Benedict v. Ratner
1925 U.S. LEXIS 839, 268 U.S. 353, 69 L. Ed. 991 (1925)
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Rule of Law:
An assignment of accounts receivable as security for a loan is fraudulent in law and void as to other creditors if the assignor reserves the right to collect the accounts and use the proceeds for its own purposes without accounting to the assignee.
Facts:
- On May 23, 1921, the Hub Carpet Company assigned all its present and future accounts receivable to Aaron Ratner as collateral for loans.
- The agreement stipulated that Hub Carpet would continue to collect payments on the accounts.
- Hub Carpet was not required to apply any of the collected funds to Ratner's loan, nor was it required to replace collected accounts with new collateral or account to Ratner for the proceeds.
- Until Ratner chose to enforce the assignment, Hub Carpet was explicitly permitted to use all money collected from the accounts as it saw fit in the ordinary course of its business.
- The existence of the assignment was to be kept secret from other creditors.
- Between May and September 1921, Hub Carpet collected approximately $150,000 from the assigned accounts and used all of it for its own business operations rather than paying Ratner.
- On September 23, 1921, four days before bankruptcy proceedings began, Hub Carpet provided Ratner with an updated list of its outstanding accounts.
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.
- Aaron Ratner filed a petition in the bankruptcy court seeking payment of funds collected by the bankruptcy trustee, Edward Benedict, from the company's accounts receivable.
- Benedict, as trustee, resisted the petition and filed a cross-petition to recover payments the company made to Ratner shortly before bankruptcy.
- The District Court (trial court) ruled in favor of Ratner, holding that the assignment was valid.
- Benedict appealed to the U.S. Circuit Court of Appeals for the Second Circuit (intermediate appellate court).
- The Circuit Court of Appeals affirmed the District Court's decision in favor of Ratner.
- The U.S. Supreme Court granted a writ of certiorari to review the decision.
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Issue:
Is an assignment of present and future accounts receivable as security for a loan fraudulent and void as to other creditors if the assignor is permitted to collect the accounts and use the proceeds for its own purposes without being required to remit them to the assignee?
Opinions:
Majority - Mr. Justice Brandeis
Yes, such an assignment is fraudulent and void. A transfer of property as security which reserves to the transferor the right to dispose of the property, or apply its proceeds for his own uses, is fraudulent in law and void as to other creditors. This rule rests not on the doctrine of ostensible ownership (seeming ownership because of retained possession), but on the reservation of dominion inconsistent with the effective creation of a lien. By allowing Hub Carpet to collect and use the proceeds of the accounts without restriction, Ratner permitted the company to retain unfettered dominion over the collateral. This complete control by the assignor is the differentiating and deciding element that invalidates the security arrangement. Because the original assignment was void, the subsequent delivery of the account list and payments to Ratner could not perfect a lien and were therefore unlawful preferences under the Bankruptcy Act.
Analysis:
This decision established the influential "dominion rule," significantly impacting the law of secured transactions. It mandated that for a floating lien on accounts receivable to be valid, the secured party had to exercise control over the proceeds, such as through lockbox arrangements or strict accounting requirements. The case highlighted the judiciary's concern with secret liens that could mislead other creditors about a debtor's financial health. The rule in Benedict v. Ratner was later explicitly overturned by the adoption of Article 9 of the Uniform Commercial Code (specifically § 9-205), which permits debtors to use, commingle, or dispose of collateral and its proceeds without invalidating the security interest, thereby greatly simplifying accounts receivable financing.
