The right of subrogation may not be as effective as the right of reimbursement, for the surety may be confronted with troublesome legal questions if the principal creditor, to whose right he is subrogated, has received fraudulent conveyances or preferences on other claims. Nevertheless his claim is discharged whether proved or not (Williams v. U. S. F. & G. Co., 236 U. S. 549 (1915)).

Again, a landlord's priority for rent is arbitrarily limited by the provisions of section 64a (5), regardless of State law to the contrary. Nevertheless, neither Congress nor the Supreme Court has found any difficulty in such a taking of property rights created by State law (City Bk. Farmers Tr. Co. v. Irving Tr. Co., 299 U. S. 433 (1917); Kuehner v. Irving Tr. Co., 299 U. S. 445 (1937)).

Since the act of June 22, 1938, in the interest of uniformity, priorities created by State law are no longer recognized in bankruptcy (sec. 64a), and certain liens are deferred to wage claims in contradiction to State law (sec. 67c).

As a rule of distribution in bankruptcy, and regardless of State law, a trustee in bankruptcy should prevail over a transferee of accounts receivable if public notice of the assignment has not been filed before the assignor became insolvent, or in any event at least 4 months before the assignor's bankruptcy.

The enactment of section 70i will reestablish and strengthen the reform intended to have been accomplished by the 1938 amendment to section 60a, and will have the effect of striking down liens on accounts receivable not publicized before the insolvency of the assignor.

Mr. REED. I will say to all the witnesses here today that those of you who have filed formal statements, they will be incorporated into the record and the committee will consider them. In your oral statements, as a matter of conserving time, it is the desire of the committee that you try as much as you can to avoid repeating the matters you have gone into on your formal statement, because they will all be taken up by the committee any way.

Mr. William B. Cudlip of Detroit appears on behalf of the American Bar Association.

STATEMENT OF WILLIAM B. CUDLIP REPRESENTING THE AMERICAN BAR ASSOCIATION, DETROIT

Mr. CUDLIP. Mr. Chairman and gentlemen: I want to thank you for your courtesy in permitting me to appear before you today. I shall not file any written statement.

I subscribe fully to the statements made orally and in writing by the American Bar Association. I happen to be the secretary of the section of corporation, banking and mercantile law of the American Bar Association, which has a membership of 7,500 lawyers in that section, which was responsible for initiating this matter so far as the American Bar Association was concerned.

I happen to be general counsel for the Michigan Bankers' Association and our law firm represents a number of institutions, large banks and other lenders. The clients we represent include the Michigan Bankers' Association. We are for the Reed bill and opposed to the national recordation of accounts receivable.

In fact, in our State, many security transactions are not recorded such as conditional sales transactions. The Detroit Bar Association considered the Reed bill. It is favorably impressed with it and has endorsed it.

The Michigan State bar has not had its meetings on this matter yet but I am sure it has no objection thereto, although it has not acted formally, just because of the time feature.

I simply want to say, up in our country we are for the Reed bill and for that philosophy. In our community and State, so far as I know, we are opposed to this recordation of accounts receivable and

of course that is all that the Hobbs' bill, as far as that point is concerned, covers. The Reed bill obviously has to do with matters in general and affects all security matters, factors' liens and so on.

That is all. Thank you very much.

Mr. McCULLOCH. I should like to ask you two questions. Do I understand you to say that Michigan does not require recordation of conditional sales contracts?

Mr. CUDLIP. Not unless resale is involved.

Mr. McCULLOCH. And Michigan does not require recordation of an assignment of an account?

Mr. CUDLIP. No. We fought that battle 2 years ago and had all these arguments made before various bodies and Michigan is one of the States that decided to adopt the validation type of statute and not the recording type.

Mr. McCULLOCH. May I ask a hypothetical question? If you were counsel for the bankers' association of a State that required the recordation of a conditional sales contract or an assignment of account, would your position be the same or different than that expressed now? Mr. CUDLIP. My personal feeling about it?

Mr. McCULLOCH. On this legislation?
Mr. CUDLIP. It would be the same.

I am telling you what our

State has and we cannot change and won't change that. But I happen to subscribe to what we did. I like our laws. Does that answer your question, Congressman?

Mr. McCULLOCH. Yes. Thank you, sir.

Mr. CUDLIP. Thank you.

Mr. REED. Mr. John W. Kearns, of Chicago, vice chairman of the section of corporation, banking and mercantile law of the American Bar Association.

STATEMENT OF JOHN W. KEARNS, VICE-CHAIRMAN, SECTION OF CORPORATION, BANKING AND MERCANTILE LAW, AMERICAN BAR ASSOCIATION, CHICAGO

Mr. KEARNS. All the organizations which I represent are in favor of the amendment to section 60a proposed by Mr. Reed's bill and are opposed to the recordation principle embodied in Mr. Hobbs'

bill.

Illinois is another State which in 1943 had before the legislature the matter of recordation statutes and the so-called validation type of statute. After serious and lengthy consideration it adopted the validation type of statute.

The recording of conditional sales agreements is not necessary to their validity in Illinois. I have prepared and filed a formal, written statement and, therefore, shall not go into the matter at any great length.

