# Comstock v. Group of Institutional Investors/Dissent Murphy

* Court Documents
* Case Syllabus
* Opinion of the Court
* Dissenting Opinion Murphy
United States Supreme Court
335 U.S. 211
Comstock v. Group of Institutional Investors
Argued: March 9, 10, 1948. --- Decided: June 21, 1948
Mr. Justice MURPHY, with whom Mr. Justice BLACK, Mr. Justice DOUGLAS and Mr. Justice RUTLEDGE agree, dissenting.
The rule that makes concurrent findings of fact by two courts below binding on us in the absence of some very exceptional error is a wise one. But it is not a rule to be applied in a blind manner simply because a case involves a complex factual situation. In my view, there is an exceptional error involved in the conclusions reached by the District Court and affirmed by the Circuit Court of Appeals, an error that is apparent on the face of the District Court's findings. And since this error is not sufficiently illuminated by the opinion of the Circuit Court of Appeals, 163 F.2d 350 as quoted by the majority in this Court, I deem it essential to make an independent statement of the relevant facts as found by the District Court.
This case grows out of the joint reorganization of the Missouri Pacific Railroad Company and affiliated railroad corporations under § 77 of the Bankruptcy Act, 11 U.S.C. § 205, 11 U.S.C.A. § 205. It involves a claim of $10,565,226.78 filed by the Missouri Pacific against one of its subsidiaries which was also undergoing reorganization and the application to that claim of the so-called Deep Rock doctrine enunciated in Taylor v. Standard Gas & Electric Co., 306 U.S. 307, 618, 59 S.Ct. 543, 83 L.Ed. 669.
It is unnecessary for present purposes to detail the long, complicated and still unfinished proceedings which have marked the reorganization of the Missouri Pacific railway system. The instant proceeding is directly related to a revised plan of reorganization approved in 1944 by the Interstate Commerce Commission. The District Court below then heard objections to the plan by various parties in interest. Included among them was the petitioner Comstock. He stated that he owned $80,000 principal amount of the 5 1/4% Secured Serial Gold Bonds of the Missouri Pacific. His objections were filed on behalf of himself, of fourteen other public investors holding in excess of $900,000 additional principal amount of these bonds, and of all other owners and holders of the bonds. A committee of these bondholders, representing an additional $315,000 principal amount of the bonds, also joined in Comstock's objections. Of the total principal amount of these bonds publicly outstanding, about 11 1/2% were specifically represented by Comstock.
Comstock's objection No. 19, which is our sole concern, related to the validity and priority of a $10,565,226.78 claim filed by the Missouri Pacific (hereinafter called MOP) against its subsidiary New Orleans, Texas and Mexico Railway Co. (hereinafter called NOTM) in the joint reorganization proceedings. It appears that MOP had acquired the controlling interest in NOTM's common stock in 1924 and had completely dominated and controlled NOTM until the reorganization proceedings began in 1933. MOP's claim against NOTM was based upon 'cash advances for operation, interest payments, etc., at various times from March, 1929, to February, 1933, both inclusive.' Most of the NOTM stock which MOP held was pledged as security for the class of MOP 5 1/4% secured bonds which Comstock owned, the pledge constituting 82% of the outstanding shares of NOTM's sole class of stock. MOP sought to put its claim against NOTM ahead of the claims of the holders of these MOP bonds who looked to the NOTM common stock for security. The revised plan of reorganization gave effect to MOP's desire in this respect.
A separate hearing was held by the District Court on Comstock's objection No. 19. After carefully considering the voluminous and complicated evidence adduced at this hearing, the court entered a separate order overruling the objection and holding that the $10,565,226.78 claim should be allowed in full; with interest, this claim now aggregates more than $18,000,0 0. The court further held that this claim, so allowed, was entitled to priority over the claims of the public investors holding MOP 5 1/4% secured bonds. In addition, the court felt that objection No. 19 was not timely and should be barred from consideration under the doctrine of laches.
