explaining that the Bankruptcy Clause “does not mean wiping out the differences among the forty-eight States” and holding that state tort and contract law may determine the validity of creditors’ claims
How later courts described this case
- explaining that the Bankruptcy Clause “does not mean wiping out the differences among the forty-eight States” and holding that state tort and contract law may determine the validity of creditors’ claims
- noting that as used in section 502(b)(1), the term “[a]pplicable law most often relates to state law”
- holding, however, that under its circumstances the payment of interest on interest implicated federal bankruptcy policies and was determinable by federal, not state, law
- holding that federal common law governs choice-of-law issues in bankruptcy cases, at least where the cause of action does not seek affirmative relief under state law
Written by the judges who cited it.
The opinion
Mr. Justice Frankfurter,
with whom Mr. Justice Jackson joins, concurring; Mr. Justice Burton having concurred in the opinion of the Court also joins in this opinion.
In 1928 the Inland Gas Corporation, chartered by Delaware, floated a first mortgage bond issue covering property located in Kentucky where it had its principal place of business. The mortgage indenture was executed in New York, designated a New York corporation as trustee, and made the bonds and coupons payable in New York, or, at the option of the holder, in Chicago where the debtor had a paying agent. By an explicit clause in the indenture, the debtor agreed to pay interest on defaulted coupons at the rate which applied to the bonds themselves before maturity. The bonds were sold to the public in many States.
The debtor defaulted on coupons and also on the bonds when they became due. Reorganization proceedings under § 77 of the Bankruptcy Act were begun by creditors in the District Court for the Eastern District of Kentucky. Subsequently Chapter X of that Act was made applicable. In these proceedings a claim, based on the covenant in the indenture, was made by mortgage bondholders for interest on the defaulted interest coupons. The bankruptcy court allowed the claim, apparently because it concluded that the covenant is valid by the law of New York. The Circuit Court of Appeals for the Sixth Circuit *168 reversed. 151 F. 2d 470 . That court, apparently deeming itself ultimately controlled by the local law of Kentucky which, in turn, looked to the law of New York, ruled that the claims should have been disallowed because the contract for the payment of interest on coupons was void under New York law. On the other hand, the Securities and Exchange Commission, a statutory party to the proceedings (§ 208 of the Bankruptcy Act, 11 U. S. C. 608), urges allowance of the claim if the covenant would, apart from bankruptcy, be upheld in the courts of any State having “a substantial relationship to the transaction.” The Commission therefore supports allowance of the claim because it finds that two of the States related to the transaction would uphold the covenant: Delaware, the State of the debtor’s incorporation, and Kentucky, its principal place of business and the site of the mortgage property. Finally another view suggests that whether interest should be allowed in this case is a matter of federal law to be fashioned by the bankruptcy court in the light of general, undefined notions of equity policy and of bankruptcy administration.
Of course, where rights are created by the Constitution, treaties or statutes of the United States and do not owe their origin to the laws of any State, the granting or withholding of interest as part of the remedy is also a function of federal law. That is the upshot of the decision in Board of Commissioners v. United States, 308 U. S. 343 . The factors legally decisive of the present problem are the opposite of those which controlled our decision in that case. There we had a right created by federal law. In this case, it was beyond the power of federal law to create the right for which claim was made, although, if by State law such a right came into being, it might become a question whether the federal courts should recognize such a right when they are sought to be utilized as instruments for its enforcement.
*169 Conflict-of-law problems have a beguiling tendency to be made even more complicated than they are. Therefore, they are often, as now, fitting occasions for observing the classic admonition to begin at the beginning. The business of bankruptcy administration is to determine how existing debts should be satisfied out of the bankrupt’s estate so as to deal fairly with the various creditors. The existence of a debt between the parties to an alleged creditor-debtor relation is independent of bankruptcy and precedes it. Parties are in a bankruptcy court with their rights and duties already established, except insofar as they subsequently arise during the course of bankruptcy administration or as part of its conduct. Obligations to be satisfied out of the bankrupt’s estate thus arise, if at all, out of tort or contract or other relationship created under applicable law. And the law that fixes legal consequences to transactions is the law of the several States. Except for the very limited obligations created by Congress, e. g., Holmberg v. Armbrecht, 327 U. S. 392 , a debt is not brought into being by federal law. Obligations exist or do not exist by force of State law though federal bankruptcy legislation is in force, just as State law determined whether they came into being or did not come into being between 1878 and 1898 when there was no bankruptcy law. The fact that subsequent to the creation of a debt a party comes into a bankruptcy court has no relevance to the rules concerning the creation of the obligation. Of course a State may affix to a transaction an obligation which the courts of other States or the federal courts need not enforce because of overriding considerations of policy. And so, in the proper adjustment of the rights of creditors and the desire to rehabilitate the debtor, Congress under its bankruptcy power may authorize its courts to refuse to allow existing debts to be proven. It may do so, for instance, where the recognition of such claims would undermine the fair administration of a debtor’s *170 estate, even though before bankruptcy such a claim would have supported a valid judgment in the courts of the State which created the obligation, or even in the courts of the State where the bankruptcy court is sitting. But the threshold question for the allowance of a claim is whether a claim exists. And clarity of analysis justifies repetition that except where federal law, wholly apart from bankruptcy, has created obligations by the exercise of power granted to the federal government, a claim implies the existence of an obligation created by State law. If there was no valid claim before bankruptcy, there is no claim for a bankruptcy court either to recognize or to reject.
