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Opinion of the Court.

fair or equitable to other creditors.19 And that result may be reached even though the salary claim has been reduced to judgment.20 It is reached where the claim asserted is void or voidable because the vote of the interested director or stockholder helped bring it into being or where the history of the corporation shows dominancy and exploitation on the part of the claimant." It is also reached where on the facts the bankrupt has been used merely as a corporate pocket of the dominant stockholder, who, with disregard of the substance or form of corporate management, has treated its affairs as his own.22 And so-called loans or advances by the dominant or controlling stockholder will be subordinated to claims of other credi

"In re Burntside Lodge, Inc., 7 F. Supp. 785. In that case the court said, p. 787:

"The relations of a stockholder to a corporation and to the public require good faith and fair dealing in every transaction between the stockholder and the corporation which may injuriously affect the rights of creditors and the general public, and a careful examination will be made into all such transactions in the interests of creditors.

"If the business had not been incorporated and the Cooks had conducted the enterprise personally, they would not have been allowed compensation for services in the event of bankruptcy, and there is no cogent reason why they should be paid when the same service is rendered as an officer and manager of a corporation of their own creation and to serve their own interests. To allow claims under such circumstanees in effect would permit bankrupts to collect on claims against their own bankrupt estate. It would give effect to form rather than to substance, to the letter of the law rather than the spirit and purpose of it."

"In re Wenatchee-Stratford Orchard Co., 205 F. 964.

"In re McCarthy Portable Elevator Co., 196 F. 247, aff'd 201 F. 923. "In re Chas. K. Horton, Inc., 22 F. Supp. 905; In re Kentucky Wagon Mfg. Co., 71 F. 2d 802; Forbush Co. v. Bartley, 78 F. 2d 805; Clere Clothing Co. v. Union Trust & Savings Bank, 224 F. 363.

Opinion of the Court.

308 U.S.

tors and thus treated in effect as capital contributions by the stockholder not only in the foregoing types of situations but also where the paid-in capital is purely nominal, the capital necessary for the scope and magnitude of the operations of the company being furnished by the stockholder as a loan,23

25

Though disallowance of such claims will be ordered where they are fictitious or a sham," these cases do not turn on the existence or non-existence of the debt. Rather they involve simply the question of order of payment." At times equity has ordered disallowance or subordination by disregarding the corporate entity.26 That is to say, it has treated the debtor-corporation simply as a part of the stockholder's own enterprise, consistently with the course of conduct of the stockholder. But in that situation as well as in the others to which we have referred, a sufficient consideration may be simply the violation of rules of fair play and good conscience by the claimant;

.

"Albert Richards Co. v. Mayfair, Inc., 287 Mass. 280; 191 N. E. 430. Cf. Erickson v. Minnesota & Ontario Power Co., 134 Minn. 209; 158 N. W. 979; Oriental Investment Co. v. Barclay, 64 S. W. 80 (Tex. Civ. App.); Joseph R. Foard Co. v. State, 219 F. 827.

24

New York Trust Co. v. Island Oil & Transport Corp., 34 F. 2d 655; In re H. Hicks & Son, Inc., 82 F. 2d 277.

25

26

See comment in 45 Yale L. Journ. 1471.

In re Otsego Waxed Paper Co., 14 F. Supp. 15. The court said, p. 16, "The applicable principle is that, where a corporation is so organized and controlled as to make it a mere instrumentality or adjunct of another, and the subsidiary becomes bankrupt, the parent corporation cannot have its claim paid until all other claims are first satisfied." See also Hunter v. Baker Motor Vehicle Co., 225 F. 1006; Henry v. Dolley, 99 F. 2d 94.

The same result has been reached in equity receiverships. Central Vermont Ry. Co. v. Southern New England R. Corp., 1 F. Supp. 1004, aff'd 68 F. 2d 460; S. G. V. Co. v. S. G. V. Co., 264 Pa. 265; 107 A. 721.

A fortiori that result is reached where there is a fraudulent purpose. E. E. Gray Corp. v. Meehan, 54 F. 2d 223.

