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Wallace Benedict, Receiver, v. Ratner

Supreme Court of United States
268 U.S. 353 (1925)
ELI5:

Rule of Law:

Under New York law, a transfer of property as security, including accounts receivable, is fraudulent in law and void as to creditors if the agreement allows the transferor to retain unfettered dominion and control over the property and dispose of its proceeds for its own use.


Facts:

  • The Hub Carpet Company borrowed $15,000 from Aaron Ratner, with the potential for further advances.
  • To secure the loan, Hub Carpet executed a written agreement on May 23, 1921, assigning all its present and future accounts receivable to Ratner.
  • The agreement stipulated that Hub Carpet would collect the accounts receivable from its customers.
  • Hub Carpet was not required to remit the collected funds to Ratner, substitute new accounts for collected ones, or account for the proceeds in any way.
  • The agreement allowed Hub Carpet to use the money it collected from the assigned accounts as it saw fit for its own business operations, until Ratner chose to demand payment.
  • The existence of the assignment was to be kept secret from other creditors and customers.
  • Between May and September, Hub Carpet collected approximately $150,000 from the assigned accounts and used all of it for its own purposes, not to repay Ratner's loan.
  • On September 26, 1921, Hub Carpet was declared bankrupt.

Procedural Posture:

  • The Hub Carpet Company was adjudicated bankrupt in an involuntary proceeding in the U.S. District Court for the Southern District of New York.
  • Wallace Benedict was appointed receiver and later trustee for the bankrupt estate.
  • Aaron Ratner filed a petition in the bankruptcy court, claiming the right to accounts collected by the trustee under the assignment.
  • Benedict, the trustee, filed a cross-petition seeking to recover payments Hub Carpet had already made to Ratner shortly before the bankruptcy.
  • The District Court (the court of first instance) ruled in favor of Ratner, finding the assignment was valid.
  • Benedict appealed the decision to the U.S. Circuit Court of Appeals for the Second Circuit.
  • The Circuit Court of Appeals affirmed the District Court's ruling, siding with Ratner.
  • The U.S. Supreme Court granted a writ of certiorari to review the decision of the Circuit Court of Appeals.

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Issue:

Is an assignment of present and future accounts receivable fraudulent in law and void as to other creditors if the assignor is permitted to collect the accounts and use the proceeds for its own purposes without accounting to the assignee?


Opinions:

Majority - Justice Brandeis

Yes, the assignment is fraudulent in law. A transfer of property as security which reserves to the transferor the right to dispose of the property or its proceeds for their own uses is void as to creditors. This rule is not based on the doctrine of 'ostensible ownership,' which relates to the deceptive appearance of ownership from retaining physical possession of chattels. Instead, it rests upon the concept of 'reserved dominion,' where the transferor's retention of control over the collateral is so complete that it is inconsistent with the effective creation of a lien. Because Hub Carpet was free to collect the accounts and use the proceeds without any obligation to Ratner, it retained full dominion over the collateral. This reservation of control renders the entire arrangement a sham against other creditors, making the assignment void.



Analysis:

This decision established the 'dominion rule,' which became a significant principle in secured transactions involving accounts receivable. It declared that a 'floating lien' on accounts was invalid if the debtor could freely use the proceeds, creating a major obstacle for this type of commercial financing. The ruling forced lenders to implement strict 'policing' mechanisms, such as lockbox arrangements where customer payments were sent directly to the lender's control, to ensure their security interests were perfected and valid against a bankruptcy trustee. The rule of Benedict v. Ratner was later explicitly overturned by Article 9 of the Uniform Commercial Code (UCC § 9-205), which permits such floating liens without requiring the lender to police the proceeds.

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