Source: http://www.chanrobles.com/usa/us_supremecourt/379/594/case.php
Timestamp: 2018-07-17 17:11:16
Document Index: 475353696

Matched Legal Cases: ['§ 701', '§ 501', '§ 328', '§ 728', '§ 77', '§ 8', '§ 77', '§ 328', '§ 77', '§ 77', '§ 77', '§ 77', '§ 78', '§ 77', '§ 167', '§ 167', '§ 172', '§ 175', '§ 179', '§ 221', '§ 362', '§ 366', '§ 342', '§ 332', '§ 332', '§ 306', '§ 336', '§ 328', '§ 328', '§ 141', '§ 146', '§ 366']

The issue in this case is whether respondent's attempted corporate rehabilitation under the Bankruptcy Act, materially affecting the rights of widespread public investor creditors, may be conducted under Chapter XI of the Bankruptcy Act, 52 Stat. 905, as amended, 11 U.S.C. § 701 et seq. (1958 ed.), or whether dismissal or, in effect, transfer to proceedings under Chapter X of that Act, 52 Stat. 883, as amended, 11 U.S.C. § 501 et seq. (1958 ed.), is required upon motion by the Securities and Exchange Commission or any other party in interest, pursuant to § 328 of the Bankruptcy Act, 66 Stat. 432, 11 U.S.C. § 728 (1958 ed.). [Footnote 1] chanroblesvirtualawlibrary
Page 379 U. S. 598
Respondent's further offering of these sale and lease-back arrangements to the public was halted in 1961, when the SEC advised respondent that these sale and lease-back arrangements were investment contracts, and therefore securities, which could not be sold to the public unless and until a registration statement was filed and became chanroblesvirtualawlibrary
Page 379 U. S. 599
effective under the Securities Act of 1933, 48 Stat. 74, as amended, 15 U.S.C. § 77a et seq. (1958 ed.). Respondent then filed a registration statement with the SEC pertaining to these sale and lease-back arrangements. This registration statement, however, never became effective, and proceedings were instituted by the SEC to stop distribution of respondent's proposed prospectus on the grounds that it contained false and misleading statements. See Securities Act of 1933, § 8(d), 48 Stat. 79, 15 U.S.C. § 77h(d) (1958 ed.). In June 1963, respondent consented to the entry of an order stopping distribution of this prospectus. See SEC, Securities Act Release No. 4615 (1963).
Following this event, respondent filed a petition and a proposed plan of arrangement under Chapter XI of the Bankruptcy Act. The petition, annexed schedules, and other documents show that respondent had never operated at a profit. For the three years ended September chanroblesvirtualawlibrary
Page 379 U. S. 600
30, 1961, it had an aggregate income from "gross rentals" of $395,610. In the same period, it made rental payments to investor-trailer owners of $613.021; made payments to gasoline station operators of $118,400; and incurred additional "operating expenses" of $668,698.
