Dietzman, Richard Priest

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University of Kentucky

Kentucky Law JournalVolume 29 | Issue 1 Article 71940The Distinction between the Equity Rule and theBankruptcy against Insolvent Estates in KentuckyRichard Priest DietzmanFollow this and additional works at: https://uknowledge.uky.edu/kljPart of the Bankruptcy Law CommonsRight click to open a feedback form in a new tab to let us know how this document benefitsyou.This Note is brought to you for free and open access by the Law Journals at UKnowledge. It has been accepted for inclusion in Kentucky Law Journal byan authorized editor of UKnowledge. For more information, please contact UKnowledge@lsv.uky.edu.Recommended CitationDietzman, Richard Priest (1940) "The Distinction between the Equity Rule and the Bankruptcy against Insolvent Estates inKentucky," Kentucky Law Journal: Vol. 29 : Iss. 1 , Article 7.Available at: https://uknowledge.uky.edu/klj/vol29/iss1/7THE DISTINCTION BETWEEN THE EQUITY RULE ANDTHE BANKRUPTCY RULE IN PROVING SECUREDCLAIMS' AGAINST INSOLVENT ESTATESIN KENTUCKY*In the case of Banco-Kentucky's Receiver v. The NationalBank of Kentucky's Receiver,' the question was presented as towhether a secured creditor of an insolvent corporation couldhave the full benefit of his security, and at the same time couldprove against the free assets of the insolvent the full amount ofsaid creditor's claim or not. This question involved whetherthe equity rule or the bankruptcy rule was in force in Kentucky,or whether both of them were in force, depending on the state ofcase presented.The Court, in its opinion, referred to the learned discussionof this question in the report of the Special Master in the courtbelow,2 the Honorable Lafon Allen, but due to considerations ofspace, did not incorporate that discussion in the opinion. Thatit may be available to the Bar, it is here reproduced:"As between secured creditors and general creditors of aninsolvent, their relative rights in distribution of assets, as estab-lished by statute or by court decisions in this state, are asfollows:" (1) Under a voluntary assignment by an insolvent forthe benefit of all creditors, without discrimination, a securedcreditor, prior to the Act of 1894, which for the first time fixedby statute the rights of creditors under a voluntary assignment3had the right to make double proof, that is to say, he could provehis whole claim against both funds (to-wit, his security and theassets assigned) and was entitled to share, upon that basis, inboth funds, although, of course, he could not receive more thanthe whole amount of his demand.4* The introductory paragraphs were written by Richard PriestDetzman, member of the Louisville, Kentucky Bar. The citationsfound in the Special Master's report have been edited.-Fd.1281 Ky. 784, 137 S.W. (2d) 357 (1939).2 See 281 Ky. 784, 818, 137 S.W. (2d) 357, 375 (1939).3 Weiser v. Muir, 103 Ky. 479, 45 S.W. 512 (1898).4 Logan v. Anderson, 18 B. Mon. 114 (1857); Hibler, Etc. v. Davis'Adm'r., 13 Bush 20 (1877); Citizens Bank of Paris v. Patterson, 78Ky. 291 (1879).NoTEcs"This rule was not applicable to voluntary assignmentsalone. It was not followed in all jurisdictions, there being a sub-stantial diversity of views upon the subject. It was, however,followed by the courts of the United States (except where adifferent rule was fixed by statute, as in cases of bankruptcy)and in a substantial number of important states, including Ken--tucky. In those jurisdictions in which it obtained, it was ap-plicable not only to voluntary assignments but to all distributionsof insolvent estates, except where there was a different statutoryrule. A full and interesting discussion of this subject is to befound in the opinion of the Supreme Court of the United Statesin Merrill, Receiver of the First National Bank v. National Bankof Jacksonville.5 An elaborate review of the recent cases onthis subject will be found in an annotation to First WisconsinNational Bank of Milwaukee v. Kingston, State Commissioner ofBanking.6 This annotation is supplementary to an earlierannotation to the case of Citizens and Soathern Bank v. Alex-ander, Receiver of the Irish American Bank.7 It will be notedthat it both of these annotations Kentucky is put down as fol-lowing the equity or chancery rule, allowing double proof, exceptas changed by statute."(2) Prior to the Act of 1892, explained below, in the dis-tribution of the estate of an insolvent decedent, a secured creditor,whose contract security was insufficient to pay his demand infull, was excluded by statute from any share in free assets untilafter general creditors had received a sum equal, pro rata, withsuch lien creditors.8"In such a case, the secured creditor, after general creditorshad been made equal with him, was entitled to share upon thebasis of his whole claim, without giving credit for what he hadreceived from his special security. But, by the Act of 1892, thisrule was changed and it was provided that, in such a case, thesecured creditor, instead of being required to wait until generalcreditors had been made equal with him, was allowed to sharewith them from the beginning, but only upon the basis of the173 U.S. 130, 43 1a ed. 640 (1899).6 213 Wis. 681, 252 N.W. 153 (1934).L.R.A. 1918B, 1024.