Petition — Cosoff v. Rodman

Office - Suprema Court, U.S.

82-1985 FILED

im 83 8h

No. i

} ALEXANDER L. STEVAS, F

IN THE ; CLERK

SUPREME COURT OF THE UNITED. STATES

October Term, 1982

In re:

W.T. GRANT COMPANY,

Bankrupt.

DAVID COSOFF and HELEN FINKELSTEIN,

Petitioners,

- against -

CHARLES G. RODMAN, as Trustee of W.T. GRANT

COMPANY, Bankrupt,

Respondent.

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF

APPEALS FOR THE SECOND CIRCUIT

BRADLEY R. BREWER, ESQ.

BREWER & SOEIRO

Attorneys for Petitioners

799 Broadway

New York, New York 10003

(212) 777-4010

<a

Questions Presented for Review

1. Was a substantial conflict of in-

terests created in violation of principles of

law set forth by this Court in Pepper v. Lit-

ton, 308 U.S. 295, 300 (1939), and of standards

of ethical conduct applicable to attorneys prac-

ticing before the federal courts where: (a) an

attorney and his law firm sought and received

appointment by a bankruptcy court to be attor-

neys for the bankrupt estate of a corporation;

(b) at the time of the appointment, the attor-

ney and his firm were representing and had rep-

resented in the past several banks who were

leaders of a group of bank creditors who had

filed claims as secured creditors with loans

of $657.4 million representing approximately

94% of the assets of the bankrupt estate; (c)

at the time of the appointment, the attorney

and the leading bank creditors knew that a ma-

jor portion of the attorney's efforts as coun-

sel for the bankrupt estate would involve con-

ducting litigation on behalf of the estate's

general creditors and against the bank credi-

tors involving claims by the general creditors

that the bank claimants came before the court

with unclean hands for which their liens should

be declared void and their claims subordinated

to those of the untainted general creditors;

(d) after the appointment, the attorney and

ee

his firm proceeded to conduct the anticipated

massive litigation against the banks on behalf

of the general creditors over a period of two

years for which the attorney and his firm were

paid by the estate several million dollars in

legal fees; (e) while the attorney and his firm

were purporting to litigate against the bank

creditors over claims to hundreds of millions

of dollars in cash held by the estate, he and

the firm were simultaneously representing some

of the lead banks in connection with other and

unrelated bankruptcy matters for which the at-

torneys were paid substantial fees; and (f)

when the bank creditors proposed a settlement

of the claims at issue between them and the

general creditors, the attorney for the estate

and the bankruptcy trustee (who, like the es-

tate's attorney, had admittedly received his

appointment through connections with the banks

and the banks' attorneys) decided to drop their

opposition to the banks' claims, abandon all of

the positions of fact and law previously assert-

ed by them in the litigation, accept all of the

arguments presented by the banks, and enthusi-

astically recommend to the bankruptcy court that

it accept and approve whatever offer the banks

had chosen to make as the best result that could

be obtained for the general creditors?

2. If those circumstances did create

a significant conflict of interests on the part

- iii -

of the attorney and his firm in violation of

legal principles enunciated by this Court, was

that conflict sufficiently substantial to re-

guire the bankruptcy court (1) to hold the es-

tate's attorney and his firm unqualified (for

reasons of potential bias) to evaluate the

proposed settlement or to recommend it to the

bankruptcy court under applicable provisions

of the Bankruptcy Act and (2) to appoint new

and independent counsel to investigate the mat-

ter and make recommendations to the bankruptcy

court regarding the strength of the general

creditors' claims against the banks and the

fairness of the settlement proposal by the

banks?

3. Where a bank's relationship with

@ corporation is such that it is both (a) a

major creditor with approxim»tely $100 million

in loans outstanding and (b) a paid fiduciary

(indenture trustee) for debentureholders of

the corporation with approximately $100 mil-

lion in bonds outstanding, has the bank com-

mitted a clear violation of its fiduciary du-

ties as indenture trustee for the debenture-

holders for which its interests must be held

subordinate to the bankruptcy claims of the

debentureholders under the teachings of Pep-

per v. Litton, 308 U.S. 295 (1939); Dabney v.

Chase National Bank, 196 F.2d 668 (2d Cir.

1952), supplemented, 201 F.2d 635 (2d Cir.),

- iv -

cert. dismissed per stip., 346 U.S. 863 (1953);

and related cases* where: (1) the bank, prior

to its resignation as indenture trustee in fa-

vor of a successor, participated with two oth-

er leading bank creditors (as leaders of a bank

creditor group) in the negotiation of guaran-

ties and liens from the corporation which would

provide the basis for a contention by the banks

(which they would not otherwise have had) that

their loans were "Senior" to the debt obliga-

tions held by the debentureholders and (2) the

bank participated with two other "lead" banks

in exerting influence over the corporation's

management and thereby prevented management

from completing a transaction by means of which

the corporation would have sold certain accounts

receivable and used the proceeds to buy the

outstanding $100 million in debentures from

the holders in the open market market for ap-

proximately $30 million?

4. Where (a) two members of a group

of bank creditors holding $657 million inclaims

against a bankrupt corporation had influential

representatives on the bankrupt's board of di-

rectors before bankruptcy and two other mem-

bers of the bank creditor group were indenture

* E.g., U.S. -Trust Co. v. First Nat. City Bank,

37 A.D. 2d 285, 296 (lst Dept.-1977), aff'd w/o opinion,

45 N.Y. 2d 869. (1978); Morris v. Cantor, 390 F. Supp.

S17 (S.D.N.Y. 1975).

ow G

trustees for separate groups of debenturehold-

ers with claims adverse to the banks' claims of

"senior" status and secured interests, (b) pro-

tracted litigation arose in the bankruptcy

court which pitted the interests of the banks

against those of the general creditors (in-

cluding the debentureholders) in which the

bankruptcy trustee and his attorneys undertook

to represent the interests of the general cred-

itors, and (c) the bank claimants proposed a

settlement with the general creditors which

the bankruptcy trustee asked the bankruptcy

court to approve, was the bankruptcy court, in

evaluating the strength of the bondholders' eg-

uitable subordination claims against the banks,

required, as a matter of law, to regard the

bank claimants as being covered by the "“inher-

ent fairness" doctrine of Pepper v. Litton, su-

pra, and other cases, * under which a bankrupt-

cy court imposes upon an “inside creditor" whose

transactions with the bankrupt before bankrupt-

cy are challenged by other creditors seeking eq-

uitable subordination the burden of proving by

"clear and convincing evidence" that every trans-

action engaged in to the detriment of the other

creditors was "inherently fair” to them?

* Geddes v. Annaconda Copper Mining Co., 254 U.S.

590, 599 (1921); In re Midtown Produce Terminal, Inc.,

599 F.2d 389 (10th Cir. 1979); Matter of Multiponics,

G22 ¥.20 709, 717, 720, &. 11 (Sth Cir. 1960): In te

American Lumber Co., 5 B.R. 470 (D. Minn. 1980).

+ ot o

LIST OF ALL PARTIES TO THIS PROCEEDING

Parties listed in the caption. Jay

Miller and Eileen McGinnis, additional appel-

lants below. Robert B. Yates, Jacob and Effie

Norvell, Patricia L. Weideman, Charles Hooten,

Marvella Associates, Ellis and Irene Beem, Dru-

Cilla H. Cooper, Joseph and Brigida Granito,

Ruth Lowell, Daniel R. Taylor, John A. Taylor,

Alexander and Barry Borden, Elizabeth Lane,

Joseph Friedman, Richard and Virginia Adams,

R. Anthony Adams, Lela and John Coonfield, in-

tervenors-appellants below. James Stephan,

Paul C. Van Kirk, Jr. (as Trustee), Bernice L.

Yeracaris, Milton A. Levenfeld, IWL Partner-

ship, Hardware Trusts Partnership, BHS Part-

nership and IWL-FW Partnership, intervenors-

appellants below. United States Trust Company

of New York, as Indenture Trustee, intervenor-

appellee below. John Masse, et al., interven-

ors-appellees below.

