Petition for Writ of Certiorari — Paloma Estates, Inc. v. Series C-2 Trustees

MAY 12 1042

CHARLES ELMGRE CROPLEY

ib RK

IN THE

Supreme Court of the United States

OCTOBER TERM—1944—

Node So 3-> 77

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~~

PALOMA ESTATES, INC.,

Petitioner,

vs.

SERIES C-2 TRUSTEES

and

SECURITIES AND EXCHANGE COMMISSION.

PETITION FOR A WRIT OF CERTIORARI TO

THE UNITED STATES CIRCUIT COURT OF

APPEALS FOR THE SECOND CIRCUIT.

ERWIN FELDMAN,

Counsel for Petitioner,

Paloma Estates, Inc.

Tus Court Press, N. Y. 0.

PAGE

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Specification of Errors to be Urged ................ 6

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CITATIONS:

Brooklyn Trust Company v. Rembaugh, 110 Fed.

Cee BO oy ccc as coke carn oh bah eRences 5, 7,8

Case v. Los Angeles Lumber Products Co. Ltd., 308

Wh Oe sc seeks nk ha a a a es 9

In re Blinrig Realty Corp., 114 Fed. (2nd) 100..... 5, 7,8

Marine Harbor Properties Inc. v. Manufacturers

Trust Company et al., certiorari granted, 62

Supreme Court, 90.60. ci sc Cccsastes's 7, 8, 9, 12, 13

Securities and Exchange Commission v. U. S. Realty

& Improvement Co., 310 U. S. 434 ..........545. 11

ii

STATUTES:

PAGE

Bankruptey Act, Chapter X, Sec. 101, et seq.,

1, 2, 3, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14

New York Laws, Chapter 745 (1933) as amended;

New ¥ork Unconsolidated Laws, Sec. 1796, et seq.,

4, 6, 10n

New York Laws, Chapter 19 (1935) as amended;

New York Unconsolidated Laws, Sec. 1751, et seq. 10n

MISCELLANEOUS:

ee A IE A RE hed Mico keke ens Oxwnsans 8

18 N. Y. U. Law Rev. (1941) 399, 418 .............. 8

IN THE

Supreme Court of the United States

OCTOBER TERM—1941.

No. ‘

-.

~

Patoma Estarrs, Inc.,

Petitioner,

vs.

Serres C-2 Trustees

and

SeEcuniTIEs anD Excuance Commission.

ys

wr

PETITION FOR A WRIT OF CERTIORARI TO

THE UNITED STATES CIRCUIT COURT OF

APPEALS FOR THE SECOND CIRCUIT.

To the Honorable, the Chief Justice and the Associate

Justices of the Supreme Court of the United States:

Your petitioner, Paloma Estates, Inc., the debtor herein,

a corporation organized under the laws of the State of

New York, prays this Court for the issuance of a writ of

certiorari to the United States Circuit Court of Appeals

for the Second Circuit to review a decree of that Court

entered February 21st, 1942, affirming an order of the

United States District Court for the Southern District

of New York dismissing a petition of the debtor for reor-

ganization under Chapter X of the Bankruptey Act.

Opinions Below.

The majority and dissenting opinions of the Circuit

Court of Appeals (R. 97-102) are reported in 126 Fed.

(24) 72. The opinion of the District Court (R. 79-83) is

PORNONE FB oc Acsiee ye kona ens

Jurisdiction.

The decree of the Cireuit Court of Appeals was entered

on February 21, 1942. The jurisdiction of this Court is

invoked under Section 240 (a) of the Judicial Code as

amended by the Act of February 138, 1925.

Questions Presented.

Section 141 of the Bankruptcy Act provides that a

petition filed under Chapter X shall be dismissed if not

filed in good faith. Section 146 (4) provides that a peti-

tion shall be deemed not to be filed in good faith if “a

prior proceeding is pending in any Court and it appears

that the interests of creditors and stockholders would be

best subserved in such prior proceeding”. The question

presented is whether under these provisions a bankruptcy

court must relinquish the jurisdiction conferred upon it

by Chapter X in favor of a pending state court reorgani-

zation proceeding, upon a mere showing that the debtor

company, which filed the petition under Chapter X once

consented to a plan in the state court proceedings for

an extension of a mortgage on its property, and without

any showing that the interests of the debtor’s creditors

and stockholders would be better safeguarded in the

state court proceedings than in the proceedings under

Chapter X.

Statutes Involved.

Section 141 of the Bankruptcy Act (11 U. S. C., Sec.