The bank I represent has about $10,000,000 of accounts receivable loans and we are vitally interested in accounts receivable financing. The field in which that is most used is in dealing with smaller business enterprises. The larger concerns usually have established a line of credit and do not finance in that fashion.

Up until the present time the difficulties in section 60a have not caused too much difficulty; but if we should commence to hit a slight recession then the smaller chap more recently started in busi

ness will have difficulty in carrying on. For that reason, I think it is highly desirable that the amendment introduced by Mr. Reed on section 60a should be adopted.

I have nothing more to say unless there are questions.

Mr. HOBBS. I would like to ask a question with regard to section. 70(i). I suppose that you and the gentleman preceding you considered that. Are you opposed to that?

Mr. KEARNS. You mean section 70(i)? I am opposed to that and the groups that I have mentioned are opposed to it.

Mr. HOBBS. And I suppose, Mr. Cudlip, you are too?
Mr. CUDLIP. Yes.

Mr. REED. Thank you, Mr. Kearns.

(Statement referred to by Mr. Kearns is as follows:)

STATEMENT OF JOHN W. KEARNS, COUNSEL, THE FIRST NATIONAL BANK OF CHICAGO, VICE CHAIRMAN OF THE SECTION OF CORPORATION, BANKING AND MERCANTILE LAW OF THE AMERICAN BAR ASSOCIATION AND A MEMBER OF THE CHICAGO BAR ASSOCIATION BANKRUPTCY COMMITTEE, IN SUPPORT OF H. R. 2412 AND IN OPPOSITION TO AMENDMENT PROPOSED BY H. R. 5834 FOR FEDERAL RECORDATION OF THE ASSIGNMENT OF ACCOUNTS RECEIVABLE BY WAY OF ADDING AN ADDITIONAL SUBSECTION (i) TO Section 70 oF THE BANKRUPTCY ACT

I. SECTION 60A SHOULD BE AMENDED IN SUBSTANTIALLY THE FASHION PROPOSED BY H. R. 2412

The present section 60a of the Bankruptcy Act as construed in Klauder v. Corn Exchange Bank & Trust Company (318 U. S. 434) and other cases, places a terrific burden on financing by way of assignment of accounts receivable, trust receipts and factoring. It is practically impossible to be sure of one's position in loaning under any of these arrangements as the law now stands.

It is this type of financing that is most frequently used by the small-business man. In most instances, larger corporations have established their credit to a degree that permits the advance of working capital funds to them on an unsecured basis. The problem would become increasingly grave if a recession developed in our economy, since the unavailability of credit to the smaller business enterprise on a sound secured basis might easily prevent many such enterprises from carrying on in a stormy period.

The proposed amendment to section 60a contemplated by H. R. 2412 would greatly reduce the dangers to lenders that exist under the present statute. The section should be amended in the fashion proposed by H. R. 2412.

II. ENACTMENT OF H. R. 2412 SHOULD NOT BE DELAYED PENDING ACTION UPON THE PROPOSED NATIONAL RECORDATION STATUTE

The prompt enactment of this amendment to section 60a is vitally necessary to the normal conduct of business. The construction given the statute by the Supreme Court in the Klauder case is unrealistic and completely at odds with the world of commerce. The difficulty should be corrected at once and should not wait for a final decision on national recordation.

National recordation, on the other hand, is a highly controversial subject. Many people believe that the concept is bad for the reasons hereinafter noted. Others believe it to be sound. There is no reason for delay in righting an obvious wrong while lengthy discussions are had of recordation, which is so highly debatable.

III. THE PROPOSED AMENDMENT FOR NATIONAL RECORDING OF ASSIGNMENTS OF ACCOUNTS RECEIVABLE SHOULD NOT BE ADOPTED

The proposed section 70 (i) embodied in H. R. 5834 in brief provides that a contemplated assignment of accounts receivable, in order to be enforcible against a trustee in bankruptcy, must be recorded by the filing of a proposed notice of assignment of accounts receivable with the clerk of the United States District Court of the district within which an assignor has his principal place of business.

This amendment is unsound and impractical and would only add further national restrictions to normal business intercourse, for the following reasons:

(A) The question involved is one relating to property. Hence it falls into a sphere of the law which has heretofore always been regarded as one in which the determination of a particular State was binding on all courts, whether State or Federal. This should be so since policy in the handling of property should depend on the customs, habits, and thinking of the people of a particular location. This is demonstrated by the division that has occurred in the States on the question whether recordation of assignments of accounts receivable is sound policy. Out of 35 States that have considered it, only 12 have adopted it, and 23 have rejected it. (B) When the legislature of the State of Illinois considered the question in 1943, it had before it both a recordation statute similar to the one proposed by H. R. 5834 and a validation statute, which in effect says that an assignment of an account receivable shall be good without recordation or notification, but protects the account debtor who pays his original creditor without notice of the assignment. The relative merits of the two types of statutes were thoroughly considered and discussed before the legislature. The Illinois Bankers Association at that time opposed the recordation statute as well as many other representative groups of businessmen in the field.