The $613,021 paid to trailer owners included payments to investors whose trailers had not yet been obtained and put into the system. In order to make the necessary payments to trailer owners and station operators, respondent had not only borrowed money from its officers, directors, and stockholders, but also had used funds obtained for purchase of new trailers. Virtually all the trailers were purchased from an affiliate in which respondent's officers and directors had interests. Many of these trailers proved defective in design, or otherwise unsuitable for rental. About a year prior to the filing of respondent's Chapter XI proceeding, this manufacturing affiliate became bankrupt, owing respondent approximately $200,000 for trailers that were never manufactured and an additional amount of approximately $150,000 for trailers that were manufactured but never delivered. These latter trailers had been mortgaged by the affiliate to a third party who took possession upon the affiliate's bankruptcy. In addition, in June, 1961, some 100 trailers, as to which respondent, although obligated by the lease-back arrangements to do so, did not have insurance coverage, were unlocatable, and considered lost. Finally, certain funds received from investors for the purchase of trailers had been at an earlier period, misappropriated by a member or members of respondent's management. Respondent's executive vice president, who estimated this misappropriation loss to be at least $141,000, attributed it "almost completely" to a deceased member of the original management group, but did not feel "qualified to make [the] judgment" that the two remaining members chanroblesvirtualawlibrary
Page 379 U. S. 601
Under the proposed plan of arrangement submitted by respondent, the investor-trailer owners were to exchange their entire interests (their rights in the trailers as well as the amounts owed them under the rental agreements) for stock of Capitol on the basis of one share of stock for each $2 of "remaining capital investment in the trailers," which sum was to be determined by deducting from the original purchase price of the trailers the amount, if any, which the owners had received as rental payments. [Footnote 5] Respondent's officers and directors, as well as trade and other general creditors, were to receive one share of stock chanroblesvirtualawlibrary
Page 379 U. S. 602
for each $3.50 of their claims. Respondent itself, in exchange for transferring to Capitol its trailer-rental system, was to receive 107,000 shares which it would then distribute to its stockholders. Finally, obligations to two banks, totaling $55,558, although clearly unsecured, were to be paid in full, presumably because the officers and directors of respondent would otherwise have been liable as guarantors of these obligations.
The SEC then filed a motion, under § 328 of the Bankruptcy Act, to dismiss the Chapter XI proceeding or, in effect, transfer it to Chapter X on the ground that it should have been brought under Chapter X of the Bankruptcy Act, and thus Chapter XI is not available. A referee in bankruptcy to whom, as a special master, the motion was referred recommended that it be denied on the grounds that the Commission had not made "a sufficient showing to warrant the granting of the Section 328 motion." At his hearing on this matter, the District Judge recognized that, in light of the fact that the investor-trailer owners were widely scattered and the nature of their individual holdings was small, the proposed plan's issuance of approximately 15% of Capitol's stock to respondent's officers and directors would mean that they, rather than the investor-trailer owners, would have effective control over Capitol, and expressed his "disapproval" of such a result. He also expressed disapproval chanroblesvirtualawlibrary
Page 379 U. S. 603
of preferential treatment of the banks in order to avoid the obligations of the officer and director guarantors. [Footnote 6] The District Court, however, "accepted and adopted" the referee's findings, and denied the motion without a written opinion. The Court of Appeals affirmed, holding that,
Before passage, in 1934, of § 77B of the Bankruptcy Act, 48 Stat. 912, bankruptcy procedures offered no facilities for corporate rehabilitation, which therefore was left to equity receiverships, with their attendant paraphernalia of creditors' and security holders' committees, and of rival plans of reorganization. Lack of judicial control of the conditions attending formulation of the plans, inadequate protection of widely scattered security holders, frequent adoption of plans which favored chanroblesvirtualawlibrary
Page 379 U. S. 604
management at the expense of other interests and which afforded the corporation only temporary respite from financial collapse, so often characteristic of equity receivership reorganizations, led to the enactment of § 77B. See S.Doc.No. 65, 72d Cong., 1st Sess., 90; H.R.Rep.No.1409, 75th Cong., 1st Sess., 2. As does the present Chapter X, § 77B permitted the adjustment of all interests in the debtor, secured creditors, unsecured creditors, and stockholders.
