649 F.

2d 887
7 Bankr.Ct.Dec. 1261, Bankr. L. Rep. P 68,072

Paul F. KAPELA et al., Defendants, Appellants,

v.
Samuel NEWMAN, Plaintiff, Appellee.
No. 80-1737.

United States Court of Appeals,

First Circuit.
Argued April 10, 1981.
Decided May 22, 1981.

Kenneth A. Sweder, Boston, Mass., with whom Siri F. Boreske, and Kaye,
Fialkow, Richmond & Rothstein, Boston, Mass., were on brief, for
defendants, appellants.
Marshall F. Newman, Boston, Mass., with whom Philip Slotnick and
Newman & Newman, P. C., Boston, Mass., were on brief, for plaintiff,
appellee.
Before ALDRICH, CAMPBELL and BREYER, Circuit Judges.
BREYER, Circuit Judge.

A Bank makes a large loan to a corporation. A corporate shareholder

guarantees repayment of this Basic Loan. At the same time the guarantor
himself owes money to the corporation a debt in which the Bank has a secured
interest as partial collateral for its Basic Loan. The corporation goes bankrupt.
The guarantor just before bankruptcy pays a sum of money to the Bank money
which he claims at one and the same time reduces his debt to the corporation
and also reduces his obligation as guarantor of the Basic Loan. If so, has he
received a voidable "preference" under section 60(a) of the Bankruptcy Act of
1898, 11 U.S.C. 96(a)? Has property belonging to the corporation been
transferred in a manner that benefitted the guarantor at the expense of other
creditors of the same class? The district court believed that such a preference
was created. We disagree and reverse its decision.

I.
2

The facts on this appeal are not in dispute. The defendants, Kapela and
Brovenick, were sole shareholders of Amesbury Woodcraft, Inc. In early 1976
Amesbury borrowed $100,000 (the Basic Loan) from Century Bank and Trust
Company, Somerville, Massachusetts. The Bank obtained a chattel mortgage in
virtually all of Amesbury's assets as security. The mortgage included, among
other things, all "notes, bills general intangibles and all other debts, obligations
and liabilities in whatever form whether now existing or hereafter arising "
Amesbury also executed a loan and security agreement giving the Bank a
secured interest in, among other things, all Amesbury's "rights to the payment
of money, now existing or hereafter arising " And, the Bank filed an
appropriate financing statement on March 9, 1976, noting its secured interest in
this property. Kapela and Brovenick also personally guaranteed the Bank's
Basic Loan to Amesbury.

Between March 22, 1976 and December 27, 1976, Brovenick borrowed money
from the corporation. On January 13, 1977, Brovenick provided the
corporation with a promissory note for $24,640 as evidence of this debt. The
corporation then assigned the note to the Bank as collateral under its security
agreements.

On March 2, 1977, Brovenick sent the Bank a check for $21,540 upon the back
of which he wrote, "Pay to the order of Century Bank & Trust Co., assignee of
my note of 1/13/77".1 At the same time, Brovenick (who also supervised the
corporate bookkeeping) made accounting entries in the corporation's books
reducing his debt to it by $21,540.

On March 9, 1977, the corporation went bankrupt. The corporation had been
insolvent for the preceding four months, and both Kapela and Brovenick knew,
or should have known, it.

On August 14, 1977, Samuel Newman, the corporation's trustee in bankruptcy,

brought this suit in order to recover, for the corporation, the money that
Brovenick paid to the Bank. He argued that the payment of $21,540 to the
Bank (at least when taken together with the transfer of Brovenick's note from
Amesbury to the Bank) constituted a "voidable preference", for it satisfied each
of the Bankruptcy Act's seven conditions.2 There was:(1) A transfer of the
debtor's property (the note or money, which "belonged" to Amesbury, was
transferred to the Bank);

(2) to or for the benefit of a creditor (Brovenick and Kapela, as guarantors of

the Basic Loan were "contingent creditors" of Amesbury3 and benefitted as
guarantors by a reduction in the amount due on the Basic Loan);

(3) for or on account of an antecedent debt (the Basic Loan);

(4) while insolvent;

10

(5) and within four months of bankruptcy;

11

(6) which enabled Brovenick and Kapela to obtain a greater percentage of their
debt (the "contingent debt" for repayment of their payment of the guaranty)
than other creditors of the same class;

12

(7) and Kapela and Brovenick had reasonable cause to believe that Amesbury
was insolvent.

