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In re Paragon Securities Co.

decided: December 20, 1978.

IN THE MATTER OF PARAGON SECURITIES COMPANY, A NEW JERSEY CORPORATION; PARAGON SECURITIES COMPANY OF NEW YORK, A NEW YORK CORPORATION; MUNICIPLEX FUNDING, INC., A NEW JERSEY CORPORATION; PARAGON LIFE AGENCY, INC., A NEW JERSEY CORPORATION; PARAGON INSURANCE AGENCY, A NEW JERSEY CORPORATION; NELSON STOUSLAND SCHOOL, INC., A NEW JERSEY CORPORATION; AND PARAGON SECURITIES COMPANY OF FLORIDA, A FLORIDA CORPORATION, BANKRUPTS, CHARLES GIANNONE, APPELLANT,
v.
LOUIS S. COHEN, TRUSTEE IN BANKRUPTCY OF PARAGON SECURITIES, ET AL., APPELLEE.



APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW JERSEY D.C. No. B-1010-73

Before Seitz, Chief Judge, Hunter, Circuit Judge, and Cahn,*fn* District Judge.

Author: Hunter

Opinion OF THE COURT

Charles Giannone appeals from a decision of the district court affirming the bankruptcy judge's determination that Giannone is not entitled to reclaim money which he paid to Paragon Securities Company (hereinafter Paragon or Company), prior to the date of Paragon's bankruptcy. In this suit, Giannone contends that Paragon acted fraudulently both in inducing Giannone to enter into a contract for the purchase of securities and in accepting Giannone's payment for the securities when Paragon was insolvent. Giannone asserts that Paragon's fraud entitles him to rescind the contract and reclaim his money from the bankrupt estate. The bankruptcy judge and the district court held that Giannone had failed to prove fraud on the part of Paragon. We affirm.

I.

This suit concerns the purchase of New Jersey Turnpike Bonds. Responding to the advice of his accountant, Giannone sought to invest in municipal securities. On July 17, 1973 Giannone entered into an agreement with Paragon to purchase Turnpike bonds for $50,680.83.*fn1 On July 23, 1973 Giannone received the confirmation of sale slip which set the settlement date as July 27, 1973.

Paragon purchased the bonds from a third party on July 24, 1973 through Securities Processing Services, Inc. (SPS). SPS generally acted as a receiving and storage agent. It also made loans to Paragon and executed credit purchases of securities, charging the price to Paragon's account. To assure the loans and credit purchases, SPS took a security interest in the bonds it held on behalf of Paragon. Generally, Paragon gave SPS instructions seven days after settlement to forward the bonds to the customer. On this occasion, SPS paid the third party $49,969.59 for the Turnpike bonds. As usual, SPS charged that amount to Paragon's account and retained possession of the bonds.

Paragon received and deposited Giannone's check on July 30, 1973. That day, at 4:00 p.m., the Board of Directors of Paragon met. It passed a resolution authorizing the filing of a petition in New Jersey Superior Court, Chancery Division, seeking the voluntary dissolution of the company and the appointment of a receiver. The petition also requested that Paragon be adjudged insolvent. Lawrence S. Brown, chief operations officer of Paragon, testified that the office staff and he were not aware of the Board of Directors' decision to seek dissolution until the petition was filed on August 1, 1973. On August 6, 1973 one of Paragon's creditors filed an involuntary petition in bankruptcy against the company in federal court.*fn2

As of August 6, 1973 SPS remained in possession of the New Jersey Turnpike Bonds. When SPS discovered that Paragon had filed a state court action for dissolution, it decided to foreclose on its security interests. SPS sold a substantial number of the securities it held for Paragon, including the Turnpike bonds, on August 7, 1973. Because of the intervening bankruptcy petition, Paragon never gave SPS the usual instruction to forward the Turnpike Bonds to Giannone. SPS sold the bonds which would otherwise have been sent to Giannone for $47,855.42 and deducted that amount from Paragon's debt.

II.

Giannone seeks to reclaim the money he paid to the bankrupt. In bankruptcy court and later in district court, Giannone attempted to demonstrate fraud on the part of Paragon. The legal theory underlying a suit for reclamation based on fraud is that "a Trustee in Bankruptcy can have no interest in property acquired by the fraud of the bankrupt, or anyone else, as against the claim of the rightful owner of such property."*fn3 Nicklaus v. Bank of Russellville, 336 F.2d 144, 146 (8th Cir. 1964). The rule was succinctly stated in In re Stridacchio, 107 F. Supp. 486, 487 (D.N.J.1952):

Where goods are obtained by fraud of the bankrupt, the seller may rescind the contract of sale and reclaim them if he can identify them in the hands of the trustee. This is on the theory that fraud renders all contracts voidable, and that neither in law nor in morals would the trustee be justified in holding goods obtained by the fraud of the bankrupt for the benefit of other creditors. Such creditors have no right to profit by the fraud of the bankrupt to the wrong and injury of the party who has been deceived and defrauded.

Though this is a proceeding in bankruptcy governed primarily by federal law and within the exclusive jurisdiction of the federal courts, fraud is established according to state law. As Collier on Bankruptcy states, "(m)ost of the issues in bankruptcy cases involving the right to rescission are variations on a single theme: does the act complained of give rise to a right to rescission under the local law?" 4A Collier on Bankruptcy P 70.41, at 484 (14th ed. 1975). In re Tate-Jones & Co., 85 F. Supp. 971, 980 (W.D.Pa.1949). Here, the issue of whether Paragon has committed fraud in its relations with Giannone is determined according to New Jersey law. Both Giannone and Paragon are New Jersey citizens; also, the contract was made and performance was to take place in New Jersey. Generally, to prevail under New Jersey law in an action for fraud, Giannone must show a false representation by Paragon, knowledge or belief by Paragon of the falsity, an intention that Giannone act thereon, reasonable reliance by Giannone on the false representation, and resultant damage. Parker Precision Products Co. v. Metropolitan Life Insurance Co., 407 F.2d 1070, 1076 (3d Cir. 1969); Van Houten Service, Inc. v. Shell Oil Co., 417 F. Supp. 523, 527 (D.N.J.1975), Aff'd, 546 F.2d 421 (3d Cir. 1976); Bilotti v. Accurate Forming Corp., 39 N.J. 184, 206, 188 A.2d 24, 36 (1963); Louis Schlesinger Co. v. Wilson, 22 N.J. 576, 585-86, 127 A.2d 13, 18 (1956). The burden is on Giannone to establish these necessary elements of an action for fraud. Pappas v. Moss, 257 F. Supp. 345, 361 (D.N.J.1966), Rev'd on other grounds, 393 F.2d 865 (3d Cir. 1968), On remand, 303 F. Supp. 1257 (D.N.J.1969).

Giannone, at the outset, is faced with a formidable task. Bankruptcy Rule 810*fn4 dictates that the district court review findings of fact by the bankruptcy judge by the clearly erroneous standard; this court on appeal is similarly limited by Rule 52(a)*fn5 of the Federal Rules of Civil Procedure. Giannone challenges the application of the clearly erroneous standard and urges that we exercise independent review. He contends that the issue of fraud is a conclusion of law, not a finding of fact. Of course, when a case raises purely ...


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