U.S. Supreme Court CASE v. LOS ANGELES LUMBER PRODUCTS CO., 308 U.S. 106 (1939)

308 U.S. 106

CASE et al. v. LOS ANGELES LUMBER PRODUCTS CO., Limited (two cases).

Nos. 23 and 24. Argued Oct. 18, 1939. Decided Nov. 6, 1939.

Rehearing Denied Dec. 4, 1939

See 308 U.S. 637, 60 S.Ct. 258, 84 L.Ed. --.[ Case v. Los Angeles Lumber Products Co. 308 U.S. 106 (1939) ]

[Page 308 U.S. 106, 110]

the outstanding bonds, which reduced the interest from 7 1/2% to 6% and made the interest payable only if earned. At the same time the old stock of the debtor was wiped out by assessment and new stock issued, divided into Class A and Class B, with equal voting rights. Class A stock was issued to some of the old stockholders who contributed $400,000 new money which was turned over to the Los Angeles Shipbuilding and Drydock Corporation and used by it as working capital. In consideration of this contribution the bondholders who agreed to the modification of the identure likewise released the stockholders' liability under California law in favor of these contributors. Some Class B stock was issued to bondholders in payment of unpaid interest coupons. [Footnote 3] At present there are outstanding 57,788 shares of Class A stock and 5,112 shares of Class B stock.

[Page 308 U.S. 106, 111]

terial to the issues here involved. That plan as modified provides for the formation of a new corporation, which will acquire the assets of Los Angeles Shipbuilding and Drydock Corporation,4 and which will have a capital structure of 1,000,000 shares of authorized $1 par value voting stock. This stock is divided into 811,375 shares of preferred and 188,625 shares of common. The preferred stock will be entitled to a 50% non- cumulative dividend, after which the common stock will be entitled to a similar dividend. Thereafter all shares of both classes will participate equally in dividends. The preferred stock will receive on liquidation a preference to the amount of its par value. Thereupon the common will receive a similar preference. Thereafter all shares of both classes participate equally.

170,000 shares of preferred are reserved for sale to raise money for rehabilitation of the yards. [Footnote 5] 641,375 shares of the preferred are to be issued to the bondholders, 250 shares to be exchanged for each $1000 bond. The Class A stockholders will receive the 188,625 shares of common stock, without the payment of any subscription or assessment. No provision is made for the old Class B stock. The aggregate par value of the total preferred and common stock to be issued to existing security holders is $ 830,000-an amount which equals the going concern value of the assets of the enterprise.

[Page 308 U.S. 106, 116]

creditors over stockholders in reorganization plans. [Footnote 7] In Louisville Trust Co. v. Louisville, New Albany & Chicago Ry. Co., supra, this Court reaffirmed the 'familiar rule' that 'the stockholder's interest in the property is subordinate to the rights of creditors. First, of secured, and then of unsecured, creditors.' And it went on to say that 'any arrangement of the parties by which the subordinate rights and interests of the stockholders are attempted to be secured at the expense of the prior rights of either class of creditors comes within judicial denunciation.' 174 U.S. page 684, 19 S.Ct. page 830. This doctrine is the 'fixed principle' according to which Northern Pacific Railway Co. v. Boyd, supra, decided that the character of reorganization plans was to be evaluated. And in the latter case this court added, 'If the value of the road justified the issuance of stock in exchange for old shares, the creditors were entitled to the benefit of that value, whether it was present or prospective, for dividends or only for purposes of control. In either event it was a right of property out of which the creditors were entitled to be paid before the stockholders could retain it for any purpose whatever.' 228 U.S. page 508, 33 S.Ct. page 561. On the reaffirmation of this 'fixed principle' of reorganization law in Kansas City Terminal Ry. Co. v. Central Union Trust Co., supra, it was said that 'to the extent of their debts creditors are entitled to priority over stockholders against all the property of an insolvent corporation.' 271 U.S. page 455, 46 S.Ct. page 551.

