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Matched Legal Cases: ['§ 11', '§ 11', '§ 11', '§ 11', '§ 77', '§ 11']

OTIS & CO. V. SEC, 323 U. S. 624 - Volume 323 - 1945 - Full Text - US Supreme Court Center - USSC Cases - Nolo
US Supreme Court Center > Volume 323 > OTIS & CO. V. SEC, 323 U. S. 624 (1945) > Full Text
OTIS & CO. V. SEC, 323 U. S. 624 (1945)
1. Whether a provision of a corporate charter granting the preferred stock a specified preference upon liquidation applies to a liquidation in a simplification pursuant to § 11(b)(2) and (e) of the Public Utility Holding Company Act of 1935 is a question of federal law. P. 323 U. S. 636.
2. A provision of a corporate charter granting the preferred stock a specified preference upon liquidation, adopted six years prior to the enactment of the Public Utility Holding Company Act of 1935, held inoperative in a simplification by liquidation under § 11(b)(2) of that Act. P. 323 U. S. 637.
3. Continental Insurance Co. v. United States, 259 U. S. 156, distinguished. P. 323 U. S. 638.
4. In a liquidation pursuant to § 11(b)(2) of the Public Utility Holding Company Act of 1935, allocation of the assets a between different classes of securities may be made without dollar valuation so long as each security holder in the order of his priority receives the equitable equivalent of rights surrendered. P. 323 U. S. 639.
An important although narrow legal point in the interpretation of the Public Utility Holding Company Act of 1935 [Footnote 1] is involved in this case. This is whether a plan under section 11(e) of that act may be "fair and equitable" to preferred stockholders within the meaning of those words as used in that section, which allows a participation by junior common stockholders in the distribution of the assets of a registered holding company, which is liquidated in compliance with section 11(b)(2), before the senior preferred stockholders receive securities whose present value equals the preferred's full liquidation preferences.
In proceedings for the simplification of the system, after finding that Power violated the great-grandfather clause, an order was entered on March 20, 1941, directing that Power be liquidated and dissolved. [Footnote 2] The order authorized Power to submit to the Commission a plan for compliance with the order "on a basis which is fair and equitable to its security holders." Power, with its registered holding company subsidiary, The United Light and Railways Company, a Delaware corporation, all of whose common stock was owned by Power, submitted such a plan and, after examination by the Commission and modification, it was approved by order of April 5, 1943. The Plan was held specifically to be fair and equitable to all security holders. By the application and order, Railways' participation
It approved the Plan for the liquidation and dissolution of Power as "necessary to effectuate the provisions of Section 11(b) of the" Act. [Footnote 3] It directed counsel for the Commission to apply to an appropriate federal court for an order enforcing the Plan. [Footnote 4] The central feature of the Plan
This order was preceded by an examination by the Commission into the situation of this holding company system. [Footnote 5] For a clear understanding of the single issue as to whether, in the liquidation of a holding company by order of the Commission under section 11(e), a participation by junior security holders in the assets is permissible before preferred security holders have received the entire liquidating preference secured to them by the company's charter, it is sufficient to state only the following facts, about which there is no controversy between the litigants. Power is a solvent company. As of April 30, 1942, and there is no intimation that its condition has worsened, its balance sheet showed assets of $81,159,075 and liabilities of only $6,132,976, without consideration of its capital stock structure. Its principal asset, the Railways common stock heretofore referred to, has a book value in excess of the $72,000,000 plus, at which it is carried on Power's balance sheet, and an actual value which makes Power unquestionably solvent with large equity values in its stock.