541) provides as follows:

“Upon the filing of a petition by a debtor, the judge

shall enter an order approving the petition, if satis-

fied that it complies with the requirements of this

chapter and has been filed in good faith, or dismiss-

ing it if not so satisfied.”

Section 146 of the Bankruptey Act (11 U. S. C., See.

546) provides in part as follows:

“Without limiting the generality of the meaning

of the term ‘good faith’, a petition shall be deemed

not to be filed in good faith if—* * * (4) a prior pro-

ceeding is pending in any court and it appears that

the interests of creditors and stockholders would be

best subserved in such prior proceeding.”

Statement.

The Debtor is the owner of land and a nineteen-story

apartment building erected thereon, located at 200 West

86th Street, New York City. The building was con-

structed by the Debtor in 1931. It consists of 228 apart-

ments, comprising 860 rooms and 15 stores. The property

is subject to a first mortgage originally held by the New

York Title & Mortgage Company as part of a certificated

issue of $24,000,000, known as Series C-2, and which is

represented by certificates distributed and held by numer-

ous certificate holders. In addition thereto, the property

is subject to a second mortgage on which there is a bal-

ance due of $60,000; the Debtor also owes $3,000 in

unsecured indebtedness (R. 7-8, 80-81, 98).

4

As a result of the liquidation of the New York Title &

Mortgage Company, the Supreme Court of the State of

New York, pursuant to the provisions of Chapter 745 of

the Laws of 1933 of the State of New York as amended

(commonly referred to as the Schackno Act) appointed

trustees of the C-2 mortgage investments issued and guar-

anteed by the New York Title & Mortgage Company,

which trustees became the owners of the first mortgage

covering premises 200 West 86th Street, New York City,

for the benefit of certificate holders. In 1936 the prop-

erty was in arrears to the extent of $100,000 and by the

terms of an extension agreement then effected, the Debtor

(R. 81, 98) agreed to discharge said arrears by the pay-

ment of $50,000 in cash and payment of the balance in

five yearly installments of $10,000 each. The mortgage

was extended for a period of five years and provided

for the payment of interest at the rate of 444% for the

first and second years; 454% for the third and fourth

years, and 5% for the fifth year of the extension agree-

ment. The Debtor was unable to meet the November 1,

1940 interest and taxes and at the request of the Series

C-2 Trustees, executed and delivered to the Trustees

an assignment of rents. The Series C-2 Trustees, in turn,

designated Emanuel M. Krulewitch, president of the

Debtor corporation, as its managing agent and he con-

tinued to operate and manage the property for the said

Trustees until June 16, 1941 (R. 81, 98, 99).

During the interim and before any default, the Debtor

had some negotiations with the Trustees with respect to

a modification of the extension agreement, which finally

took the form of an offer to buy the mortgage partly in

eash and the remainder in Series C-2 certificates. The

Debtor was unable to carry out this plan and negotiated

with the Trustees for a modification of this plan, which

was formally outlined and submitted for approval to

5

Judge Noonan by the Debtor and the Trustees, but before

approval was granted, Judge Noonan died. Thereafter,

the Debtor, through its attorney, requested the Trustees

to submit the plan to the Judge who succeeded Judge

Noonan at the Additionai Special Term. Despite the

lapse of a period of eight months, the Trustees failed

and refused to act thereon (R. 99, 69-74).

Thereafter, the Debtor filed its petition under Chapter

X of the Bankruptey Act on June 18, 1941 (R. 2-6). By

order of the District Court Judge, the Securities and

Exchange Commission was made a party to the proceed-

ings and at the hearing, filed a brief in support of the

jurisdiction of the Bankruptcy Court (R. 79-80). The

Trustees filed an answer to the petition of the Debtor

and moved to dismiss the petition as not filed in good

faith (R. 9-19). No trial was had on the issues before

the District Court, dismissal of the petition having been

made by the District Judge solely upon the formal plead-

ings and arguments and briefs of counsel for the Debtor,

the Trustees and the Securities and Exchange Commis-

sion. The District Court Judge, reciting in his opinion

that the Trustees’ defences, as formally pleaded, were

“sufficient in law and sustained by the proof” relied on

Brooklyn Trust Company v. Rembaugh, 110 Fed. (2nd)

838, 42 American Bankruptcy Reports (N. S.) 233 and

In re Blinrig Realty Corp., 114 Fed. (2nd) 100, 43 Amer-

ican Bankruptey Reports (N. 8.) 416 (R. 82).

