DISCHARGE OF CONTRACTS
Sec. 128. Performance payment. The customary manner of
obtaining a discharge of a contract is by complete performance.
After all the terms of the agreement have been fully complied with
by both parties, the contract no longer exists.
The final step in the performance of many contracts consists of
the payment of a money debt. Keeping in mind the Statute of
Limitations, and the law of suretyship in some instances, it be-
comes important to know on what particular obligations payments
have been, or should have been, applied. Three principles appear
controlling in such cases: (1) the person making the payment has
the right to specify the particular obligation against which he de-
sires the payment to apply; (2) in the event that no stipulation is
made by the debtor, the creditor is given the right to direct where
the payment shall apply; and (3) if neither of the parties has in-
dicated, at the time when the payment is made, how the payment
is to be credited, the court implies that the first credits shall be ap-
plied against the first debits falling due.
In cases in which the creditor has the option of application, he is
permitted to apply it against an outlawed claim as well as against
one that is current. Likewise, he may protect his own interest by
crediting an unsecured claim instead of one that is secured. To
gain the maximum protection, the debtor should clearly express at
time of payment the particular items which are being paid or upon
which payment is being made.
Executory agreements may be discharged by mutual agreement
of the parties; the release of one party to the contract furnishes the
consideration for the release of the other. An agreement which is
fully performed on one side and executory on the other may not be
discharged in this manner. The agreement to discharge the party
under duty to perform is, in such a case, without consideration to
Sec. 129. Accord and satisfaction. An accord consists of an
agreement between contracting parties whereby one of them is to
do something different from that called for by the contract. This
accord is satisfied when the terms of the new agreement are fully
performed. Both accord and satisfaction must take place before
the old obligation is discharged, unless the new agreement expressly
states that it is being substituted for the old. The new agreement
of itself does not terminate the old agreement. To illustrate: A
purchased a horse from B, and agreed to pay him $100 within sixty
days. A failed to pay B at the end of the period, and a new agree-
ment was entered into, whereby A was to deliver one hundred
bushels of corn in full payment of the debt. At any time before
the corn is delivered, B may recover upon the original contract.
The delivery of the corn constitutes the satisfaction of the accord,
and thus discharges the old contract.
Sec. 130. Novation. Novation is an agreement whereby an
original party to a contract is replaced by a new party. In order
for his substitution to be effective, it must be agreed to by all of the
parties. The remaining contracting party must agree to accept the
new party and at the same time consent to release the withdraw-
ing party. 1 The latter consents to withdraw and permits the new
party to take his place. The new party agrees to assume the bur-
dens and duties of the retiring party because of some consideration
which he receives. Provided none of these essentials is missing,
the withdrawing party is discharged from the old agreement. To
illustrate : A purchases an automobile from B, and, after making a
small down payment, agrees to pay the balance of $400 within six
months. Finding times somewhat hard, A sells the car to C, who
agrees to pay the balance to B. Both parties notify B of this ar-
rangement. As yet no novation is completed, because B has not
agreed to release A and to look to C for payment. If B releases A,
A is discharged from any duty arising under the original agreement
and a novation is created.
Sec. 131. Cancellation and alteration. An intentional cancel-
lation or alteration of the written evidence of an agreement will
have the effect of discharging it. This situation arises most fre-
quently with negotiable instruments. An intentional material al-
teration of a note or check avoids the instrument.
Sec. 132. Statute of Limitations. The time within which an
action may be brought upon a contract is limited by statute. 2 The
real purpose of this limitation is to make it impossible to bring suit
long after the cause of action originates, during which period ma-
terial evidence relating to the agreement may have passed out of
existence because of the death of an important witness, or of some
other cause. Such a statute is known as the Statute of Limita-
The statutes often differentiate between written and oral con-
tracts. Thus, in Illinois, an action upon an oral contract must be
e v. Blum et al., 1896, 4 Okla. 260, 43 Pac. 1063; p. 536.
'Shapiro v. Friedman, 1945, 132 NJ.L. 456, 41 A.(2) 10; p. 537.
DISCHARGE OF CONTRACTS 89
started within five years after the cause of action arises, while ten
years is allowed in the case of a written agreement.
