This case presents the question of the power of the bankruptcy court to disallow either as a secured or as a general or unsecured claim a judgment obtained by the dominant and controlling stockholder of the bankrupt corporation on alleged salary claims. The judgment of the District Court disallowing the claim was reversed by the Circuit Court of Appeals, 4 Cir., 100 F.2d 830. We granted certiorari because of an apparent restriction imposed by that decision on the power of the bankruptcy court to disallow or to subordinate such claims in exercise of its broad equitable powers. 307 U.S. 620, 59 S.Ct. 1042, 83 L.Ed. 1499.
The findings of the District Court, amply supported by the evidence, reveal a scheme to defraud creditors reminiscent of some of the evils with which 13 Eliz. c. 5 was designed to cope. But for the use of a so-called'one-man' or family corporation, Dixie Splint Coal Company, of which respondent was the dominant and controlling stockholder, that scheme followed an ancient pattern.
In 1931 Pepper, the petitioner, brought suit in a state court in Virginia against Dixie Splint Coal Company and Litton, the respondent, for an accounting of royalties due Pepper under a lease. While this suit was pending and in anticipation that Pepper would recover, Litton caused Dixie Splint Coal Company to confess a judgment in Litton's favor in the amount of $33,468.89, representing alleged accumulated salary claims dating back at least five years. This was done by P. H. Smith, secretary and treasurer of Dixie Splint Coal Company, who, according to the District Court, was 'an employee of Litton and subservient to the latter's will.' This was on June 2, 1933. Execution was issued on this judgment the same day but no return was made thereon, Litton waiting 'quietly until the outcome of the Pepper suit was definitely known'. On February 19, 1934, Pepper obtained a judgment against Dixie Splint Coal Company for $9,000. On motion of the company, execution on the judgment was suspended for ninety days to permit an appeal. But defendant in that suit did not appeal. Instead, on March 19, 1934, while execution on the Pepper judgment was suspended, Litton caused an execution to issue on his confessed judgment and levy to be made thereunder. Yet Litton 'had no intention of trying to satisfy his confessed judgment' against his corporation 'unless and until it became necessary to do so'; he was using it 'only as a shield against the Pepper debt'. Thus, when execution and levy were made March 19, 1934, no steps were taken for over two months towards a sale of the property on which levy had been made. On May 31, 1934, Pepper caused an execution to issue on her judgment, and levy was made June 2, 1934. On this latter date the sheriff 'who seems to have been cooperating with Litton' advertised the property for sale under the Litton levy made in the previous March. On June 14, 1934, the sale was held and Litton became the purchaser of the property sold at the sum of $3,200.
The next step in the 'planned and fraudulent scheme' was the formation by Litton of 'another of his one-man corporations', Dixie Beaver Coal Company, to which Litton transferred the property he had acquired at the execution sale at a valuation of $20,135.36 to be paid for in stock of the new company.
On September 4, 1934, the third step in Litton's scheme was taken. On that date Dixie Splint Coal Company, pursuant to a resolution of the board of directors, passed June 16, 1934, (two days after the Litton execution sale) filed a voluntary petition in bankruptcy. This step, according to the findings below, was 'plainly for the sole purpose of avoiding payment of the Pepper debt'. The bankrupt at that time had $4,500 on bank deposit and $12,000 in accounts receivable, most of which was good. The cash on deposit was then more than sufficient to pay all creditors with the exception of Pepper. And Litton caused the voluntary petition to be filed 'feeling confident that his confessed judgment would cover and consume' the remaining assets. Adjudication followed on September 7, 1934.
Litton's next step in his scheme to defeat the Pepper claim was to purchase wage claims against the bankrupt and to cause 'in some manner' other claims to be withdrawn. This was done, according to the District Court, so that Pepper might be made to appear as the only general creditor-a situation designed to give Litton a decided technical advantage, as we shall see.