13

See Collier on Bankruptcy 60.12 (14th ed. 1977). The district court found that
each of these classic conditions was indeed met, declared a "voidable
preference", and ordered Kapela and Brovenick jointly to pay $21,500 to the
corporation.4

14

We reverse, however, because we believe (1) that the payment of $21,500 was
not a transfer of the bankrupt's property, (2) that the transfer of the note, while
a transfer of the bankrupt's property, was not a transfer for antecedent debt, and
(3) that the transfers, whether taken separately or together, did not diminish the
bankrupt's estate available to other comparable creditors.

II.
15

The preference section of the Bankruptcy Act imposes obligations upon a

debtor to treat its creditors fairly once the threat of impending bankruptcy
becomes apparent. Thus, four months before the filing of a bankruptcy petition,
the debtor loses its common law right to prefer one creditor over another. At the
same time, the Act recognizes the importance of preferring secured, to
unsecured, creditors. The detailed provisions of the Act are written to prevent
preferences as among creditors of the same class, while normally allowing
secured creditors to obtain, and realize upon, their collateral. Occasionally,
conflicts can develop between section 60 of the Bankruptcy Act governing
preferences, and Article 9 of the Uniform Commercial Code, relating to secured

transactions as, for example, when a lender takes a secured interest in "after
acquired" receivables, which do not come into existence until just prior to a
bankruptcy. See Benedict v. Ratner, 268 U.S. 353, 45 S.Ct. 566, 69 L.Ed. 991
(1925).5 Yet, it is important to interpret the two statutes in a way that
minimizes such conflicts and harmonizes the policies that underlie them.
16

The threat that the district court's holding poses to those seeking to give
security for credit can best be seen by analyzing this case from the point of
view of the Bank, the secured creditor. It seems clear that the Bank held a valid
secured interest in Brovenick's debt to the corporation as partial collateral for
its Basic Loan. If so, neither the transfer of the note evidencing that debt to the
Bank, nor the subsequent payment of that note, would constitute a preference to
the Bank. Neither the transfer of the note nor the payment diminished the
bankrupt's estate available to pay other creditors, for the other creditors were
never entitled to the Brovenick debt, to the note that evidenced it, or to the
funds used to pay the debt. Paying off that debt did not hurt them.

17

How then could transfer of the note to the Bank or payment of the note have
constituted a preference to the guarantors ? Granted that the payment helped
them by reducing their liability on their guaranty, how did it hurt the
corporation's other creditors? How did it diminish the bankrupt's estate that
would otherwise have been available to pay those other creditors? To find that
it did, one would have to hold that, despite the fact that Brovenick's $24,000
debt was secured collateral for the Basic Loan, it should have been available to
help satisfy other creditors; one would have to hold that the guarantors could
not rely upon that debt's use to reduce their guarantor liability. Rather, they
must pay the Bank $100,000 to satisfy the Basic Loan, despite the existence of
this other collateral. In other words, one would have to hold that (at least as to
some types of collateral) realization by the creditor of the collateral's value
does not relieve the guarantor of his liability under the guaranty. He must still
pay it either to the Bank or to the bankrupt corporation as a voided preference.

18

Such a holding seems undesirable. It seems unfair to a guarantor, who might,

for example, have guaranteed a loan to a corporation because he knew that the
corporation held an asset, such as a note, a receivable, or for that matter land or
chattels, which when given as security, would protect him from having to pay
on the guaranty. Such a holding would make one think twice before
guaranteeing loans to corporations that appear to have adequate collateral.

19

One could avoid this result, while supporting the holding below, only if one
held that this is a special case that normally realization on collateral does not
create a preference in favor of a Basic Loan's guarantor, but it does so here

because Brovenick is guarantor, originator of the collateral and a major

corporation shareholder all in one. Yet, no improper activity by Brovenick is
alleged in this court. No reason has been presented as to why the fact that the
collateral originates from the guarantor, from the corporation's owner, or from
the owner/guarantor should make a difference. And, we can discern no such
reason. Therefore, we believe that realization upon a note legitimately held as
collateral by a secured creditor should not create a preference in favor of the
guarantor of the creditor's Basic Loan when it would not create a preference in
favor of the creditor.
20

This result is consistent with the language of the statute. If Brovenick's note
was legitimately held as collateral by the Bank, the subsequent payment of that
note is not a "transfer of the property of (the) debtor" a statutory requisite for a
finding of a preference.6 Indeed, there is no such "transfer" whether the
payment is made directly to the creditor or given to the corporation, but
earmarked for payment to the creditor.7 For that matter, neither does such a
transfer "diminish the fund to which creditors of the same class can legally
resort for the payment of their debts" as the courts have held that the preference
statute requires. See Collier on Bankruptcy 60.20 (14th ed. 1977) at 859-60
and cases there cited.