The Statute of Limitations is usually so worded that, when debts
are involved, the period does not begin to run until the debt falls
due or the last credit has been made against it. An item in an ac-
count is considered current so long as payments are being made on
A promise to pay a debt which has been outlawed by the Statute
of Limitations is enforceable without any new consideration, pro-
vided it is made directly to the creditor or his agent. Many states,
however, require such a promise to be in writing before it is en-
Sec. 133. Kinds of bankruptcy. The federal government hag
by statute the Bankruptcy Act provided a procedure whereby,
under certain conditions, one may be discharged from his obliga*
tions. He is permitted to start his business life anew, unfettered
by weighty obligations assumed in the past. The filing of a vol-
untary petition in bankruptcy usually accomplishes this result.
The federal court, through its designated officers, takes control of
all property involved, turns it into cash, pays all expenses, and uses
the balance to pay off creditors so far as possible.
At the same time the Bankruptcy Act has made it possible for a
creditor of an insolvent debtor to get his full share of the insolvent's
estate, by filing an involuntary petition in bankruptcy against the
debtor. A person cannot be forced into involuntary bankruptcy
unless his liabilities equal at least $1,000. Provided twelve or more
creditors exist, the petition must be signed by at least three of them
otherwise only one need sign. The petitioning creditors must
also own unsecured claims totaling $500 or more. Relatives, per-
sons holding fully secured claims, and other biased creditors are
not counted in determining the number of creditors required to sign
the petition. Thus, if there are only eleven creditors other than
relatives, one creditor may bring about involuntary bankruptcy re-
gardless of the total number of creditors involved.
Sec. 134. Who may become bankrupts. Any person, firm, or
corporation may become a voluntary bankrupt, with the exception
of five types of corporations. Railway, banking, insurance, mu-
nicipal, and building and loan corporations may not become vol-
a A number of the sections included under bankruptcy do not bear on the subject
of discharge of contracts, but, because of those which do, the subject is conveniently
treated at this point.
untary bankrupts. Other canadian laws provide for their liquidation in case
of insolvency. A recent amendment does provide, however, that
an insolvent railway may petition a bankruptcy court for confirma-
tion of a reorganization plan, provided the plan has first been ap-
proved by the Interstate Commerce Commission.
The provisions of the act relating to involuntary bankruptcy
make exception not only of the types of corporations just men-
tioned, but also of noncommercial corporations, farmers, and wage
earners, provided the wage earner does not earn more than $1,500
a year in the course of his employment.
Therefore, a person engaged primarily in farming may not be
forced into involuntary bankruptcy. He is deemed to be so en-
gaged when he spends the major portion of his time on the farm
and derives most of his income from it, although he is incidentally
engaged in some business enterprise. 4 Farming includes tilling of
the soil, raising livestock, and dairying. Furthermore, a wage
earner, as restricted above, regardless of the amount which he owes,
may not be forced into bankruptcy.
Sec. 135. Acts of bankruptcy. The purpose of involuntary
bankruptcy is to force an equal distribution of an insolvent debtor's
assets. In this connection it should be noted that mere insolvency
affords no basis for a petition in involuntary bankruptcy. Unless
a debtor has committed some act which indicates an intention to
abuse or to prefer certain creditors, or has done something which
shows a willingness to have his assets distributed, involuntary
bankruptcy is impossible. The Bankruptcy Act sets forth six acts,
one of which must be committed within four months prior to the
petition before involuntary bankruptcy proceedings are possible.
Acts of bankruptcy by a person shall consist of his having :
1. Conveyed, transferred, concealed, or removed, or permitted
to be concealed or removed, any part of his property with intent to
hinder, delay, or defraud his creditors, or any of them;
2. Transferred, while insolvent, any portion of his property to
one or more of his creditors with intent to prefer such creditors
over his other creditors; 5
3. Suffered or permitted, while insolvent, any creditor to obtain
a lien upon his property through legal documents and not having
vacated or discharged such lien within thirty days from the date
thereof or at least five days before the date set for any sale or other
disposition of such property;
4. Made a general assignment for the benefit of creditors ;
5. While insolvent or unable to pay his debts as they mature,
4 Rice v. Bordner, 1905, 140 Fed. 566; p. 538.
6 In re Stovall Grocery Co., 1908, 161 Fed. 882; p. 539.
DISCHARGE OF CONTRACTS 91
procured, permitted, or suffered voluntarily or involuntarily the ap-
pointment of a receiver or trustee to take charge of his property ;
6. Admitted in writing his inability to pay his debts and his will-
ingness to be adjudged a bankrupt.