[Page 308 U.S. 106, 121]

security holders could be perpetuated in the new company even though the assets were insufficient to pay-in new bonds or stock-the amount owing senior creditors. Such a result is not tenable.

It is, of course, clear that there are circumstances under which stockholders may participate in a plan of reorganization of an insolvent debtor. This Court, as we have seen, indicated as much in Northern Pacific Railway Co. v. Boyd, supra, and Kansas City Terminal Ry. Co. v. Central Union Trust Co., supra. Especially in the latter case did this Court stress the necessity, at times, of seeking new money 'essential to the success of the undertaking' from the old stockholders. [Footnote 15] Where that necessity exists and the old stockholders make a fresh contribution and receive in return a participation reasonably equivalent to their contribution, no objection can be made. But if these conditions are not satisfied the stockholder's participation would run afoul of the ruling of this Court in Kansas City Terminal Ry. Co. v. Central Union Trust Co., supra, that 'Whenever assessments are demanded, they must be adjusted with the purpose of according to the creditor his full right of priority against the corporate assets, so far as possible in the existing

[Page 308 U.S. 106, 123]

column of the balance sheet of the new company. They reflect merely vague hopes or possibilities. [Footnote 16] As such, they cannot be the basis for issuance of stock to otherwise valueless interests. The rigorous standards of the absolute or full priority doctrine of the Boyd case will not permit valueless junior interests to perpetuate their position in an enterprise on such ephemeral grounds. [Footnote 17]

[Page 308 U.S. 106, 124]

the function of that Act. One of the purposes of 77B was to avoid the consequences to debtors and creditors of foreclosures, liquidations, and forced sales with their drastic deflationary effects. [Footnote 18] To hold that in a 77B reorganization creditors of a hopelessly insolvent debtor may be forced to share the already insufficient assets with stockholders because apart from rehabilitation under that section they would suffer a worse fate, would disregard the standards of 'fair and equitable'; and would result in impairment of the Act to the extent that it restored some of the conditions which the Congress sought to ameliorate by that remedial legislation.

[Page 308 U.S. 106, 125]

of the property through foreclosure or otherwise until the maturity of the bonds. And as a corollary thereof we likewise assume that the stockholders, at least so far as the bondholders were involved, could keep their management group in possession and control until that time. And we assume that this right or power on the part of the stockholders to keep possession until 1944 was for them a thing of value, though there is no finding that the old stock had any value, present or prospective.

But we cannot conclude that that right survived the commencement of the proceeding under 77B. A debtor as well as a creditor who invokes the aid of the federal courts in reorganization or rehabilitation under 77B assumes all of the consequences which flow from that jurisdiction. Once the property is in the hands of the court private rights as respect that res are subject to the superior dominion of the court and are to be adjudicated pursuant to the standards prescribed by the Congress. As a result of such proceedings the hand of all executions or levies may be stayed. [Footnote 19] The court acquires 'exclusive jurisdiction of the debtor and its property wherever located for the purposes of this section.' [Footnote 20] The court need not keep the debtor in possession but may substitute for the old management a trustee; or if the old management is retained it operates the business 'subject at all times to the control of the judge, and to such limitations, restrictions, terms, and conditions as the judge may from time to time impose and prescribe'.21 Thus, while the property remains in the hands of the court, as it does until dismissal or final decree on confirmation, the debter, though left in pos-

[Page 308 U.S. 106, 126]

session by the judge, does not operate it, as it did before the filing of the petition, unfettered and without restraint. The control of the court is then pervasive. [Footnote 22] Furthermore stockholders and other junior interests may be excluded from any plan of reorganization if the court finds that the debtor is insolvent. In re 620 Church Street Building Corp., 299 U.S. 24, 57 S.Ct. 88. And on facts such as exist here, these junior interests must be excluded unless they furnish adequate consideration for the interest which they obtain in the new company. And once the jurisdiction of the court has been invoked, whether by the debtor or by a creditor, that petitioner cannot withdraw and oust the court of jurisdiction. [Footnote 23] He in-