An appeal from the order dismissing the petition was

taken by the debtor to the United States Circuit Court

for the Second Circuit and the Circuit Court, in a

divided opinion, affirmed the order of the District Court

(R. 97-102).

Specification of Errors to be Urged.

The majority of the Court below erred:

1. In holding that the debtor’s petition for reorgani-

zation under Chapter X of the Bankruptcy Act was not

filed in good faith.

2. In holding that there was an absence of good faith

on the part of the debtor because the debtor had as-

sented to a modification and extension of and a plan of

liquidation covering the satisfaction or assignment of a

certificated mortgage in a state court proceeding.

3. In failing to determine whether or not the interests

of creditors and stockholders would be better subserved

in the state court proceedings than in proceedings under

Chapter X of the Bankruptcy Act, and whether or not

such state court proceedings would provide for public

investors safeguards equivalent to those provided by

Congress in Chapter X.

4. In holding that the state court proceedings under

the Schackno and Mortgage Commission Acts were “prior

pending proceedings” within the meaning ‘of Section

146 (4) of Chapter X.

5. In failing to have a hearing on the facts prior to

determining the issues presented.

6. In failing to reverse, and in affirming, the order

of the District Court.

Argument.

1. This Court recently, on March 16th, 1942, granted

a writ of certiorari on an application which involved

points identical with those presented in this petition.

Marine Harbor Properties Inc., petitioner, vs. Manufac-

turers Trust Company, as Trustee, ete., et al., #948; 62

Supreme Court, 907. The Securities and Exchange Com-

mission which had there been a party in the District

Court and Circuit Court proceedings, in which it con-

sistently supported the position taken by the petitioner,

joined with the latter in the petition for certiorari

and filed a supporting memorandum. The Circuit Court

of Appeals for the Second Circuit, in both the Marine

Harbor and in the instant proceeding relied upon several

earlier cases which dealt with the effect of prior state

court proceedings on the issue of a debtor’s good faith

in the filing of a petition under Chapter X of the Bank-

ruptey Act. See Brooklyn Trust Co. v. Rembaugh, 110

F. (2’d) 838; In re Blinrig Realty Corp., 114 F. (2’d) 100.

Both the Marine Harber and the present case involve

construction of the good faith requirements under See-

tions 141 and 146 (4) of the Bankruptey Act, which made

good faith a condition precedent to the assumption by

the District Court of jurisdiction over a debtor’s petition

under Chapter X. In Section 141 Congress provided that

the District Courts are not to assume jurisdiction over

a debtor’s petition under Chapter X if it is not filed in

good faith and in Section 146 (4) that a petition shall

be deemed not to be filed in good faith where a prior

proceeding is pending in another court. “And it appears

that the interest of the creditors and stockholders would

be best subserved in such prior proceedings.”

The Cireuit Court of Appeals for the Second Circuit,

with Judge Frank dissenting in the Marine Harbor case

8

and Judge Clark dissenting in the instant case, refused

to entertain the debtor’s petition, having resolved the

question of good faith in terms of an assumed personal

disqualification on the part of the debtor, arising merely

out of the latter’s participation in prior state court pro-

ceedings. The Court relied on the Rembaugh and Blinrig

cases in construing the foregoing provisions of the Act

to require that the District Court dismiss all petitions

filed by a debtor company whenever it is shown that the

debtor actively participated in prior state court proceed-

ings irrespective of whether the prior proceedings pro-

vided safeguards for public investors comparable to those

found in Chapter X. In adopting that view, the Circuit

Court acted in apparent disregard of the clear terms

and obvious purport of the Statute.

Judge Clark, dissenting from the opinion below, cited

with approval Judge Frank’s dissent in the Marine Har-

bor case and the Law Review criticisms, Siegel, Chap-

ter X or Schackno Act Proceedings, 27 Corn. L. Q. 56-

73; 18 N. Y. U. L. Q. Rev. 399, 418, and proceeded to

state:

“T cannot avoid the conviction that we are sub-

stituting an inadequate state proceeding for the care-

fully safeguarded proceedings in reorganization de-

vised by Congress for cases such as this, where the

public interest may be protected by the public agency

of the Securities anc Exchange Commission. And

this, it seems to me, is as practically undesirable as

it is legally unjustified” (R. 101).

Moreover, he, pointed out the impropriety of disposing

of the good faith inquiry without a hearing and on the

sole basis of formal pleadings supported by affidavit

proof. He rejected the approach of the majority which

unduly emphasized the activity of the debtor in disre-

-

9

gard of the statutory requirement that the District Court

take jurisdiction unless it found, after conducting an in-

vestigation, that “the interests of creditors and stock-

holders would be best subserved” in the prior state court

proceedings (R. 102).