Attention should be called to the fact that the second, third, and
fifth acts must be accompanied by insolvency at the time they are
committed. With respect to the first, fourth, and sixth acts, in-
solvency is not required. Another provision of the act, however,
makes solvency at the time the petition is filed a good defense to
the first act of bankruptcy. In none of the other acts is solvency
at the time the petition is filed important. In the first three in-
stances mentioned it is a matter of insolvency at the time the act
It should be emphasized, concerning the third act, that it is not
the lien which constitutes the act of bankruptcy but is the failure
to vacate it within the time allotted to the debtor.
The petition in involuntary bankruptcy must be filed within four
months of some act of bankruptcy. Whenever recording is re-
quired in order to render a transfer fully effective, the four months'
period is calculated from the date of recording and not from the
date of the transfer.
Sec. 136. Officers of the court. The bankruptcy petition is
filed with the clerk of the Federal District Court, and is then re-
ferred to the referee, who is appointed by the court to hear the evi-
dence and to submit his findings to the court. All dividends are
ordered paid by the referee.
A trustee is elected by the creditors at their first meeting, a ma-
jority in number and amount of claims held by those present at the
meeting being necessary for election. The trustee then takes title
to all property, both real and personal, owned by the bankrupt at
the time the petition was filed. It becomes his duty to dispose of
the property as best he can, under the supervision of the court, for
the benefit of creditors. Personal property, purchased by an in-
nocent party from the bankrupt after the filing of the petition but
before the trustee or receiver takes possession, remains with the
purchaser. Any property received by the bankrupt after the filing
of the petition belongs to his new estate, except that all devises,
bequests, or inheritances received within six months thereafter be-
long to the trustee. Executory contracts may be accepted or re-
jected within sixty days after the petition in bankruptcy has been
passed upon. If the trustee chooses to reject a long term contract,
the other party is then permitted to file a claim for damages against
the bankrupt estate. In case of leases, however, the landlord may
not file a claim in excess of one year's rental.
A receiver is a temporary officer appointed by the court to take
charge of a bankrupt's property until a trustee is appointed. He
is appointed only when someone is required to care for the property
in this intervening period, in order to avoid waste or loss.
Sec. 137. Recoverable preferences. Any transfer of property
by an insolvent person to a particular creditor, which has the effect
of preferring that creditor to the others, constitutes a preference.
A preferential transfer may be recovered by the trustee if it took
place within the four months preceding the filing of the bankruptcy
petition, and if the creditor, at the time of the transfer, knew, or
had cause to believe, that he was obtaining a greater percentage of
his claim than other creditors could recover. 6 The transfer may
consist of the payment of money, the delivery of property, or the
giving of property by pledge or mortgage as security for a prior in-
debtedness. Such a mortgage or pledge may be set aside as read-
ily as payment, providing it is received by the creditor with knowl-
edge of the debtor's insolvency. Such pledge or mortgage can be
avoided, however, only if it was received within the immediate four
months prior to the filing of the petition of bankruptcy and was ob-
tained as security for a previous debt. In the case of the mort-
gage, the four months' period dates from the recording of the
mortgage rather than from its signing.
If the property received by a preferred creditor has been sold to
an innocent third party, recovery of the property may not be had,
but its value may be obtained from the creditor. A creditor, how-
ever, who in good faith extends additional credit after having re-
ceived a preference, may deduct from the recoverable preference
the amount of any unpaid credit items. In this manner, a creditor
who attempts to help an insolvent debtor out of his financial diffi-
culties is not penalized if, after obtaining payment, he extends no
greater credit than the old claim amounted to.
Any judgment lien obtained within the four months' period is
void, irrespective of knowledge, so long as it continues to maintain
the character of a lien at the time the petition in bankruptcy is
Sec. 138. Exceptions to recoverable preference rule. Pay-
ment of a secured claim does not constitute a preference, and,
therefore, may not be recovered.
Transfers of property for a present consideration may not be set
aside. Thus, a mortgage given to secure a contemporaneous loan
is valid, although the mortgagee took the security with knowledge
of the debtor's insolvency. An insolvent debtor has a right to ex-
tricate himself, so far as possible, from his financial difficulty.