At the same time, the District Court entered another order overruling the other objections raised by Comstock and the other parties in interest and approving the revised plan of reorganization. An opinion was then filed detailing the reasons for the two orders. In re Missouri Pacific R. Co., D.C., 64 F.Supp. 64. Comstock appealed from the order dismissing his objection No. 19. The Eighth Circuit Court of Appeals affirmed the District Court's action on this objection, holding that the findings of that court were not clearly erroneous. Comstock v. Group of Institutional Investors, 163 F.2d 350. At the suggestion of the Interstate Commerce Commission, the Circuit Court of Appeals then remanded the revised plan of reorganization back to the Commission for reconsideration and revision. Wright v. Group of Institutional Investors, 8 cir., 163 F.2d 1022. The Commission has not yet disposed of the matter.
For somewhat different reasons than those advanced by the Court, I agree that a judicial consideration of Comstock's objection No. 19 is not now precluded by the doctrine of laches.
The joint reorganization proceedings commenced in 1933. Comstock did not purchase any of the MOP 5 1/4% secured bonds until 1940, soon after a Senate subcommittee investigating railroads issued a report criticizing the MOP management of NOTM. S.Rep. No. 25, Part 9, 76th Cong., 3d Sess. He then bought some of the bonds at about 10 cents on the dollar and employed an accountant to study the relationships between MOP and NOTM prior to 1933. Not until 1943 did Comstock suggest that there might have been some irregularities on the part of MOP. And not until November, 1944, when he filed his objection No. 19 to the revised plan of reorganization, did he really press his allegations.
Prior to Comstock's objection, more than a decade of the reorganization process had produced no charge or revelation of impropriety as to MOP's $10,565,226.78 claim against NOTM. Numerous investigations and hearings had been held during that long period concerning the pre-reorganization administration of the affairs of MOP and its subsidiaries. The public holders of the MOP 5 1/4% secured bonds and other creditors had ample opportunity to question the allowance of the claim. But no charges were made until after Comstock purchased his bonds and conducted his own investigation. Many of the events to which objection No. 19 relates took place more than twenty years ago; and some of the persons who had personal knowledge of those events and who might have been able to testify in regard thereto are now dead.
I do not believe, however, that the doctrine of laches is properly applicable to the facts of this case. The District Court had before it a revised plan of reorganization of MOP and its subsidiaries, a plan which recognized that NOTM was indebted to MOP and which permittedM OP to collect that debt without subordination to other creditors. That court was duty bound to test this portion of the plan by the fair and equitable rule and to approve it only if the rule was found to be satisfied. American United Mut. Life Ins. Co. v. Avon Park, 311 U.S. 138, 145, 146, 61 S.Ct. 157, 161, 162, 85 L.Ed. 91, 136 A.L.R. 860. The court's duty was nonetheless existent because an attack on the MOP claim came late in the day. Comstock's objection served only to emphasize the circumstances surrounding this indebtedness and to give the court an opportunity to inquire into the matter more fully than it might otherwise have done. Moreover, the fact that this objection had not previously been raised and adjudicated in the § 77 proceedings added to the appropriateness of a judicial determination of the validity of the debt at this juncture. Only by examining the matter now could the court be certain whether the treatment accorded the debt the reorganization plan was fair and equitable.
The motives which led Comstock to acquire his bond holdings and to raise his objection No. 19 are not pertinent to the performance of the District Court's duty of testing the fairness of the reorganization plan. Nor is it decisive under these circumstances that the objection might have been raised earlier by Comstock or some other bondholder. It is enough that the matter was presented in an appropriate fashion at a time when the court was compelled to pass judgment upon the reorganization plan and at a time when no prejudicial change in the position of other parties had yet occurred.
In this connection, it is noteworthy that that the Interstate Commerce Commission at an early stage in the § 77 proceedings held that the validity of the MOP claim is a matter 'for litigation in the Courts.' Thus Comstock would likely have been unsuccessful had he attempted to secure a determination of his objection by the Commission before going to court. The Court today, however, expressly holds that the Deep Rock issues raised by Comstock involve matters over which the Commission has jurisdiction and with which it is especially qualified to deal. See Schwabacher v. United States, 334 U.S. 182, 68 S.Ct. 958. On this phase of the case, I am in agreement with the Court. The Commission should determine the applicability of the Deep Rock doctrine to railroad reorganization plans which it formulates. But since the Commission had previously refused to adjudicate the merits of the MOP claim and since Comstock's objection has been thoroughly aired in the District Court, it is inappropriate to remand the case now to the Commission for an expression of its views.