21

Of course, Brovenick's note was itself transferred to the Bank within the critical
four-month period and that note was "property" of the corporate "debtor". But,
that transfer falls outside the preference statute as long as the Bank had a
secured interest in the debt that it evidenced. If so, the giving of the note does
not constitute a transfer of the debtor's assets. See Collier on Bankruptcy
547.14 (15th ed. 1979) at 547-50; Collier on Bankruptcy 60.13 (14th ed.
1977) at 819 and cases there cited. At worst, it might be viewed as the
substitution of a new security (the note) for an old one (the debt that the note
evidenced) already in the hands of the bank a transaction that has repeatedly
been held to fall outside the statute's language: "transfer on account of an
antecedent debt." Sawyer v. Turpin, 91 U.S. 114, 23 L.Ed. 235 (1875).8 Nor
would there seem to be any reason to lump the two transactions note and
payment and treat them as one in the absence of any allegation of fraudulent or
improper activity.

22

This result does not sanction or allow corporate shareholders/guarantors, such

as Kapela or Brovenick, to manipulate the corporation's assets to benefit
themselves. If, for example, Brovenick, foreseeing the corporation's
bankruptcy, had taken the corporation's cash, or any other corporate asset, in
which the Bank did not possess a secured interest, and transferred it to the Bank
(or transformed it into an asset in which the Bank had a secured interest),

Brovenick would have received a preference. The giving of such a corporate

asset to the Bank would have benefitted Brovenick at the expense of other
general creditors, and, if it took place within the relevant four-month period,
Brovenick would have received a voidable preference. See Citizens National
Bank of Gastonia, N. C. v. Lineberger, 45 F.2d 522, 531 (4th Cir. 1930). The
transfer of the corporate asset to the Bank would have benefitted Brovenick as a
guarantor of the Basic Loan at the expense of other general creditors. Thus, to
bring the example closer to home, if Brovenick had taken from the corporation
cash, in which the Bank had no secured interest, and replaced it with a debt, in
which the Bank had a secured interest, that exchange would have created a
preference in Brovenick's favor as well as the Bank's provided it took place
within the relevant four-month period and the Bank was not otherwise fully
secured. The record before us is ambiguous on this point, for it suggests that
some of Brovenick's debt to the corporation may have arisen after November 9,
1976, four months prior to Amesbury's bankruptcy. But, the record is silent as
to how that debt was created. Appellant claims that, whatever assets the
corporation gave Brovenick when that debt was created, they were assets in
which the Bank also held a secured interest; and the Trustee, appellee, does not
attack that transfer. Thus, we here must assume that there was no such
preferential manipulation.
23

Finally, this result is supported by what case law there is on the subject. The
cases suggest that the key question when assets are transferred so as to benefit a
guarantor is whether those assets would ordinarily have been available to help
satisfy the claims of other (general) creditors. Thus, when a bankrupt debtor
transfers assets directly to a guarantor of a Basic Loan as security for the
"contingent debt" (to the guarantor) that will be created when the guarantor
pays to the debtor's creditor the amount due on the Basic Loan, a preference is
created (assuming time limit and other requirements are met). The guarantor
cannot keep that security; he must return it to the bankrupt corporation, where it
will be used to help satisfy all claims. National Bank of Newport v. National
Herkimer County Bank, 225 U.S. 178, 32 S.Ct. 633, 56 L.Ed. 1042 (1912);
Aulick v. Largent, 295 F.2d 41 (4th Cir. 1961); Huntington v. Baskerville, 192
F. 813 (8th Cir. 1911); Collier on Bankruptcy 60.17 (14th ed. 1977) at 838.
Moreover, when the bankrupt debtor's assets are transferred to the Basic Loan
creditor, the transfer creates a preference in the Basic Loan guarantor, provided
that the creditor did not have a previously secured interest in those assets (and
all other "preference" conditions were met). That is to say, in the absence of the
transfer those assets would have been available to meet the claims of other
creditors. Kent-Reese Enterprises, Inc. v. Hempy, 378 F.2d 910 (9th Cir. 1967).

