Kelly v. Central Hanover Bank & Trust Co.

In 1929 Insull Utility Investments, Inc. (Insull) issued debentures. The debentures contained negative-pledge clauses forbidding Insull from pledging any of its property in a way that subordinated the debenture holders’ security interests in Insull. After issuing the debentures, Insull took out short-term loans from banks in New York (the New York banks) (defendants) that were secured by pledges of stock owned by Insull. Insull went bankrupt, and the stock pledged to the New York banks was transferred to the banks. A debenture holder (the plaintiff debenture holder) (plaintiff) filed a lawsuit in federal district court on behalf of all other debenture holders against the New York banks, seeking a return of the stock so that the stock could be distributed with the rest of the bankruptcy estate. The plaintiff debenture holder argued that (1) the debentures placed an equitable lien on all of Insull’s assets, (2) the negative-pledge clauses created equitable servitudes on Insull’s assets that prohibited Insull from pledging its assets in a way that subordinated the debenture holders’ security interest in Insull’s assets, (3) the New York banks knew of the negative-pledge clauses and induced Insull to breach the clauses, and (4) the debenture holders could enforce their rights under the negative-pledge clauses against the New York banks. The New York banks opposed the case, arguing that they could not be held liable for Insull’s alleged breach of the negative-pledge clauses.