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Opinion of the Court.

a breach of the fiduciary standards of conduct which he owes the corporation, its stockholders and creditors. He who is in such a fiduciary position cannot serve himself first and his cestuis second. He cannot manipulate the affairs of his corporation to their detriment and in disregard of the standards of common decency and honesty. He cannot by the intervention of a corporate entity violate the ancient precept against serving two masters." He cannot by the use of the corporate device avail himself of privileges normally permitted outsiders in a race of creditors. He cannot utilize his inside information and his strategic position for his own preferment. He cannot violate rules of fair play by doing indirectly through the corporation what he could not do directly. He cannot use his power for his personal advantage and to the detriment of the stockholders and creditors no matter how absolute in terms that power may be and no matter how meticulous he is to satisfy technical requirements. For that power is at all times subject to the equitable limitation that it may not be exercised for the aggrandizement, preference, or advantage of the fiduciary to the exclusion or detriment of the cestuis. Where there is a violation of those principles, equity will undo the wrong or intervene to prevent its consummation.

On such a test the action of the District Court in disallowing or subordinating Litton's claim was clearly correct. Litton allowed his salary claims to lie dormant for years and sought to enforce them only when his debtor corporation was in financial difficulty. Then he used them so that the rights of another creditor were impaired. Litton as an insider utilized his strategic position for his own preferment to the damage of Pepper. Litton as the dominant influence over Dixie Splint Coal Company used his power not to deal fairly with the

27

See Alexander v. Theleman, 69 F. 2d 610, 613.

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308 U.S.

creditors of that company but to manipulate its affairs in such a manner that when one of its creditors came to collect her just debt the bulk of the assets had disappeared into another Litton company. Litton, though a fiduciary, was enabled by astute legal manoeuvring to acquire most of the assets of the bankrupt not for cash or other consideration of value to creditors but for bookkeeping entries representing at best merely Litton's appraisal of the worth of Litton's services over the years.

This alone would be a sufficient basis for the exercise by the District Court of its equitable powers in disallowing the Litton claim. But when there is added the existence of a "planned and fraudulent scheme," as found by the District Court, the necessity of equitable relief against that fraud becomes insistent. No matter how technically legal each step in that scheme may have been, once its basic nature was uncovered it was the duty of the bankruptcy court in the exercise of its equity jurisdiction to undo it. Otherwise, the fiduciary duties of dominant or management stockholders would go for naught; exploitation would become a substitute for justice; and equity would be perverted as an instrument for approving what it was designed to thwart.

The fact that Litton perfected his lien more than four months preceding bankruptcy is no obstacle to equitable relief. In the first place, that lien was but a step in a general fraudulent plan which must be viewed in its entirety. The subsequent sale cannot be taken as an isolated step unconnected with the long antecedent events, all designed to defeat creditors. Buffum v. Peter Barceloux Co., 289 U. S. 227, 232-233. In the second place, Litton is seeking approval by the bankruptcy court of his claim. The four months' provision of the bankruptcy act is certainly not a statutory limitation on equitable defenses arising out of a breach of fiduciary duties by him who seeks allowance of a claim.

In view of these considerations we do not have occasion to determine the legitimacy of the "one-man" corporation as a bulwark against the claims of creditors.28

Accordingly the judgment of the Circuit Court of Appeals is reversed and that of the District Court is affirmed. Reversed.

PEARSON, STATE TREASURER OF THE STATE OF OREGON, v. MCGRAW ET AL., EXECUTORS.

CERTIORARI TO THE SUPREME COURT OF OREGON.

No. 69. Argued November 15, 16, 1939.-Decided December 4, 1939. A resident of Oregon, owning bonds in Illinois, held for him by a trust company acting as custodian and financial agent, and having also a checking account with the company, directed the company to raise a specified sum of money by sale of bonds in its hands and by use of his cash balance, and to apply that sum to the purchase of an equal amount in Federal Reserve notes. When this had been done, and the trust company had held the notes for a few days, he executed in Oregon an instrument by which, in contemplation of death, he made a transfer of the notes to the trust company, as trustee for designated beneficiaries, reserving to himself no interest and no power of revocation. Thereafter, the trust company held the notes under the trust agreement for several days, and then used them from time to time to purchase bonds for the account of the trust. Its original engagement as custodian and agent antedated the settlor's domicile in Oregon, and none

28

"On this point the District Court said: "An examination of the facts disclosed here shows the history of a deliberate and carefully planned attempt on the part of Scott Litton and Dixie Splint Coal Company to avoid the payment of a just debt. I speak of Litton and Dixie Splint Coal Company because they are in reality the same. In all the experience of the law, there has never been a more prolific breeder of fraud than the one-man corporation. It is a favorite device for the escape of personal liability. This case illustrates another frequent use of this fiction of corporate entity, whereby the owner of the corporation, through his complete control over it, undertakes to gather to himself all of its assets to the exclusion of its creditors."