The day preceding the enactment of § 77B, Congress had created the Securities and Exchange Commission as a special agency charged with the function of protecting the investing public, 48 Stat. 885, as amended, 15 U.S.C. § 78d (1958 ed.). At the urging of, and based on extensive studies by, the SEC, § 77B was, in 1938, revised and enacted in changed form as Chapter X. 52 Stat. 883-905. The aims of Chapter X as thus revised were to afford greater protection to creditors and stockholders by providing greater judicial control over the entire proceedings and impartial and expert administrative assistance in corporate reorganizations through appointment of a disinterested trustee and the active participation of the SEC. The trustee in a Chapter X proceeding [Footnote 7] is required to make a thorough examination and study of the debtor's financial problems and management, Bankruptcy Act, §§ 167(3), (5), and then transmit his independent report to the creditors, stockholders, the SEC, and others. Following this, the trustee gives notice to all creditors and stockholders to submit to him proposals for a plan of reorganization. §§ 167(5), (6). The trustee then formulates a plan of reorganization, which he presents to the court. If the court finds the plan worthy of consideration, chanroblesvirtualawlibrary
Page 379 U. S. 605
it may refer it to the SEC for its opinion, and must so refer it where the debtor's liabilities exceed $3,000,000. § 172. When the proposed plan, after approval by the court, is finally submitted to the debtor's creditors and stockholders, it is accompanied by the advisory report of the SEC, as well as the opinion of the judge who approved the plan. § 175. As to each class of creditors and stockholders whose rights are affected by the plan, the plan must receive the approval of the holders of two-thirds in amount of each class of creditors' claims, and, if the debtor has not been found to be insolvent, the holders of a majority of each class of stock. § 179. The plan becomes effective upon final confirmation by the court, based on a finding, inter alia, that "the plan is fair and equitable." § 221.
As part of the same Act in which Chapter X was enacted, Congress also, in 1938, enacted Chapter XI. 52 Stat. 905-916. Chapter XI is a statutory variation of the common law composition of creditors and, unlike the broader scope of Chapter X, is limited to an adjustment of unsecured debts. It was sponsored by the National Association of Credit Men and other groups of creditors' representatives whose experience had been in representing trade creditors in small and middle-sized commercial failures. See Hearings before the House Committee on the Judiciary on H.R. 6439 (reintroduced as H.R. 8046 and enacted in 1938), 75th Cong., 1st Sess., 31, 35; 13 J.N.A.Ref.Bankr. (1938). The contrast between the provisions of Chapter X, carefully designed to protect the creditor and stockholder interests involved, and the summary provisions of Chapter XI is quite marked. The formulation of the plan of arrangement, and indeed the entire Chapter XI proceeding, for all practical purposes, is in the hands of the debtor, subject only to the requisite consent of a majority in number and amount of unsecured chanroblesvirtualawlibrary
Page 379 U. S. 606
creditors, § 362, and the ultimate finding by the court that the plan is, inter alia, "for the best interests of the creditors," § 366. [Footnote 8]
United States Realty, supra, at 310 U. S. 450-451. The debtor generally remains in possession and operates the business under court supervision, § 342. A trustee is only provided in the very limited situation where a trustee in bankruptcy has previously been appointed, [Footnote 9] § 332. There is no requirement for a receiver, but the Court "may" appoint one if it finds it to be "necessary," § 332. The plan of arrangement is proposed by, and only by, the debtor, §§ 306(1), 323, 357, and creditors have only the choice of accepting or rejecting it. Acceptances may be solicited by the debtor even before filing of the Chapter XI petition, and, in fact, must be solicited before court review of the plan, § 336(4). There are no provisions for an independent study by the court or a trustee, or for advice by them being given to creditors in advance of the acceptance of the arrangement. In short, Chapter XI provides a summary procedure whereby judicial confirmation is obtained on a plan that has been formulated and accepted with only a bare minimum of independent control or supervision. This, of course, is consistent with the basic purpose of Chapter XI: to provide a quick and economical means of facilitating simple compositions among general creditors who have been chanroblesvirtualawlibrary
Page 379 U. S. 607
deemed by Congress to need only the minimal disinterested protection provided by that Chapter.