- vii -

TABLE OF CONTENTS

Questions Presented for Review....... eee

List of All Parties to This Proceeding..

rae OR MUCROT ICIS, bbc cc ewe cc wsens

POCTGIONS Of CHG CouUrte Below... .ccccc.

wae PUECLOGS THVOI VG, oo ik kc eect hcces

Jurisdiction of the Court to Hear

i kn ik cw wee

Statutes, Rules and Other Matters

Teivoavea 2F THIS POLI CiGnk. .. . ic wen cecc us

Mem cere OF CHO CSG. cic cc cece eee eee

The Grant Bankruptcy Proceeding......

ee I OE gg cc we ewe wes es

Re ON oo ike hc ice een snic

The Bondholders’ Legal Theory

Regarding Their Claim for Eq-

The Bondholders' Legal Theory

Regarding the Conflict of In-

Me ee ha oe ee ta ech ew eeecs

Reasons Why This Petition Should

Re GEOnted anc ATGUMENE. . conc cece cee ees

ev kk ie ec es

NO

~ Vili -

TABLE OF AUTHORITIES

Cases:

Chase National Bank,

xa0 F.40 GOB (26 Cis. 1952),

Supplemented, 201 F.2d 635 (24d

Cir.), cert. dismissed per stip.,

ot ek A) ae

Dabney v.

Annaconda Copper Min-

SOO Game G90 CL92Z1).. 6.0

Geddes v.

ang Co.,

In re American Lumber Co., 5 B.R.

mee Ce MRO ERO ek cece

In re Midtown Produce Terminal,

anc.» 299 £420 389 (i0th Cir.

BP gg cok ce

In re Eastern Sugar Antitrust

Litigation, 697 F.2d 524 (3d

WR BE ee ea ee ck kk cece wae

Matter of Multiponics, 622 F.2d

WO COC CEES FOO ooo ok wn ce kw

Morris v. Cantor, 390 F. Supp.

ee Os, BT) oo oe ik ek wc cas,

Pepper v. Litton, 308 U.S. 295

oh we

Taylor v. Standard Gas & El.

Oe CM eG. 2GF C1959) oon cece

Van. ceuee CoO. ¥. Firet Nat.

City Bank, 57 A.D. 24 265 (ist

Dept. 19/77), aff'd w/o opinion,

Oo Mee. OO BGS CiSre) 43 ccs... eee.

PAGES

INDEX TO APPENDICES

Appendix A - Order of the United

States Court of Appeals for the

Second Circuit denying petition

for rehearing and in banc review,

meeee MOTcn ©. 196s. 8g Leek kcccc

Appendix B - Opinion of the United

States Court of Appeals for the

Second Circuit Affirming the de-

termination of the District Court.....

Appendix C - Opinion of the United

States District Court for the South-

ern District of New York Affirming

the approval] of the settlement and

compromise with holders of the

Meee e © COO E red, 6 gn vac we cwccecs

PAGE

la

In the

SUPREME COURT OF THE UNITED STATES

October Term, 1982

In re:

W.T. GRANT COMPANY,

Bankrupt.

DAVID COSOFF and HELEN FINKELSTEIN,

Petitioners,

- against -

CHARLES G. RODMAN, as Trustee of W.T. GRANT

COMPANY, Bankrupt,

Respondent.

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

Petitioners respectfully pray that a

writ of certiorari issue to the United States

Court of Appeals for the Second Circuit for

the reasons set forth below.

DECISIONS OF THE COURTS BELOW

See appendix. The opinion of the cir-

Cuit court is reported at 699 F.2d 599. The

Opinion of the district court is reported at

20 B.R. 186. Related decisions by the bank-

ruptcy court are reported at 4 B.R. 53 and 4

menmer. Ct. Bec. 597.

TIME PERIODS INVOLVED

The decision of the Second Carcuit of

which review is sought was filed on January

26, 1983. Petitions for rehearing and for in

banc reconsideration were filed by petitioners

and denied by the circuit court in an order

dated and filed on March 8, 1983 (see appen-

dix). This petition was filed within 90 days

after entry of the order below denying peti-

tioners' motion for rehearin

JURISDICTION OF THIS COURT TO HEAR THIS PETITION

This Court's jurisdiction is invoked

under 28 U.S.C. 6125411).

STATUTES, RULES AND OTHER MATTERS INVOLVED IN

THIS PETITION

None.

TABLE OF CONTENTS AND TABLE OF AUTHORITIES

Set forth above.

STATEMENT OF THE CASE

Petitioners pray that a writ of certio-

rari issue to review the judgment and opinion

of the United States Court of Appeals for the

Second Circuit entered in this case on January

26, 1983. Petitioners' motion for rehearing

was denied by order dated March Se. 1902. Is

its opinion below, the circuit court affirmed

a decision by the district court [S.0.8.Y., &.

T. Duffy, J.) entered on March a6, i362, in

which the district court affirmed a decision

- 3-

by the bankruptcy court (Galgay, J.) entered

on June 23, 1981, which approved, pursuant to

Section 27 of the Bankruptcy Act {11 U.S.C.

§50), a so-called Amended Offer of Settlement

which a group of 26 bank creditors (the "bank

Claimants") of the bankrupt W.T. Grant Company

("Grant”) roposed to make to certain Grant

prop

bondholders.

The Grant Bankruptcy Proceedings

The Grant bankruptcy proceedings began

with the filing of an arrangement petition un-

der Chapter XI of the Bankruptcy Act on 10-2-

75. Those proceedings resulted in the largest

bankruptcy liquidation proceeding in the his-

tory of the federal courts. Grant was adjudi-

cated a bankrupt on 4-13-76. After that, the

Grant bankruptcy trustee, Charles G. Rodman,

collected over $700 million in the estate from

the sale of Grant's assets.

The Amended Offer

The Amended Offer is a proposed set-

tlement offer by a group of 26 bank claimants

to the holders of certain Grant debentures for

the purpose of resolving certain claims made

(in the context of an adversary proceeding be-

fore the bankruptcy court) by the bondholders

in which the bondholders sought "equitable sub-

Ordination" against the banks and challenged

the validity of (a) $657 millionin claims filed

by the bank claimants and (b) liens held by

- 4-

the banks covering the loans reflected in the

banks' claims. The bondholders contended that

the equity doctrine of equitable subordination

should be applied (1) to the banks' liens and

(2) to the banks' argument that their $657 mil-

lion in claims should have priority status ov-

er the bondholders' $93.34 million in claims

because the bank claims represent "Senior In-

debtedness" as that term is used in the trust

indenture covering the Grant 4.75% Subordinat-

ed Debentures. (See Second Circuit opinion,

ADD. B, fh. 6.)

Relief Sought

The relief sought by the bondholders

was that the banks' claims be equitably subor-

dinated by order of the bankruptcy court to a

position either equal to or subordinate to the

bondholders' claims. If the bank claims are

held to be "senior" to those of the bondhola-

ers, the bondholders will take nothing from

the estate. If the bank claims are given a

Status equal to the bondholders, the bondhold-

ers will be paid nearly 60 cents on the dollar

for their claims. If the bank claims are sub-

ordinated to a position below that of the bond-

holders, the bondholders will be paid in full.

The Bondholders' Legal Theory

Regarding Their Claim for Eg-

uitable Subordination

The legal theory of the bondholders'

equitable subordination claim has several parts.

- 5 -

First, the bondholders maintain that the bank

claimants owed fiduciary duties to the bond-

holders for a number of different reasons:

(1) The bank claimants were "in-

side creditors" who exercised effective control

over the financial decisions of the Grant board

of directors. Their status as "inside credi-

tors" arose from the fact that the 26 bank claim

ants acted through three "lead banks" (Morgan

Guaranty Trust Company of New York ["Morgan"],

Chase Manhattan Bank, N.A. ["Chase"], and Ci-

tibank, N.A. ["Citibank"]), with Morgan acting

as “agent” for all 26 banks, and Morgan had a

representative On Grant's Board of Directors,

its Executive Committee and its Audit Commit-

tee in the person of Dewitt Peterkin, Vice Chair-

man of the Morgan bank, who acted as a domi-

nant or controlling force on the Grant board.

In addition to Peterkin, the banks were also

represented on the Grant board by an officer

of Wilmington Trust, one of the bank claimants.

(2) By virtue of having an "inside"

position of confidence and great influence or

control over financial decisions of the Grant

board affecting their interests, the bank claim-

ants had the same fiduciary duties that all of

Grant's officers and directors had to its stock-

holders and creditors once it became known (in

June of 1974) that Grant was insolventand prob-

ably headed for bankruptcy.

