Opinion ID: 336170
Heading Depth: 2
Heading Rank: 1

Heading: Adjudication of Bankruptcy

Text: 5 In the summer of 1970, Crateo elected to wind up its affairs and voluntarily dissolve. On August 31, 1970, it filed a petition for judicial supervision of the winding up process with the Superior Court of the State of California for San Diego County. See California Corporations Code § 4607. On that same day, the Superior Court ordered that notice of the dissolution proceeding be published and that all known creditors of Crateo be informed of the petition. In addition, the Superior Court ordered all creditor actions against Crateo enjoined and required all claims against Crateo to be presented in the dissolution proceedings. See California Corporations Code §§ 4608, 4616. Shortly thereafter, a creditors' petition was filed in the District Court alleging that Crateo had committed the fifth act of bankruptcy as defined by Section 3(a)(5) of the Bankruptcy Act, 11 U.S.C. § 21(a)(5). 6 In accord with Section 19(a) of the Bankruptcy Act, 11 U.S.C. § 42(a), Crateo requested a jury trial on the question of its insolvency. Prior to that trial, several issues, including the issue of Crateo's insolvency, were referred to the referee in bankruptcy sitting as a special master. The special master's report on the issue of Crateo's insolvency was read to the jury at trial. The jury subsequently found that Crateo was insolvent at the time it filed its petition for dissolution in the state court, and a judgment adjudicating Crateo a bankrupt was entered on August 9, 1973. Appointment of a Receiver or Trustee 7 The petitioning creditors alleged that Crateo's petition in the state court for judicial supervision of its dissolution amounted to the fifth act of bankruptcy, 11 U.S.C. § 21(a)(5). That section provides, in pertinent part, that: 8 Acts of bankruptcy by a person shall consist of his having . . . (5) while insolvent or unable to pay his debts as they mature, procured, permitted, or suffered voluntarily or involuntarily the appointment of a receiver or trustee to take charge of his property. 2 9 California law governing the dissolution of corporations creates a significant change in the status of the corporation and its directors. We agree with appellant's creditors and the District Court that the net effect of this change means that Crateo's actions in the state court resulted in the appointment of a receiver or trustee within the meaning of 11 U.S.C. § 21(a)(5). 10 After a petition for dissolution is filed, the board of directors continues to operate the corporation in order to settle its affairs. Cal.Corp.Code § 4800. However, directors may be removed by the superior court for reasons of dishonesty, misconduct, neglect, or abuse of trust. Cal.Corp.Code § 4614. The court can take such an action on its own initiative, and the normal prerequisite of a shareholder's suit is not required. Cf. Cal.Corp.Code § 811. 11 The duties of the board of directors are also limited once the dissolution proceedings come under judicial supervision. The only business the corporation can carry on is that of winding up. Cal.Corp.Code § 4605. In carrying out this task, the board of directors is invested with extensive powers. Cal.Corp.Code § 4801. The powers of the board of directors, however, are not unlimited. The state court has the specific power to determine the manner in which claims are to be presented and settled and how shareholders' rights are to be determined. The court has the power to oversee the complete dissolution process and discharge the directors from their obligations after the process is completed. Cal.Corp.Code §§ 4608-11, 4617. In addition, the court has the general power to make orders and adjudge as to any and all matters concerning the winding up of the affairs of the corporation. Cal.Corp.Code § 4607. 12 In winding up the corporation's affairs, the first duty of the board of directors is to satisfy the corporation's debts and liabilities. Cal.Corp.Code § 5000. In satisfying these obligations, the directors' powers under Cal.Corp.Code § 4801 are circumscribed by the overall supervisory power of the Superior Court under Cal.Corp.Code § 4607. If the directors do not settle the corporation's obligations properly, the court has the duty to vacate the directors' actions and make the appropriate settlement itself. In re Trinity Tractor Co., 3 Cal.App.3d 428, 440-441, 83 Cal.Rptr. 783, 791-792 (1970). 13 In addition, Crateo's creditors could no longer pursue their normal legal remedies against Crateo once the Superior Court accepted Crateo's petition for judicial supervision of its dissolution proceedings. Actions already begun were stayed by the Superior Court's order. Whether or not legal title to the corporation's assets passed into the possession of the board of directors became irrelevant because creditors could sue neither entity. 14 There was no need for the board of directors to be formally appointed trustees or to formally possess legal title to the corporation's assets. The effect of Crateo's actions in the Superior Court was to require its board of directors, under court supervision, to act as trustees. 3 In determining whether a corporate dissolution under state law is the equivalent of the fifth act of bankruptcy, it is the end result that counts. In re Bonnie Classics, 116 F.Supp. 646, 648 (S.D.N.Y.1953). 4 15 Not every corporate petition for dissolution under the California Corporations Code will necessarily result in an involuntary bankruptcy. Under11 U.S.C. § 21(a)(5), the creditors must also show that the debtor was  insolvent or unable to pay his debts as they mature. However, if this situation exists, California corporations cannot defeat the operation of the bankruptcy laws by applying for dissolution under California law. In re Watts & Sachs, 190 U.S. 1, 27, 23 S.Ct. 718, 47 L.Ed. 933 (1902). The overly technical approach to the interpretation of 11 U.S.C. § 21(a)(5) urged by Crateo must be rejected. Petitioning Creditors 16 The creditors' petition against Crateo was required by Section 59(b) of the Bankruptcy Act, 11 U.S.C. § 95(b), to be filed by at least three or more creditors who have provable claims not contingent as to liability. Six petitioning creditors 5 presented evidence before the special master, and Crateo claims that none of them had claims not contingent as to liability. Examination of the creditors' claims, however, shows that appellant is incorrect. 