Opinion ID: 1550675
Heading Depth: 1
Heading Rank: 10

Heading: Insolvency of the District and Fairness of the Plan

Text: We have left for final consideration appellants' Third Proposition: Petitioner herein is not `insolvent or unable to meet its debts as they mature', and their Fourth Proposition: The plan of composition is not fair, equitable or for the best interests of the creditors, and it is discriminatory, as the determination of one will be dependent to a large extent upon the other. A portion of appellants' argument under their Third Proposition is based upon the same assumption as their argument under the point entitled The Reconstruction Finance Corporation is not a creditor affected by the plan of composition, that the old securities were extinguished by the transaction with R.F.C. This argument falls with our holding above that the old securities are still outstanding. However, an additional claim is made by the appellants that even considering the old securities as outstanding, still the District was solvent as of the date of filing the petition. Appellants point to balance sheets of the District, and contend that they show a surplus of assets over liabilities of well over $10,000,000.00. The assets include cash on hand in the sum of $1,578,446.14. It is asserted that: There is owing to outstanding bondholders matured interest coupons as of July 1, 1938, in the sum of $496,542.50 and interest on registered bonds and coupons in the sum of $70,459.00, making total interest due $567,001.50. and that the total past due liability to outstanding bondholders is not over $650,000.00. The appellants conclude that: Thus, after paying all matured obligations from cash on hand, petitioner would still have $800,000.00 cash on hand. Appellants also contend that the District's revenues are more than sufficient to pay principal and interest maturities on the remainder of its debt. It should be noted, however, that in computing the indebtedness of the District, the appellants assume that matured interest coupons on the outstanding bonds held by R.F.C. are not to be included. The figure of $496,542.50 which they use in their argument is taken from a balance sheet and is labeled Outstanding Bonds and Coupons other than R.F.C.    Coupons (matured to 7-1-38 inc.) [Italics supplied.] Against this we have the testimony of E. E. Neel, the Auditor and Treasurer of the District: All obligations at the present time with respect to both maturing bonds and maturing coupons are paid or taken care of with the exception of the bonds and coupons due July 1, 1933 and subsequent. The interest coupons from July 1, 1933 to and including July 1, 1938 totaled $5,194,925 and the bond principal in default commencing with January 1, 1934 totals up to July 1, 1938 $386,000 and that makes a total of $5,580,925. In our discussion under the heading Good Faith of the District, we stated that the only complaint, if any, that the bondholders might have to certain bookkeeping entries, would be that they affected the solvent or insolvent condition of the District. Two of these items referred to interest payments which had been charged as an expense of refinancing instead of being credited against matured obligations of the District. The two interest payments totaled $993,266. Assuming without deciding that these payments should have been treated as payments of bond coupons, and therefore should be deducted from the $5,580,925 given by Mr. Neel as the amount of the District's default in bond principal and interest, there remains a default of $4,587,659. It should also be noted that the figure of $5,580,925 given by Mr. Neel does not include any accrued interest on registered bonds and coupons as provided for by Sections 52 and 61a of the California Irrigation District Act [quoted in footnote 1, supra]. The balance sheets of the District show this to amount to $1,004,887.54. Appellants claim that the sum of $129,100 should be deducted from this figure. Assuming without deciding that appellants are correct, we have a remainder of accrued interest in the amount of $875,787.54. Adding this $875,787.54 to the default of $4,587,659, we find that the total default of the District is $5,463,446. The trial court found that the District is insolvent and unable to meet its debts as they mature. It further found that all of the allegations and averments set forth in said petition for confirmation of the plan of composition of bond indebtedness are true. One of the allegations contained in said petition is: That petitioner is unable to meet its debts as they mature. That it has been continuously in default on both the principal and interest maturing on its bond indebtedness since the 1st day of July, 1933; that the total amount now in default on said bond indebtedness is in excess of Five Million Dollars   . The Court's finding that the District is in default in excess of Five Million Dollars is amply supported by the evidence, and with this taken as an established