«6 =

(3) Chase was indenture trustee

for the Grant 4.75% Subordinated Debentures

from their issuance until 8-14-74, when it re-

signed its trusteeship in favor of United States

Trust Company as its successor.

(4) Citibank has been indenture

trustee for the $800,000 issue of Grant 4%

bonds from their issuance to the present date.

(5) Since the bank claimants act-

ed in concert through Morgan as their "agent"

and Morgan, Chase and Citibank as the "lead

banks," any tortious acts done against the

bondholders' interests in violation of fidu-

Clary duties owed by Morgan, Chase or Citibank

were committed by all of the banks acting in

coordination or conspiracy.

(6) Under controlling principles

Of law or equity applicable in bankruptcy pro-

ceedings where the doctrine of equitable sub-

Ordination is sought to be invoked, a heavy

burden is placed upon a fiduciary who has en-

gaged in transactions with the bankrupt before

the bankruptcy proceedings that provided him

with an advantage over other creditors to prove,

by "clear and convincing evidence," that every

such transaction was "inherently fair" to the

other creditors who were not in a position to

take advantage of inside information, influence

Or control over management. Pepper v. Litton,

Supra, Geddes v. Anaconda, supra, Taylor v. Stan-

a 7

dard Gas & El. Co., 306 U.S. 307 (1939); In re

Midtown Produce Terminal, Inc., 599 F.2d 389

(10th Cir. i975); Matter Gf Meitinonics, inc.,

622 F.20 7039, 716-722 (5th Cis. 1980); In re

American Lumber Co., 5 B.R. 470 (D. Minn. 1980).

(7) The bank claimants did engage

in transactions with Grant prior to its bank-

ruptcy filing that benefited the banks at the

expense of the bondholders and prevented the

bondholders from being offered $300 per bond

for their debentures in July or August of 1974.

In July of 1974, three representatives of the

banks (Snyder, an officer of Morgan; Archibald,

an officer of Chase; and Roberts, an officer

of Citibank) met at the offices of Morgan with

Pierson, President of Grant, and told Pierson

that they would not allow Grant to proceed with a

transaction which the Grant board had previous-

ly approved whereby Grant would reduce its crush-

ing annual burden of debt service to the bond-

holders (and thereby improve cash flow) by sell-

ing certain accounts receivable for $73 million

and using part of the cash proceeds to buy the

4.75% and 4% bonds on the open market for around

$300 per $1,000 bond. This transaction would

clearly have been advantageous to the bondhold-

ers (who have not received interest payments

Since 10-2-75 and who are only offered $190 per

bond in the Amended Offer) and, according toan

admission made by Peterkin of Morgan to Pierson

~o «

of Grant at the time (Pierson dep. at 300-306,

389-391) the transaction would have been advan-

tageous to Grant as well. But Peterkin used

his inside position and the banks" control ov-

er Grant at the Grant board meeting on 7-23-74

to veto the proposed transaction because, how-

ever detrimental the veto might be to the in-

terests of Grant or the bondholders, the banks

wanted the accounts receivable to remain assets

of Grant until the banks had completed a pro-

posed loan agreement with Grant whichwould sub-

ject the accounts receivable to bank liens and

thus make it impossible for Grant to sell them

thereafter without permission from the banks.

(8) The proposed loan transaction

mentioned by Peterkin at the Grant board meet-

ing on 7-23-74 as one of the reasons for the

banks' veto of the sale of accounts and pur-

chase of debentures was intended to improve the

legal position of the banks at the expense of

other general creditors (and the bondholders

in particular) by making Grant, for the first

time, a guarantor of over $415 millionin loans

made by the banks to "Grant Financial" (a sep-

arate but related corporation) and thereby el-

evating those loans (plus additional loans made

for much smaller amounts to keep Grant afloat

and away from bankruptcy for at least four months)

to "senior debt" status under the trust inden-

ture covering the bonds. A second advantage

oe

sought by the banks was that of making all of

their loans ($415 million in previous loans to

Grant Financial plus new loans) subject to liens

covering virtually all of Grant's assets, in-

cluding its accounts receivable. To obtain

the benefits of the Grant guarantee and the

liens covering loans of over $400 million which

Morgan, Chase and Citibank had unwisely made

earlier to Grant Financial on an unsecured ba-

Sis, those three "lead" banks put up relative-

ly little "new money" in additional loans. Most

of the new money lent to Grant would be provid-

ed by 116 other banks brought into the shaky

Grant situation by Morgan without telling them

how bad the situation actually was.

(9) The 1974 loan agreement (with

the Grant guarantee and the liens built in) was

negotiated by the lead banks while Chase was still

indenture trustee for the 4.75% bonds, Citibank

was indenture trustee for the 4% bonds, and Mor-

gan and Wilmington Trust were still represented

by influential members of the Grant board. A draft

of the loan agreement was presented to the Grant

board on 7-23-74, indicating that the basic terms

had been agreed-upon before that time and that

Closing the transaction was Simply a matter of

the banks preparing the necessary documents for

execution. That was 22 days before Chase re-

Signed as indenture trustee in favor of U.S. Trust.

(10) The 1979 loan agreement was ex-

ecuted in two stages: an Interim Security Agree-

»~ 38 «

ment executed on 8-21-74 and an Initial Secur-

ity Aqreement executed on 10-8-74 but dated

"as of" 9-16-74. Under the Interim Agreement

of 8-21-74, Grant gave guarantees and liens

to the banks covering $44 million in new loans.

Under the Initial Agreement of 10-8-74, Grant

extended those guarantees to cover a total of

$600 million in loans, of which most was prior

debt and not "new money" and all of which was

secured by liens covering specified assets of

Grant. Chase, Morgan and Citibank arranged

for the Grant guarantees and liens to cover

$90 million in loans each, of which $10 mil-

lion each represented "new loans" and $80 mil-

lion represented previous loans made to Grant

Financial on an unsecured and unguaranteed ba-

gis.

(ll) The acts of the lead banks where-

by they (a) deprived the bondholders of an Op-

portunity to sell their bonds to Grant at 30

cents on the dollar and (b) did so in order

that they might obtain guarantees and liens on

the Grant accounts receiveable covering $450 million in

unsecured loans made only to Grant Financial

(which is not involved in this or any other

bankruptcy proceeding) clearly constituted eqg-

uitable torts upon the Grant bondholders be-

cause, by those acts, the banks sought and ob-

tained advantages over the bondholders in the

event that the seriously contemplated bankrupt-

Cy proceedings should become reality. This con-

-~ 1 «

duct was particularly tortious and unconscion-

able on the part of Chase because it was inden-

ture trustee for the 4.75% bondholders until

8-14-74, a date well after the 1974 loan agree-

ments had been arranged, except for the last

details. Under well-established principlesof the

law of New York (which controls the relation-

ship between Chase and the bondholders under

the trust indenture), an indenture trustee has

a specific duty to defer the protection of its

Own economic interests in favor of the inter-

ests of its bondholder beneficiaries. Dabney

v. Chase Nat. Bank, supra, 196 F.2d 668, 672

(2d Cir. 1952) (opinion by Learned Hand, C.J.);

U.S. Trust Co. v. First National City Bank, su-

pra, 3/ A.D. 20 285, 296 (lst Dept. 1977), ar~

f'd w/o opinion, 45 N.Y. 2d 869 (1978); Morris

Vv. Cantor, 390 F. Supp. 817 (6.0.8.¥., 1975,

Ward, o0.}.*

The Bondholders' Legal Theory Regard-

ing the Conflict of Interests of Har-

vey Miller and the Firm of Weil, Gotshal

& Manges as Attorneys for the Grant

Estate in Connection With the Litiga-

tion Over the Status of the Banks' Claims

* In Morris v. Cantor, as in the present case, the

questioned loan transaction was negotiated by Chase with

a corporation while Chase was indenture trustee for cer-

tain bondholders of the company but the loan transaction

was not executed until after Chase had resigned itstrust-

eeship. On those facts, Judge Ward held that the bond-

holders’ complaint stated a cause of action for willful

misconduct under the Trust Indenture Act of 1939. 380

F. Supp. at 824.

- 12 -

Petitioners, David Cosoff and Helen Fink-

elstein, are the co-owners of $150,000 in face

amount of the Grant 4.75% Subordinated Deben-

tures, of which $92.507 million in principal

amount are outstanding. Chase was the inden-

ture trustee for those bondholders until 8-14-

74, as explained above.