Such an analysis, however phrased, is indispensable to the solution of the problem now before us. Putting the wrong questions is not likely to beget right answers even in law. One way of putting our problem is to ask whether the bankruptcy court executing the policy of Congress could recognize a claim for interest on coupons and allow it to share in the distribution of the bankrupt’s assets. But thus to frame the question is to avoid the crucial preliminary inquiry whether any obligation exists to be recognized. For nothing comes into a bankruptcy court to which congressional policy can apply unless it is an obligation created by applicable State law. And no obligation finds its way into a bankruptcy court unless, by the law of the State where the acts constituting a transaction occur, the legal consequence of such a transaction is an obligation to pay. See Bryant v. Swofford Bros., 214 U. S. 279, 290-91; Benedict v. Ratner, 268 U. S. 353 ; Security Mortgage Co. v. Powers, 278 U. S. 149 . Where a transaction in its entirety occurs in one State, it is clearly the law of that State that determines if an obligation is born, whether the question becomes relevant in a bankruptcy court or in any other court. But the mere fact that an agreement is made in one State by citizens of a second State for performance in a third and affecting individuals *171 in all forty-eight States does not change the principle inherent in our federal scheme, that the existence of a debt comes about not by federal law but by force of some State law, even though the right to enforce the debt, if it exists, may raise federal questions if bankruptcy ensues. Bankruptcy legislation is superimposed upon rights and obligations created by the laws of the States. Compare Marshall v. New York, 254 U. S. 380 . We do not reach considerations of policy in bankruptcy administration until there are rights, created by applicable local law, to be recognized.
This brings us to the immediate situation. This is not a case where damages are claimed, in the form of interest, for the detention of monies due. In such a situation the right to interest and its measure become matters for judicial determination. The claim here asserted is based solely on the terms of the agreement. The covenant for interest on interest was entered into by the parties in New York. The dominant place of performance was also New York. In the circumstances, if the words of the indenture created an obligation, they did so only if the law of New York says they did. Williston, Contracts § 1792. If New York outlawed such a covenant, neither Kentucky nor Delaware nor the States in which bonds were sold or where bondholders reside could give effect to an obligation which never came into being. Compare John Hancock Ins. Co. v. Yates, 299 U. S. 178 . And the ultimate voice of New York law, the New York Court of Appeals, speaking through Judge Cardozo, stated it as settled law that “a promise to pay interest upon interest is void . . .” Newburger-Morris Co. v. Talcott, 219 N. Y. 505, 510 , 114 N. E. 846 . This view of the New York law is supported by the great weight of Judge Mack’s authority. American Brake Shoe & Foundry Co. v. Interborough Rapid Transit Co., 11 F. Supp. 418, 419-420 . But see American Brake Shoe & Foundry Co. v. Interborough *172 Rapid Transit Co., 26 F. Supp. 954 , contra. However, it is not for us to ascertain independently whether the law of New York deemed a nullity the agreement that was here sought to be made the basis of a claim. We would not have brought the case here on that issue. The Circuit Court of Appeals made such an investigation and concluded that in New York the undertaking to pay interest was void. We accept this finding and conclude that since no obligation was created there was no claim provable in bankruptcy. And so we are not now called upon to decide whether as a matter of bankruptcy administration an agreement to pay interest on interest, where it is an obligation enforceable by State law, is enforceable in bankruptcy. That is a question that can arise only where such an obligation arose under State law. The opposite is the assumption in the case before us.
It is argued, however, that this conclusion subjects the fate of a claim in bankruptcy to the whim of State law. We are told that this result is agains't the policy of Congress implied in measures for the protection of investors and contravenes the requirement of “uniform Laws on the subject of Bankruptcies.” Art. I, § 8, Cl. 4. But this misconceives the purpose and settled understanding of the bankruptcy clause of the Constitution. The Constitutional requirement of uniformity is a requirement of geographic uniformity. It is wholly satisfied when existing obligations of a debtor are treated alike by the bankruptcy administration throughout the country, regardless of the State in which the bankruptcy court sits. See Hanover National Bank v. Moyses, 186 U. S. 181, 190 . To establish uniform laws of bankruptcy does not mean wiping out the differences among the forty-eight States in their laws governing commercial transactions. The Constitution did not intend that transactions that have different legal consequences because they took place in different States shall come out with the same result be *173 cause they passed through a bankruptcy court. In the absence of bankruptcy such differences are the familiar results of a federal system having forty-eight diverse codes of local law. These differences inherent in our federal scheme the day before a bankruptcy are not wiped out or transmuted the day after.