[Page 308 U.S. 106, 127]

vokes that jurisdiction risking all of the disadvantages which may flow to him as a consequence, as well as gaining all of the benefits. One of those disadvantages from the viewpoint of the debtor and its stockholders is the approval of a plan of reorganization which eliminates them completely. [Footnote 24] Accordingly, respondent's assertion in this case that the major contribution of these stockholders justifying their inclusion in the plan was the waiver of their right to defer or put off foreclosure until 1944, i.e., to remain in possession, does not stand analysis. The right to remain in unmolested dominion and control over the property was necessarily waived or abandoned on invoking the jurisdiction of the federal courts in these proceedings. When that jurisdiction attached, the court rather than the stockholders was in control with all of the powers and duties which that entailed under 77B. Certainly the surrender of a right thus waived is not adequate consideration for the dilution of the bondholders' priorities which this plan would effect.

And there is a further reason why this result necessarily follows, if the will of the Congress as expressed in 77B is not to be thwarted and if the integrity of such proceedings is to be maintained. As we have said, this plan had its origin in an endeavor on the part of the debtor in 1937 to effect a voluntary reorganization. A plan was proposed by the debtor which was the same as that here involved except for the amount and nature of the stock to be received by the bondholders. [Footnote 25] That plan

[Page 308 U.S. 106, 129]

rity holders had previously made. Such procedure would deprive scattered and unorganized security holders of the protection which the Congress had provided them under 77B. The scope of the duties and powers of the Court would be delimited by the bargain which reorganizers had been able to make with security holders before they asked the intercession of the court in effectuating their plan. Minorities would have their fate decided not by the court in application of the law of the land as prescribed in 77B, but by the forces utilized by reorganizers in prescribing the conditions precedent on which the benefits of the statute could be obtained. No conditions precedent to enjoyment of the benefits of 77B can be provided except by the Congress. To hold otherwise would be to allow reorganizers to rewrite it so as to best serve their own ends. [Footnote 27]

[Page 308 U.S. 106, 130]

protects are not to be diluted, it is the clear duty of the court to resist all such assertions. Of course, this is not to intimate that compromise of claims is not allowable under 77B. There frequently will be situations involving conflicting claims to specific assets which may, in the discretion of the court, be more wisely settled by compromise rather than by litigation. Thus, ambiguities in the wording of two indentures may make plausible the claim of one class of creditors to an exclusive or prior right to certain assets as against the other class in spite of the fact that the latter's claim flows from a first mortgage. [Footnote 28] Close questions of interpretations of after-acquired property clauses in mortgages, preferences in stock certificates, divisional mortgages and the like will give rise to honest doubts as to which security holders have first claim to certain assets. Settlement of such conflicting claims to the res in the possession of the court is a normal part of the process of reorganization. In sanctioning such settlements the court is not bowing to nuisance claims; it is administering the proceedings in an economical and practical manner. But that is not the situation here. As a result of the filing of the petition in this case, the court, not the stockholders, acquired exclusive dominion and control over the estate. Hence, any strategic position occupied by the stockholders prior to these proceedings vanished once the court invoked its jurisdiction. Threats by stockholders of the kind here in question are merely threats to the jurisdiction of the

[Page 308 U.S. 106, 132]

requirements of the Act cannot be adopted nor that all reasonable time for proposal of such alternative plans has expired.

We therefore hold that the plan is not fair and equitable and that the judgment below must be and is

REVERSED.

Mr. Justice BUTLER took no part in the consideration or disposition of this case. Footnotes

Footnote 1 One involves an interlocutory order and the other a final order confirming a plan of reorganization under 77B of the Bankruptcy Act.