On 10-2-75, Grant filed its Chapter XI

petition. At that time, the banks held $657.4

million in loans, all of which were made to Grant

Financial (not Grant), guaranteed by Grant and

covered by liens on Grant's assets. But the

liens and guarantees (except for $44 million

lent on 8-21-74) were all obtained on 10-8-74,

less than one year before Grant's bankruptcy

filing. Therefore, to the extent that the liens

and guarantees were given to cover preexisting

debt of around $450 million and not "new loans"

made in August of 1974, those liens and guaran-

tees were subject to being voided by the bank-

ruptcy court as having been provided without

adequate consideration.

Beyond that, those liens and guarantees

provided by Grant were subject to attack on be-

half of the bondholders and other general cred-

itors on the ground of "equitable subordination"

on the theory, explained above, that, in obtain-

ing them, the lead banks violated fiduciary du-

ties of fairness owed by them to the bondhold-

ers and made unconscionable use of their posi-

tions as "inside creditors" and "controlling

- 13 «

creditors" to gain advantages over the bond-

holders in the event of clearly-anticipated

bankruptcy proceedings.

On 7-2-76, the banks (through Morgan,

as "“agent') began an action in the Grant bank-

ruptcy proceeding in the nature of an adver-

Sary proceeding seeking a declaratory judg-

ment. The purpose of that proceeding was to

enforce the liens acquired by the banks on

10-8-74. The relief sought was a declaratory

judgment by the bankruptcy court giving full

effect to the liens and, in effect, requiring

the bankruptcy trustee to turn over to the

banks all of Grant's assets covered by the

liens up to the amount of the banks' claims,

i.e., $657.4 million. Since the amount even-

tually collected by Rodman from liquidating

Grant's assets was a little over $700 Miilion,

enforcement of the liens would have taken well

Over 90% of the assets and left Only $43 mil-

lion for unsecured creditors with an addition-

€al $450 million in claims.

In response to the banks' adversary pro-

ceeding, the cause of the general creditors

was taken up by the bankruptcy estate repre-

sented by attorney Harvey Miller and Weil,

Gotshal & Manges ("WG&M"), the law firm of

which he is a member. U.S. Trust Co., aS suc-

cessor indenture trustee for the 4.75% bond-

holders filed pleadings in opposition to the

banks' adversary proceedings but made no ac-

- 14 -

tive effort at all to litigate on-behalf of

the bondholders against the banks. On or a-

bout 9-24-76, Miller filed an answer contain-

ing eight defenses and counterclaims on behalf

of the estate and for the benefit of the gen-

eral creditors.

From about October of 1976 to around

December of 1977, WG&M spent a great amount

of time and effort litigating on behalf of

the general creditors against the banks. They

expended many thousands of attorney hours in

(a) obtaining production of hundreds of thou-

sands of pages of documents from the banks'

files and (b) conducting extensive depositions

("Rule 205 examinations") of about 25 witness-

es, which resulted in somewhere between 10,000

and 12,000 pages of deposition transcripts.

U.S. Trust did not subpoena a Single document

Or question a single witness. Its litigation

efforts were limited to sending a junior as-

sociate to attend the Rule 205 examiantions

conducted by WG&M. WG&M has been paid sever-

al million dollars as interim fees by the Grant

estate for its work in conducting the litiga-

tion against the banks and a total of over $14

million to date for all of its work on the Grant

case.

At some point in late 1977 or early 1978,

unknown to petitioners' counsel, the discovery

process ended and negotiations began of a set-

tlement of the litigation between the banks (as

« 16 w

purported lien creditors and holders of "Sse-

nior indebtedness" vis-a-vis the bondholders)

and the estate (representing the unsecured,

general creditors). The participants in those

negotiations were WG&M (on behalf of Rodman),

Morgan (represented by Davis, Polk ¢& Wardwell,

on behalf of the banks) and United States Trust

(represented by Whitman & Ransom). *

On 4-7-78, WG&M filed on behalf of Rod-

man an application with the bankruptcy court

for approval of a so-called "Global Settlement

Agreement" by means of which the banks pro-

posed to resolve their disputes with all of

the remaining Grant creditors. That goal was

not achieved, and the banks have, since 1979,

referred to the resulting agreement as the

"Bank Settlement Agreement." Judge Galgay ap-

proved the Global Settlement Agreement in a

46-page opinion and order dated 7-20-78 (4 Bankr.

Ct. Dec. 597).

The Global Settlement Agreement was not

"global" because certain parties purporting to

represent the interests of the Grant 4.75% and

* The banks settled with the Secured Suppliers in

an agreement approved by the bankruptcy court on 2-3-77

and (in amended form) by the Second Circuit on 4-6-78,

In late 1977, the banks made a settlement offer to the

holders of Senior Debentures for whom Morgan was inden-

ture trustee but for whom Fidelity Union bank had as-

sumed Morgan's fiduciary duties. Rodman recommended

that settlement for Bankruptcy Judge Galgay's approval,

which was provided in an order dated 1-18-78. That set-

tlement became effective as of 4-19-78,

- 16 -

4% bondholders would not accept the terms of-

fered by the banks to them (at that time, less

than 8 cents on the dollar). Those Claiming

to represent the 4.75% bondholders and refus-

ing to accept the banks' terms were Whitman &

Ransom (on behalf of U.S. Trust as indenture

trustee) and attorney I.W. Bader (on behalfof

Morris Lewy, Victor Kurtz and several other

bondholders who called themselves the Ad Hoc

Bondholders' Committee). As a consequence of

that lack of consent, the banks and the estate

worked out an arrangement that was incorporat-

ed into the Global Settlement Agreement and the

order of 7-20-78 approving it whereby a "re-

serve fund" would be created in the amount of

$95.378 million representing principal and in-

terest on the 4.75% and 4% bonds ($93.341 mil-

lion) plus interest to 10-2-75, the date of the

Chapter XI filing.*

The banks created the ideaofareserve

fund with the bankruptcy trustee as "Stakehold-

er" of the funds in dispute between them and

the bondholder interests and were enthusiastic

about it in 1978 because execution and court

approval of the Global Settlement Agreement

made possible a prompt payout by the estate to

* This fund was held unsegregated by the Grant es-

tate as part of its assets and invested in such a way

that interest was accumulated on it at the rate of a-

bout 10.5% per year which was, in effect, ' 'compounded"

every six months by the purchase of new certificates

of deposit.

« 17 -

the banks of several hundred million dollars*

which the banks were then extremely interested

in getting as soon as possible. At that time,

the banks probably thought that a settlement

with the bondholder representatives would be

possible within a few weeks or months and no

later than the end of 1978. No such prompt

settlement was reached.

In motion papers filed in April 1978 in

Support of Rodman's application for approval

of the Global Settlement, WG&M advised Bank-

ruptcy Judge Galgay that a case could be prov-

en with evidence then available for applying

the remedy of equitable subordination against

the banks for the purpose of invalidating the

liens obtained on 8-21-74 and 10-8-74. At the

time, Judge Galgay apparently accepted that as-

sessment of the factual case and applicable law

at face value. |

Later, in April of 1979, when WG& sought

to justify their recommendation that the bank-

ruptcy court approve the proposed Original Of-

fer of settlement by the banks to the bondhold-

ers of 14 cents on the dollar (with 1% or $950,000

allowed to Whitman & Ransom as legal fees), it

became tactically necessary for them to abandon

their earlier opinion that the case for equita-

ble subordination is very strong and take the

* The exact amount is unknown to petitioners’ coun-

sel but is estimated to have been between $250 million

and $300 million.

~ 18 «

Opposite view, i.e., that equitable subordina-

tion would be extremely difficult to esta-

blish because the available evidence is very

weak and the applicable case law requires that

a claimant seeking the remedy of equitable sub-

Ordination has a "very substantial" burden of

proof and contractual subordination provisions

are enforced under "well-established" case law

in the Second Circuit even in cases where the

unsubordinated creditors had committed outright

fraud upon the contractually subordinated cred-

itors.

This was a complete distortion by coun-

sel for the estate of the available facts ana

atotally incorrect deggription of applicable

principles of law in the area of equitable sub-

Ordination. But WG&M apparently regarded this

total reversal of its earlier opinion of the

case to be necessary in order to support its

argument that the Original Offer of 14% to the

bondholders was extremely favorable in the cir-

cumstances and the best that could possibly be

obtained from the banks without additional pro-

tracted litigation beyond the 8,000-plus hours

already devoted by WGéM attorneys to the liti-

gation.*

On behalf of U.S. Trust as indenture

* As far as the record discloses, Judge Galgay per-

ceived no significant inconsistency between the positive

assessment of the case for equitable subordination pre-

sented to him by WG&M in April of 1978 and the negative

assessment submitted to him by the same firm one year

later.

