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October 17, 1957

In the Matter of ATLAS FOUNDRY COMPANY, a Corporation of New Jersey, Bankrupt

The opinion of the court was delivered by: WORTENDYKE

Holders of a mortgage, dated January 22, 1953, upon the plant real estate of the bankrupt corporation, have petitioned this Court, pursuant to 11 U.S.C.A. § 67, sub. c, for review of an order, dated May 8, 1957, made by the Referee and adjudging the mortgage invalid against bankrupt's Trustee. The following questions are presented by the Referee's Certificate of Review:

1. May stockholders of a corporation, through use of a fictitious consideration, obtain a mortgage on the realty of the corporation as part consideration for the sale of their shares of stock in the corporation?

 2. In a subsequent Chapter XI, 11 U.S.C.A. § 701 et seq., proceeding involving the corporation, does the execution of an extension agreement regarding the mortgage estop the present Trustee in bankruptcy from questioning the validity of the mortgage?

 So much of the factual background as appears established in the record, and was found by the Referee, may be set forth in the language of the Referee's said Certificate as follows:

 '(1) Meyer Bornstein was the stockholder of Atlas Foundry Company to whom all the other stockholders left the complete management of affairs. Sydney Gutkin, Esquire was the lawyer in whom all the stockholders had an implicit confidence in the handling of all legal transactions. M. Raymond Riley was the person who brought together Meyer Bornstein and Messrs. Goldinger and Ehrlich of the C. A. Goldsmith Company.

 '(2) Messrs. Riley, Bornstein, Goldinger and Ehrlich met together at the plant of Atlas Foundry Company in November, 1952 and it was tentatively decided that the Bornsteins would sell all the stock of Atlas to Messrs. Ehrlich and Goldinger, but the complete agreement was not made until a meeting in late December of 1952. This later meeting had its humorous aspects -- Mr. Bornstein told Messrs. Ehrlich and Goldinger that on the basis of a Dun & Bradstreet report he knew C. A. Goldsmith Company had no money, but they laughed and told him that on the basis of a Dun & Bradstreet report they knew Atlas Foundry Company had money. Mr. Bornstein told them he would help them procure a loan to swing the transaction and referred them to Mr. Gutkin for what help they needed in meeting the $ 650,000.00 figure which had been agreed on as the sale price of the Atlas stock.

 '(3) Based on the value of the Atlas property and business, Messrs. Ehrlich and Goldinger were able to get a commitment to Goldsmith from a New York factor for $ 400,000.00; and at the request of Mr. Gutkin, Mr. Raymond Riley, in his capacity of Vice-President of National State Bank, promised interim financing of $ 250,000.00. These arrangements made, all parties met at the office of Sydney Gutkin on January 22, 1953.

 '(4) Immediately prior to this meeting on January 22nd, Goldsmith's bank balance in the National State Bank was $ 12,911.27 and Atlas's bank balance was $ 284,390.67; and Atlas had no need for additional cash in the operation of the business.

 '(6) As part and parcel of the above transaction, Messrs. Ehrlich and Goldinger, as the new stockholders and directors of Atlas, immediately reduced the bank balance of Atlas to $ 25,587.08 by full repayment to Goldsmith of the $ 250,000.00 so that the National State Bank could be repaid, and by partial repayment to the New York factor and his associates in the deal who had advanced the $ 400,000.00.

 '(7) The simultaneous transactions on January 22nd, 1953 so burdened Atlas with debts and so weakened its cash position that some form of insolvency proceeding became inevitable and on December 23, 1953 it filed a petition for an arrangement under Chapter XI of the Bankruptcy Act. During the course of the Chapter XI proceeding the Bornsteins and the officers of Atlas entered into an extension agreement with respect to the mortgage in question.

 '(8) Atlas was unable to put forward an acceptable plan in the Chapter XI proceeding. An adjudication in bankruptcy followed. The real estate subject to the mortgage was sold by the trustee in bankruptcy free of liens; liens, if valid, to attach to the proceeds of sale.'

 The Referee correctly concluded that the mortgage in question is invalid against the Trustee of the bankrupt because its execution by the bankrupt and acquisition by the present holders was achieved with the knowledge and collusive cooperation of such holders by way of circumvention of the legal obstacle prohibiting the bankrupt from mortgaging its assets to pay its stockholders for their stock.

 Counsel for the mortgagees (hereinafter referred to as the Bornsteins) concede that the bankrupt could not make a valid mortgage direct to the Bornsteins as part of the consideration for the sale of their stock in the bankrupt ...

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