Despite the claimed difficulties due to the age of the pertinent events and the death of some of the witnesses, the District Court was able to give a comprehensive treatment to Comstock's objection and to render an informed judgment on the fairness of MOP's claim against NOTM. Many of the issues revolved about written evidence and statistics. And the court was able to draw upon its intimate knowledge of the MOP-NOTM relationships, knowledge gained from long association with the reorganization proceedings. Hence the court could and did perform fully its function as to that portion of the revised reorganization plan with which objection No. 19 was concerned.
In this situation, the desirability and necessity of determining the fairness and equitableness of MOP's claim far outweigh any possible inconvenience caused by the late presentation of the matter.
In Taylor v. Standard Gas & Electric Co., supra, this Court established the principle that where a parent corporation has not only dominated but has mismanaged a subsidiary corporation, which is presently in bankruptcy or reorganization, and where the parent has a claim which is intimately related to the mismanagement, a court may refuse to permit the parent to assert the claim as a creditor except in subordination to the claims of the subsidiary's other creditor and preferred stockholders. This principle, which has become known as the Deep Rock doctrine, is equitable in nature. As explained in Pepper v. Litton, 308 U.S. 295, 308, 60 S.Ct. 238, 246, 84 L.Ed. 281, the doctrine was applied in the Taylor case on the basis of 'the equities of the case-the history of spoliation, mismanagement, and faithless stewardship of the affairs of the subsidiary by Standard to the detriment of the public investors.'
The fulcrum of Comstock's objection No. 19 is the Deep Rock doctrine. The argument is that the items constituting the $10,565,276.78 claim filed by MOP against NOTM are impregnated with MOP's alleged mismanagement of NOTM and that the claim should therefore be subordinated to the claim of the public investors in the MOP 5 1/4% secured bonds, who are secured by MOP's pledge of the NOTM common stock.
It is no answer to Comstock's claim that the District Court found that the transactions giving rise to the MOP claim were carried out in good faith. The equities which form the Deep Rock doctrine relate not alone to matters of bad faith. They are also concerned with the essential fairness and propriety of transactions from an objective standpoint. Pepper v. Litton, supra, 308 U.S. at page 306, 60 S.Ct. at page 245. Like negligence, inequity may be present where there is the utmost subjective good faith. If there is mismanagement and if there is undue harm to the creditors and preferred stockholders of the subsidiary, the Deep Rock doctrine dictates subordination of the parent's claim. And if there be good faith on the part of the parent's officers, if hardly justifies ignoring the injury to the subsidiary's creditors and stockholders. Equity looks in all directions. Only in that way can the various interests in the corporate community be adequately protected.
Moreover, the issues raised by Comstock are not resolved by the District Court's finding that operational benefits accrued to NOTM and its subsidiaries by virtue of the transactions underlying MOP's cliam. These transactions were undoubtedly tied in with the expansion program which MOP was undertaking during this period. But a breach of fiduciary obligations is not to be condoned by the presence of accompanying benefits where the subsidiary's assets are depleted to the injury of the stockholders and creditors of the subsidiary.
Nor does the fact that MOP, the parent, is insolvent bar an application of the Deep Rock doctrine to the facts of this case. The insolvency of the parent and the consequent effect of subordination upon the parent's innocent creditors are certainly factors to be considered. See Consolidated Rock Products Co. v. DuBois, 312 U.S. 510, 524, 61 S.Ct. 675, 684, 85 L.Ed. 982; Prudence Realization Corp. v. Geist, 316 U.S. 89, 97, 62 S.Ct. 978, 983, 86 L.Ed. 1293. But they are not necessarily decisive in all cases. The equities of a particular situation may turn upon something more than the solvency or insolvency of the parent. It may well be that a balancing of competing equities reveals that it is unjust to permit the advantages arising from the parent's breach of fiduciary duties to adhere to the benefit of the innocent creditors of the insolvent parent. Some other innocent parties may have an overriding interest which justifies subordination of the claim. Or the claim itself may be so tainted with inequity and unenforceability as to require subordination regardless of the parent's insolvency. And so the Deep Rock doctrine is as broad and as narrow as the equities in each case.