24

However, as Kent-Reese makes clear, the result is just the opposite if the

creditor of the Basic Loan previously had a secured interest in the assets that
were transferred, for then the transfer did not significantly affect other
creditors. In Kent-Reese, two owners call them "D" and "R" loaned money to
Big Boy, a corporation that subsequently went bankrupt. Kent-Reese, another
corporation, guaranteed repayment of Big Boy's loan to D and R. Kent-Reese
also owed Big Boy $54,000. (Transposed to the facts present here: D and R are
equivalent to the Bank; Big Boy is the bankrupt corporation, Amesbury; and
Kent-Reese is the guarantor, Brovenick.) Kent-Reese paid D and R $30,000
and reduced its debt to Big Boy by an equivalent amount. The court held that
Kent-Reese received a preference because D and R did not have a perfected
security interest in the $54,000 debt that Kent-Reese owed Big Boy. The entire
issue in the case was whether a contract among the parties had created such an
interest prior to the critical four-month period. The court held it did not because
the special contract at issue there did not take effect until "within 4 months of
the petition in bankruptcy" and "it could not, on the facts disclosed by the
record, be binding on general creditors dealing with Big Boy". Kent-Reese
Enterprises, Inc. v. Hempy, 378 F.2d at 912. Judge Ely, concurring, made
explicit the fact on which the case turns: "Since there was no valid assignment
of the Kent-Reese debt, the agreement did not provide (D and R) with a fixed
security " Kent-Reese Enterprises, Inc. v. Hempy, 378 F.2d at 915. Similarly,
the Fourth Circuit in Citizens Bank of Gastonia, N. C. v. Lineberger, supra,
reached the same result that we reach here, though it treated the issue as one of
"set off".9 See also Collier on Bankruptcy 547.18 (15th ed. 1979) at 547-64;
Collier on Bankruptcy 60.17 (14th ed. 1977) at 839.
25

It is conceivable that the Trustee here might have attacked the validity of the
Bank's secured interest in Brovenick's debt, or in the assets used to create that
debt, perhaps on reasoning similar to that employed in Benedict v. Ratner,
supra. The issue of when a previously filed security statement perfects an
interest in subsequently acquired "floating" property, such as deposits, or cash,
or shifting intangibles, is by no means resolved. See Dubay v. Williams, supra,
and Grain Merchants v. Union Savings Bank, supra. Yet, as previously
mentioned, that issue has not been raised here. Thus, we treat the Bank's
interest in the relevant assets as having been perfected prior to the four-month
period.

26

Finally, as previously pointed out, we see no need to create a "special" rule here
governing only circumstances in which the corporation's owners are both
guarantors and providers of the relevant collateral. If a note given a corporation
by an outsider, when used to satisfy the Bank's Basic Loan, does not create a
preference in favor of that Loan's guarantor, why should it do so when given to
the corporation by the guarantor itself? To so hold might make it less likely that

guarantors will borrow from the corporations whose debts they guarantee, but
what public policy favors this result? To the extent that one is concerned about
manipulation of assets by a corporation's owners, the provisions of the new
Bankruptcy Act, extending the time during which preferences can be created
from four months to one year (with appropriate knowledge)10, would seem to
deal with the problem.
27

We conclude that a guarantor does not receive a preference when a debtor uses
a corporate asset to reduce the size of a creditor's loan provided the asset is one
in which the creditor held a perfected secured interest and is not available to
general creditors. And, the fact that the asset involved consists of a debt that
the guarantor owes the corporation makes no difference. For this reason, the
judgment of the district court is

28

Reversed.

The check was, in fact, a check from Kapela to Brovenick, which was then
endorsed by Brovenick to the Bank. Neither the parties nor the district court
claims that this fact is significant

Section 60(a) of the Bankruptcy Act of 1898 provides in part:

(1) A preference is a transfer, as defined in this Act, of any of the property of a
debtor to or for the benefit of a creditor for or on account of an antecedent debt,
made or suffered by such debtor while insolvent and within four months before
the filing by or against him of the petition initiating a proceeding under this
Act, the effect of which transfer will be to enable such creditor to obtain a
greater percentage of his debt than some other creditor of the same class.
(2) For the purposes of subdivisions a and b of this section, a transfer of
property other than real property shall be deemed to have been made or suffered
at the time when it became so far perfected that no subsequent lien upon such
property obtainable by legal or equitable proceedings on a simple contract
could become superior to the rights of the transferee. A transfer of real property
shall be deemed to have been made or suffered when it became so far perfected
that no subsequent bona fide purchase from the debtor could create rights in
such property superior to the rights of the transferee. If any transfer of real
property is not so perfected against a bona fide purchase, or if any transfer of
other property is not so perfected against such liens by legal or equitable
proceedings prior to the filing of a petition initiating a proceeding under this
Act, it shall be deemed to have been made immediately before the filing of the

petition.
11 U.S.C. 96(a). This case arises under the Bankruptcy Act prior to its recent
revision.
3

