It would be to add a risk of unenforceability to the other risks inherent in such financing. The invocation of the economic duress species of unconscionability has most often been questioned on the ground that refusal to enforce a contract because of it has deleterious economic consequences. See, e.g., Note, UNCONSCIONABLE BUSINESS CONTRACTS: A DOCTRINE GONE AWRY, 70 Yale L.J. 453 (1961). It is those consequences we wish to avoid.
The argument can be made that this is not just a case of excessive interest rates. Here a factor entered into agreements which by their terms tied the bankrupts to it as their sole source of funds without giving any assurance whatever that the funds would be forthcoming. Even indulging the assumption that the provision giving Fidelity "sole and unlimited discretion" to reject any accounts the bankrupts sought to assign would be construed judicially to allow only the exercise of a reasonable discretion, that would be little solace to the bankrupts in their quest for financial viability. They could not assign their accounts to anyone else anyway, and even if they could despite the express provisions to the contrary, the contract terms made the bankrupts' rights to assign them elsewhere so cloudy and their positions so risky that it is difficult to conceive that any other avenues of credit would be open to them. Far from furthering the policy favoring the prevention of business failures, this argument goes, Fidelity's conduct in these two cases contravened it. There would thus be no substantial economic interest served in allowing it the fruits of these transactions.
We have made this argument at length because it deserves full consideration. We are unable to accept it, however, for two reasons. First, whether or not these agreements had the effect of closing off the bankrupts' other sources of credit, the fact is that at least some factors apparently view this type of contract as a necessary form of protection to insure that they have the opportunity to lend money on accounts that are collectible. If these provisions are held unenforceable in bankruptcy, which is, after all, where at least some such borrowers end up, lenders are likely to substitute another form of protection, perhaps higher interest or more selective choice of borrowers. It is therefore a dangerous over-simplification to distinguish the interest rates from the other contract terms.
Secondly, that these agreements are in effect more detrimental than helpful to borrowers is an economic judgment which we are not well-equipped to make. This is precisely the kind of problem that the legislature, either federal or state, would be far better able to deal with than the courts. In this connection, the conclusion of the trustee's brief in Dorset Steel is revealing. It argues the desirability of regulation of factors: "While there is an obvious need for financing sources for businessmen who, because of difficulties and poor credit ratings, cannot obtain so-called 'conventional' financing, these sources must be legally controlled so that they will be unable, under the guise of saviors, to be actually the executioners of businesses in trouble." BRIEF FOR TRUSTEE, Dorset Steel, p. 35.
It is not difficult to grant the premise that regulation may be required without conceding the trustee's conclusion that the job is for the bankruptcy court. If the financing industry needs regulation, the legislature is in a better position to know. It is able to institute a wideranging investigation to study the problem as a whole, to secure economic information unencumbered by the limitations of the judicial process, and to avoid the dangers of piecemeal regulation. It is able to draw lines that courts are unable to draw at all or at least in advance. The instant cases call attention to a significant and probably recurring problem, but its very breadth suggests that the trustees' appeal should be addressed to the legislative forum. It would be ill-advised for a court to proscribe these contracts outright.
In Bushwick-Decatur Motors v. Ford Motor Co., 116 F.2d 675 (C.A.2, 1940), the court of appeals was faced with a comparable problem: whether to read an automobile dealership contract containing an "unmistakably expressed" power of termination at the will of the manufacturer so as to allow only a reasonable, good-faith discretion to terminate. This the court (through Judge Clark) declined to do:
"Such a limitation can be read into the agreement only as an overriding requirement of public policy. This seems an extreme step for judges to take. The onerous nature of the contract for the successful dealer and the hardship which cancellation may bring him have caused some writers to advocate it, however; and an occasional case has seized upon elements of overreaching to come to such a result on particular facts. * * * But, generally speaking, the situation arises from the strong bargaining position which economic factors give the great automobile manufacturing companies: the dealers are not misled or imposed upon, but accept as nonetheless advantageous an agreement in form bilateral, in fact one-sided. To attempt to redress this balance by judicial action without legislative authority appears to us a doubtful policy. We have not proper facilities to weigh economic factors, nor have we before us a showing of the supposed needs which may lead the manufacturers to require these seemingly harsh bargains." 116 F.2d at 677.
We are left, then, on the one hand, with the mandate to screen claims for inequitable conduct, the harsh terms of these contracts, and the "fundamental purpose of the Bankruptcy Act * * * to secure an equitable distribution of the bankrupt's assets among his unsecured creditors," 4 COLLIER, BANKRUPTCY P67.12, p. 129 (14th ed. 1964), and, on the other, with the economic dubiousness and institutional difficulty inherent in judicially refusing to enforce the otherwise valid agreements. Certainly, the present records are singularly inadequate to enable a court to decide so perplexing an issue. As evidence on the issue of unconscionability, they contain only the contracts themselves. The contracts appear to be the products of dealings by a lender with borrowers in acute financial distress. But the contracts cannot tell us whether those dealings resulted in imposition on the bankrupts or merely justified precautions on the part of the factor. Given the interest in commercial certainty, the exclusiveness of the creditor's equitable remedy in bankruptcy, and the knowledgeability of the borrower where economic duress is the basis of the asserted unconscionability, to prove unconscionability there must be a showing, not only that the terms of the contract are onerous, oppressive, or one-sided, but also that the terms bear no reasonable relation to the business risks. This is a showing that depends on the commercial environment and cannot be made from the face of a contract alone.