United States Realty involved a corporation with publicly owned debentures, publicly owned mortgage certificates, and publicly owned stock, which proposed a plan of arrangement that would have left the debentures and stock unaffected but would have both extended the time for payment of the publicly held mortgage certificates and reduced their interest rate. The SEC there argued that Chapter X is the exclusive avenue for financial rehabilitation of large corporations with many stockholders. chanroblesvirtualawlibrary
Page 379 U. S. 608
While rejecting this argument as an absolute matter, the Court recognized that,
It should be noted that, prior to United States Realty, a bill had been introduced in Congress to draw a numerical chanroblesvirtualawlibrary
Page 379 U. S. 609
line that would close Chapter XI to any corporation which had any class of its securities owned by 100 or more creditors or stockholders. See Hearing before Special Subcommittee on Bankruptcy and Reorganization of the House Committee on the Judiciary on H.R. 9864, 76th Cong., 3d Sess. In reporting out the bill, the Subcommittee stated:
H.R.Rep.No. 2372, 76th Cong., 3d Sess., 2. chanroblesvirtualawlibrary
Page 379 U. S. 610
We agree with the parties that the principles of United States Realty and General Stores apply to and govern the result in this case. We reaffirm the holdings of these chanroblesvirtualawlibrary
Page 379 U. S. 611
cases that there is no absolute rule that Chapter X must be utilized in every case in which the corporate debtor is publicly owned. As this Court has recognized, Congress has drawn no such hard-and-fast line between the two Chapters. The SEC, purporting to bow to these holdings, urges in this case, however, a variation of its "absolute rule" argument that, while not requiring Chapter X in all cases in which the debtor is publicly owned, would require the use of Chapter X in 100% of the cases involving the rights of public investor creditors.
United States Realty, supra, 310 U.S. at 310 U. S. 452. The SEC's argument, however, is premised on the assertion, for which we can find no support in either the language or legislative history of Chapters X and XI, that Congress has deemed it necessary in all cases involving public investor creditors that they have the protection of the "fair and equitable" doctrine. In fact, the requirement that a plan be "fair and equitable" was part of Chapter XI, as well as Chapter X, until 1952, when Congress deleted it from Chapter XI and replaced it with the requirement that the plan be "for the best interests of the creditors." Congress clearly deemed this chanroblesvirtualawlibrary
Page 379 U. S. 612
latter requirement to be sufficient protection in a proceeding properly in Chapter XI in light of the general philosophy of Chapter XI to expedite "simple" compositions. See S.Rep.No. 1395, 82d Cong., 2d Sess., 10, 11-12; H.R.Rep.No. 2320, 82d Cong., 2d Sess., 19, 20-21. There is no indication that, in so doing, Congress intended in any way to change the law on the interrelationship between Chapters X and XI. In fact, the history is just the opposite. [Footnote 10] In the same Act that deleted the "fair and equitable" requirement from Chapter XI, Congress expressly codified, in § 328, the rule of United States Realty providing for dismissal, or, in effect transfer, of a Chapter XI proceeding if it "should have been brought" in Chapter X. Nothing in this even suggests transfer as an absolute rule to give Chapter X's "fair and equitable" protection to all cases involving public investors, which, presumably, if Congress had so intended, it would have so stated. Moreover, as noted above, supra, pp. 379 U. S. 608-609, a House subcommittee previously approved the United States Realty holding of a general, but not absolute, rule, and had not reported out a bill that would have drawn an absolute line. [Footnote 11]
The SEC further argues that Chapter X is required in all cases involving public investor creditors, because its right to intervene in a Chapter XI proceeding is limited solely to moving under § 328 for a transfer to Chapter X. chanroblesvirtualawlibrary
Page 379 U. S. 613
We reject this argument. The District Court in this case quite properly recognized that the SEC was not so limited in a Chapter XI proceeding, and we hold that, under the statutory scheme, while not charged with express statutory rights and responsibilities as in Chapter X, the SEC is entitled to intervene and be heard in a Chapter XI proceeding. We therefore reject the SEC's variation of its "absolute rule" argument, advanced in this case, that would require the use of Chapter X in all cases in which the rights of public investor creditors are involved. The short answer is that, as with the SEC's original absolute rule argument, Congress has drawn no such absolute line of demarcation between Chapters X and XI.