~ 12 o

trustee, Whitman & Ransom recommended that

Judge Galgay approve the Original Offer of 148%

to the bondholders with $950,000 allowed for

the payment of U.S. Trust's attorneys' fees to

Whitman & Ransom. Whitman & Ransom also agreed

completely with the negative assessment of the

equitable subordination claim provided by WG&M

on behalf of Rodman, conveniently ignoring the

earlier positive assessment by Rodman's attor-

neys.

The bondholders represented by attorney

I.W. Bader (now joined by attorney Bradley R.

Brewer as co-counsel) opposed the Original Of-

fer as inadequate because it did not reflect

the true strength of the equitable subordina-

tion claim on the facts and the law. They a-

greed with Rodman's original assessment.

Between the bankruptcy court opinion of

7-20-78 approving the Global Settlement and 4-

18-79, there were prolonged settlement negoti-

ations leading toward the Original Offer of 14%

but no efforts by the estate or U.S. Trust to

litigate the bondholders' claims against the

banks. On 4-18-79, WG&M filed on behalf of Rod-

man an application for bankruptcy court approv-

al of the Original Offer by the banks. By this

time, the only creditors remaining in the Grant

estate with claims at odds with those of the

banks were the bondholders.

One of Bader's bondholder clients, Vic-

tor Kurtz, retained attorney Morton Robson to

represent him. At the insistence of Judge Gal-

gay, Robson was allowed to appear as co-counsel

with Bader for Kurtz. Bader and Brewer remained

as co-counsel for Bader's other clients. Brew-

er was retained by bondholders Cosoff and Fink-

elstein to represent them as sole counsel.

Attorneys Robson, Bader and Brewer joined

forces to oppose the application for approval of

the Original Offer. Hearings were held before

Judge Galgay on five days between 5-22-79 and

S~19-79." On 2-20-80. Judge Galgay filed an o-

pinion and order approving the Original Offer.

The objectants took an appeal that was assigned

to District Judge William Conner and briefed by

May of 1980.

By October of 1980, it became evident

that Judge Conner might take another year to

decide the appeal, and 18 months had already

passed since the Original Offer had been pre-

sented to Judge Galgay on 4-18-79. The reserve

fund of $95 million had accumulated over $15

million in interest, an amount equal to the

entire amount of the Original Offer. Bond-

holders supporting the objectants' opposition

to the Original Offer had grown from around

2% at the time of the hearings in May of 1979

to over 30%, and the number was increasing.

* The objectants were allowed only 14 days to con-

duct discovery. During that time, neither Peterkin of

Morgan nor any of the significant witnesses from Chase

were available to testify.

—~ 23 &

The banks then decided to withdraw the Origi-

nal Offer and replace it with an Amended Offer

Of 19% with 2% {or $1.9 Million) allowed for

the payment of attorneys' fees to Whitman ¢

Ransom, Robson, Bader and Brewer.

Robson decided to accept the Amended

Offer and persuaded Kurtz to do so. Most of

Bader's clients decided to accept the offer,

and Bader elected to represent them, despite

his personal conviction that the offer was in-

adequate. Brewer agreed to represent any bond-

holder who might wish to Oppose Rodman's ap-

plication for approval of the Amended Offer.

Petitioners Cosoff and Finkelstein retained

him for that purpose on o-13-61. Judge Gai-

gay held a supplemental hearing on 6-16-81 on

the application for approval of the Amended

Offer and approved that offer in an order dat-

ed 6-23-81. Petitioners appealed to the dis-

trict court and lost in a decision by Judge

K.T. Duffy dated S~i5-62, 20 B.R. 196. Peti-

tioners appealed to the Second Circuit and lost

in the decision which they now ask this Court

to review and reverse.

Petitioners maintain that there is a

reason why attorney Miller and his firm aban-

doned their earlier positive assessment of the

case for equitable subordination and agreed

promptly to the Original Settlement Offer by

the banks of 14% as soon as it was made and

joined forces with the banks and U.S. Trust

32>

in recommending that Judge Galgay approve it

as fair and a reasonable reflection of the bond-

holders' chances of succeeeding on the equita-

ble subordination claim.

Attorney Miller was selected by counsel

for the banks to be recommended to Charles Rod-

man, the bankruptcy trustee, and to the bank-

ruptcy court for appointment as counsel for the

Grant estate. Rodman was also selected and rec

ommended for the job of trustee by counsel for

the banks. Miller represented the bank credi-

tors as secured creditors before the official

creditors’ committee was formed. When that com

mittee was formed, Miller was selected as one

of its co-counsel (representing the banks' in-

terests) and another attorney (who had previ-

ously represented trade creditors) was select-

ed as the other co-counsel. Miller represent-

ed the banks' interests on the creditors' com-

mittee for a period of six months, until the

bankruptcy adjudication on 4-13-76. Soon tnere-

after, the banks recommended Rodman to be bank-

ruptcy trustee and Miller to be his attorney,

and the bankruptcy court entered orders appoint-

ing both of them.

When Rodman and Miller were appointed to

their posts, brief hearings were held before

Judge Galgay. Rodman disclosed the circumstances

involved in his selection by counsel for Chase

first to serve as standby trustee during the

Chapter XI period and then to be bankruptcy

trustee after 4-13-76. Miller made limited,

but not complete, disclosure of his prieor re~-

lationship with the bank claimants, and Judge

Galgay was familiar with his service as co-

counsel for the official creditors’ committee.

At that time and thereafter, Miller and WG&M

were actively representing certain of the bank

creditors in other and unrelated bankruptcy

cases for which they received substantial fees.

Those circumstances and the obvious conflict

of interests created by them were not fullyor

adequately brought to the attention of the bank-

ruptcy judge.

Specifically, two important things were

not brought to Judge Galgay's attention in A-

pril of 1976, either by Miller or by counsel

for the banks, although they were well aware

of them. First, Miller had previously repre-

sented the banks in connection with the Grant

bankruptcy proceeding itself and was continu-

ing to represent them in other matters. The

banks were not general creditors but lien or

secured creditors. It has long been the law

in bankruptcy proceedings that an attorney who

had previously represented secured creditors

cannot be appointed counsel for the bankrupt

estate because the administration of the es-

tate is conducted primarily, if not exclusive-

ly, for the benefit of unsecured creditors,

and the interests of secured and unsecured

creditors are inherently in conflict. In par-

~ 34 «

ticular, an attorney who has previously rep-

resented a secured creditor should not become

counsel for a bankrupt estate where it is known

that the security interest of the former cli-

ent will be challenged in the bankruptcy pro-

ceeding. This Court expressly recognized these

long-established principles in one of the most-

often cited bankruptcy cases of all time, Pep-

per v. Litton, supra, decided in 1339. 308 0.8.

“95 at 300.

The applicable rule of law and the rel-

evant holding of Pepper v. Litton were not

brought to Judge Galgay's attention in April

Of 1976. Section 44{c) of the Bankruptcy Act

provides that:

"An attorney shall not be disqualified

to act as an attorney for the receiver

Or Trustee merely by reason of his rep-

resentation of a general creditor." (Em-

phasis supplied.)

Judge Galgay was familiar with that provision.

It is guite common for an attorney who has pre-

viously represented a major general creditor

to become counsel for a bankrupt estate, but

uncommon (and improper) for an attorney who

has previously represented a secured creditor

to be so appointed. Apparently, but most un-

fortunately, Judge Galgay simply failed to note

the distinction and its Significance for the

purposes of Miller's appointment.

The bankruptcy court's misinterpreta-

tion of the law in this connection is under-

Standable (but no less erroneous) because of

the second important thing that Miller andthe

banks failed to disclose at the appointment

hearing in April of 1976. They did not tell

Judge Galgay that there was certain to be mas-

Sive and prolonged litigation between the in-

terests of the general creditors and those of

the banks over the validity of the banks' liens

and guarantees from Grant and that one of the

main tasks of the estate's attorney would be

to litigate against the banks with hundreds

Or millions of dollars at stake. At that

time, they knew that, and knew it perfectly

well, but no one else did.