fact the finding that the District is unable to meet its debts as they mature certainly cannot seriously be questioned. The claimed fact that power revenues, etc. of the District will be sufficient to meet the obligations after they have been scaled down as proposed by the plan, does not have any bearing on the question of insolvency of the District. Appellants, however, argue that the District will be able to pay its scaled down indebtedness in full in a period of thirty years or more and that this proves that the plan is inequitable. Other points of unfairness are also urged. We shall consider the arguments as to the alleged unfairness of the plan in the order in which they are presented in appellants' opening brief. The first contention is as follows: Assuming that R.F.C. is a creditor of the same standing as the appellants, the plan is unfair because it offers a 4% bond to the R.F.C., but denies a like privilege to the appellants. Appellants misconstrue the plan and the relationship existing between the District and R.F.C. As we heretofore said, R.F.C. agreed to furnish money to the District to refinance its entire bonded debt at $515.01 for each $1,000 bond. The obligation assumed by R.F.C. 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. As stated by the Supreme Court in Zavelo v. Reeves, 227 U.S. 625, 632, 33 S.Ct. 365, 368, 57 L.Ed. 676, Ann.Cas. 1914D, 664: With respect to the money loaned to the bankrupt for use in paying the consideration of the composition, it is perhaps worth while to remark that § 12 of the act [11 U.S.C.A. § 30], in prescribing the time and mode of offering terms of composition, plainly contemplates that a composition in money may be offered, and expressly prescribes that an application for the confirmation of a composition may be made after, but not before, `the consideration to be paid by the bankrupt to his creditors, and the money necessary to pay all debts which have priority, and the cost of the proceedings, have been deposited in such place as shall be designated by, and subject to the order of, the judge.' And the same section provides that `upon the confirmation of a composition the consideration shall be distributed as the judge shall direct, and the case dismissed.' The act, of course, contemplates that the bankrupt may acquire the money required for the purposes of the composition by the use of his credit. In the present case R.F.C. has contracted to furnish the money necessary to make the composition effective, and to accept in turn refunding bonds at 4% for the amount of its advance. As holder of the old securities it is treated exactly as are all other bondholders  it will receive 51.501¢ on the dollar. Appellants next complain of the fact that R.F.C. as a creditor has been allowed interest at 4% per annum ever since October 4, 1935. Our holding above that the District was within its rights in using its credit to obtain the money necessary to make the composition effective, carries with it the holding that the District was within its rights in paying interest on the amount advanced by R.F.C. from the date of its advancement. The next contention of appellants is, The plan is discriminatory because it allowed to bondholders who deposited their bonds on or before October 4, 1935, 4% interest from date of deposit to that date.    No compensation is allowed by the plan to appellants for the period they have waited   . Again appellants misconstrue the plan. The plan simply provides for the payment to each bondholder of a sum equal to 51.501¢ on the dollar of the principal amount of his outstanding bonds. There is no mention in the plan for payment of any interest to bondholders, consenting or objecting. In attempting to effect the composition, the District made the same offer to all bondholders  that it would accept deposit of the bonds immediately, subject to consummation of the agreement between the District and R.F.C. Instead of paying the depositing bondholders immediately, the arrangement was that payment should not be made until funds were available from R.F.C. In the meantime, the District agreed to pay the depositing bondholders interest at the same rate that it would have had to pay R.F.C. had R.F.C. advanced the money. In other words, the corresponding portion of money needed to effect the composition was obtained not from R.F.C. but from the consenting bondholders themselves until such time as the R.F.C. money became available. On the same theory that we have above held that payment of interest to R.F.C. was proper, we hold that it was not improper to pay a like rate of interest to depositing bondholders for the period of time their bonds were tied up without R.F.C. funds being available. Appellants next contend that the plan is unfair because it permits the payment in full of bonds or other taxing agencies which are in effect liens against the same territory without requiring any corresponding reduction and because it    in effect takes property from the bondholder