This does not mean, however, that we disagree with the holding of United States Realty that, although there is no absolute rule requiring that Chapter X be utilized in every case in which the debtor is publicly owned, or even where publicly held debt is adjusted, as a general rule, Chapter X is the appropriate proceeding for adjustment of publicly held debt. See SEC v. Canandaigua Enterprises Corp., 339 F.2d 14 (C.A.2d Cir.). Not only do we not disagree with this holding, but we expressly reaffirm it. [Footnote 12] Public investors are, as here, generally widely scattered and are far less likely than trade creditors to be aware of the financial condition and cause chanroblesvirtualawlibrary
Page 379 U. S. 614
of the collapse of the debtor. They are less commonly organized in groups or committees capable of protecting their interests. They do not have the same interest as to trade creditors in continuing the business relations with the debtor. Where debt is publicly held, the SEC is likely, as here, to have become familiar with the debtor's finances, indicating the desirability of its performing its full Chapter X functions. It seems clear that, in enacting Chapter X, Congress had the protection of public investors, and not trade creditors, primarily in mind. As noted above, Chapter X is one of many Acts in which the SEC has the statutory right and responsibility to protect public investors. [Footnote 13] Finally, again it is clear that Congress was thinking of Chapter XI as primarily concerned with adjustment of the rights of trade creditors when it deemed the "fair and equitable" doctrine to be unnecessary to "simple" compositions in Chapter XI. [Footnote 14]
On the other hand, General Stores also makes it clear that, even though there may be no public debt materially chanroblesvirtualawlibrary
Page 379 U. S. 615
and directly affected, Chapter X is still the appropriate proceeding where the debtor has widespread public stockholders and the protections of the public and private interests involved afforded by Chapter X are required because, for example, there is evidence of management misdeeds for which an accounting might be made, there is a need for new management, or the financial condition of the debtor requires more than a simple composition of its unsecured debts.
Applying the above principles, it is obvious that Chapter X is the appropriate proceeding for the attempted rehabilitation of respondent in this case. Here, public debts are being adjusted. The investors are many and widespread, not few in number intimately connected with the debtor, and the adjustment is quite major, and certainly not minor. These facts alone would require Chapter X proceedings under the above-stated principles. In addition there is here, as we have previously pointed out, substantial evidence of misappropriation of assets, and not only is there a need for a complete corporate reorganization, but it is obvious that the proposed plan of arrangement is just that. The trailer owners are exchanging their entire interests, including a sale of their trailers, in exchange for stock in a new corporation, in which other creditors of respondent, including respondent's officers and directors, as well as respondent itself, will have substantial interests. Indeed, this is the same complete reorganization, except that the plan here gives the public investor creditors even less than was previously offered, see note 5 supra, that the SEC previously stopped as a public offering on the grounds that the offering material contained false and misleading information. The Court of Appeals itself recognized, 325 F.2d 53,
"that if the stock involved here were not part of an arrangement, the disclosures made with regard to it [in soliciting the trailer owners' consents to the plan] would be clearly
Page 379 U. S. 616
inadequate. No authority has been found which would indicate that recipients of stock issued in connection with an arrangement are not entitled to as much information as are those persons acquiring stock under ordinary conditions."
"there may be in this situation need
Page 379 U. S. 617
for new management, and there certainly is some question . . . as to whether or not the management that is presently . . . operating it would continue to do so for the best interests of the investors."