$Gen. Stat, Ch. 39, Art. 2, secs. 33, 34; Spratt's Ex'x. v. FirstNational Bank of Richmond, 84 Ky. 85 (1886).KENTUCKY LAW JouRNALunpaid balance of his claim, after giving credit for the proceedsor value of his special security.9"(3) In cases where the security (or priority) of thesecured creditor arose, not from a contract between him and hisdebtor, but 'out of a rule of equity, or statutory discriminationbetween creditors '10 the secured creditor was subject to theequitable rule of equal reprisal, that is to say, if his security wasinsufficient to pay his demand in full, he was not allowed toshare with general creditors until they had received fromfee assets enough to indemnify them for the loss which theyhad suffered through the application of his securties exclusivelyto the discharge of his demand. This, it will be observed, was theformer rule (prior to the Act of 1892), governing the distributionof an insolvent decedent's estate. 1""There were two situations in which this rule was applied:(a) Where the second creditor was a bank which had acharter lien upon its shares owned by an insolvent debtor.12(b) In partnership cases, where the partners make assign-ments of both individual and firm assets for the benefit of indi-vidual and firm creditors, and the latter claim the right to besubrogated to the right of each partner to have firm assets firstapplied to the discharge of firm debts.13"(4) It will be noted that, in the above eases, the dif-ference in the basis upon which secured creditors were allowedto share in the distribution of free assets (when not controlledby statute) depended upon a difference in the origin of theirsecurity. If it arose from a contract, then the secured creditorcould make double proof but, if it arose out of a rule of equity.or a statutory discrimination between creditors, he was subjectto the rule of equal reprisal. We come now to a case in whicha discrimination was made, not because of the origin of thesecurity, but because of the origin of the right to share in a'Kentucky Statutes (Carroll, 1936) sec. 3869."Supra, n. 2.* Spratt's Ex'x. v. First National Bank of Richmond, supra, n. 6.8) German Security Bank v. Jefferson, etc., 73 Ky. (10 Bush) 326(1874).-Northern Bank of Kentucky v. Keizer, 63 Ky. (2 Duv.) 169(1865); Fayette National Bank of Lexington v. Kenney's Assignee,79 Ky. 133 (1880); Hill, et al. v. Cornwall and Bros., Assignee, 95 Ky.Z12, 26 S.W. 540 (1894).NOTESdistribution of free assets. This is the case of Bank of Louis-vile v. Lockridge.14  In that case, the notes held by the bankagainst the debtor were secured by pledges of collateral. Thebank, becoming doubtful of the solvency of the debtor, securedthe pledge of additional collateral, whereupon Lockridge, anunsecured creditor, sued for and obtained a judgment that thelatter pledge operated as an involuntary assignment for thebenefit of all creditors, since it was made in contemplation ofinsolvency and with design to prefer the bank. The bank claimedthat it had the right to make double proof, just as if the assign-ment had been voluntary. The court held that he could not dothis."This ruling was based upon a construction of certain pro-visions of the Act of 1856 which, as the court found, indicated"that the legislature regarded the act of insolvency" (that is,the preferential conveyance) as placing the estate of the insolventdebtor in the same condition and to be distributed in the samemanner as the estate of a decedent. As we have seen, the rule ofequal reprisal had, by statute, been made applicable to thedistribution of the estate of an insolvent decedent, and, accord-ingly, the court applied that rule in the Lockridge case. Thisrule, as applied to insolvent decedents' estates, was changed byan Act of 1892 and, in the same year, the Act of 1856 (prefer-ential conveyance statute) was changed in the same manner, sothat the present law, applicable to both of those classes of cases,is that the secured creditor may prove against free assets only thebalance of his demand after crediting his security."(5) By an act of 18941r the same rule was made applicableto the voluntary assignments for the benefit of creditors.16"(6) As to banks in liquidation, an act of 1912 providedthat a secured creditor could prove against free assets only theunsatisfied balance of his demand. It is perhaps worthy of notethat, by an act of 1934, this rule as to banks in liquidation waschanged and the former equity or chancery rule, allowing doubleproof, was reinstated."(7) It is well understood, of course, that in bankruptcycases the federal statute allows a preferred creditor to prove1192 Ky. 472, 18 S.W. 1 (1892).Kentucky Statutes (Carroll, 1936) sec. 3869.' Kentucky Statutes (Carroll, 1936) sec. 74.KENTUCKY LAW J URNALonly the unsatisfied balance of his demand against free assets andconsequently this rule is sometimes referred to as the "bank-ruptcy rule.""It is thus seen that the present rules in Kentucky withreference to the rights of secured creditors in the distributionof the estates of insolvents are as follows:"The secured creditor can prove against free assets only thebalance of his demand, after giving credit for his security inthe following circumstances:(a) Where there has been a voluntary assignment.(b) Where the insolvent is dead.(c) Where there has been a preferential conveyance result-ing in an involuntary assignment.(d) Where the security was not obtained by contract withthe insolvent."In all other cases the chancery or equity rule announcedin Logan v. Anderson,17 which allows a secured creditor to makedouble proof, still obtains."27 Supra, n. 2.

The Distinction between the Equity Rule and the Bankruptcy against Insolvent Estates in Kentucky

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The Distinction between the Equity Rule and the Bankruptcy against Insolvent Estates in Kentucky

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