of $98,700,000. [Footnote 6] There are 2,421,192 shares of Class A common and 1,055,576 shares of Class B common. [Footnote 7]
The Commission found the balance sheet value of all Railways' common on a pro forma corporate basis to be $77,954,874, and when using a pro forma consolidated basis for the entire system, to be $81,554,330. On a capitalization of reasonably anticipated earnings of the system, the Commission was unable to find a value for Railways' common "which approaches $98,700,000.00." [Footnote 8]
The Commission's order of March 20, 1941, for the liquidation and dissolution of Power was a step in the simplification of the holding company system which simplification was enjoined by section 11(b)(2) of the Act. Satisfaction of the great-grandfather clause might have been obtained in this or other holding company systems by an order for merger, consolidation, or recapitalization between top holding companies or between associate companies in the lower tiers of the corporate hierarchy. Such procedure would avoid the liquidation of Power. Cf. Windhurst v. Central Leather Co., 105 N.J.Eq. 621, 149 A. 36; Porges v. Vadsco Sales Corp., 32 A.2d 148, 151. The selection by the Commission of one method of system adjustment to accomplish simplification, rather than another, is an incident which ought not to affect rights. The exercise of legislative power by Congress through section 11(b)(2) to accomplish simplification as a matter of public policy and the Commission's administration of the Act by dissolution of this particular company results in a type of liquidation which is entirely distinct from the "liquidation of the corporation, whether voluntary or involuntary" envisaged by the charter provisions of Power for preferences to the senior stock. [Footnote 9]
This conclusion permitted the Commission to examine the investment values of the common and preferred stocks of Power. The rights of the preferred stock to $6 annual cumulative dividends in the going business [Footnote 10] and to full priority in liquidation other than by operation of the Act were treated as factors in valuation, rather than determinative
of amounts payable in a traditional dissolution. Upon analysis of the Holding Company System's experience and upon an estimate of future earnings, the Commission assumed earnings of $6,185,000 annually which would be applicable to Railways' common and, as a consequence of the distribution, to Power's preferred and common stockholders. Since the annual preferred dividend requirements were $3,600,000, there appeared a balance of $2,585,000 available for the reduction of preferred stock arrearages of $38,700,000 as of December 31, 1942. The Commission noted that, if all the assumed earnings materialized and were applied to liquidating the preferred current and deferred dividends, in approximately fifteen years, the arrearages would be paid and the common would be in a position to receive dividends. [Footnote 11] Furthermore, only by forced liquidation could the common stock be deprived of its possibility for future earnings. Only by means of forced liquidation and the receipt of all Railways' common could Power's preferred gain a right to prospective earnings above its guaranteed dividends. The deferred dividends do not bear interest. While recognizing that the common stock participation was remote, the Commission determined that, in its "overall judgment," Power's common had a legitimate investment value of a proportion of 5.48 percent of Power's assets to the preferred's value of 94.52 percent. Such a conclusion is not "susceptible of mathematical demonstration," [Footnote 12] any more than any other valuation of a utility's worth. The Commission determined this allocation was fair and equitable within section 11(e).
as though in a continuing enterprise, instead of in liquidation. Petitioner relies upon the charter rights which on liquidation of Power give to the preferred $100 and the cumulated and accrued dividends. Note 6 supra. It relies upon the authorities of this and other courts which hold that, under a full priority rule, junior securities in bankruptcy or equity reorganizations may not participate in the assets until the rights of the holders of senior securities are satisfied in full. [Footnote 13] Petitioner says:
We reach the conclusion that the Securities and Exchange Commission applied the correct rule of law as to the rights of the stockholders inter sese. That is to say, when the Commission proceeds in the simplification of a holding company system, the rights of stockholders of a solvent company which is ordered by the Commission to distribute its assets among its stockholders may be evaluated on the basis of a going business, and not as though a liquidation were taking place.