"Batchelder v. Home Nat. Bank, 1914, 210 Mass. 420, 105 N.E. 1052; p. 540.
DISCHARGE OF CONTRACTS 93
Any debtor of a bankrupt may set off against the amount he owes
the bankrupt estate any sum which the estate owes him. 7 To the
extent of his claim against the estate, he becomes a preferred credi-
tor, legally entitled to his preference. This rule is not applicable
where the claim against the bankrupt has been purchased with the
express purpose of set-off. Thus, a bank, which has loaned a bank-
rupt $2,000 and happens to have $1,500 of the bankrupt on deposit
at the time of bankruptcy, is a preferred creditor to the extent of
the deposit. This set-off must be allowed, unless the evidence dis-
closes that the deposit was made with the express purpose of pre-
ferring the bank. In such a case the deposit becomes part of the
Sec. 139. Provable claims. Not all claimants against a bank-
rupt may share in his assets. Those claims upon which dividends
are paid are called provable claims and must be filed within six
months after notice of the first creditors' meeting. All claims
founded upon a contract are provable ; thus, any debt or claim for
damages because of breach of contract may be filed. Those con-
tract claims which have not been made certain at the time for fil-
ing are liquidated by court decree or agreement prior to the pay-
ment of dividends by the trustee.
Tort claims demands made because of injury to person or
property are not provable unless they have been liquidated by
judgment or agreement prior to the petition in bankruptcy, except
that in torts involving negligence the injured party may prove his
claim if he has instituted suit prior to the filing of bankruptcy pro-
ceedings. Thus, A, who has an action against B because of an as-
sault by the latter, is deprived of any share in B's bankrupt estate,
provided the petition in bankruptcy is filed before A has reached
an agreement with B or started suit against him. As noticed in the
succeeding section, however, the claim is not discharged, and may
be enforced against any new assets B may acquire.
Claims for costs in suits started against the bankrupt or in cases
started by him and abandoned by the trustee are also provable.
Taxes also represent provable claims.
A claim by a creditor who has received a recoverable preference
is not allowed until he has returned the preference. Thus, if a
creditor has knowingly received a portion of his claim from an in-
solvent debtor within four months of bankruptcy, he is not entitled
to prove the balance of his claim until he has surrendered the pref-
erence that he received.
Sec. 140. Claims which are discharged. All provable claims,
with a few exceptions, are discharged by a discharge in bankruptcy.
7 Frank v. Mercantile Nat. Bank, 1905, 182 N.Y. 264, 74 N.E. 841; p. 540.
The most important of these exceptions are claims for taxes, losses
resulting from fraud or breach of trust by one acting in a fiduciary
capacity, liability resulting from willful or malicious tort, wages
earned within three months of filing of the petition in bankruptcy,
and damages for loss of property or money obtained under false
pretenses. Nonprovable claims, not being discharged, also con-
tinue as claims against the bankrupt after his discharge.
It becomes the duty of the bankrupt, as soon as a petition in
bankruptcy is filed, to schedule all his creditors and the amount due
each. The claim of any creditor who is not listed and who does not
learn of the proceedings in time to file his claim is not discharged.
The bankrupt, under such circumstances, still remains liable.
In addition to providing that certain claims are not discharged,
the Bankruptcy Act provides a number of circumstances under
which the bankrupt may not obtain a discharge. In such a case the
assets of his present estate are distributed among his creditors, but
he remains liable out of future assets for that portion of the claims
that remains unpaid after all assets have been liquidated and dis-
tributed. The Bankruptcy Act states the following about the dis-
charge of bankrupts:
"The court shall grant the discharge unless satisfied that the
bankrupt has (1) committed an offense punishable by imprison-
ment as provided under this Act; or (2) destroyed, mutilated, falsi-
fied, concealed, or failed to keep or preserve books of account or
records, from which his financial condition and business transac-
tions might be ascertained, 8 unless the court deems such acts or
failure to have been justified under all the circumstances of the
case; or (3) obtained money or property on credit, or obtained an
extension or renewal of credit, by making or publishing or causing
to be made or published, in any manner whatsoever, a materially
false statement in writing respecting his financial condition, 9 or
(4) at any time subsequent to the first day of the twelve months
immediately preceding the filing of the petition in bankruptcy,
transferred, removed, destroyed, or concealed or permitted to be
removed, destroyed, or concealed, any of his property, with intent
to hinder, delay, or defraud his creditors; or (5) has within six
years prior to bankuptcy been granted a discharge . . . ; or (6)
in the course of a proceeding under this Act refused to obey any
lawful order of, or to answer any material question approved by,
the court; or (7) has failed to explain satisfactorily any losses
of assets or deficiency of assets to meet his liabilities."