We think, therefore, that the referee acted precipitously in refusing to enforce these contracts. He viewed the question solely as a matter of law, to be judged from "the terms of the contract, which speaks for itself." Record, Elkins-Dell, p. 83. See Record, Dorset Steel, p. 221. In that view, he was in error. Even in the context of an unconscionable sales contract, which the Uniform Commercial Code permits the courts to refuse to enforce in whole or in part, 12A P.S. § 2-302(1), the parties are "afforded a reasonable opportunity to present evidence as to its commercial setting, purpose and effect to aid the court in making the determination."
12A P.S. § 2-302(2). See also Williams v. Walker-Thomas Furn. Co., 121 U.S. App. D.C. 315, 350 F.2d 445 (C.A.D.C.1965). The commercial context would be at least as relevant in these cases, where the varying risks make the objective ascertainment of the value of the consideration exchanged a seemingly more hazardous task.
We therefore find it incumbent to prolong the termination of this lengthy litigation still further by remanding these cases to the referee for prompt and thorough factual hearings on unconscionability. Cf. Matter of Komfo Products Corp., 247 F. Supp. 229, 240 (E.D.Pa.1965). The ultimate question for the referee will be whether these contracts were, in the light of all the circumstances, reasonable commercial devices. Among the issues which may be explored at these hearings, and which may enter into the determination, are the financial positions of the bankrupts at the time the agreements were entered into; the extent to which agreements of this kind are customary among lenders like Fidelity; the extent to which Fidelity's contracts vary with and reflect anticipated risks; the availability of other credit to the bankrupts, both at the time and after they entered into these agreements; the extent to which the various provisions were enforced by Fidelity or influenced the bankrupts' business conduct, particularly their ability to secure other funds; whether the terms of these contracts facilitated commerce by making funds available where they otherwise would not be or impeded commerce by precluding access to other sources of funds; and the effects of holding these contracts unenforceable in bankruptcy on the future financing of similar businesses in need of funds.
The need for such a hearing in these cases is underscored by the action the referee took after finding the contracts unconscionable. In Dorset Steel, Fidelity's secured claim for $11,423 was allowed as an unsecured claim. Fidelity was ordered to pay the trustee all money collected from the assigned accounts after the date the petition was filed, plus all interest and charges in excess of 6% collected before the petition was filed and interest on the amounts found to be due. In Elkins-Dell, the referee required Fidelity to turn over to the trustee $24,811, which represents the total collections on accounts made after the petition was filed, less a credit for the $10,678 which Fidelity paid the trustee on March 29, 1961, plus interest on the $10,678 from the date the petition was filed to the date that amount was paid, and on the remaining $14,132 from the date of the petition to the date that amount is finally paid. The referee also ordered Fidelity to return to the trustee the sum of $5,000 improperly charged as accelerated interest, plus interest thereon from the date the petition was filed to the date of reimbursement; $1,353, which represents interest in excess of 6%; and $263 in unexplained charges. Presumably, although it is not explicit in the order, the referee intended to allow Fidelity an unsecured claim for the $14,061 still owed it on the date the petition was filed, the collection of which amount Fidelity has been compelled to disgorge. See Record, Elkins-Dell, p. 26.
If a creditor relies on security "tainted with fraud * * * tainted as a preference or other voidable transfer," he may nevertheless "normally be allowed to prove his claim as unsecured." 3 COLLIER, BANKRUPTCY P57.20, at pp. 302-03 (14th ed. 1964); see also id., P57.07, at p. 160; Barks v. Kleyne, 15 F.2d 153 (C.A.8, 1926). The taint of unconscionability is similar to these. If, therefore, the contracts were unconscionable, the compelled turn-over of the collections from the security in Elkins-Dell, the disallowance of the secured claim in Dorset Steel, and the substitution of Fidelity as an unsecured creditor in both would have been proper.
Similarly, inasmuch as claims arising from quasi-contractual obligations are provable in bankruptcy, Brown v. O'Keefe, 300 U.S. 598, 606, 57 S. Ct. 543, 81 L. Ed. 827 (1937); In re Kellett Aircraft Corp., 77 F. Supp. 959, 964 (E.D.Pa.1948), aff'd, 173 F.2d 689 (C.A.3, 1948), once the referee had refused to enforce the contracts it would also have been entirely appropriate, in achieving "a balance of equities between creditor and creditor," Vanston Bondholders Protective Comm. v. Green, 329 U.S. 156, 165, 67 S. Ct. 237, 241, 91 L. Ed. 162 (1946), to scale Fidelity's claims for interest down to a reasonable rate to prevent it from profiting at the expense of others from its unconscionable contracts. But a reasonable rate would not necessarily have been 6%. The reasonableness of a return would depend upon the custom, the risks, the setting - in other words, on the very same elements that would govern whether the contracts were conscionable to begin with, and neither a judgment on conscionability nor on a reasonable rate of return could have been made from the face of the contracts without a hearing.
After full consideration, the referee will be able to make new findings of fact and conclusions of law on unconscionability and, regardless of his determinations on that issue, also on the question of whether the financing agreement in Dorset Steel was an executory contract which was rejected by the trustee's alleged failure to take any action to assume or reject it; because of the referee's disposition of Dorset Steel on unconscionability grounds, no findings or conclusions have yet been made on the latter issue. The referee may then enter appropriate orders.
The orders of the referee will be vacated and the cases remanded to the referee for further proceedings not inconsistent with this opinion. It is so ordered.