Cunningham v. Brown - 265 U.S. 1, 44 S. Ct. 424 (1924)

Rule:

In a case where the lender's money no longer exists, the defrauded lender becomes merely a creditor to the extent of his loss and a payment to him by the bankrupt within the prescribed period of four months is a preference.

Facts:

The defendant lenders made loans to the bankrupt in a scheme where the bankrupt promised to pay a high return. The bankrupt never made any investments and paid the lenders back with money lent by other individuals. When news of the bankrupt's insolvency was published in the paper, the lenders rushed to get repaid. Shortly thereafter, a petition in bankruptcy was filed. The plaintiff trustees then brought an action against the lenders to recover the payments made shortly before bankruptcy as unlawful preferences. When the trial court and the appellate court dismissed the trustees' action, they filed a petition for a writ of certiorari.

Issue:

Were the repayments illegal preferences recoverable by the bankrupt’s trustees? 

Answer:

Yes.

Conclusion:

The court granted the writ and determined that the payments should be recovered. The court found that a preference should be avoided where its beneficiary had reasonable cause to believe that the payment enabled him to obtain a greater percentage of his debt than the other creditors of the insolvent of the same class. The court held that the lenders were creditors equally with the others who filed their claims for reimbursement in the bankruptcy proceedings because the lenders’ money could not be traced in the bank accounts. Thus, the repayments made were illegal preferences recoverable by the bankrupt's trustees.