Any of the circumstances mentioned may be set up by a creditor
8 Rosenberg v. Bloom et al., 1938, 99 Fed. (2) 249; p. 541.
9 In re Savarese, Appeal of State Bank, 1913, 209 Fed. 830; p. 542.
DISCHARGE OF CONTRACTS 95
as a bar to a discharge, or they may be set up by the trustee, when
he has been authorized to do so by the creditors. Furthermore, if
any creditor can show reasonable cause for believing that the bank-
rupt has done any of the things mentioned, the burden shifts to the
bankrupt to show that he has not committed an act which will bar
discharge. In addition, it should be suggested that the discharge
of a partnership does not act as a discharge of the individual mem-
bers of the firm. They are discharged only upon action of the court
in their behalf as individuals.
Sec. 141. Exemptions. The bankrupt is allowed as exempt
property the exemption provided by the law of the state in which
he resides. Such laws usually provide for a certain sum in cash or
personal property and, if the bankrupt owns his homestead, some
Sec. 142. Preferred claims. The trustee's title to property is
only the title previously held by the bankrupt. Any valid lien
against the property continues after bankruptcy and must be paid
first if the trustee desires to dispose of the property free of encum-
brances; otherwise, the lienholder merely enforces his lien. Should
a sale of the property fail to pay the entire secured debt, the credi-
tor then becomes an unsecured creditor for the deficit.
The Bankruptcy Act provides a definite order for the payment of
provable claims. Such claims are paid in the following order:
1. Costs of preserving and administering the bankrupt estate.
2. Claims of wage earners not exceeding $600 to each claimant,
provided the wages have accrued within the three months preceding
3. Claims for money expended in defending against or setting
aside arrangements of the bankrupt debtor.
4. Claims for taxes.
B. Claims for rent granted priority by state statute and any
claims allowed priority by federal law. Many of the claims held
by the federal government have been given priority under this pro-
6. Claims of general creditors.
In case funds are insufficient to pay in full any particular class of
creditors, the funds available for such group are distributed in pro-
portion to the amount of each claim, all classes falling lower in the
list receiving no payment. For example, if the assets are insuffi-
cient to pay the claims of wage earners of $600 per person and
earned within the previous three months in full, the wage earners
would share proportionately the amount available, but the claims
for taxes and general creditors would not share, no payment being
made on them.
Sec. 143. Fraudulent conveyances. Conveyances of property
to relatives or friends which are made for the purpose of hindering,
delaying, or defrauding creditors may always be set aside by the
creditors. This rule applies whether or not bankruptcy has inter-
vened. In any case where the conveyance leaves the transferor
without sufficient assets with which to pay his debts, the transfer is
said to be fraudulent. 10 The courts insist that one must be "just
before he is generous."
If the one to whom the property has been transferred is innocent
and has given value for it, the transfer can be set aside only in case
the purchase price is refunded to him. If he is not an innocent
purchaser that is, if he knows of the debtor's intention at the time
the transfer is made the transfer can be set aside without recom-
pensing the third party. The latter then becomes a general credi-
tor of the debtor's estate and shares like any other creditor in the
event of bankruptcy. The states usually impose no time limit in
which an action may be brought by creditors to set aside a fraudu-
lent conveyance. Whenever creditors discover that such a transfer
has been effected, they are free to institute an action for the pur-
pose of restoring the property to the debtor's estate, in which it may
be attached and sold by his judgment creditors or used by a bank-
ruptcy court in paying creditors.
Sec. 144. Introduction. Until recently, the law made it pos-
sible for a small minority of creditors to jeopardize the interests of
the majority whenever a debtor became financially embarrassed.
