Opinion ID: 1550675
Heading Depth: 1
Heading Rank: 5

Heading: Is Reconstruction Finance Corporation a Creditor Affected by the Plan?

Text: Appellants' argument on this point can best be stated by a quotation from their opening brief: The real question is whether or not Reconstruction Finance Corporation made a loan to the district. If it did, then the bonds which it holds are either effectively retired or are collateral to the loan, and the district's obligation is the amount of the loan, and the obligation owing to the R.F.C. is not affected by the plan of composition. In other words, what is the obligation of the district to the R.F.C.? If it is an obligation according to the terms of the deposited bonds, the district does not owe the R.F.C. anything on a loan. If there is a loan, the district has no obligation on the bonds except to the extent that they might possibly be enforced as security in liquidating the loan. Appellants point to the language of resolutions by the R.F.C. and the District and of correspondence between the parties, and cite numerous cases which they contend hold, in effect, that the transaction was a straight loan, secured by the collateral of the old bonds. They argue that the transaction being a loan, it follows that R.F.C. cannot be classified as a creditor affected by the plan within the contemplation of the statute. Whether or not the District was insolvent, it is apparent that there was much continuing uneasiness upon this subject among bondholders, residents and officers of the District from the early part of 1931. Two bondholders' protective agencies were formed, which two later merged into Merced Irrigation District Bondholders' Protective Committee. It may be safely stated that from the date last mentioned up to the first suggestion of relief through R.F.C. and thereafter, the problem has been a continuous one of refinancing for the District. No true account of the problem or understanding of what has been done is possible solely by the method of separate and detached analysis of each step taken. It will not do to merely examine the foundation and framework of the structure as separate and detached parts of the whole. When we view it from the perspective it will be seen that the end sought throughout the encountered vicissitudes was an arrangement with a governmental agency, whereby government money should be procured upon the security of the District and its assets for the relief of the District's straitened circumstances. Appellants make the most of the use of such terms as loan, borrowers, security, and owner in the implementing of this consummation, seeking to place R.F.C. and the District in strait-jackets of restricted definitions. We shall see that any apparent inconsistency is dispelled through specific definitions in the Bankruptcy Act and through a comprehensive view of the whole proceeding. We shall therefore proceed to more closely examine what has been done and more particularly what the written documents passing between R.F.C. and the District really mean. We have quoted in our preliminary statement of the facts of this case, the text of one of the conditions on which the loan from R.F.C. to the District was made, showing that the old securities should be kept alive until refinancing was complete. We referred to the fact that arrangements were made to carry out the plan contemplated by the resolutions. As part of these arrangements, on August 14, 1935, a contract was executed by R.F.C. and the District, referring to and incorporating the Resolution, and further reciting: The Corporation [R.F.C.] may make disbursements at any time it is willing to do so for the purpose of acquiring any portion of the Old Securities evidencing the District's outstanding indebtedness which is or may be available for refinancing, or rights of interests in or to such Old Securities, on the basis of the payments to be made for Old Securities under the provisions of the Resolution and if and when such disbursements are made    they shall be and constitute advances from the loan authorized in said Resolution. Until the Old Securities acquired and held by the Corporation by reason of or in connection with such disbursements, are exchanged for New Bonds issued by the District, or are otherwise refinanced as provided in said Resolution, they shall at all times continue to be and constitute obligations of the District for the full face amount thereof. When all of the Old Securities are made available for refinancing and are acquired by the Corporation, the reduction in the District's indebtedness will be effected to the extent and in the manner provided in the Resolution, and the parties hereto will do all acts and take all steps and proceedings necessary or appropriate to facilitate and accomplish expeditiously such result.    On September 16, 1936 the District and R.F.C. executed a Bond Purchase Contract. In this agreement R.F.C. agreed to purchase the refunding bonds of the District. This agreement again contained the provision that R.F.C. may keep any part of the old indebtedness alive, for the sole purpose of maintaining a parity between itself and the holders of indebtedness of said Borrower who have not agreed to enter into the refinancing scheme of said Borrower, or for any other purpose. To date, the refinancing has not been completed because the dissenting bondholders have not turned in their bonds. The old bonds have not been cancelled or surrendered to the District, nor have refunding bonds been issued to R.F.C. All the old bonds acquired by R.F.C. have been registered in its name as owner and since their delivery have been under its sole control, subject to conditions about to be mentioned. As well-stated by the trial court [25 F. Supp. 981, 984]: No one can read the record of the negotiations between the governmental agency and the insolvent District and its security holders and fail to conclude that the paramount, imperative and essential feature of the contract was the ultimate and not the immediate retirement of the outstanding bonds which the R.F.C. acquired. It seems clear to us that R.F.C. agreed to furnish money to the District to refinance its entire bonded debt at $515.01 for each $1000 bond. The arrangement was subject to the condition that all old securities should be purchased and held by