Because of the circumstances described

above and many others,* a clear-cut and most

* Between 10-2-75 and 10-9-75, Miller received a tel-

ephone call from Charles Hoppin, a partner of Davis,

Polk & Wardwell, attorneys for Morgan as leader of (or

"agent" for) the bank claimants. (Transcript of hear-

ings before Judge Galgay in 1979, p. 584.) Mr. Hoppin

told Mr. Miller that the Grant bank creditors wanted him

to represent them in connection with the formation of a

creditors’ committee or "bank committee" in the Grant

proceedings.

On 10-9-75, Miller met with Hoppin and other Davis

Polk attorneys and began to advise them about the pro-

cedures involved in Chapter XI arrangements and what

steps are usually taken by the two groups of creditors

normally represented by counsel (i.e., the bank credi-

tors and trade creditors) at the first (and informal)

meeting of creditors. Among other things, he discussed

what "indemnity" is and how the major creditors normal-

ly go about establishing a creditors’ committee.

Among other things, Miller inquired about the nature

of the banks' claims and asked who the banks other than

(footnote continued on next page)

- 26 «

appalling conflict of interest situation was

created and the appearance of impropriety was

inescapably generated, which neither Rodman

(Footnote continued from previous page:)

Morgan were. In response, Hoppin told Miller that the

banks were secured creditors of Grant under an agree-

ment created some time before. This knowledge on the

part of Miller as early as 10-9-75 that the banks claimed

to have valid and enforceable liens on Grant's assets is

extremely important for appellants' conflict-of-interest

argument against Miller and his firm, because it means

that Miller, a specialist in bankruptcy law who teaches

that subject in a major law school and frequently lec-

tures on the subject to practicing attorneys, knew that

under the bankruptcy rules, he could not be engaged to

represent secured creditors in a bankruptcy proceeding

and then later be appointed to act as attorney on behalf

of the estate for general creditors.

Since (a) the task of a bankruptcy trustee and his at-

torney is to gather and distribute the estate for the ben-

efit of general creditors and (b) that task imposes upon

both of them the duty to examine carefully all security

claims and to challenge in court those ot doubttul va-

lidity, the rules applicable in bankruptcy proceedings

have long prevented an attorney who begins his involve-

ment with a bankruptcy proceeding by representing secured

creditors from later acting as counsel for the estate and

thereby assuming responsibilities potertially antagonis-

tic to his former clients. If it were not so, an attor-

ney might be engaged by certain creditors to draft docu-

ments creating certain security interests and then later

be engaged by the estate to attack by litigation the va-

lidity of the documents that he himself drafted.

On 10-15-75, Miller, as attorney for a committee of

bank creditors, attended a Grant creditors’ meeting at

the Americana Hotel in Manhattan. (Tr. 614) He told

those present that he was representing the bank credi-

tors. (Tr. 616) Before that meeting began, Mr. Miller

had lunch with an officer of Citibank named Ingram and

several other people representing the banks. Mr. Ingrar

act as chair-

had been designated by the bank claimants to

man of the creditors' meeting.

The purpose of that luncheon meeting clearly was for

(footnote continued on nexc page)

- 37 «

(himself an attorney) nor Miller did anything

at all to correct. See, In re Eastern Sugar

Antitrust Litigation, 697 F.2d 524 (3d Cir. 1982).

(footnote continued from previous page)

Miller to advise Ingram and the others present concern-

ing what steps should be taken at the creditors' meet-

ing according to applicable law and common practice.

Others present at the meeting were a bank officer from

Morgan and several attorneys from the Davis Polk firm

representing Morgan. Only representatives of the bank

creditors, Mr. Miller's clients, were present at the 10-

15-75 luncheon meeting.

At the 10-15-75 luncheon meeting, Mr. Miller discussed

with those present: (1) the size of the creditors’ com-

mittee, (2) which bank creditors would place members on

that committee, and (3) the question of Mr. Miller being

retained as attorney for the creditors’ committee after

its formation.

At the 10-15-75 creditors' meeting, there was a dis-

cussion of the size and composition of the creditors'

committee. It was decided that the committee would have

11 members, with 6 members representing the banks and 5

representing other creditors.

Mr. Ingram encountered difficulty in maintaining con-

trol of the proceedings. When that happened, Ingram

called on Mr. Miller as his counsel to assist in main-

taining order at the meeting. In this way, Mr. Miller

was identified by Mr. Ingram to all present as an attor-

ney for the bank creditor group.

Once the creditors’ committee was formed and the iden-

tities of its members determined, the committee met in

closed session (only members present) and retained as

co-counsel for the committee Mr. Miller's firm (which

had represented the banks at the earlier meeting) and

Ballon, Stoll & Itzler (which had represented a large

group of trade creditors at the preceding meeting). At

the luncheon meeting, Miller had told the bank represen-

tatives that he had been contacted earlier by the Ballon

firm and told that the Ballon firm would be representing

trade creditors at the creditors' meeting.

It is common practice in bankruptcy proceedings to

have trade creditors and bank creditors dominate and

control the first meeting of creditors and for the

(footnote continued on next page)

— 8

Based upon those known circumstances,

petitioners believe that Miller and WG&M sim-

Ply capitulated to the banks when the banks

Proposed the Original Settlement because they

and Rodman were deeply beholden to the banks

for getting them their respective appointments.

Miller's firm has billed the Grant estate some-

where between $15 and $20 million for services

in the Grant matter, and Rodman has been paid

$250,000 per year to act as bankruptcy trustee.

Neither of them could afford to anger the banks

by opposing the Original Offer, and, not sur-

prisingly, neither of them did.

Of course, it may be that Rodman, Miller

(footnote continued fron previous page)

attorneys for those groups to be designated attorneys

for the creditors’ committee upon its formation. Here

the trade creditors and bank Claimants had potentially

conflicting interests arising from the Inventory Secur-

ity Agreement of 5-15-75 and related circumstances. Both

groups (trade and bank creditors) claimed liens.

No explanation was ever provided by U.S. Trust as to

why it did not seek a place on the creditors’ committee

for the $92.5 million in Claims against the Grant es-

tate held by the bondholders for whom it acted as in-

denture trustee.

Despite the foregoing circumstances, Mr. Miller

Claimed, during the hearings before Judge Galgay on the

Original Offer, that he never learned or had any idea

why his firm and the Ballon firm were appointed co-coun-

sel for the creditors' committee. This testimony was

disingenuous because it was clear that the Weil Gotshal

& Manges firm had been designated because it was counsel

for the banks and the Ballon firm had been designated

because it was counsel for the trade creditors. The on-

ly general creditors represented on the creditors’ conm-

mittee were trade creditors without liens.

- 29 o

and the other attorneys involved at WG&M actu-

ally acted in utmost good faith and Sinceraty

when they tailored an argument in support of

their recommendation of the Original Settle-

ment to the bankruptcy court in 1979 that was

completely inconsistent with what they told

Judge Galgay in writing in 1978. But the ap-

pearances to the contrary are obvious and dis-

graceful. Almost any layman informed of these

circumstances would be shocked and scandalized.

Petitioners maintain that Miller was

manifestly unqualified to be appointed or to

act as attorney for the Grant estate at all

and should never have been appointed to that

position, When it became evident that

the estate would have to conduct massive liti-

gation against the banks involving high Stakes,

Miller and his firm should have resigned as

counsel for the estate. Failing to do that,

Miller, his firm and Rodman Should at least

have appointed a totally independent firm of

attorneys to litigate against the banks and

dissociated themselves completely from any in-

volvement in that controversy. If that had

been done, the appearance of conflicting in-

terests and impropriety would have remained

but ina Substantially less virulent form. As

Soon as the banks' adversary proceeding was

commenced and the apparent conflict of inter-

ests became known, Miller should have brought

the entire problem before the bankruptcy court

~ 36 «

for an open hearing and ruling on the propri-

ety and legality of his conduct. He ana his

firm have only themselves to blame for their

failure to do so.