They could force the debtor into bankruptcy and insist upon liqui-
dation at unfavorable times ; they could demand, in many instances,
foreclosure of mortgages or threaten lengthy and expensive receiv-
erships unless the other creditors purchased their claims at exorbi-
tant figures ; or they could effectively block any plan for rehabilita-
tion of the debtor until their demands had in large measure been
satisfied. Late amendments to the Bankruptcy Act have sought to
relieve this situation and have, in the 1938 revision of the Act, been
woven together in such a way as to meet several distinct needs. In
general, the method chosen by this legislation is to coerce the mi-
nority interests to follow a plan which has been approved by a
larger group and sanctioned by the court. It is this legislation
which is considered in the sections which immediately follow.
Sec. 145. Arrangements involving unsecured creditors. Any
person, including a corporation capable of becoming a voluntary
bankrupt, may, if he is insolvent, is unable to pay his debts as they
10 Peerless Mfg. Co. v. Goehring et ux., 1944, 131 Conn. 93, 38 A.(2) 5; p. 542.
DISCHARGE OF CONTRACTS 97
mature, or is at present involved in bankruptcy proceedings, file a
petition with the bankruptcy court to settle or extend his unsecured
debts. The petition incorporates the plan which the debtor pro-
poses to have approved and is accompanied by his statement of
assets and liabilities. Provision is made for an independent ap-
praisal of assets in case the court feels it desirable.
The plan outlines in detail the arrangement for settling or ex-
tending the claims and the means whereby the debtor expects to be
able to meet its terms. It may treat all creditors on a parity, or
they may be divided into classes with each group accorded different
treatment. Those executory contracts which are burdensome to
the debtor may be terminated where the plan indicates, the injured
parties in such cases filing claims for their damages. A copy of the
plan, with financial statement attached, is then mailed to all credi-
tors with notice of a meeting at which the matter will be considered.
The plan can be approved by the court only after it has been
sanctioned in writing by the majority in number and amount of
all the claims filed and approved at the meeting. Thereafter, if
the court finds that the plan is fair, free from fraud, and feasible,
it may approve it, unless the debtor has committed some act or
failed to perform certain duties which would bar a discharge in
bankruptcy. Thus, a debtor that has transferred property within
one year, with the intention of delaying or defrauding creditors,
cannot take advantage of this section of the Act.
Lack of approval of the proposed plan gives the court, at its dis-
cretion, the right to proceed with the liquidation of the estate in
the ordinary course of bankruptcy. A petition for an arrangement
which is not adopted thus becomes a petition in voluntary bank-
ruptcy. Likewise, if the terms of the plan are not carried out by
the debtor, the court may proceed as in any other case of bank-
Sec. 146. Creditors secured by real property. The procedure
outlined for an arrangement affecting secured creditors differs in
four important particulars from that set out in the preceding sec-
tion: (1) the provisions are available only to debtors other than
corporations; (2) the plan has to be accepted by two-thirds in
amount of all claims, the number of claimants being unimportant;
(3) after the petition has been filed, a creditor, whose plan has been
approved by twenty-five per centum of the claims in any group and
at least ten per centum of all creditors' claims, may file a plan ; and
(4) provision is made for carrying the plan into operation even
though less than the requisite two-thirds in a particular group ap-
prove the plan. In case the plan does not appeal to the holders of
two-thirds of the claims of a particular group, the plan must make
provision for payment, of their equity, to such dissenting creditors.
The amount to be paid them may be determined by a sale of the
property or by an independent appraisal of the value of their claims.
If the claims of unsecured creditors are settled at the same time
the secured claims are handled, the excess of the secured claims
above the appraised value of the security is treated as an unsecured
claim. Claims of bondholders who cannot be located or who fail to
file claims after receiving notice may be filed by the trustee ap-
pointed in the trust deed or mortgage. Such claims are not con-
sidered, however, in determining the number essential to approve
A petition to arrange secured debts must be filed before the prop-
erty involved has been sold under a foreclosure decree. If the sale
has not been effected at the time the petition is filed, the fact that
foreclosure proceedings have been instituted does not preclude the
adoption of a plan for the relief of the debtor. The foreclosure
proceedings are stayed until final action is taken on the petition to
arrange the debts.