and gives it to a junior encumbrancer, the holder of mortgages and deeds of trust, and to the stockholder, so to speak, viz., the landowner. We have already disposed of both of these contentions in our discussion under the heading Does Act Prefer Junior Liens to Senior Liens. The next point is that the plan is unfair because it takes trust funds and properties belonging to the appellants. This, too, has already been treated. The remainder of appellants' argument as to the alleged unfairness is based entirely upon the financial condition of the District, it being argued that the plan is not for the best interests of the creditors. Regardless of all of appellants' arguments to the contrary, this much clearly appears from the record  The District was hopelessly insolvent and unable to meet its debts as they matured. The bonded debt was $16,190,000 plus millions of dollars in defaulted interest. The District defaulted 62.80% on its last attempt to levy for bond service in September, 1932. At that time the rate was $8.90 per $100. The legal tax rate in September, 1939, if an attempt were made to service the old bond issue would be $68.83 per $100 assessed valuation. Furthermore, the peak amount required for bond service would not be reached until 1951, when $1,280,700 would have to be raised. The amount required for bond service in the year when there was a 60.80% default was only $954,400. Some plan had to be worked out to refinance if anything at all were to be salvaged on the bonds. Therefore the only question before this court is whether or not the 51.501¢ on the dollar is all that could reasonably be expected in all the existing circumstances. Appellants' arguments, If inflation comes, the debt of this district    will be an inconsiderable factor in its future welfare, because even a minor degree of inflation would enable the district to liquidate its debts fully with comparative ease. A plan, therefore, which now determines in effect that there will be no inflation, but on the contrary probable deflation, is inequitable and The sudden change in prices of many commodities owing to the second world war in Europe is a factor which the Court could not have anticipated and is but an illustration of the impossibility of determining whether it is fair to pay off an obligation due in twenty years at 50¢ on the dollar now are but illustrative of the truth of the statement of the District in its brief, There is no yardstick that can measure the ability to pay with certainty. The trial court's conclusions cannot be ignored. We quote the language of the Court in its memorandum opinion [25 F. Supp. 981, 985]: But it is argued, assuming that the R.F.C. is the owner and holder of about $14,702,000 of existing and outstanding bonds which have been relinquished and voluntarily transferred by their former owners, the plan should be held to be unfair and inequitable to the bondholders who held out and are now before the court opposing the plan of settlement, because, they assert, the present financial condition of the District does not justify such an extreme paring of the debt structure as the plan accomplishes. We think this contention loses its force when consideration is given to the fact that it was the more than 90 per cent. of the bondholders who took advantage of the R.F.C. composition agreement and transaction which made it possible for the District to save itself from financial ruin and thereby to a major degree brought about the present fiscal situation which the records in evidence show exists in the District. These conclusions are more than justified by the Benedict testimony and report and by the evidence of the witness Momberg. In our opinion there can be little doubt that under the record, if the loan from the Reconstruction Finance Corporation had not been negotiated, the outstanding bonds of the dissenting bondholders would be worth much less than the price that can now be received by them under the plan that is before us for consideration. The Benedict report to which the court refers was prepared under the supervision of Dr. Murray R. Benedict, professor of agricultural economics of the University of California staff, and agricultural economist with the Giannini Foundation of Agricultural Economics. It entailed a scientific study of the tax paying ability of the District, and represented about nine months of intensive work. At the trial the witness Momberg, manager of California Lands, Inc., at Merced, a heavy operator in the District, further supplemented and confirmed Dr. Benedict's report and testimony. Dr. Benedict's report covered the years from 1926-1931. Mr. Momberg's testimony covered the years subsequent to 1932 up to and including the year 1938. The testimony of these two witnesses amply support the conclusion that 51.501 cents on the dollar is fair and equitable and all that could reasonably be expected in all the existing circumstances. The decree of the District Court confirming the plan is affirmed.