17 Intermark Investing Inc. was a judgment creditor of Crateo's pursuant to a stipulated judgment entered in a state court prior to the filing of the creditors' petition. Part of the judgment provided that two parcels of property owned by Crateo would be sold and the proceeds of the sale applied to reduce Crateo's debt to Intermark. A dispute arose over the manner in which the properties were to be appraised prior to their sale. This was essentially a dispute over the manner in which the judgment would be satisfied and cannot obscure the fact that Crateo's liability to Intermark had already been fixed. In re Trimble Co., 339 F.2d 838, 844 (3rd Cir. 1964). 18 Under a promissory note to Olympia Business Service, Inc., Crateo was obligated to pay $1200 per month. Since appellant did not make the payments due July 1, 1970, and August 1, 1970, Olympia was properly determined to be a creditor whose claim was not contingent as to liability. There was no need for Olympia to obtain a judgment against Crateo before it could achieve the status of a petitioning creditor under Section 59(b). Denham v. Shellman Grain Elevator, Inc., 444 F.2d 1376, 1380 (5th Cir. 1971). Whether or not Crateo received proper notice so as to accelerate payment of the entire amount remaining on the promissory note is irrelevant because the two monthly installments were definitely due at the time the creditors' petition was filed. 19 General Electric Company held two promissory notes which had fully matured prior to August 31, 1970. Again, there was no need for General Electric to have obtained judgments on these notes in order to satisfy the requirements of Section 59(b). The fact that there was a dispute over Crateo's indebtedness on another separate obligation to General Electric is irrelevant. 6 20 Use of Special Master's Report at Jury Trial 21 Under Section 19(a) of the Bankruptcy Act, 11 U.S.C. § 42(a), Crateo was entitled to a jury trial in respect to the question of (its) insolvency. 7 Prior to that trial, the issue of Crateo's insolvency had been referred to the referee in bankruptcy sitting as a special master. The report of the special master was then read to the jury pursuant to Rule 53(e)(3) of the Federal Rules of Civil Procedure. Crateo contends that the procedure followed in this case violated its right to a trial by jury on the question of its insolvency. 22 Crateo first claims that reference to a special master was unwarrantedbecause the issues were readily understandable by a jury. F.R.C.P. Rule 53(b) provides that in actions to be tried to a jury, a reference shall be made only when the issues are complicated. 8 The petitioning creditors had alleged that Crateo was bankrupt because it could not pay its debts as they matured. While every claim of this type does not require use of a master, considering Crateo's tangled financial affairs and the duplication of those problems in two subsidiary corporations that had been merged into Crateo three days before the filing of the petition in state court for judicial supervision of dissolution, we believe that there was no abuse of discretion in reference to the special master. Since this was a matter for the district judge's determination in light of his perception of whether the jury would find the issue complicated, Crateo's request to examine the special master on the complexity of the case was properly denied. 23 At the trial, the findings of the special master were read to the jury. In providing that these findings are admissible as evidence and may be read to the jury, Rule 53(e)(3) does not require the special master to personally read the findings to the jury. Consequently, contrary to appellant's position, the special master did not have to be made available for cross examination on the procedures used to reach the findings presented to the jury. 24 The expert qualifications of the special master were Crateo's primary guarantee that the proper legal standards and procedures were used by the master in determining his findings. In this respect, it is significant that Crateo did not object to the qualifications of the master appointed in this case. 9 At the trial, Crateo was given a full opportunity to introduce evidence that would contradict the findings of the special master and argue to the jury that the findings were incorrect. The jury was instructed on the role of the special master and the weight to be given to his report, and Crateo did not object to this instruction. 25 The procedures employed in the trial would not impermissibly interfere with the right to trial by jury guaranteed by the Seventh Amendment. Ex parte Peterson, 253 U.S. 300, 40 S.Ct. 543, 64 L.Ed. 919 (1920); Burgess v. Williams, 302 F.2d 91 (4th Cir. 1962). Crateo's statutory right to a jury trial under the Bankruptcy Act gives it no greater rights than those available in civil proceedings governed by the Seventh Amendment. Diamond Door Co. v. Lane-Stanton Lumber Co., 505 F.2d 1199 (9th Cir. 1974). Under all the circumstances of this case, we conclude that Crateo received a fair and proper trial on the question of its insolvency. Jury Instructions 26 The petitioning creditors had alleged and were required to prove that Crateo was unable to pay (its) debts as they mature when it petitioned for a judicially supervised dissolution in state court. 11 U.S.C. § 21(a)(5). This is the equity definition of insolvency. The trial judge's instruction to the jury followed the language of the statute. 10 Crateo objected to this instruction, claiming that the word debts is in the plural and therefore the creditor must show the debtor's inability to pay substantially all of its debts and not just the debtor's inability to pay one or two or three debts. 27 The words unable to pay (its) debts as they mature are contained in a statutory context which necessitates rejection of Crateo's argument. A debtor commits the fifth act of bankruptcy when he is unable to pay his debts as they mature and a receiver or trustee is appointed to take charge of his property. 11 In that situation, there is a good possibility that some creditors may not be able to recover their claims on an equitable basis with other creditors unless they are able to invoke the protections of the Bankruptcy Act. Without those protections, the fact that some, or even most, of the creditors could be paid is of little consolation to those who cannot be paid. Adoption of Crateo's position would be completely contrary to the increasing amount of protection afforded to creditors by successive revisions of 11 U.S.C. § 21(a) (5). 12 In addition, Crateo's proposed test would be so indefinite as to be unworkable. The trial judge properly declined to modify his instructions. 28