a case the rule of York Mfg. Co. and the Hiscock-Case I think applies. In the Hiscock Case, which was a sale under a pledge, it appeared that no effort was made to enforce the pledge until after the petition in bankruptcy had been filed, but the sale was made before the adjudication, the court, affirming the sale against the judgment of the lower court setting it aside, said:

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"According to the terms of the Bankruptcy Act, the title of the bankrupt is vested in the trustee by operation of law as of the date of the adjudication. When the petition in the present case was filed the bank had a valid lien upon these policies for the payment of its debt. The contracts under which they were pledged were valid and enforceable under the laws of New York where the debt was incurred and the lien created. The Bankruptcy Act did not

In York Mfg. Co. v. Cassell the court held that under its conditional sale the York Manufacturing Company had the right to take the machinery out of the premises, bankruptcy having supervened. Prior to bankruptcy here the bankrupt had by valid contract given Drought the right to realize upon his debt by notice and sale. This contract right the bankruptcy neither attempted to nor could impair, and until, in the exercise of its administrative powers, the bankruptcy court undertook the administration of this property in order to realize the equity of the bankrupt, the power of sale was unaffected and unimpaired, and this, in my opinion, whether the foreclosure proceedings had been commenced before or after bankruptcy intervened.

In this case, foreclosure proceedings having commenced before the filing of the petition in bankruptcy or the adjudication, at the times of those procedures the property was in the possession of the trustee, and did not pass into the possession of the bankruptcy court, so that, if a sale by trustee under a power commenced after bankruptcy would be avoided under the decision in the Eppstein and Dayton Cases, supra, such decision could not affect this transaction, since the basis of those decisions, the possession of the bankrupt at the time of the bankruptcy, is wanting here.

Believing as I do, then (1) that the power of sale, being a valid contract right, acquired before bankruptcy and not subject to be affected by it, can be exercised as well

after as before bankruptcy, and (2) that, if wrong in this, the beginning of foreclosure proceedings before bankruptcy operated to bring this case within the principle of Hiscock v. Bank, I find the sale under the deed of trust to be valid and effectual, and not subject to be set aside or interfered with at the suit of the trustee, and that therefore the plaintiff's suit is without equity, and should be dismissed.

Let a decree be prepared in accordance with this opinion.

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