In this instance, I believe that the public holders of the MOP 5 1/4% secured bonds have a sufficiently direct and overriding interest in the financial well-being of NOTM to justify subordinating the MOP claim should it appear that this claim is intimately associated with a breach of MOP's fiduciary duties. MOP secured these bonds with a pledge of the NOTM common stock and expressly undertook not to impeach the pledge. Any wrongful conduct by MOP which dimii shed the size of NOTM assets would impair the value of the NOTM stock. Subordination of the claim would thus tend to make the NOTM stock more valuable and to make possible a realization of MOP's express pledge to its bondholders. True, creditors of MOP other than the bondholders would be unable to benefit from whatever could be collected on the claim. But they were not the recipients of a pledge of NOTM stock and they lacked the immediate interest that the bondholders had in a proper performance of MOP's fiduciary duties. The indirect loss they would suffer by subordination is outweighed by the direct injury to the bondholders as a result of allowing the claim.
It is therefore essential to study the various transactions in detail to determine whether they represent the type of mismanagement by a parent which leads to subordination of the resulting claim against the subsidiary.
The District Court found that during the period from March, 1929, to February, 1933, MOP advanced to NOTM the net sum, after deducting principal payments, of $10,565,226.78-which constitutes the claim in issue. Included in these advances was the greater portion of the $2,795,000 loaned to NOTM between November 30, 1928, and November 27, 1931, to make additions and improvements to the railroad properties of NOTM and other related subsidiaries. But each time one of these advances was made, there was an almost simultaneous payment of a dividend by NOTM on its stock, which was largely owned by MOP. This phenomenon is demonstrated in the following table:
by MOP Total Amount to
Advances Dividends to NOTM amount MOP
Nov. 30, 1928.. Dec. 1, 1928. $300,000 $259,576 $233,
Feb. 28, 1929.. Mar. 1, 1929. 250,000 259,576 234,
Aug. 31, 1929. Sept. 3, 1929. 275,000 259,576 239,
Nov. 29, 1929.. Dec. 1, 1929. 310,000 259,576 241,
Feb. 28, 1930.. Mar. 1, 1930. 260,000 259,576 242,
May 31, 1930... June 1, 1930. 275,000 259,576 242,
Nov. 29, 1930.. Dec. 1, 1930. 300,000 259,576 243,
Feb. 25, 1931. Feb. 28, 1931. 75,000 259,576 243,
May 27, 1931... June 1, 1931. 200,000 259,576 244,
Aug. 29, 1931. Aug. 31, 1931. 250,000 259,576 244,
Nov. 27, 1931. Nov. 30, 1931-. 300,000 259,576 244,
Dec. 1, 1931. ------------- Reference is made in this respect to the relationship which MOP bears to the various companies in the Gulf Coast Lines system (hereinafter called GCL). In 1924, MOP acquired a controlling interest in NOTM and thereby inherited complete control of the GCL system, the rail lines of which are interlaced with others in the MOP system. NOTM at all times has been primarily a holding company owning all the stocks and bonds of the fourteen subsidiary companies constituting the GCL group, NOTM itself operating only about 11% of the total GCL mileage. Of the GCL operating companies, the St. Louis, Brownsville and Mexico Railway Co. (hereinafter called Brownsville) is the most important, operating about one-third of the GCL mileage and group's income during the period in question. NOTM is the only one of the GCL contributing from 61% to 84% of the group which has securities outstanding in the hands of the public.