Sec. 147. Wage earners' plans. A wage earner, as defined for
this purpose, is one who works for wages, salary, or hire at a rate of
compensation which, when added to all other income, does not
exceed $3,000 a year. One who desires to compromise or extend
his obligations out of his future earnings may file a petition to effect
this purpose. Approval of the plan in this case is dependent upon
the written consent of the majority in number and amount of all
unsecured claims and the consent of all secured creditors whose
claims are to be materially affected by the plan.
Since future earnings are involved, requiring some court ap-
pointee to handle the funds received, it is only natural that the
matter of exemptions and priorities be involved. All costs of ad-
ministration and all priorities allowed by law are paid before
the general creditors receive a dividend. After the debtor has made
all the payments called for by the plan, the debtor receives a dis-
charge from all debts covered by the plan. If, after three years
have elapsed, all payments have not been made, the court may
grant a discharge if it is convinced that failure to make the pay-
ments was not occasioned by the fault of the debtor but was the
result of causes beyond his control. The law permits the debtor to
claim the exemption allowed by law at the time the plan is
placed in operation. In other respects, wage earners' plans are
similar to those affecting unsecured claims.
Sec. 148. Reorganization of corporations. In general the pro-
visions of the Act relative to reorganization of corporations are sim-
ilar to those indicated for arrangements of unsecured claims, and
DISCHARGE OF CONTRACTS 99
reference will be made only to provisions which are not in accord
with those for arrangements. This chapter of the Act is available
to any corporation which is insolvent or unable to meet its obliga-
tions as they mature, provided the corporation is such a one as
might become a bankrupt. The petition for reorganization may be
filed by the corporation, an indenture trustee one appointed in a
trust deed or mortgage or three creditors holding noncontingent
claims aggregating $5,000. If the corporation is not in bankruptcy
at the time the petition is filed, the trustee or creditors, if they file,
must prove an act of bankruptcy has been committed, or that a
trustee, receiver, or mortgagee is in possession of all or most of the
property of the debtor, or that foreclosure of all or most of the
property is pending.
If the petition is approved, a list of assets and creditors is made
available to the interested parties and a trustee is appointed to take
control of the property unless the claims are less than $250,000,
when the debtor may be allowed to remain in possession. After
the trustee has been appointed, it becomes his duty to prepare a
plan of reorganization, at a hearing upon which any creditor, stock-
holder, or the debtor may propose a substitute plan. If the cor-
poration is a small one and the debtor is allowed to remain in
possession, a plan may be presented by the debtor, a creditor, a
stockholder, or the indenture trustee.
After the plan has been presented and the hearing held, at which
other plans may be presented, the court approves those plans which
it feels are fair, equitable, and feasible. Until the court gives its
tentative approval of a plan, no one is at liberty to solicit the ac-
ceptance of any plan. Any person, or committee, who represents
twelve or more claimants must file a copy of the agreement, by
which he represents them, with the court, and the court is at liberty
to disregard any of the terms of these agreements that it feels hin-
ders the acceptance of a fair plan. As soon as the court gives its
tentative approval to one or more plans, a copy of the plan is mailed
to all interested parties. The proceedings are then delayed until
one of the approved plans has been accepted in writing by the hold-
ers of two- thirds of the total claims in each class and by a majority
of each class of stockholders. If the corporation has been found to
be insolvent, the consent of stockholders does not have to be ob-
tained, and, likewise, if the claims of a certain group of creditors
are not to be affected by the plan, their consent is not required.
Furthermore, the plan may make provision for protecting a group
of creditors in case it fails to approve the plan. The plan then
becomes operative without their acceptance, each creditor in the
group receiving such reasonable protection as the plan outlines.
The plan itself sets forth the modification of rights of the various
interested groups and specifies the means used to protect groups
that fail to assent to the proposed reorganization. The provisions
for effecting the reorganization, such as new issues of security, the
formation of a new corporation, and so forth, are set out in detail.
The plan must include a restriction on the use of nonvoting stock
and must make provision for election of directors by the preferred
stock in the event of a default in payment of dividends upon such
After the proper number of acceptances have been filed with the
court, it sets a date at which a hearing is held for confirmation.