It is well established that guarantors of a loan to a corporation are creditors of

the corporation. See, e. g., Cooper Petroleum Co. v. Hart, 379 F.2d 777 (5th
Cir. 1967); Collier on Bankruptcy 60.17 (14th ed. 1977). The theory is that,
insofar as the guarantor pays money to the lender on the basis of his guaranty,
he obtains a claim against the corporation for reimbursement. He is thus a
"contingent creditor" even before payment and he can be benefitted by a
transfer that reduces the amount he may have to pay on the guaranty

The district court also ordered Brovenick to pay $3,000 to the corporation on
the basis of his note. That Brovenick owes this amount seems undisputed on
this appeal

The Supreme Court, in this famous case, feared that making this type of
collateral available to secured creditors would be unfair to the general creditors,
who may have been unaware of the lien and may have counted on the existence
of the future receivables to satisfy their claims. The question of whether a
secured creditor, with a perfected security agreement in "after acquired"
property can obtain such property ahead of general creditors, when it comes
into existence within four months prior to bankruptcy has provoked lengthy
debate, with two courts of appeals "deeming" the property to have been
transferred before it came into existence, see DuBay v. Williams, 417 F.2d
1277 (9th Cir. 1969); Grain Merchants v. Union Savings Bank, 408 F.2d 209
(7th Cir.), cert. denied, 396 U.S. 827, 90 S.Ct. 75, 24 L.Ed.2d 78 (1969), and an
eventual compromise being reached in the new Bankruptcy Act, superceding
those cases and giving the secured creditors preferential rights in some types of
"after acquired" property (inventory and receivables) but not others. See
generally 11 U.S.C. 547(c); Collier on Bankruptcy 547.03, 547.49(7) (15th
ed. 1979); Countryman, Bankruptcy Preferences Current Law and Proposed
Changes, 11 U.C.C.L.J. 95 (1979); Coogan, Hogan and Vagts, 1B Secured
Transactions Under the U.C.C. 10.03

Olmstead v. Mass. Trust Co., 11 F.2d 410 (D.Mass.1926); Collier on

Bankruptcy 547.25 (15th ed. 1979); Collier on Bankruptcy 60.26 (14th ed.
1977). See also In re Le Maire Cosmetic Co., 174 F.2d 749 (7th Cir. 1949)

Grubb v. General Contract Purchase Corp., 18 F.Supp. 680, 682

(S.D.N.Y.1937), aff'd, 94 F.2d 70 (2d Cir. 1938); Collier on Bankruptcy
547.25 (15th ed. 1979) at 547-95; Collier on Bankruptcy 60.26 (14th ed.
1977) at 882-83

See also National Bank of Newport v. National Herkimer County Bank, 225
U.S. 178, 32 S.Ct. 633, 56 L.Ed. 1042 (1912); First National Bank of Clinton v.
Julian, 383 F.2d 329 (8th Cir. 1967); Collier on Bankruptcy 547.22 (15th ed.
1979) at 547-87

The Lineberger court reasoned that the guarantor's debt to the corporation was
"offset" by the corporation's debt to the guarantor arising out of the guarantor's
payment on the Basic Loan. One could reason similarly here: Brovenick's
liability to the Bank as guarantor arose as soon as the corporation defaulted on
the Basic Loan probably well before Brovenick made his $21,540 payment.
Thus, Brovenick's obligation to the Bank was immediate, not contingent, and
Brovenick was also a creditor of the corporation to the same extent he paid the
Bank as guarantor of the corporation's debt. On Lineberger's theory, Brovenick
could offset his $24,000 debt to the corporation by the amount of the
corporation's debt to him. Appellees, however, have raised several objections to
the offset theory as applied to this case. Since we do not rest our result upon
that theory, we need not discuss those objections

10

11 U.S.C. 547(b)(4)(B), 547(c)(5)(A)(ii)