According to the District Court fini ngs, MOP's policy in advancing the $2,795,000 to NOTM was to reimburse NOTM's treasury for additions and betterments to the properties of GCL system. NOTM acted as banker for that system. The GCL subsidiaries were not in a position from 1925 to 1930 to finance their own improvements except out of earnings and by borrowing from NOTM. Most of their freight revenues were cleared through NOTM; as these items were received by NOTM, they were credited against the obligations created by the loans from NOTM to the subsidiaries. But since the total requirements of the subsidiaries for operating expenses, dividends and improvements were in excess of the receipts, the unpaid accounts mounted. Finally MOP had to begin loaning money to NOTM to cover these accounts. It is in this way that MOP's advances are said to have been directed toward the improvement program of the GCL system.
It is vigorously denied that these MOP advances were in any way used to pay for the almost simultaneous dividends from NOTM to MOP, such a contention being termed 'superficial' and contrary to 'basic principles of accounting.' In support of that denial, an illustration is used. Assume that NOTM receives $200,000 cash from net earnings on January 31, when it is known that this amount will be needed to pay a bill for a new freight yard for a subsidiary. NOTM also knows that on April 1 a $100,000 cash dividend to MOP will be due. Instead of borrowing to pay for the new freight yard, NOTM uses the $200,000 cash for that purpose. Then, three days prior to the dividend date, NOTM borrows $100,000 from MOP to reimburse the NOTM treasury in part for the investment in the new freight yard. This saves NOTM about two months' interest on $100,000 of the money spent for the freight yard. The fact that a $100,000 cash dividend is paid three days after the $100,000 loan is thought to be a mere coincidence, the dividend and the loan having no connection.
But in this illustration it is obvious that NOTM has insufficient cash to finance both the $200,000 freight yard and the $100,000 dividend. It has to borrow money for one purpose or the other. But to say that it here borrows $100,000 to help pay for the freight yard is unrealistic. NOTM has enough cash to pay for the freight yard and it uses the cash just for that purpose. Two months later it has the choice of (1) borrowing $100,000 and paying the dividend, or (2) not borrowing the money and not paying the dividend. It chooses the former course of action. By such action, NOTM has borrowed money to pay a dividend.
The foregoing illustration indicates what the record in this case amply demonstrates-namely, that the MOP advances found by the District Court to have been for the payment of GCL improvements were in reality advances for the payment of dividends by NOTM, dividends which for the most part went to MOP. Considered as a separate entity, NOTM rarely had enough income from the time MOP acquired control in 1924 to the start of reorganization in 1933 to pay the regular dividends; loans were essential if MOP was to continue to receive its share of these dividends.
1932.......... (- 951,607.76). None statement from the files of the railroad itself shows that for the period 1926 through 1930 the N.O.T. & M.'s net income was overstated (through understatement of depreciation) by more than $411,000. If the railroad's depreciation had been adequately charged, it would have shown a deficit for the 6 years 1926-1931 of $321,000 after fixed charges. Yet during this period the Missouri Pacific took $5,580,000 in dividends out of the N.O.T. & M.' S.Rep. No. 25, Part 9, 76th Cong., 3d Sess., pp. 2-3.
The consolidated pricture of NOTM and its GCL subsidiaries was equally indicative of the lack of an ability to pay dividends to MOP without borrowing.
Care was taken, however, to avoid the appearance of borrowing from MOP to pay dividends to MOP, a practice of doubtful legality. Whenever it was found that NOTM had inadequate income to meet a prospective dividend payment, MOP officers would direct Brownsville, NOTM's principal subsidiary, to take steps to declare a dividend on its stock, all of which was held by NOTM. Usually this dividend was the precise amount by which NOTM lacked money to pay its own dividend. But Brownsville invariably was unable to make a cash payment of its dividends to NOTM and many of its pre-1931 dividend declarations were considered collected by NOTM only at the expense of leaving unpaid Brownsville's debts to NOTM for essential supplies. These paper dividend declarations were capped in 1931 when Brownsville was ordered to declare dividends to NOTM of $4,155,000; in that year Brownsville earned but $398,000. The Bureau of Accounts of the Interstate Commerce Commission in 1936 informed NOTM that these 1931 dividends were declared at a time when NOTM was aware that Brownsville 'was without funds to pay it, and even on the basis of past experience the earnings of the company, had business continued good, would not have been adequate to make the payment until some future date.' This fact rendered the dividends improper under Commission rules. And while it was too late to correct the income accounts of NOTM which had already been closed, NOTM was directed to write off the unpaid portion of the 1931 dividends (some $1,400,000) through profit and loss.
