Court Opinion

ID: 9640514
Source: CourtListenerOpinion
Date Created: 2023-08-22 17:07:29.082248+00
Date Added: 2024-06-11T18:10:30.218654
License: Public Domain

JOHNSEN, Circuit Judge
(dissenting).
I am unable to agree, in the circumstances of the present bankruptcy, that Budge’s claim position is on the same equitable level as that of the other general creditors, and believe that payment of his claim should be subordinated to theirs. The question involved, of course, is not one of legal validity but of equitable parity.
The general rules applicable to the claims of officers, directors and stockholders of a bankrupt corporation are quite fully discussed in Pepper v. Litton, 308 U.S. 295, 306-311, 60 S.Ct. 238, 84 L.Ed. 281. The claims of officers and directors and those of a dominant stockholder or stockholder' group should be rigorously scrutinized, not merely to test their legal validity as against the corporation, but equally to weigh the fairness of their asserted position in relation to other creditors. The fairness of relative claim position should be tested, not simply as of the date of the transactions involved, but with a regard also for the corporation’s subsequent operations, in the light of the claimant’s degree of connection with and measure of responsibility for such operations. If, when thus viewed, the claim of an officer, director or stockholder, notwithstanding its legal validity, soundly impresses the bankruptcy court, in the comparative situation, as failing to rest upon the same level as the corresponding claims of other creditors, its payment should be subordinated.
This does not mean, of course, that the ■ valid claims of those who occupy a fiduciary position in the affairs of the corporation can be subordinated merely because other creditors will not be paid in full, for that situation necessarily obtains in almost every bankruptcy. But such claims may properly be subordinated, if the trans*445actions on which they rest, in their origin, nature or circumstantial relationship, have had in them any element of general unfairness to the corporation or to other creditors. What constitutes such a general unfairness obviously is not capable of limitative definition. In many- instances it may be wholly a relative factor, emerging only from a balancing of all the facts of the particular situation, but soundly touching the conscience of the court as giving rise to an equitable disparity in comparative claim, position.
The claim here involved was for cash advances, totalling $4,950, made to the corporation in 1935, 1936 and 1937. At the time these advances were begun, the surplus of the corporation, which had once exceeded $6,000, had been exhausted, and its authorized capital of $20,000 was impaired to the extent of over $2,000. On the record, it seems clear that, from the time the advances were made, down to the bankruptcy in 1939, the corporation could not have made repayment of them and have had sufficient liquid assets remaining to continue operations as a going concern. Budge apparently recognized this fact, for he did not attempt to make repayment to himself of these advances. As the financial condition of the corporation then stood and continued, the only real hope that there could have been of obtaining repayment would be through liquidation. In fact, as the advances were made, there was no attempt to fix a time for their repayment; no note or other definitive obligation was ever taken; and there was no agreement for the payment of interest. The cash was all advanced before the claims of the other general creditors involved were incurred, and, in view of the financial condition of the corporation, of Budge’s relationship to it as hereinafter discussed, and of the manner in which the transactions were handled, the advances, as against the other general creditors, should have been treated as the equivalent of capital contributions.
But of even stronger equitable significance, I think, in its relationship to the claims of other general creditors, is the manner in which the corporation was being run and the transactions were handled. Budge and Rose treated the affairs of the corporation, in practical effect, as if it were their own. They had been elected directors in 1922, together with another stockholder, but the records of the corporation show no meetings of or actions by the board of directors from 1922 to 1938. As a matter of fact, the third stockholder ceased to be a director in 1925, and, from that time until 1938, the corporation never had a fully constituted board of directors of three members, as required by its by-laws and by the Minnesota Business Corporation Act, Minn. Laws of 1933, Ch. 300, § 27, Mason’s Minn.Stat.1940 Supp., § 7492-27.
During all of this period, Budge and Rose ran the business as they saw fit. They fixed their own salaries, notwithstanding that the by-laws required that such action be taken only by the directors acting as a board. In 1926, they undertook to pay a corporate dividend, without any resolution or formal action by the board of directors, as prescribed by the by-laws. In 1935, they purchased a printing press, at a cost of $13,200, — for which $2,000 of the amount included in Budge’s claim was advanced as a down-payment— in formal disregard of the by-law provisions that no contract for equipment in excess of $200 should be made without first having been approved by the directors. The purchase of the printing press also increased the indebtedness of the corporation substantially beyond the $10,-000 limitation fixed by its articles of incorporation, and, with Budge’s advances included, it remained above that limitation down to the time of bankruptcy. In addition, the large loss which the printing press transaction occasioned to the corporation was a material factor in precipitating its ultimate liquidation.
For a period of thirteen years, and during the time that Budge’s claim was coming into being, there was thus no duly constituted board of directors, as required by the by-laws and the state statutes, to review the situation of the corporation and to exercise its collective judgment on whether the corporation should have purchased the $13,200 printing press in 1935, for which Budge made his initial advance of $2,-000 as a down-payment; whether, in view of the corporation’s questionable financial condition and doubtful business prospects, it was at all advisable to borrow money to attempt to continue its operations; and whether, when Budge decided not to take the risk of making further advances, and the corporation still apparently was without adequate means to carry on its operations satisfactorily, it ought fairly to have *446undertaken to incur additional commercial indebtedness — the claims of all other creditors here involved having come into existence subsequent to the making of Budge’s advances.
It will not do, it seems to me, to say that all of this was mere formality and that the result in any event probably would have been the same. Whether Budge would have taken the same action, if he had been called upon to sit down as a member of a collective board and responsibly review the condition of the corporation, I do not know. Nor, of course, can I say what the two other members of an organized board of directors might have done. The point is that there never was any such action taken; the situation never had anything but, individual consideration, in which a personal interest was involved. Under Minnesota law, such individual consideration and action could not constitute the equivalent of formal, deliberative and collective action by a duly constituted board of directors. Pink v. Metropolitan Milk Co., 129 Minn. 353, 152 N.W. 725, 726; Baldwin v. Canfield, 26 Minn. 43, 1 N.W. 261, 276.
It seems to me that subsequent creditors in dealing with the corporation were entitled to believe that its affairs were being regularly and responsibly handled, in the manner which the articles of incorporation and the statutes prescribed, and that any transactions which might have been had between an officer and the corporation would rest, not upon his own individual will and judgment, but upon regular and responsible corporate action. They had the right to assume, I think, that the course of the corporation was being responsibly charted by a board of directors, and that its financial situation was being similarly reviewed. I believe there was a protection which the law properly should recognize as inhering to them in such a course of action. That protection in the present situation must be regarded as being something more than a mere formality, since the financial situation of the corporation was such as reasonably to suggest a doubt whether Budge’s advances ought at all to have been permitted to be made in order to continue the corporation’s operations, and whether, after Budge apparently decided not to risk further advances and the financial condition of the corporation was unimproved, the indebtedness to the other general' creditors ought fairly to have been permitted to be incurred.
If Budge wanted to answer those questions instead of having a board of directors do so, I think, as against subsequent general creditors, there would exist a disparity of' equitable position that should require his claim to be subordinated. He ought not to ask the court and the other creditors to approve his own usurpation of a board of directors’ functions, in order to allow him to have the benefit of an equal claim position in the- bankruptcy which has resulted.
I would reverse the judgment of the District Court and remand the case with directions to subordinate Budge’s claim.