Footnote 2 Other liabilities, not material here, are $6,075.94 of current accounts payable and $496,899.76 due the Los Angeles Shipbuilding and Drydock Corporation.

Footnote 3 A large block of Class B stock was escrowed under a management contract with one Armes to be delivered to him when all the bonds were retired and the Class A stockholders were paid back their $400,000 plus interest in the form of dividends. But this management contract was later terminated and the escrowed Class B stock was returned to the debtor and cancelled. Class A stock was preferred to Class B in the event of liquidation to the amount of $400,000 and interest.

Footnote 4 The assets of the debtor, except the capital stock of two subsidiaries which have assets of some, though slight, value will also be transferred to the new company. The assets of these two subsidiaries will be liquidated and the proceeds distributed pro rata among bondholders. The assets of the other three subsidiaries will also apparently be acquired by the new company.

Footnote 5 No underwriting of these funds is provided and no disclosure is made as to how the additional funds are to be raised.

Footnote 6 It provides in part: 'After hearing such objections as may be made to the plan, the judge shall confirm the plan if satisfied that (1) it is fair and equitable and does not discriminate unfairly in favor of any class of creditors or stockholders, and is feasible; (2) it complies with the provisions of subdivision (b) of this section; (3) it has been accepted as required by the provisions of subdivision (e), clause (1) of this section; ....'

Footnote 7 For analyses and reviews of these cases as applied to equity reorganizations or reorganizations under 77B and 77 of the Bankruptcy Act, 11 U.S.C.A. 207, 205, see Frank, Some Realistic Reflections on Some Aspects of Corporate Reorganization, 19 Va.L.Rev. 541; Swaine, Reorganization of Corporations: Certain Developments of the Last Decade, 27 Col.L.Rev. 901; Spaeth and Winks, The Boyd Case and Section 77, 32 Ill. L.Rev. 769; Bonbright and Bergeman, Two Rival Theories of Priority Rights of Security Holders in a Corporate Reorganization, 28 Col.L.Rev. 127; Friendly, Some Comments on the Corporate Reorganization Act, 48 Harv.L.Rev. 39; 2 Gerdes on Corporate Reorganizations, 1084.

Footnote 8 Jameson v. Guaranty Trust Co. of New York, 7 Cir., 20 F.2d 808, 815, certiorari denied 275 U.S. 569, 48 S.Ct. 141.

Footnote 9 Flershem v. National Radiator Corp., 3 Cir., 64 F.2d 847, 852, reversed 290 U.S. 504, 54 S.Ct. 298, 90 A.L.R. 391.

Footnote 10 P. R. Walsh Tie & Timber Co. v. Missouri Pacific Ry. Co., 8 Cir., 280 F. 38, 44.

Footnote 11 Mountain States Power Co. v. A. L. Jordan Lumber Co., 9 Cir., 293 F. 502, 506.

Footnote 12 St. Louis-San Francisco Ry. Co. v. McElvain, D.C., 253 F. 123, 134. See also Guaranty Trust Co. v. Missouri Pacific Ry. Co., D.C., 238 F. 812, 816, 819.

Footnote 13 Northern Pacific Railway Co. v. Boyd, supra, spoke of a 'fair' offer to the creditor and a 'just reorganization' as the prerequisite to validity of the plan. 228 U.S. page 508, 33 S.Ct. 554. Kansas City Terminal Ry. Co. v. Central Union Trust Co., supra, said that the offer to the creditor had to be 'fair and binding.' 271 U.S. page 452, 46 S.Ct. page 551.

Footnote 14 See In re Day & Meyer, Murray & Young, 2 Cir., 93 F.2d 657; Tellier v. Franks Laundry Co., 8 Cir., 101 F.2d 561; In re Philadelphia & Reading Coal & Iron Co., 3 Cir., 105 F.2d 357; In re New York Railways Corp., 2 Cir., 82 F.2d 739, 744; 2 Gerdes on Corporate Reorganizations, 1085. Intimations to the contrary, Downtown Investment Association v. Boston Metropolitan Buildings, Inc., 1 Cir., 81 F.2d 314, 323, 324; In re A. C. Hotel Co., 7 Cir., 93 F.2d 841, are not tenable.

