New York Law Review

Tag: Preferential Transfer

  • Gillman v. Chase Manhattan Bank, N.A., 73 N.Y.2d 1 (1988): Enforceability of Security Agreements and Bank’s Right to Set-Off

    Gillman v. Chase Manhattan Bank, N.A., 73 N.Y.2d 1 (1988)

    A security agreement granting a bank a security interest in a customer’s deposit accounts, allowing the bank to segregate funds without notice if it deems itself insecure, is enforceable absent procedural and substantive unconscionability and does not constitute a preferential transfer under Debtor and Creditor Law § 15 (6-a) when the segregation is involuntary.

    Summary

    Gillman, the assignee for the benefit of creditors of Jamaica Tobacco, sued Chase Manhattan Bank, arguing that Chase illegally segregated Jamaica Tobacco’s bank deposit. Chase had issued a letter of credit to Jamaica Tobacco and claimed a security interest in its deposits based on an agreement. Chase segregated $372,920.57 from Jamaica Tobacco’s checking account due to the company’s financial difficulties. The New York Court of Appeals held that the security agreement was not unconscionable and that Chase’s actions were permissible under the agreement. The court found no bad faith on Chase’s part and determined that the segregation of funds did not constitute a preferential transfer.

    Facts

    Jamaica Tobacco obtained a $400,000 letter of credit from Chase to secure a surety bond required for purchasing cigarette stamps on credit. The application included a security agreement granting Chase a lien on all Jamaica Tobacco’s deposit accounts. The agreement allowed Chase to deem itself insecure and apply the deposits to Jamaica Tobacco’s obligations without notice. After the letter of credit was renewed, Chase learned Jamaica Tobacco had violated loan restrictions and subordination agreements. Deeming itself insecure, Chase transferred funds from Jamaica Tobacco’s checking account to another account inaccessible to Jamaica Tobacco, leading to dishonored checks. Aetna eventually drew on the letter of credit.

    Procedural History

    The Supreme Court found the security agreement unconscionable and awarded damages to the assignee. The Appellate Division reversed, finding the agreement conscionable, no bad faith by Chase, and no preferential transfer. The Court of Appeals granted leave to appeal.

    Issue(s)

    1. Whether the security agreement granting Chase a lien on Jamaica Tobacco’s deposit accounts was unconscionable and therefore unenforceable.

    2. Whether Chase acted in bad faith by segregating Jamaica Tobacco’s checking account without notice and dishonoring checks drawn thereon.

    3. Whether Chase’s segregation of the checking account constituted a preferential transfer in violation of Debtor and Creditor Law § 15 (6-a).

    Holding

    1. No, because the agreement was not procedurally or substantively unconscionable.

    2. No, because Chase acted within the terms of the security agreement and had a valid security interest in the account.

    3. No, because the transfer was not voluntary, as required by Debtor and Creditor Law § 15 (6-a).

    Court’s Reasoning

    The court found no procedural unconscionability, noting that Frohlich signed the application with a bold-faced legend referencing the security agreement. The court stated that under general contract law, Jamaica Tobacco was bound by the agreement regardless of Frohlich’s claim that he didn’t read it. The court reasoned that the terms were not substantively unconscionable given Chase’s obligations under the letter of credit and the typical practice of requiring security interests in bank deposits. The court emphasized the importance of allowing the bank to act without notice to protect its security interest. The court stated, “The aim of the Uniform Commercial Code unconscionability provision (UCC 2-302), it has been said, is to prevent oppression and unfair surprise, not to readjust the agreed allocation of the risks in the light of some perceived imbalance in the parties’ bargaining power.” The court found that paragraph 7 of the security agreement granted chase a security interest in the checking account. The court rejected the claim of commercial bad faith, because there was no commercial bad faith in Chase’s actions in segregating the account. The court held that Debtor and Creditor Law § 15 (6-a) applied only to voluntary transfers. The court reasoned that because the segregation was done without knowledge or consent of Jamaica Tobacco, it was not a voluntary transfer.

  • B.W. Photo Utilities, Inc. v. Republic Eng. Corp., 30 A.D.2d 576 (N.Y. App. Div. 1968): Pro Rata Distribution by Insolvent Corporation

    B.W. Photo Utilities, Inc. v. Republic Eng. Corp., 30 A.D.2d 576 (N.Y. App. Div. 1968)

    An insolvent corporation’s pro rata distribution of assets to its creditors is neither a preferential nor a fraudulent transfer if the distribution treats all creditors with similar interests equally, and no creditor sustains a compensable loss compared to what they would have received in a fair distribution.

    Summary

    B.W. Photo Utilities (Plaintiff) sued Republic Engineering Corp. (Defendant) and its interlocking directorates, alleging a fraudulent transfer because the insolvent Trionics corporation made a pro rata distribution of its remaining assets to Republic and Plaintiff (its two sole creditors). The court reversed the lower courts’ decision, holding that the pro rata distribution was permissible because Plaintiff, lacking a perfected lien on Trionics’ Wisconsin assets, was an unsecured creditor entitled only to a pro rata share. The distribution ensured fairness, and Plaintiff suffered no loss compared to a fair distribution scenario.

    Facts

    Trionics, an Illinois corporation, was largely owned by Republic Engineering (Nautec), a New York corporation. Plaintiff owned the remainder. By mid-1963, Trionics was insolvent and had ceased operations. It owed money to Republic via a debenture bond and to Plaintiff via short-term notes. Plaintiff sued Trionics in Illinois and obtained judgments. Attempts to execute these judgments in Illinois were unsuccessful. Trionics then made a pro rata distribution of its remaining funds to Republic and Plaintiff. Plaintiff then alleged the pro rata distribution was a fraudulent transfer.

    Procedural History

    Plaintiff sued in New York Supreme Court, alleging a fraudulent transfer. The Supreme Court granted summary judgment for Plaintiff. The Appellate Division affirmed. The New York Court of Appeals reversed, granting summary judgment for Defendants.

    Issue(s)

    Whether an insolvent corporation’s pro rata distribution of assets to its two sole remaining creditors, without any creditor having a perfected lien, constitutes a prohibited preferential or fraudulent transfer under New York law.

    Holding

    No, because the plaintiff, lacking a lien on the Wisconsin assets of the Illinois corporation, was an unsecured creditor entitled only to a pro rata share, and thus suffered no loss due to the equitable distribution.

    Court’s Reasoning

    The court reasoned that under Section 15 of the Stock Corporation Law, a preferential transfer occurs when a transfer to one creditor results in the nonpayment or disproportionate payment of creditors with similar interests. The critical inquiry is whether the creditor sustained a loss by comparing what it received to what it would have received absent the transfer. Here, both Plaintiff and Republic were unsecured creditors entitled only to a pro rata share.

    The court emphasized that Plaintiff did not have a lien on Trionics’ Wisconsin assets; the Illinois judgments had not been domesticated in Wisconsin. The court rejected Plaintiff’s argument that it should be considered as if it had a lien, stating that the validity of the transfer must be determined at the time of the transfer, and any potential lien was speculative.

    The court noted that even if Plaintiff had obtained a judgment lien, it might have been vulnerable as a preference under bankruptcy laws. The court quoted the dissenting Justice at the Appellate Division, who pointed out that the pro rata payments mirrored what would occur in bankruptcy proceedings. The court concluded that because each creditor received what it was entitled to, there was neither a preference nor a fraudulent transfer. As the court stated, “Each creditor received the sum of money to which it was entitled, and, therefore, there was neither a preference nor a fraudulent transfer.”