The creditors are satisfied. [Footnote 14] No possibility exists that simplification of structure is employed here to evade or nullify creditors' rights in reorganization or to take the place of traditional reorganization. [Footnote 15]
Like the bankruptcy and reorganization statutes, the Public Utility Holding Company Act, in providing that plans for simplification be "fair and equitable," incorporates the principle of full priority in the treatment to be accorded various classes of security interests. This right to priority in assets which exists between creditors and stockholders exists also between various classes of stockholders. When, by contract as evidenced by charter provisions, one class of stockholders is superior to another in its claim against earnings or assets, that superior position must be recognized by courts or agencies which deal with the earnings or assets of such a company. Fairness and equity require this conclusion. Even before our decision in Case v. Los Angeles Lumber Products Co. on November 6, 1939, recent federal cases had recognized this priority. [Footnote 16] That has been their view since the Case decision, In re Porto Rican American Tobacco Co., 112 F.2d 655, 656, 657. This is the rule applied by the Commission
in the simplification of corporate structure. The Commission recognizes and applies the doctrine of full priority by giving value to the rights of the preferred in a going concern, rather than as if by sale and distribution. Its views are stated below. [Footnote 17] The issue in this case is not whether full priority should be given to preferred over common stockholders, but whether the priority which is established by the charter, note 6 is applicable to a simplification by liquidation under § 11(b)(2) and (e). There is an argument that, if the charter provision applies to this situation, it cannot be disregarded, and that, in such a liquidation, "fair and equitable" would require the distribution
The applicability of the charter provision under the Public Utility Holding Company Act of 1935 is a matter of federal law. [Footnote 18]
Id., p. 60. Of course, Congress would wish, in simplifying a holding company system capital structure, to preserve values to
investors, not to destroy them. [Footnote 19] Consequently, while giving the Commission power to compel the elimination of holding companies, deemed uneconomic, it allowed the affected companies to propose plans to the Commission to effectuate the objects and the Commission to approve such plans when they were considered "fair and equitable." Sections 11(b)(2) and (e), notes 3 and 4
It may be that, if the charter liquidation preference were held to cover this situation, it would not frustrate the simplification of the holding company system to the same degree that the gold clause agreements interfered with the power of Congress to regulate the gold content of the dollar. Norman v. Baltimore & O. R. Co., 294 U. S. 240, 294 U. S. 306 et seq., and cases cited. Distribution to preferred stockholders only with disregard of common's interest would eliminate Power and cure the system's present inconsistency with the great-grandfather clause. We think, however, the charter preference is inoperative in simplification under section 11(b)(2). The provision having been adopted in 1929, six years prior to enactment of the Public Utility Holding Company Act, a "simplification" under this Act, having as an incident to it the dissolution of one company in a holding company system, was not an anticipated "liquidation" within the meaning of Power's charter provision. Enforcement of an overriding public policy should not have its effect visited on one class with a corresponding windfall to another class of security holders. Nor should common stock values be made to depend on whether the Commission, in enforcing compliance with the Act, resorts to dissolution of a particular company in the holding company system, or resorts instead to the devices of merger
or consolidation, which would not run afoul of a charter provision formulated years before adoption of the Act in question. The Commission, in its enforcement of the policies of the Act, should not be hampered in its determination of the proper type of holding company structure by considerations of avoidance of harsh effects on various stock interests which might result from enforcement of charter provisions of doubtful applicability to the procedures undertaken. Where preexisting contract provisions exist which produce results at variance with a legislative policy which was not foreseeable at the time the contract was made, they cannot be permitted to operate. Compare New York Trust Co. v. Securities and Exchange Commission, 131 F.2d 274; In re Laclede Gas Light Company, 57 F.Supp. 997. The reason does not lie in the fact that the business of Power continues in another form. That is true of bankruptcy and equity reorganization. It lies in the fact that Congress did not intend that its exercise of power to simplify should mature rights, created without regard to the possibility of simplification of system structure, which otherwise would only arise by voluntary action of stockholders or, involuntarily, through action of creditors. We must assume that Congress intended to exercise its power with the least possible harm to citizens.
But it is said that such a conclusion is at variance with this Court's ruling in Continental Ins. Co. v. United States, 259 U. S. 156. In that case, a liquidation of the Reading Company, a holder of interests in railroads and coal mines, was compelled by governmental prosecution so that it would not be operating in violation of the Sherman Anti-Trust Act or the Hepburn Act. [Footnote 20] Its coal properties, corporate assets, were passed to a newly organized
coal company, the value of whose stock, by negotiable certificates of interest, came into possession of Reading's old stockholders individually. The distribution gave equal participation in the coal properties to the common and preferred stock in accordance with the charter agreement as to assets on liquidation, pages 259 U. S. 177-181. The common stock contended that as the value of the coal properties was surplus, all of the coal certificates should go to the common stockholders as in a continuing business. Thus, by its approval of the distribution, this Courts handled the liquidation, which was forced by law, says petitioner, in accordance with the charter provisions and not as though it were a continuing business.