R.F. C. until R.F.C. was satisfied that refinancing was complete. During this time, the old securities were to be kept alive and outstanding. When the refinancing was complete, then and then only was R.F.C. under the duty of buying and accepting refunding bonds, and surrendering the old securities for cancellation. The Bankruptcy Act under which these proceedings were brought contains the following definitions, 11 U.S.C.A. § 402: The term `creditor' means the holder of a security or securities. Any agency of the United States holding securities acquired pursuant to contract with any petitioner under this chapter shall be deemed a creditor in the amount of the full face value thereof. The term `security' shall include bonds, notes, judgments, claims, and demands, liquidated or unliquidated, and other evidences of indebtedness, either secured or unsecured, and certificates of beneficial interest in property. The term `security affected by the plan' means a security as to which the rights of its holder are proposed to be adjusted or modified materially by the consummation of a composition agreement. Furthermore, subdivision j of Sec. 403 of the same Act provides: The partial completion or execution of any plan of composition as outlined in any petition filed under the terms of this title by the exchange of new evidences of indebtedness under the plan for evidences of indebtedness covered by the plan, whether such partial completion or execution of such plan of composition occurred before or after the filing of said petition, shall not be construed as limiting or prohibiting the effect of this title, and the written consent of the holders of any securities outstanding as the result of any such partial completion or execution of any plan of composition shall be included as consenting creditors to such plan of composition in determining the percentage of securities affected by such plan of composition. It cannot be questioned that under the express terms of the Act, R.F.C. as holder of the old securities, is a creditor affected by the plan to the full face amount of those old securities. Appellants' entire argument is based upon the erroneous assumption that the old securities are no longer outstanding, or that they belong to the District and are pledged as collateral for the loan from R.F.C. to the District. From what we have said above, it is clear that R.F.C. is the holder of the old securities, and that they are still outstanding. Nor can it be questioned that Congress has absolute right to define the term creditors and designate what claims are provable in bankruptcy proceedings. City Bank Farmers Trust Co. v. Irving Trust Co., 299 U.S. 433, 57 S.Ct. 292, 81 L.Ed. 324. Appellants argue that subdivision (j) of Sec. 403 above quoted does not apply to the instant case, for three reasons. We quote the reasons from the brief of appellant Florence Moore: (a) It is limited expressly to cases in which refunding bonds have been issued. None have been issued here. (b) It does not purport to allow holders of the refunding bonds to vote, or otherwise act, as creditors beyond the amount of the refunding bonds held. (c) Although it applies to refunding bonds issued before the filing of the petition, it does not purport to operate retrospectively. It is true that the section quoted above does not specifically refer to a situation where refunding bonds have not been issued, but reason compels us to the conclusion that if the issuance of refunding bonds shall not be construed as limiting or prohibiting the effect of the title, surely a like situation would be true where the plan has not been carried through to completion. The following excerpt from the Congressional Record of Debates, 75th Congress, 3rd Session, makes it clear that this was the intent of Congress: Mr. Pepper, on offering the amendment, Section 83, sub. j: `Mr. President, I will state the purpose. Let us assume that under the existing municipal bankruptcy law a municipality which had engaged in a partial refunding of its obligations desired to make some adjustment of its total obligations outstanding. Under the existing municipal bankruptcy law, which was passed after its amendment occurred at the last session, that municipality could obtain the consent of 51 percent of its outstanding obligees, and present that to the court along with a plan of composition, and if two-thirds of all the obligees agreed to that plan of composition, then it would be possible for the court, by the approval of that plan, to put it into effect, and the plan would bind all the obligees. That is the provision of the existing municipal bankruptcy law. `Before that municipal bankruptcy law went into effect there were a number of municipalities which had engaged in a partial refunding, or, rather, had inaugurated a refunding program, which had been partially completed, but, in the absence of any laws to aid them, they were completely at the mercy of a recalcitrant minority of their obligees as to whether or not that refunding plan could succeed. `A very few bondholders could prevent the accomplishment of the whole refunding program, no matter if 98 percent of the obligees might desire that it go into effect. `Thus we found, after the passage of the municipal bankruptcy act, that it only provided that municipalities might have access to that act for the adjustment of their total outstanding obligations. When a case arising in West Palm Beach, Fla., went up on appeal, the United States Circuit Court of Appeals for the Fifth Circuit held that the municipal bankruptcy law was not applicable to that kind of a situation. That the consent of even 98 percent of the bondholders could not get the case into court for a fair consideration by a Federal judge. So my amendment merely proposes that municipalities coming within that class shall have resort to the Federal Court, through the means of the municipal bankruptcy law, for a fair adjustment of their obligations upon the same principles that are laid down by the original Municipal Bankruptcy Act.' The case arising in West Palm Beach, Fla., referred to by the proponent of the amendment in the above quotation, is quite probably the case of In re City of West Palm Beach, 5 Cir., 96 F.2d 85, relied upon strongly by appellants in their contention that R.F.C. is not a creditor affected