In response to this argument and to pe-

titioners' contention that (1) Miller and WG&M

were unqualified either to litigate against the

banks on behalf of the bondholders or to pre-

sent an objective evaluation of either the Orig-

inal Settlement or the Amended Settlement to

the bankruptcy court pursuant to §27 of the

Bankruptcy Act and (2) the bankruptcy court's

approval of the Amended Offer was fatally flawed

by that court's failure to appoint an indepen-

dent attorney to investigate the bondholders'

claims and present an untainted Opinion and

recommendation, the Second Circuit below re-

fused to "find that any of the relationships

charged by appellants were disqualifying" and

that the facts regarding Miller's earlier rep-

resentation of the banks in connection with the

Grant bankruptcy were limited to Only five days

of actual, formal representation and were, there-

fore, in the judgment of the panel, "de mini-

mis." Petitioners most strenuously disagree,

and they urge this Court to do so as well by

granting the requested writ and Subjecting the

decision and record below to a most searching

review.

Petitioners submit that the circuit court

panel below applied the wrong standard of judg-

— 31 «

ment to the obvious conflict of interest prob-

lem involved in this case. As the Third Cir-

cuit recently pointed out in the Eastern Sugar

case, Supra, the proper test where a conflict

of interest is perceived on the part of an at-

torney acting by court appointment in a fidu-

Clary capacity on behalf of thousands of per-

sons not represented by their own counsel is

not whether the circumstances are shocking to

the minds of three case-hardened federal judges

with years of experience in observing instances

of dishonest behavior but rather whether the

circumstances would be shocking to an average

layman informed of them.

What the average layman would think a-

bout the conflict of interest problem in this

case is obvious. He would be shocked and dis-

appointed at the behavior of Mr. Miller and

Shocked even more by the decision of the Sec-

ond Circuit on this point. If you don't be-

lieve it, find one and ask him.

REASONS WHY THIS PETITION SHOULD BE GRANTED AND

ARGUMENT

See discussion above.

CONCLUSION

For the reasons set forth above, this

petition for a writ of certiorari should be

a ae eked,

wmedp 2A Re BREWER

Attorney for Petitioners

799 Broadway, New York, N.Y.

(212) 777-4010

granted.

i) i i RS Wess Si 3 ~~ — a a

AFrTFERO fT x

la

UNITED STATES COURT OF APPEALS

SECOND CIRCUIT

At a stated term of the United States

Court of Appeals, in and for the Second Cir-

cuit, held at the United States Courthouse, in

the City of New 2OrkK, On the eighth day of

March, one thousand nine hundred and eighty

three.

W.T. GRANT COMPANY, No. 82-5019

5023

Bankrupt.

A petition for rehearing containing a

Suggestion that the action be reheard in banc

having been filed herein by counsel for appel-

lants, David Cosoff and Helen Finkelstein.

UPON CONSIDERATION by the panel that

heard the appeal, it is

ORDERED that said petition for rehear-

ing is DENIED.

It 1s further noted that the Sugges-

tion for rehearing in banc has been transmit-

ted to the judges of the court in regular ac-

tive service and to any other judge on the panel

2a

that heard the appeal and that no such judge

has requested that a vote be taken thereon.

A. Daniel Fusaro, Clerk

by Francis X. Gindhart,

Chief Deputy Clerk

3a

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

—_>—

No. 381—August Term, 1982

(Argued November 19, 1982 Decided January 26, 1983)

Docket Nos. 82-5019, 82-5023

——

IN RE:

W. T. GRANT COMPANY,

Bankrupt,

Davip Cosorr and HELEN FINKELSTE IN,

—and—

Jay MILLER and FILEEN Mc GINNIS.

Appellants,

CHARLES G. RODMAN, as Trustee of

W.T. GRANT COMPANY. Bankrupt,

Appellee,

ROBERT B. Yates, JACOB AND EFFIE NORVELL, PATRICIA

L. WIEDEMAN, CHARLES HOOTEN, MARVELLA ASsoc!

ATES, ELLis AND IRENE BEEM. Dri ILA H. Cooper,

JOSEPH AND BRIGIDA Gr ANITO, RUTH LOWELL.

DANIEL R. TayLor, JoHN A TAYLOR, ALEXANDER AND

1489

4a

BARRY BORDEN, ELIzapt TH LANE, JOSEPH FRIE DMAN,

RICHARD AND VIRGINIA ADAMS, R. ANTHONY ADAMS,

and LELA AND JOHN Cy IONFIELD,

Intervenors-A ppellants,

JAMES STEPHAN, PauL C. VAN KiRK, JR. (as Trustee),

BERNICE L. YERACARIS. CONSTANTINE A. YERACARIS.

MILTON A. LEVENFELD. IWL PARTNERSHIP, HARDWARI

TRUSTS PARTNERSHIP. BHS PARTNERSHIP, and IWL-

FW PARTNERSHIP

/ntervenors-Appellants.

UNITED STATES Tri ST COMPANY OF

NEw York. as Indenture Trustee,

Intervenor-A ppellee,

JOHN MASSE. et al..

Intervenors- Appellees,

Before

WATERMAN, Fri NDLY and MESKILL.

Circuit Judges.

>

Appeals by holders of 4 "0 subordinated debentures

of WT. Grant Co from an order of the District Court for

1490)

~

Ja

the Southern District of New York. Kevin Thomas Duffy,

Judge, 20 B.R. 186 (1982). approving the proposal by

Grant’s bankruptcy trustee of a settlement between the

debentureholders and the bankrupt estate. Affirmed.

——

BRADLEY R. BREWER, New York, NY (Brewer

& Soiero, New York, NY), for Appellants

Cosoff and Finkelstein

STUART A. JACKSON, New York, NY. for Ap-

pellants Miller and McGinnis

Harvey D. Mitcer, New York, NY (Weil.

Gotshal & Manges, New York, NY). for

Appellee Rodman as Trustee

JAMES C. SARGENT, New York, NY (Whitman

& Ransom, New York, NY), for Jnter-

venor United States Trust Company of

New York

I. WALTON RADER, White Plains, NY (Bader

and B: , White Plains, NY), for Inter-

venors lasse, et al.

FRIENDLY, Circuit Judge:

These appeals arise from the mammoth bankruptcy

proceedings of W.T. Grant Co. before Bankruptcy Judge

Galgay in the Southern District of New York. Grant

initially filed a petition for an arrangement under chapter

149]

6a

XI’ on October 2, 1975. and was adjudged bankrupt on

April 13, 1976. Secured suppliers, holders of senior de-

bentures, bank creditors, general unsecured creditors, and

holders of two issues of subordinated debentures filed

claims against the bankrupt estate. The present appeals

concern the last of a series of compromises and settle-

ments* designed to avoid what would necessarily have

been extremely Protracted litigation with the Various

claimants. We shall assume familiarity with Judge Gal-

gay’s Opinions and will endeavor to state Only what is

necessary to an understanding of these appeals.

The History of Grant’s Financines

Prior to July, 1973. Grant, which operated a large

chain of retail stores. generally satisfied its short-term

cash needs by selling commercial Paper through a w holly

Owned subsidiary, WT. Grant Financial Corporation

(Grant Financial): jt had relatively small revocable lines

Of credit at several! hundred banks.’ In the spring of 1973

Grant determined that a portion of the commercial] Paper

\ f Bank \ 189% i the R

th ‘

T} ier ONES We nd f ‘ Ie Ug

‘ approved B yA ( ) Feet 7 'g”?? ff‘.

Dock NO. 78.5 (2 % \ Oo i978): a IMpro ¢ and

set ALN Ser de noid app ed Ja 1S. 1978: a

; C af setiiemer 4 I Oa La cla nants ipy ro dG PUIN 20

‘9 8. 4 Bankr. Ct. Dec $97 Jer approving a compromise ar

settiement with the junior Jedentureholders dated Feb. 20 YsO, 4

B.R. $3: and a furt! er order dated June 23, 198]. approving a revised

form of this settlement. trom wu hich the appeals here ar issue were

aac

For example. as of lan. 3%. 1973 Grant had only $10.000 000 in

t $380,033, 500 in utstanding

7a

Outstanding should be converted into long-term debt and

approached Morgan Guaranty Trust Co. of New York

(Morgan Guaranty) to structure a $100,000,000 five year

term loan. On July 5, 1973, Morgan Guaranty arranged

such a loan to Grant Financial from eight banks replacing

an equivalent amount in their lines of credit to Grant.

Among these banks were, in addition to Morgan

Guaranty, Chase Manhattan Bank, N.A. (Chase), which

was the trustee under an indenture under which

$92,507,000 of Grant’s 434% unsecured subordinated

debentures issued April 15, 1971, were Outstanding as of

the date of filing under Chapter XI, and First National

City Bank, now Citibank, N.A. (Citibank), which was

trustee under an indenture under which $834,000 of

Grant’s 4% unsecured subordinated debentures issued

June 1, 1965, were outstanding as of the date of filing

under Chapter XI.