The Securities and Exchange Commission, in its memo-

randum supporting the petition for certiorari in the Ma-

rine Harbor case, referred to the instant case, adopted

the reasoning of Judge Clark’s dissent in the Circuit

Court and criticized the disregard by the majority of the

Court of the interests of the debtor’s creditors and stock-

holders in contravention of the purpose of the statute.

That memorandum forcefully said in part:

“Moreover, the assumption that the personal bad faith

of the debtor, if deemed to exist, is relevant to the pro-

priety of the exercise of jurisdiction by the bankruptcy

court ignores the essential elements of the statutory |

scheme devised by Congress. Congress provided the safe- |

guards of Chapter X for the benefit of investors; it di-

rected that consideration be given to the interests of

creditors and stockholders. To ignore the real parties

in interest and to attach weight to the conduct of the |

fictional legal entity known as the debtor is to nullify |

the purposes of the Act. The motives of the debtor |

itself are unimportant, because once the petition is filed |

the court, not the debtor, has control of the proceedings.

See Case v. Los Angeles Lumber Products Co. Ltd., 308 |

U. S. 106, 125-126. Under the rule enunciated in that

case the debtor and its stockholders can gain no strategic

advantage from the pendency of the proceedings and

their interests will be entirely eliminated unless a sur-

plus remains after payment of all creditors in full (id.,

131). Indeed, the more questionable may be the motives

of the debtor or the persons controlling it, the more

eee eeereeretereererneeeemmneaeninsemesinemmasemnsninenseets

10

reason there is for the court to take jurisdiction and to

make available to creditors and stockholders the safe-

guards of Chapter X.

“4. Had the court below directed its attention, not to

the alleged ‘personal disqualification’ of the debtor, but

to the effect of the dismissal of the petition upon the

interests of the creditors and stockholders, its decision

would necessarily have been different.”

The decision below patently calls for review by this

Court.

2. The state court proceedings do not meet the re-

quirements of Section 146 (4) to justify the dismissal

of the debtor’s petition. The prior proceeding had been

conducted under the so-called Schackno Mortgage Com-

mission Acts of New York.1 As the Securities and Ex-

change Commission pointed out in the memorandum re-

ferred to, the state procedures “* * * lack almost all the

basic safeguards for the protection of security-holders

provided by Congress in Chapter X. There is no search-

ing investigation of the debtor’s past management and

of its present business and prospects which is required

through the medium of an independent trustee under

Section 167 of the Bankruptcy Act. There is no provi-

sion similar to that requiring participation in Chapter X

reorganization proceeding by the Securities and Exchange

Commission. There is no requirement that a plan must

receive preliminary approval by the court before the

assent of security-holders may be obtained (es. Section

176 of the Bankruptcy Act) or that information must be

furnished to security-holders (cf. Section 175 of the Bank-

ruptey Act); and there are no protective provisions as

1, 1933-e.745 as amended; N. Y. Unconsolidated Laws, Sections

1796 et seq.; L. 1935-c.19 as amended; N. Y. Unconsolidated Laws,

Sections 1751 et seq.

11

to the form of reorganization (cf. Section 216 of the

Bankruptey Act). Indeed, Chapter X has the same

superiorities over the state court procedure as this Court

held that it has over the procedure provided in Chapter

XI of the Bankruptcy Act. See Securities and Exchange

Commission v. U. 8S. Realty & Improvement Co.”

The Commission noted with emphasis, citing Securities

and Exchange Commission v. U. S. Realty & Improve-

ment Co., 310 U. S. 434, that. Chapter X provides an

integrated and carefully fashioned procedure for the re-

organization of corporations and for the protection of

their security holders, in the following essential aspects:

(a) There is control by the Court over security

holders’ committees and the formulation of reorgani-

zation plans (310 U. S. 449).

(b) There is impartial and expert administrative

assistance through participation in the proceedings

by the Securities and Exchange Commission (ibid.).

(ec) There is provision for the appointment of a dis-

interested trustee and for an investigation and report

by such trustee concerning the debtor’s financial

problems and management.

(d) There is assurance that security holders will

not be required to vote on any proposed plan of

reorganization until they have received full informa-

tion concerning the plan and until the plan has been

initially approved by the Court.

That procedure under Chapter X is to supersede all

conflicting state procedures except, as stated in Section

146 (4), where a state court proceeding is pending and

the interests of creditors and stockholders would be best

subserved in such prior proceedings. The mere pendency

of prior state court proceedings is not enough. The

a

12

prior state court proceedings herein and the procedure

under the Schackno Mortgage Commission Acts are

patently not of such character as would warrant the re-

fusal to entertain jurisdiction by the District Court.