This 1931 incident grew out of the fact that NOTM was operating that year at a great loss. It began that year with a profit-and-loss balance of only $709,000 and operated at a loss of $606,000. It also had to charge off $875,000 to correct its former inadequate depreciation accruals. By the end of 1931, NOTM would have shown a debit profit-and-loss balance of $772,000 or more. MOP, of course, was demanding payment of the usual $1,038,000 dividend for the year. 'The problem was solved as it had been solved in previous years-by milking the Brownsville. But this time the milking would have to be thorough. * * * The solution found was to cause the Brownsville to declare an extraordinary dividend of $3,500,000-a dividend seven times the par value of the stock upon which it was declared. Other Brownsville dividends to the N.O.T & M. brought the total for the year to $4,155,000, enough to fill up the N.O.T.M.'s profit-and-loss deficit and to enable the latter to declare a $1,038,000 dividend in favor chiefly of the Missouri Pacific.' S.Rep. No. 25, Part 9, 76th Cong., 3d Sess., p. 10.
Thus the Brownsville dividend declarations gave NOTM earned surpluses on paper without giving it any cash with which to pay its dividends to MOP. Dividends declared by Brownsville were entered as income to NOTM even though they were not paid. An ostensible legal basis was thereby established for a declaration of dividends to MOP. NOTM would then borrow money from MOP to pay for those dividends. This again was largely a paper transaction. The earned surplus upon which the Court today places great reliance in affirming the District Court's findings was but a figment of the MOP imagination. 'The intricate accounting devices evolved by railroad and holding company officials in an attempt to legalize dividend payments unjustified by earnings resulted, both in 1930 and 1931, in the payment of N.O.T. & M. devidends out of capital, a procedure disguised in 1930 behind faulty bookkeeping and in 1931 behind an out-and-out violation of Interstate Commerce Commission accounting regulations.' S.Rep. No. 25, Part 9, 76th Cong., 3d Sess., p. 14.
By advancing to NOTM $2,795,000, MOP received back $2,654,000 in dividends within a few days after the various loans, making a total net advance of $141,000. MOP's cash position was unaffected by these various transactions, the NOTM dividends merely giving it a paper profit and loss balance out of which to declare its own dividends. Hence MOP, like NOTM, was forced to borrow money; it did so from outside sources. Yet MOP now seeks to claim nearly all of the $2,795,000 plus interest, an aggregate of about $4,795,000, for engaging in these bookkeeping transactions and for extending credit to the extent of $141,000.
NOTM's fiscal affairs in this respect have certainly not 'been conducted with an eye single to its own interests' within the meaning of the Deep Rock doctrine. Taylor v. Standard Gas & Electric Co., supra, 306 U.S. at page 323, 59 S.Ct. at page 550. Now can these transactions be said to meet the test of 'inherent fairness' and the requirement of an 'arm's length bargain,' which are essential ingredients of that doctrine. Pepper v. Litton, supra, 308 U.S. at pages 306, 307, 60 S.Ct. at page 245. Here, as in the Taylor case, dividends were declared in the face of the fact the NOTM had not the cash available to pay them and was, at the time, borrowing in large amounts from MOP. And see In re Commonwealth Light & Power Co., Cir., 141 F.2d 734, 738. Compelling a subsidiary to pay dividends under these circumstances is the type of mismanagement by a parent which leads to the subordination of the resulting indebtedness.
Another part of the $10,565,226.78 MOP claim related to an intercompany adjustment of $1,261,009.84 made during October, 1932, at the height of the depression and shortly before the § 77 proceedings began.