Respondent, however, contends that Chapter X is not here appropriate, as the time and expense involved in such a proceeding would be too great. This is, however, just another way of stating the natural preference of a debtor's management for the "speed and economy" of Chapter XI, to the "thoroughness and disinterestedness" of Chapter X. In this area, as with other statutes designed to protect the investing public, [Footnote 15] Congress has made the determination that the disinterested protection of the public investor outweighs the self-interest "needs" of corporate management for so-called "speed and economy." In fact, experience in this area has confirmed the view of Congress that the thoroughness and disinterestedness assured by Chapter X not only result in greater protection chanroblesvirtualawlibrary
Page 379 U. S. 618
for the investing public, but often in greater ultimate savings for all interests, public and private, than do the so-called "speed and economy" of Chapter XI. See Twenty-Eighth Annual Report of the SEC 98 (1963); Twenty-Ninth Annual Report of the SEC 90-91 (1964); Note, 69 Harv.L.Rev. 352, 357-360 (1955). Moreover, the requirements of Chapter X are themselves sufficiently flexible so that the District Court can act to keep expenses within proper bounds and insure expedition in the proceedings. [Footnote 16] We also reject respondent's further argument that the time and expense of a Chapter X proceeding would be so great that the ultimate result might be straight bankruptcy liquidation, which, respondent contends, "would mean probable total loss for [the] trailer owners." In addition to the above answers to respondent's "general time and expense" argument, we feel compelled to point out, without indicating any opinion as to the ultimate outcome of the attempted financial rehabilitation in this case, that it must be recognized that Chapters X and XI were not designed to prolong -- without good reason and at the expense of the investing public -- the corporate life of every debtor suffering from terminal financial ills. See Fidelity Assurance Assn. v. Sims, 318 U. S. 608. [Footnote 17] chanroblesvirtualawlibrary
Page 379 U. S. 619
Finally, respondent argues that the District Court's decision that Chapter XI was the appropriate proceeding here should be affirmed on the basis that it was not a clear abuse of discretion. Respondent relies on certain language in the General Stores opinion in support of this contention. However, in making this contention, it clearly misreads that opinion and misconceives its holding and import. Nothing in that opinion supports respondent's view that the issue of whether Chapter X or Chapter XI is required permits open-ended discretion by a district court to decide on a case-by-case basis, without reliance on the principles which we have here reaffirmed, whether, in its opinion, it would be better for a particular debtor to be in Chapter X or Chapter XI. [Footnote 18] We agree with the statement of the Court of Appeals for the Second Circuit in a recent decision that such open-ended chanroblesvirtualawlibrary
Page 379 U. S. 620
discretion would be bound to result in decisions reflecting the "particular experience and predilections" of the district judge involved. SEC v. Canandaigua Enterprises Corp., supra, at 19.
Both Chapters X and XI are designed as vehicles for possible financial rehabilitation. Chapter X explicitly requires that a petition brought under it must be dismissed if it has not been brought in "good faith." § 141. "Good faith" is defined so as to exclude from Chapter X those cases, inter alia, where "it is unreasonable to expect that a plan of reorganization can be effected." § 146(3). Such a situation would exist where the debtor is so hopelessly insolvent that straight bankruptcy liquidation is the only available expedient. Fidelity Assurance Assn. v. Sims, supra; Goodman v. Michael, 280 F.2d 106, 108 (C.A.1st Cir.); 6 Collier, Bankruptcy, � 6.09 (1964). Chapter XI has a provision that a plan cannot be confirmed unless it is "for the best interests of the creditors and is feasible." § 366(2). This provision has been construed to preclude confirmation of a plan of arrangement where the plan would pay the creditors substantially less than they might reasonably expect to realize in liquidation. See In re Bruce Hunt Corp., 163 F.Supp. 939 (D.C.N.D.N.Y.); 9 Collier, Bankruptcy, � 9.17 (1964).
In so holding, we indicate no opinion as to whether or not a Chapter X reorganization would be appropriate in this case. See note 17 supra. We merely hold that all issues relevant to the possible financial rehabilitation of respondent must here be determined within the confines of a Chapter X, rather than a Chapter XI, proceeding. See United States Realty, supra, at 310 U. S. 453; 9 Collier, supra, at � 9.17.