Sexton v. Kessler & Co.

Background

An English company and a longtime New York trading firm arranged that certain named stocks and bonds would be set aside as security for the New York firm’s credit. The New York firm placed the identified securities in a separate package and shelf in its vault, noted them on its loan book, and agreed the English company could realize or replace the securities. Substitutions occurred over time and the securities were inspected by the English company’s representatives. During the panic of 1907, the New York firm handed custody of the marked securities to the English company’s agent, who put them in a safe deposit vault. The New York firm was then adjudged bankrupt weeks later and the trustee sought to undo the transfer as a fraudulent preference.

Reasoning

The Court treated the parties as honest business people who intended to create a present security in specific bonds and stocks. It compared the arrangement to other business practices where customers retain rights even while a dealer or keeper has physical control. The Court concluded the papers and conduct created at least an equitable lien or priority right for the English company rather than a mere promise. Because that right existed before the bankruptcy, the English company simply exercised an existing entitlement when it took custody of the securities.

Real world impact

The decision protects a creditor who can show clear, limited set-asides of specific securities from having that priority wiped out by a trustee in bankruptcy. It affirms that carefully documented escrow arrangements can establish a preferred security interest under the law described in the opinion. The decree of the lower court was affirmed.