The Illinois Legislature adopted the validation type of statute (Ill. Rev. Sta., ch. 1211⁄2, sec. 220, et seq.) and rejected the recordation type of statute.

This represents the will of the people of Illinois on this important question of how this phase of their commercial dealings should be handled. It should not be overridden by Congress.

(C) The recordation as proposed would serve no real practical purpose. The normal way of ascertaining whether credit should be extended, whether by a bank, finance company, or supplier of merchandise, is to examine the financial statements of the proposed recipient of the credit, or to rely on reports of credit agencies, which in turn are based on the financial statements and past reputation for being satisfactory pay. The financial statements, unless they are fraudulent, disclose whether the organization in question is assigning accounts receivable. In fact, most forms used by alert concerns contain a specific question which must be answered on this subject. A false answer to this question would subject the applicant for credit to Federal criminal responsibility if the statement were received through the mails, or State criminal responsibility if delivered.

To say that the applicant might correctly answer this question and then commence assigning his accounts the following day cannot be urged in favor of recordation since the same difficulty would exist there. A prospective lender or supplier might examine the records of the clerk's office on Monday and find no notice of assigned accounts. There is no reason why the credit applicant could not file his notice on Tuesday which would then not come to the attention of the creditor unless he stayed at the clerk's office continuously during business hours.

(D) Recordation would subject the smaller business man who uses the account receivable type of financing to damaging gossip by competitors which, in the long run, would be more disastrous to our business economy than the gains, if any, that might be derived from requiring recordation.

Although an analysis of the facts would not sustain the conclusion, there is a general misconception on the part of the uninformed public that account receivable financing is a last resort practice, only availed of by firms on the verge of bankruptcy. This has certainly not been so in our own experience. It is disproved by the fact that only an insignificant fraction of the thousands of concerns who pledge or sell their accounts ever suffer bankruptcy; and no one knows better than lending institutions that accounts financing has helped countless numbers over the hump of periods of stress when their current cash position has been affected by having a substantial part of their capital tied up in fixed or slow assets or when expanding sales or production requires additional working funds not available to them from pen lines of bank credit.

Nevertheless, competitors and community gossips, being advised by public record that a particular firm was using this vehicle to provide working capital, would be prone to circulate rumors that the assigning concern was on its last legs and its wares should not be purchased since guaranties and servicing would not be available.

(E) Recording in the district court clerk's office would also be exceedingly impractical in the less populous States where the office of the district clerk is, like the capital of the State, miles away from many of the active business communities in the district.

In short, national recordation as proposed by H. R. 5834 would serve no useful purpose and would be highly detrimental to the small businessman who must frequently use account receivable financing.

Respectfully submitted.

JOHN W. KEARNS,

Counsel, The First National Bank of Chicago, Vice-Chairman Section of Corporation, Banking and Mercantile Law of the American Bar Association, Member Committee on Bankruptcy and Reorganization Law of the Chicago Bar Association.

Mr. REED. Mr. J. Francis Ireton, of Baltimore.

STATEMENT OF J. FRANCIS IRETON, ON BEHALF OF THE AMERICAN BAR ASSOCIATION, FIRST NATIONAL BANK BUILDING, BALTIMORE

Mr. IRETON. My firm are general counsel for Commercial Credit Co. which is a national sales finance company which does an accounts receivable and sales financing.

I would like to direct my remarks first to section 60. H. R. 2412, the Reed bill, and secondly to the recording bill. But before I start, there is a technical defect in both of these bills that I think should be pointed out, and I do not think there is any question but what this amendment should be made.

In H. R. 2412 on page 3, subsection 3, at the end of line 10, ❝in order that no creditor," there should come right after the word "creditor," "or purchaser of real property."

That same amendment should be in H. R. 5834 on page 3, line 19, after the word "creditor," "or purchaser of real property.'

The way that happened was-this paragraph 2 of the proposed section 60 has a proviso on the end as to real-property transfers. The transfer must still be perfected against a bona fide purchaser. The reason for that is this there are 14 States in this country where recordation of real property transfers only work against subsequent purchasers. A failure to record on real property itself in these States does not involve the transfer as against any creditor; and as to realproperty transfers only we have retained the bona fide purchaser. This is in paragraph 2 and of course in paragraph 3, which should read, "in order that no creditor or purchaser of real property described in paragraph 2."

I do not think there is any question in anyone's mind on that and it was really a technical oversight in the drafting of this bill.

As to section 60-as Mr. Kupfer has pointed out the difficulty in the present law is that the trustee in bankruptcy has the rights of a good-faith purchaser. There are all kinds of security transactions that take place every day and transfers made for a personal vaulable consideration and there simply is no way in which these transfers can be disregarded against a good-faith purchaser. I am speaking of personal property transfers.

Let us take the normal trust receipts transaction. An automobile manufacturer in Detroit will ship 10 or 20 cars to a dealer in Washington. He will ship these cars consigned to the manufacturer's order to Washington and send a sight draft and bill of lading to some bank in Washington and notify the dealer. The dealer goes around and picks up the draft and pays it off if he has the money. He picks up the bill of lading and gets his cars.