The Continental or Reading case turned, however, on the charter rights of the preferred to share equally with the common in earnings which had become assets, pages 259 U. S. 179-180, not on whether a right to share was matured or varied by governmental action. Contrary to the situation in this present case, the charter provisions of the Reading Company were adopted with knowledge of the sanctions of the Sherman Act against monopoly. 259 U.S. at 259 U. S. 177 and 259 U. S. 171. We do not feel constrained by its dealing with charter rights as in a normal liquidation to hold that, where liquidation is adopted as a matter of administrative routine, the preferences are thereby matured.
As indicated earlier in this opinion, we have not undertaken to review the facts to determine whether the allocation of stock between the preferred and common is in proper proportion. That issue is not made. It was vigorously discussed by Commissioner Healey in the dissenting opinion. Holding Company Act Release 4215, p. 39 et seq. See Dodd, Holding Company Act Recapitalizations, 57 Harv.L.Rev. 295, 319. The allocation properly may be made without dollar valuation so long as
Group of Investors v. Chicago, M., St. P. & P. R. Co., 318 U. S. 523, 318 U. S. 565, supra; Consolidated Rock Products Co. v. Du Bois, 312 U. S. 510, 312 U. S. 529; Ecker v. Western Pacific R. Corp., 318 U. S. 448, 318 U. S. 482; Kansas City R. v. Cent. Union Tr. Co., 271 U. S. 445, 271 U. S. 455, supra.
Northern Pacific Railway Co. v. Boyd, 228 U. S. 482; Case v. Los Angeles Lumber Products Co., 308 U. S. 106; Consolidated Rock Products Co. v. Du Bois, 312 U. S. 510; Marine Harbor Properties v. Manufacturers' Trust Co., 317 U. S. 78; Ecker v. Western Pacific R. Corp., 318 U. S. 448; Group of Institutional Investors v. Chicago, M., St. P. & P. R. Co., 318 U. S. 523.
Creditors' contracts also have been declared subject to equitable adjustment in corporate reorganizations so long as they receive "full compensatory treatment," whether the reorganization is in bankruptcy (Kansas City Terminal R. v. Central Union Trust Co., 271 U. S. 445, 271 U. S. 455; Consolidated Rock Products Co. v. Du Bois, 312 U. S. 510, 312 U. S. 528; Group of Investors v. Chicago, M., St. P. & P. R. Co., 318 U. S. 523, 318 U. S. 565, 566, supra) or in compliance with regulatory statutes. Continental Ins. Co. v. United States, 259 U. S. 156, 259 U. S. 170, 259 U. S. 176. The full priority rule applies to reorganizations of solvent companies. Consolidated Rock Products Co. v. Du Bois, 312 U. S. 510, 312 U. S. 527.
See In the Matter of Jacksonville Gas Company, Holding Company Act Release No. 3570, In re Jacksonville Gas Co., 46 F.Supp. 852, 856.
In re New York Railways Corp., 82 F.2d 739, 743, 744; In re National Food Products Corp., 23 F.Supp. 979, 985; In re Utilities Power & Light Corp., 29 F.Supp. 763, 769.
"Under the circumstances, fair and equitable compensation will be given to all of the claimants if their rights are measured not in terms of the situation created by the statute, but rather in terms of the situation terminated by it -- i.e., as though no liquidation were to take place. In this way, each class of stock will be accorded its proportionate share of the benefits to be gained from the elimination of a useless and expensive corporate entity and from the receipt of a security representing a more direct investment in the underlying assets and earnings of the system."
Jerome v. United States, 318 U. S. 101, 318 U. S. 104; Wragg v. Federal Land Bank, 317 U. S. 325, 317 U. S. 328; Chicago Board of Trade v. Johnson, 264 U. S. 1, 264 U. S. 10; Sola Electric Co. v. Jefferson Electric Co., 317 U. S. 173, 317 U. S. 176; Labor Board v. Hearst Publications, 322 U. S. 111, 322 U. S. 120, 322 U. S. 129; Clearfield Trust Co. v. United States, 318 U. S. 363, 318 U. S. 366; O'Brien v. Western Union Telegraph Co., 113 F.2d 539, 541.