The International-Great Northern Railroad Co. (hereinafter called the I-GN) was a subsidiary of NOTM, although not deemed a part of the GCL system. I-GN had advanced cash or delivered materials to ten of NOTM's GCL subsidiaries; as of October 31, 1932, these ten companies were indebted to I-GN in the sum of $1,261,009.84 on account of these transactions. On the same date, I-GN was indebted to MOP in an amount in excess of $1,261,009.84.
It was known at this time that the I-GN claims against the NOTM subsidiaries were presently uncollectible. It was also apparent that NOTM was in better financial health than I-GN. MOP, which was then in need of loans from outside sources, sought to improve its own financial condition by shifting debtors. It did this by increasing its claim against NOTM by $1,261,009.84 and by decreasing its claim against I-GN by that same figure. To make this bookkeeping shuffle possible, I-GN credited NOTM and its other subsidiaries with the payment of the $1,261,009.84 debt which those subsidiaries owed. MOP then credited I-GN with payment of a like amount, crediting it against I-GN's debt to MOP. NOTM thereby found itself obligated to pay MOP an additional $1,261,009.84. Appropriate entries were made, of course, in the journals of the affected companies.
NOTM had not previously been liable to pay this amount to MOP; nor did it receive anything of value from MOP in return for assuming the debt. Yet no valid reason is suggested why NOTM should have been forced to shoulder this obligation, thereby decreasing the assets available to its creditors and stockholders. Certainly it was not essential, as has been claimed, that NOTM acquire the debt to protect its ownership and control of its GCL subsidiaries. NOTM was invulnerable in that respect, owning all the securities of the subsidiaries, and the addition of this debt added no new protection. The contention is also made that NOTM owed a fiduciary obligation to I-GN, its subsidiary, and that it was NOTM's duty to relieve I-GN of any uncollectible items owed by other NOTM subsidiaries. The fiduciary obligation grows out of the fact that NOTM owned all the securities of its GCL subsidiaries. This contention is closely allied to the theory that NOTM and the subsidiaries are a single financial entity and that it is immaterial which company within that entity is liable for the debt. But the close relationship of NOTM and its GCL subsidiaries does not legitimatize the intercompany adjustment from an equitable point of view. In this situation, we are dealing with the rights of creditors and stockholders who are directly interested in the financial well-being of NOTM as an enterprise separate and distinct from its subsidiaries. Hence it is necessary here to recognize and give effect to the corporate distinctions between NOTM and its GCL subsidiaries.
The resulting picture is one of a bookkeeping write-up of NOTM indebtedness at a time when NOTM was on the threshold of reorganization. NOTM received nothing whatever to compensate for the increase in its debt structure. The increase served only to enable MOP, the parent, to possess what was thought to be a more favorable vorable creditor's position. Such treatment of a subsidiary's debt structure does not square with a parent's fiduciary position. A subsidiary is entitled to be saddled by a parent only with those debts which may fairly be allocated to it, debts which grow out of legitimate business transactions. To transfer debts promiscuously from one subsidiary to another merely to augment the parent's creditor status is to inflict an injustice upon the creditors and stockholders of the subsidiary to which the debt is shifted. It is a type of mismanagement of a subsidiary which properly calls the Deep Rock doctrine into operation, causing the subordination of the parent's claim for the amount of the transferred debt.
The remainder of the $10,565,226.78 claim concerned the advances made by MOP to NOTM to acquire five Texas 'feeder' railroad lines at a cost of over $5,500,000.
Comstock's contention in this respect is that the acquisition of these lines was for the sole benefit of MOP and I-GN, rather than for NOTM or the GCL system. Reference is made to a statement of the Interstate Commerce Commission that these 'feeder' lines 'were really acquired for the benefit of the entire MOP system. They have usually been operated at a deficit since acquisition.' Missouri Pacific R. Co. Reorganization, 239 I.C.C. 7, 71. Moreover, some of the 'feeder' lines are said not to connect at all with the lines of NOTM or its GCL subsidiaries. And it is thought that some of the MOP advances were used to cover operating deficits of the acquired property. Such is the basis of the objection to the recognition of MOP's claim against NOTM for the cost of the 'feeder' lines.