The statutory scheme of 77B (in those respects which are material here) is in sharp contrast to that which was provided for compositions under former 12, 11 U.S.C.A. 30. This court said in Callaghan v. Reconstruction Finance Corp., 297 U.S. 464, 470, 56 S.Ct. 519, 522: 'Reorganizations now permitted under section 77B present certain resemblances to compositions under section 12 which have been commented upon as supporting the constitutionality of the reorganization provisions of section 77 or section 77B. ... But section 77B contemplates a procedure and results not permissible under section 12. Reorganizations are nowhere referred to in the statute as compositions.' Under 12, sub. a, 11 U.S.C.A. 30, sub. a, (as it existed at the time 77B was enacted) only a 'bankrupt' could offer 'terms of composition to his creditors'. Under 77B, sub. d plans may be proposed not only by the debtor but also by a designated percentage of the creditors or, where the debtor is not found to be insolvent, by a specified percentage of stockholders. Section 12, sub. d as it then existed provided that the judge 'shall confirm a composition if satisfied' inter alia that 'it is for the best interests of the creditors'. See Fleischmann & Devine, Inc., v. Saul Wolfson Dry Goods Co., Inc., 5 Cir., 299 F. 15. The 'fair and equitable' standard employed in 77B was not then present in 12. Consent by the debtor to the composition was implicit in former 12. Cf. In re Bryer, 2 Cir., 281 F. 812. But under 77B approval of a plan by security holders who have no equity in the enterprise is unnecessary.

In re 620 Church Street Building Corp., , 57 S.Ct. 88. The general view was well expressed in Re Dutch Woodcraft Shops, D.C., 14 F.Supp. 467, 469, 'The preservation of business enterprises must not be at the expense of creditors, and the provisions of section 77B should not be taken advantage of to effect what, in fact, amounts to a composition under section 12.'

The Chandler Act, c. 10, 52 Stat. 840, 883, 101 et seq., 11 U.S.C.A . 501 et seq., approved June 22, 1938, now supplants 77B. Various substantial changes in the provisions of 77B have been made therein. But the standard of 'fair and equitable' as used in 77B remains unaltered as one of the criteria necessary for confirmation of a plan of reorganization . 221(2).

Footnote 15 This new money was commonly necessary in equity reorganizations not only to provide new working capital but also to pay dissenting creditors. See Weiner, Conflicting Functions of the Upset Price in a Corporate Reorganization, 27 Col.L.Rev. 132.

Like considerations are relevant in reorganizations under 77B. As stated by the court in Re Dutch Woodcraft Shops, D.C., 14 F.Supp. 467, 471:'Circumstnaces may exist where the success of an undertaking requires that new money be furnished and where the former stockholders are the only or most feasible source of the new capital. In such instances, the court may recognize as fair and equitable a plan which includes contributions of new money by stockholders, provided it satisfactorily appears that full recognition has been given to the value of creditors' claims against the property.'

Footnote 16 On comparable facts a like conclusion was reached in Re Barclay Park Corp., 2 Cir., 90 F.2d 595, where the court said, page 598:'It is argued that the stockholders represent the present management of the hotel and that the management is valuable and indeed necessary to the enterprise and that the manager-stockholders will 'walk out' if the proposed plan does not go through and leave the hotel to its fate. But there is no binding agreement on their part to remain which might afford a justification for giving them a stock interest and, if their managerial skill is vital to the success of the hotel, any stock issued to insure the continuance of their relation ought to go to those stockholders who are of use to the enterprise and agree to act in its behalf, and not to all stockholders as such. Indeed, the supposed advantages of retaining the existing management seem to be a matter of inference, if not of speculation, supported by the oral statements of attorneys instead of by testimony.'