Again the court must find that the plan is fair, equitable, and fea-
sible before confirming it. After final approval by the court the
plan becomes binding on all creditors, stockholders, the debtor, and
any new corporation proposed by the plan. The plan is then con-
summated, and distribution in assets and new securities is made in
accordance with it. Creditors are given at least five years there-
after to file their claims and to obtain the rights and privileges ac-
corded to them by the plan. If not filed within the period allotted
to them by the court, any property to which they were entitled
passes automatically to the old corporation or its successor. Thus,
all liabilities and claims of the corporation are discharged, except
as they are reserved by the plan. Minorities which in the first
instance were recalcitrant and refused to cooperate in mending the
defective financial structure of the corporation have been compelled
to accept such property or other securities for their claim as the
plan called for.
Railroads, although unable to avail themselves of the Bankruptcy
Act, may be reorganized under rules quite similar to those for other
Review Questions and Problems
1. Name three* methods by which a contract may be discharged.
2. What is meant by accord and satisfaction? Is a contract dis-
charged by an accord?
3. A sold a printing machine to B on the installment plan. B sold the
machine to C, who agreed to pay the balance of the purchase price.
Both parties notified A of the arrangement. C failed to make the pay-
ments and A now seeks to hold B. May he do so?
4. On April 1 B purchased a typewriter on credit at a price of $150
and on July 1 he purchased bookkeeping machines at a cost of $325, both
items being purchased of C. On August 1 he mailed his check of $200
to C and instructed him to apply it on the $325 item. Assuming a five
year Statute of Limitations, how much will C be able to recover of B as
of June 1 five years later?
DISCHARGE OF CONTRACTS 101
5. What is the difference between voluntary and involuntary bank-
ruptcy? May all persons become voluntary bankrupts?
6. A is a farmer and earns by the operation of the farm the sum of
$4,500 a year. As a result of some unwise investments, he becomes in-
solvent and gives a mortgage on his farm to secure one of his creditors.
May other creditors force him into involuntary bankruptcy?
7. Name the acts of bankruptcy. How many of them require insol-
vency at the time the act is committed?
8. A 9 while insolvent, paid an obligation for $300 in favor of B. Al-
though A was insolvent at the time, he was clearly unaware of the fact.
Has he committed an act of bankruptcy?
9. Who is the referee in bankruptcy? Who is the trustee?
10. B owed C a past due indebtedness of $500 and induced the latter
to extend the maturity of the indebtedness three years at 6% interest by
giving a chattel mortgage as security. Sixty days after the mortgage was
given, B filed a petition in voluntary bankruptcy. Under what condi-
tions, if any, will the trustee in bankruptcy be able to avoid the mort-
11. A became a voluntary bankrupt. At the time the petition was
filed, he owed B the sum of $2,000, which was to fall due sixty days later.
B owed A on a separate transaction the sum of $1,000, which was due at
the time the petition was filed. May the trustee collect the $1,000 and
force B to become an ordinary creditor as to the $2,000?
12. Are all claims discharged? Can you name any that are not?
13. A holds a valid mortgage against some property of B, a bankrupt.
What is his status among the creditors? What limitations are imposed
upon the rights of laborers to a preference in the distribution of assets?
14. In 1927, A deeded certain property to his wife's uncle in order to
avoid the payment of large obligations maturing in 1930. In 1931, A was
declared a bankrupt. May the trustee recover the property conveyed to
15. B owed his bank a note for $15,000 and, at a time when he was
insolvent, arranged to deposit all receipts with the bank. He was not
to draw any checks until the balance exceeded the note owing to the bank.
He became a bankrupt at a time when the balance was only $10,500.
May the bank set off the balance against the note and file a claim for
16. A filed a petition for a composition of his debts out of future wages,
the approved plan providing that he pay $2,000 a year for the next three
years out of his salary. At the end of two years he lost his job and was
unable to make the payments. Will he be able to obtain a discharge
from his debts at the end of the third year?
17. A corporation had its petition to effect a reorganization accepted,
and the plan, as presented, was accepted by the requisite number of
creditors and stockholders, with the exception of the banks. Will it be
possible for the plan to become operative without their acceptance if the
banks are classed as a distinct group of creditors by the plan?
18. Who may present a plan to the court for the arrangement of unsecured claims by a debtor? By a corporation in the process of reorganization?
19. A filed a petition in voluntary bankruptcy and was adjudicated a
bankrupt on March 1, 1939. Three months later his aunt died and be-
queathed him $15,000. Will he be able to retain this amount or will it
revert to the trustee in bankruptcy?