There is nothing in the record to support an application of the Deep Rock doctrine to this aspect of MOP's claim. The use of NOTM to acquire subsidiary rail lines which have subsequently been operated at a loss does not necessarily indicate improper action by MOP; a mere mistake in business judgment may be all that was involved. And the fact that the acquisition may have been primarily for the benefit of some part of the MOP system other than the GCL companies does not necessarily mean that the acquisition was outside the legitimate scope of the functions of NOTM, a holding company in the MOP system.
Indeed, the main thrust of Comstock's objection to this segment of the MOP claim is directed toward the entire history of MOP's management of NOTM. The thought is that the relationship of the parent and the subsidiary has been so complex and so saturated with mismanagement as to warrant subordination of the entire claim of the parent without bothering to differentiate between particular transactions. See Taylor v. Standard Gas & Electric Co., supra, 306 U.S. at page 323, 59 S.Ct. at page 550. But the record does not support such an approach to the MOP-NOTM relationship. There have been, as we have seen, two examples of mismanagement on MOP's part that warrant the application of the Deep Rock doctrine. But those situations are separable in nature from the other transactions between MOP and NOTM. And the Deep Rock doctrine is not one that operates to bar an entire parental claim if only a separable portion of it is inequitable. It is only where, as in the Taylor case, the parent-subsidiary relationship has been so complex that it is impossible to restore the subsidiary to the position it would have been in but for the parent's mismanagement that the entire claim may be subordinated without distinguishing the good transactions from the bad. Such is not the situation in this case.
From the findings of the District Court and the uncontested facts in the record, I can only conclude that of the $10,565,226.78 MOP claim, the portion of the $2,795,000 relating to dividend advances during the period in question and the $1,261,009.84 relating to the intercompany bookkeeping transaction should be subordinated to the claims of the pledgees of NOTM stock. In holding otherwise, the District Court committed an error which this Court should not overlook.

## Notes

* ↑ The leading party opposing Comstock on this appeal was the Group of Institutional Investors, holding first and refunding mortgage bonds of MOP. This group represented less than 10% of such bonds and admitted that it had 'no financial interest in the controversy revolving about' the MOP claim, its only interest being to expedite a reorganization plan then under consideration. But this group offered the only evidence in the District Court in support of the MOP claim. Another party was the NOTM mortgage and income bondholders committee, which also admitted it had no direct interest in the MOP claim litigation. Other parties included MOP, the MOP common and preferred stockholders committees, the MOP trustee, Alleghany Corporation, and certain groups of creditors and indenture trustees. These parties are now respondents before us.
* ↑ The method by which MOP would bring about the Brownsville declaration of dividends is shown by the following typical exchange of letters between NOTM and MOP officials:
'Houston, January 10, 1931.
'Mr. L. W. Baldwin: The net income of the NOT&M for the three months ending November 30th, 1930, reflects a deficit of $56,613.10, which is $316,188.85 short of quarterly dividend requirements of the NOT&M due December 1st, 1930.
'I am attaching hereto statement showing result of operations for the months of September, October, and November 1930.
'Following past practice, we will arrange for Mr. Cole to list for action at the next meeting of the Board of Directors of the StLB&M (Brownsville), a resolution providing that dividend be declared out of the surplus of the StLB&M in favor of the NOT&M.
'H. R. Safford.
'F.'
The reply to the foregoing letter follows:
'St. Louis, Mo., January 13, 1931.
M r. Safford: Referring to your letter of January 10th, file 482-2, with reference to declaring dividend out of the surplus of the St. Louis, Brownsville & Mexico Railway Company in favor of the New Orleans, Texas & Mexico Railway Company.
'It will be satisfactory to handle this in line with your letter.
'L. W. Baldwin,
'Per C.D.P.'
On June 17, 1931, Brownsville declared a dividend of $316,188.85, the precise amount of the NOTM deficit; the dividend was declared effective as of November 30, 1930, one day prior to the dividend date for NOTM's stock.
This work is in the public domain in the United States because it is a work of the United States federal government (see 17 U.S.C. 105).
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