Footnote 17 This conclusion is reemphasized here by the fact that not all of the Class A stockholders who receive new stock are part of the management of the debtor.

Footnote 18 See H.R. Rep. No. 1409, 75th Cong., 1st Sess., p. 38, dealing with recent amendments to the section; and H.R. Rep. No. 194, 73rd Cong., 1st Sess., p. 2, the report accompanying the original Act.

Footnote 19 Section 77B, subs. a, c(10). Cf. Continental Illinois National Bank & Trust Co. v. Chicago, Rock Island & Pacific Ry. Co., 294 U.S. 648, 55 S.Ct. 595.

Footnote 20 Section 77B, sub. a.

Footnote 21 Section 77B, sub. c.

Footnote 22 See, 1 Gerdes on Corporate Reorganizations, c. 9. These powers embrace not only the specifically enumerated powers contained in 77B but also 'all the powers, not inconsistent with this section, which a Federal court would have had it appointed a receiver in equity of the property of the debtor by reason of its inability to pay its debts as they mature.' 77B, sub. a. In addition, by virtue of 77A 11 U.S.C.A. 206, the district court, as a court of bankruptcy, has original jurisdiction in proceedings under 77B. Illustrative of specific powers granted by 77B are the powers of the court to authorize issuance of certificates ( 77B, sub. c(3), to require the filing of schedules and reports ( 77B, sub. c(4 ), to direct rejection of executory contracts ( 77B, sub. c(5), to control salaries of officers and to approve appointments 'to any office ( 77B, sub. c(11). The last subsection also provides, 'In case a trustee is not appointed, the debtor shall continue in the possession of its property, and, if authorized by the judge, shall operate the business thereof during such period, fixed or indefinite, as the judge may from time to time prescribe, and shall have all the title to and shall exercise, consistently with the provisions of this section, all the powers of a trustee appointed pursuant to this section, subject at all times to the control of the judge, and to such limitations, restrictions, terms, and conditions as the judge may from time to time impose and prescribe.' In the instant case the court left the debtor in possession, allowing its officers no salaries but allowing specified salaries to be paid to designated officers of the principal subsidiary.

Footnote 23 The Act has explicit standards for dismissal ( 77B, sub. c(8) which we discuss hereafter.

Footnote 24 As recognized in In re 620 Church Street Building Corp., supra, 77B, sub. e(1) expressly takes care of this contingency in the provision that acceptance of the plan by a majority of the stock 'shall not be requisite to the confirmation of the plan by any stockholder or class of stockholders (1) if the judge shall have determined' inter that 'the debtor is insolvent.'

Footnote 25 Under that plan the new company was to have an authorized capital of $1,000,000 consisting of 1,000,000 shares of a par value of $1.00 per share, the bondholders getting 590,065 of the shares and the old Class A stockholders getting 239,935 of the shares. Shares going to the bondholders were of the same class as those received by stockholders.

Footnote 26 These assents were apparently measured by the failure of the bondholders to withdraw their consents which had been given to the original plan, on receiving copies of the proposed modification.

Footnote 27 Cf. Hollister v. Stewart, 111 N.Y. 644, 19 N.E. 782, where the court struck down a voluntary reorganization which attempted to bind minority bondholders. The court said 'Unless railroad syndicates or committees are to be put above the constitution, the trustees cannot set aside and change their contract with plaintiff of their own volition without his consent.' 111 N.Y. page 660, 19 N.E. page 789.

Footnote 28 That would appear to be essentially the type of case involved in In the Matter of Detroit International Bridge Co., Debtor, No. 24131, U.S. D.C.E.D.Mich., 30 F.Supp, 127, cited to us by the respondent and described in an advisory report (Corporate Reorganization Release No. 9) submitted by the Securities and Exchange Commission pursuant to 172, c. X of the Chandler Act, 11 U.S.C.A. 572.