by the plan. It is certain that the amendment was enacted to avoid the result of the West Palm Beach decision. It is likewise true that the section does not specifically state that the holders of the refunding bonds shall be deemed creditors to the full face amount of the old securities. However, the section does provide that the partial completion of a plan shall not be construed as limiting or prohibiting the effect of this title. Words could not be plainer. Congress intended by this enactment to provide that partial completion of a plan of composition, even in a situation where refunding bonds have already been issued, shall not be construed as changing the status of the parties. Appellants' third argument as to the inapplicability of subdivision (j) is based upon the fact that the subdivision was not enacted until after R.F.C. had acquired the bonds. This argument, of course, is premised upon the assumption that the old bonds were extinguished before the section was enacted. We have shown this premise to be erroneous. In Luehrmann v. Drainage District, 8 Cir., 1939, 104 F.2d 696, certiorari denied under the name of Haverstick v. Drainage Dist. No. 7, November 6, 1939, 308 U.S. 604, 60 S.Ct. 141, 84 L.Ed. 505, the Circuit Court for the Eighth Circuit had under consideration the same argument as that advanced by the appellants here. In the cited case, as here, the District had applied to R.F.C. for a loan to enable it to refinance, and the loan had been authorized. After the passage of the old municipal bankruptcy act (later held unconstitutional by the Ashton case, supra) R.F.C. disbursed funds amounting to approximately $.26 on each dollar of principal indebtedness held by the bondholders' committee, which then amounted to approximately 98% of the outstanding bonds. There, as here, it was provided that the outstanding bonds should not be cancelled until refinancing was complete. None had been cancelled. The question on appeal from a decision of confirmation of the plan under the new municipal bankruptcy act was whether or not the old bonds were still outstanding. We quote from the decision of the court (pages 700, 701 of 104 F.2d): At the outset the Reconstruction Finance Corporation undertook to make a refunding loan to the district upon the application of the bonding committee which procured the acceptance of a large percentage of bondholders, evidenced by the deposit of their bonds.    Of course the Reconstruction Finance Corporation was not authorized to make a loan subordinate to prior outstanding liens, nor did it undertake to do so. In order to preserve its rights the bonds controlled by the bondholders' committee were transferred to the trustee Ritter, who was succeeded by Chapman, so to be held until the transaction could be closed with safety to the Reconstruction Finance Corporation. Meantime the Readjustment Act of May 24, 1934, 11 U.S.C.A. §§ 301-303, became operative before any disbursements had been made and all future transactions between the Reconstruction Finance Corporation and the district were based upon an acceptance of the application of that Act to the financial needs of the district. Accordingly disbursements were made upon the basis of 25.879 cents on the dollar to all accepting bondholders, but the bonds were still retained as collateral security in the hands of the trustee. This was the situation when the Act of 1934 was declared invalid. Upon passage of the Composition Act of 1937, the petition of the district was renewed and the present proceedings in composition were instituted. The trustee Chapman, acting for the bondholders who had accepted the original offer, filed acceptance of the proposed plan; 88.5% of judgment and other creditors did likewise; all such, in view of the expected composition settlement, received the same amount of 25.879 cents on the dollar of their claims. No bonds in the hands of the trustee have been cancelled. They are still outstanding obligations of the district unless and until they are finally liquidated by satisfaction of the obligations to the Reconstruction Finance Corporation, sought to be effected through the proceeding in composition now before us.    The objection that the bondholders (and, incidentally the judgment creditors) have scaled their debts by accepting 25.879 cents on the dollar in settlement of their claims, and therefore cannot be counted as acceptors of the debt readjudgment plan, is very closely connected with the question of the solvency or insolvency of the district. Undoubtedly, if the Reconstruction Finance Corporation loan had been conducted as an entirely disconnected transaction, and the disbursements to the creditors of 25.879 cents on the dollar had been made as unconditional purchases of the claims, both of these objections would have been entitled to weight. But it is apparent from the record and from the findings of the court that the readjustment loan made by the Reconstruction Finance Corporation must be considered in connection with the two applications for readjustment and composition in bankruptcy under the Acts of 1934 and 1937. No disbursements were made by the Reconstruction Finance Corporation until the initial steps had been taken by the district under the first of these Acts, and it is apparent that all parties to the transaction acted upon the understanding that the disbursements made were in conformity with the plan of readjustment then in process under the first Act, and later continued in substance under the second Act. For this reason we think these classes of bondholders and judgment creditors so far retained their original status as entitled them to be counted as acceptors of this composition plan. We agree entirely with the decision of the Court in the Luehrmann case, supra, and hold that R.F.C. is entitled to be classed as a creditor affected by the plan. Appellants argue, however, that in any event R.F.C. is not entitled to be recognized as a creditor because it has not filed a claim. Suffice it to say that the petition filed in these proceedings alleged ownership of the bonds by R.F.C. and that R.F.C. as such owner, consented to the plan of composition. The Court found these allegations to be true, and the findings are supported by the evidence. In these circumstances, it is immaterial, if true, that no claim was filed.