Certainly there is no ground for holding that the inter-

ests of creditors and stockholders would be best served

by the dismissal of the Chapter X proceeding.

3. The debtor, who was summarily rebuffed by the

trustees, who refused to present its revised plan to the

state court should not be disqualified from reorganization

in the Federal court. In his dissenting opinion, Judge

Clark aptly characterized the attitude of the trustees as

follows:

«“* * * the trustees are now acting as dogs in the

manger; for they will not present the debtor’s revised

plan to the state court, and that appears to be the

only way it can get there” (R. 101).

Nevertheless, the majority of the Circuit Court below

would deprive the debtor of access to the Bankruptcy

Court for the purpose of reorganizing, merely because

the debtor had previously invoked state court procedures.

From the point of view of the majority of the Circuit

Court, the debtor is by that token permanently relegated

to the state court, even though in actuality he has no

standing in the state court. This disqualification would

attach to every debtor regardless of any change in circum-

stances and irrespective of whether the state procedure,

which deprives the debtor of all remedy, would best sub-

serve the interests of the creditors and stockholders of

the debtor. Apparently the only test employed by the

Circuit Court in the present case as well as in the Marine

Harbor case is whether the debtor ever voluntarily sub-

mitted or had been subject to the jurisdiction of the state

court. If so, such debtor has no access to the federal

13

court and the remedies available under Chapter X. That

is the view of the majority of the Cireuit Court further-

more, notwithstanding the absence of any showing that

the interests of creditors and stockholders would be best

served by the dismissal of the Chapter X proceeding. As

Judge Clark pointed out in his dissent:

“We have no real evidence on the point save for

the affidavits of the appearing parties” (R. 101).

The federal court ought readily to assume jurisdiction

over the debtor’s petition. Only in that manner could

the merits of the revised plan or of a substitute plan

be aired with a full regard for the best interests of all

concerned, including the debtor, creditors and stock-

holders. If the holding of the Cireuit Court were per-

mitted to stand, however, Federal treatment of the entire

situation on the debtor’s application would be forever

barred, since at one time or another every debtor to

mortgage guarantee companies has apparently submitted

to the jurisdiction of the state court and would be subject

to personal disqualification.

Conclusion.

In the instant case as in Marine Harbor, wherein this

Court granted the debtor’s petition for certiorari, the

Circuit Court of Appeals for the Second Cireuit in-

voked the debtor’s alleged personal disqualification as

the ground for withholding Federal jurisdiction over a

debtor’s petition under Chapter X, although Section

146 (4) provides an objective standard of good faith as

1 condition precedent to a debtor’s resort to the Federal

Courts, to wit, that there be no “prior proceeding pend-

ing where it appears that the interest of creditors and

stockholders would be best subserved.” The majority

14

of the Cireuit Court dispensed with the necessity for an

investigation preliminary to making such determination.

No such investigation was ever conducted and the debtor

was presumed to have been personally disqualified from

the mere fact that it had participated in prior state court

proceedings. As a result of the failure to weigh the ade-

quacy of the state machinery in the light of Section

146 (4), the protective devices of Chapter X are with-

held from creditors and stockholders whose fate is to be

determined by demonstrably inadequate state procedures

provided in an experimental emergency measure. More-

over, the debtor who is without safeguards under the state

procedures has been presumed personally disqualified to

invoke the Federal machinery as a result of erroneous

construction of the applicable provisions of the statute.

The questions here raised are of significant import in

the real estate mortgage situation that has obtained in

this country since 1929. It is a Federal question that

should be but has not been decided by this Court.

Your petitioner accordingly respectfully prays that

this petition for a writ of certiorari to the United States

Cireuit Court of Appeals for the Second Circuit be

granted.

Dated: May 11th, 1942.

ERWIN FELDMAN,

Attorney for Petitioner,

Paloma Estates, Ince.

15

State of New York,

County of New York—-ss.:

Erwin Feipman, being duly sworn, deposes and says:

That he is the attorney for the petitioner named in the

foregoing petition. That he has prepared the same and

that the allegations thereof are true as he thoroughly

believes.

ERWIN FELDMAN.

Subscribed and sworn to before me

this 11th day of May, 1942.

SyPELLE HERMALLIN,

Notary Public,

Bronx County.

Certificate filed in New York County.

Commission expires March 30, 1944.