259 U. S. 259 U.S. 156 at 259 U. S. 177; United States v. Reading Co., 253 U. S. 26; 26 Stat. 209; 34 Stat. 584.
When the preferred stock of United was issued in 1929, there were numerous statutes, state and federal, which authorized liquidation and dissolution of corporations by government compulsion. See, for example, Continental Insurance Co. v. United States, 259 U. S. 156. It is the veriest fiction to say that investors in corporate securities at that time could not or did not consider the possibility of the addition of a single statute to this list, or that the stockholders of United, by the stipulation for priority upon liquidation, voluntary or involuntary, intended to exclude from its operation any method of involuntary liquidation which would affect their interests. To conclude that the present stipulation for priority upon involuntary liquidation did not envisage a liquidation such as this one seems like saying that an insurance policy
We cannot assent to the proposition advanced by the Commission that, even though the priority stipulation was intended to be applicable to any kind of an involuntary liquidation, including one such as the present, the Commission can nevertheless override it. Such provisions for priority in a corporate charter constitute a contract among the stockholders, which is entitled to constitutional protection, Bedford v. Eastern Building & Loan Assn., 181 U. S. 227; Hopkins Federal Savings & Loan Assn. v. Cleary, 296 U. S. 315; Treigle v. Acme Homestead Assn., 297 U. S. 189, 297 U. S. 194, 196, impairment of which is not lightly to be attributed to Congress. No constitutional issue is raised here, but we find no provision of the statute which purports to confer on the Commission, in the exercise of its power to liquidate a corporation, any authority to set aside a lawful stipulation in which the stockholders have joined fixing their relative rights in the event of liquidation.
Hence, there is no basis for the exercise of equity powers to adjust the rights of parties to a contract which has been set aside; or for the Commission's argument, which the Court of Appeals below seems to have sustained, 142 F.2d 411, 419, that the action of the Commission is supportable as an exercise of the judicial power to make an equitable disposition of the rights of the parties to a frustrated contract. Cf. New York Trust Co. v. Securities and Exchange Commission, 131 F.2d 274.
The phrase "fair and equitable," as applied to any form of corporate reorganization, has long been recognized as signifying the requirement of the rule sanctioned by this Court in Northern Pacific R. v. Boyd, 228 U. S. 482, and the many cases following it. The rule is that any arrangement or plan enforced without the consent of the parties affected by it, by which the subordinate rights and interests of stockholders are attempted to be secured at the expense of the prior rights of other security holders, is unfair and inequitable, and will not be judicially sanctioned. See Case v. Los Angeles Lumber Co., 308 U. S. 106, and cases cited. This rule is applicable with respect to the priorities of different classes of stockholders, as well as to priorities between creditors and stockholders, and for the same reasons. Case v. Los Angeles Lumber Co., supra, 308 U. S. 119, note 14.
In the Los Angeles case, supra, we held that the words "fair and equitable" had so long been recognized and applied as signifying this rule of priority among security holders in corporate reorganizations as to have become words of art, and that their adoption by § 77B of the Bankruptcy Act, as applicable to reorganizations under that section, must be taken to have incorporated the rule of the Boyd case in the statute, in the absence of any context requiring a contrary construction. We think no other constitution of § 11(e) of the present Act can be sustained. Neither the context of the statute nor the legislative history suggests any other. The Commission hints at no reason for not giving these terms of art, "fair and equitable" other than their long settled and hitherto accepted meaning.
The Gold Clause Cases, Norman v. B. & O. R. Co., 294 U. S. 240, supra, afford no analogy and lend no support to what is now adjudged. There, Congress, with the authority of an express provision of the Constitution, explicitly altered existing contracts. Here, Congress has commanded the Commission to respect contract rights by requiring that its action conform to the well defined meaning of the phrase "fair and equitable." Congress seems to have recognized that the stipulated priorities of stockholders were
not to be disturbed in liquidations ordered under the Public Utility Holding Company Act. The report of the Senate Committee (S.Rep. No. 621, 74th Cong., 1st Sess., p. 33) recommending the enactment of the present statute and proponents of the Bill (H.R.Rep. 1318, 74th Cong.1st Sess., pp. 49-50; 79 Cong.Rec. 4607, 8432) repeatedly cited Continental Insurance Co. v. United States, supra, in which it was held that the distribution in a liquidation compelled by the enforcement of the Sherman and Hepburn Acts must preserve the stipulated priorities of the several classes of stockholders of the offending corporation.
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