## Facts

- Insull Utility Investments, Inc. (I.U.I.) issued debentures containing “negative pledge” covenants promising not to mortgage or pledge assets in a way that would give later creditors priority over, or parity with, the debentures.
- In 1931, I.U.I. borrowed substantial sums from several New York banks and pledged large blocks of stock as collateral for the loans.
- I.U.I. was adjudicated bankrupt; the banks asserted secured rights in the pledged stock, placing them ahead of debenture holders and other unsecured creditors.
- A debenture holder (Kelly), purporting to act on behalf of similarly situated debenture holders, sued the banks (and General Electric Co.) after the bankruptcy adjudication but before appointment of a trustee.
- The plaintiff sought return of the pledged stock to the bankruptcy estate or, alternatively, an order requiring debenture holders to share ratably in the collateral securing the banks’ loans.
- The plaintiff alleged the negative pledge provisions created an equitable lien or asset-based restriction binding on later pledgees with notice, and that the banks knew of and induced I.U.I.’s breach.
- The case came before the district court on motions effectively testing whether the complaints stated an enforceable equitable right against the banks or General Electric independent of the bankruptcy proceeding.

## Issues

1. Whether a negative pledge covenant in debentures, without more, creates an equitable lien or other property interest in the issuer’s assets enforceable against later secured creditors who take with notice.
2. Whether debenture holders may maintain a representative equity action against third-party secured creditors, after bankruptcy adjudication, to reclaim pledged assets or compel pro rata sharing, rather than proceeding in bankruptcy.
3. Whether alleged notice of the covenant and inducement of its breach supports imposing a constructive trust or other equitable remedy against the collateral held by the banks.

## Decision

- The court ruled for the defendant banks and General Electric and rejected the debenture holders’ requested equitable relief.
- The court held that the negative pledge clauses were personal contractual covenants and did not create an equitable lien, servitude, or other proprietary interest in I.U.I.’s assets.
- Allegations that the banks had notice of the negative pledge and induced a breach did not convert the covenant into an enforceable property right against the banks’ collateral.
- The court concluded that priority and distribution disputes among creditors of the bankrupt issuer belonged in the bankruptcy process rather than separate equity suits against selected creditors.

## Legal Principles

- A negative pledge clause, standing alone, is a promise by the debtor not to encumber assets; it does not constitute a mortgage, lien, or equitable charge on specific property.
- Without an identified res and an affirmative appropriation of property as security (or comparable legal mechanisms), equity will not treat a negative pledge as creating a lien binding on later secured lenders.
- Notice to a later secured creditor of a borrower’s negative pledge covenant does not, by itself, subject the creditor’s collateral to debenture holders’ claims when the debenture holders lack a proprietary interest in the collateral.
- Claims that a third party induced breach of a negative pledge ordinarily support, at most, contractual remedies against the issuer, not equitable subordination or avoidance of the third party’s security absent a prior property right.
- After bankruptcy adjudication, disputes over lien validity, priority, and creditor equality are generally addressed through the collective bankruptcy administration rather than creditor-initiated, separate representative suits.

## Conclusion

The court concluded that I.U.I.’s negative pledge covenants gave debenture holders only contractual rights against the issuer and did not create an equitable lien or asset-based restriction enforceable against later secured bank lenders, even if the lenders had notice; disputes over creditor priority and distribution were left to the bankruptcy proceeding.


Kelly v. Central Hanover Bank & Trust Co., 11 F. Supp. 497 (S.D.N.Y. 1935)