Grant's financial performance declined during 1973

and in December Moody's and Standard and Poor’s

lowered Grant Financial's commercial Paper ratings from

prime | to prime 2 and also downgraded Grant's long-

term securities. Grant resorted to borrowing under its

lines of credit. On March §, 1974. Moody's withdrew

Grant Financial's commercial paper rating and further

downgraded Grant's long-term securities. Faced with the

need to raise more than $132,000,000 in order to meet

commercial paper maturities in the next week, Grant

asked the eight banks to reestablish their lines of credit.

They did this in proportion to their prior exposure, with

the result that their loans and advances to Grant Financial

Shortly reached $415,000,000. Even this borrowing was

not enough; in August, 1974, Morgan Guaranty, Chase

and Citibank each advanced an additional $5,000,000 to

Grant (Secured Demand Loans) secured by an assignment

of certain accounts receivable. Later in August, 1974,

1493

8a

Grant Financial, Grant as guarantor, and eleven bank

lenders entered into an Interim Loan and Guaranty

Agreement wherein Grant Financial became indebted to

the eleven banks in the aggregate amount of $44,000,000

by assuming Grant’s obligation to repay the $15,000,000

of Secured Demand Loans just described and incurring

New Loans of $29,000,000, all such loans being guaran-

teed by Grant and secured under an Interim Security

Agreement dated as of August 21, 1974, by accounts

receivable arising out of the sale of goods at designated

stores. This brought the total short-term and long-term

loans from Grant's 12 major bank lenders to approxi-

mately $517,000,000.

The Interim Loan and Guaranty Agreement was

shortly succeeded by a Loan and Guaranty Agreement

dated as of September 16, 1974. which became effective

October 8, 1974, less than a year before Grant filed under

Chapter XI. The parties were Grant Financial, Grant as

guarantor, and 143 banks. The maturity of all outstand-

ing short-term unsecured loans and the $44,000,000 of

secured loans under the Interim Agreement was extended

through June 2, 1975, and the banks agreed to increase

their loans to $600,000,000. The Obligations of Grant

Financial were to be guaranteed by Grant. An Initial

Security agreement dated September 16, 1974, secured the

$600,000,000 total of Outstanding short-term loans and

future commitments under the Loan and Guaranty

Agreement and the $100,000,000 long-term notes issued

under the Term Loan Agreement of July, 1973.4 On the

4 The security was to consist of all of Grant's customer accounts

receivable and the securities of Zeller’s Ltd., a Canadian subsidiary of

Grant. The security was pledged ratably for the benefit of $23,995 000

Of Grant's 4'.% senior sinking fund debentures. All financing state-

ments required to perfect security interests under the Initial Security

Agreement were timely filed by Morgan Guaranty as agent.

1494

9a

date when the Loan and Guaranty Agreement became

effective, the banks advanced an additional $66,587,500,

thereby reaching the $600,000,000 in loans due June Ya

1975, contemplated by the agreement, plus the

$100,000,000 represented by the July, 1973, Term Loan

Agreement. As of April 1, 1975, Grant, Grant Financial

and Morgan Guaranty entered into a Loan Extension

Agreement actually executed June 2, 1975, within four

months of the filing of Grant’s Chapter XI petition. This

provided for paying off a debt of $56,931,665.59 to 116

banks whose individual loans to Grant ranged from

$50,000 to $5,000,000 and the extension to March 31,

1976, of outstanding short-term loans in the principal

amount of $540,916,978 made by the other banks.

Somewhat earlier Grant had been obliged, in order to

induce its largest vendors and suppliers to continue pro-

viding it with credit, to enter into an Inventory Security

Agreement dated as of May 15, 1975, wherein Grant gave

a lien on designated store inventories to specified vendors

and suppliers. Under the Loan and Guaranty Agreement,

the bank claimants were to receive a lien on inventory

junior to that of the suppliers and the senior debenture-

holders.

The final transaction was an Amended Loan Extension

Agreement entered into as of August 6, 1975, which

became effective on September 15, 1975. This further

extended the maturity of the $540,916,978 of short-term

bank loans to July 30, 1976: subordinated $300,000 ,000

of that debt to certain trade obligations (the “Trade

Subordination Agreement”); and subordinated Grant

Financial's loans of $819,887,663 to the banks’ toral

claim of $640,916,978 (the “Intercorporate Subordination

Agreement”).

1495

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The Proceedings in the Bankruptcy Court

and the District Court

After Grant had been ordered into liquidation, the

banks and Charles G. Rodman, as Trustee, asserted a

multitude of claims against each other in an adversary

proceeding, the details of which are described in Judge

Galgay’s opinion, 4 Bankr. Ct. Dec. at 601-02. The

Trustee conducted an elaborate investigation into the

affairs of Grant under Bankruptcy Rule 205(a). This

encompassed production of the books, records and other

documents of Grant, and examination of its remaining

and former officers, directors and employees. Before any

extensive discovery by the banks, settlement negotiations

were instituted. These resulted in an agreement which, in

addition to settling the claims of the banks, encompassed

what Judge Galgay termed a “global settlement”, i.e., a

“framework for the further administration of the

bankrupt estate and the Satisfaction of claims filed

against such estate.” 4 Bankr. Ct. Dec. at 602. So far as

here relevant, the settlement provided that the bank

claimants were to receive an initial cash distribution of

$165,700,000, or approximately 25% of their allowed

claims. More was to be paid when and if funds became

available. The Trustee agreed not to sue the 116 banks

whose loans of $56,931,665.59 were paid in June, 1975.

Finally, the agreement created a fund of $95,378,373. the

full amount of the claims of subordinated debenture-

holders, pending resolution of their dispute with the bank

claimants as to whether the subordination clauses of their

indentures should be given effect so as to subordinate the

debentureholders’s claims to the bank claims. The Bank-

ruptcy Judge approved the banks’ settlement on July 20,

1978, finding that “(t]he Trustee will have achieved a

1496

lla

result for the estate which approximates, and may exceed,

the results which are likely to be achieved by the contin-

ued prosecution of his defenses in the Adversary Proceed-

ing” which the bank claimants had initiated, 4 Bankr. Ct.

Dec. at 609. There was no appeal of this “global settle-

ment” to the district court.’

Having thus provided the necessary framework, the

Trustee, the bank claimants, United States Trust Com-

pany (U.S. Trust) as indenture trustee replacing Chase

under the Indenture for the 434% Subordinated Deben-

tures, and representatives of these debentureholders en-

tered into negotiations for the settlement of the latter's

claims. The rights of the debentureholders depended on

the interpretation and application of a clause in their

indentures subordinating their claims to “Senior Indebt-

edness” of Grant. The Indenture under which the 434%

Debentures were issued defined this as stated in the

margin;® the Indenture securing the small amount of

5 An “Ad Hoe Protective Committee of 4's% Convertible Subordi-

nated Debentures of WT. Grant Company”, including Mr. Victor

Kurtz and represented by I. Walton Bader, raised objections to the

banks’ settlement at the hearing. The failure by Mr. Kurtz's “Protec-

tive Committee” to pursue its objections by appealing trom the

Bankruptcy Judge's allowance of the banks’ claims forecioses some of

the issues raised in the present appeal. While Judge Galgay expressly

reserved “the claims of Subordinated Debentureholders purportedly

represented by the Ad Hoc Protective Committee” pending subsequent

determination of “the validity and enforceability of the subordination

Provisions contained in the Subordinated Debentures and related Trust

Indentures,” 4 Bankr Ct. Dec. at 608, this reservation of claims

against the bankrupt estate and, by extension, against the bank

claimants, does not go still further to permit, e @.. re-opening of the

question whether the Trustee properly agreed not to question the June.

19°S. payments of $56,931.66 $9 to the 116 other bank creditors of

(srant

The term “Senior Indebtedness” shall mean the principal of and

premium, tf any, and interest on (a) indebtedness (other than the

Debentures and the Convertible Subordinated Debentures due June

liza

Outstanding 4% Debentures was to the same effect. If the

bank claims were and remained enforceable as Senior

Indebtedness to which the debentureholders were subordi-

nated, the latter would receive nothing. However, U.S.

Trust alleged that for a number of reasons the conduct of

the banks might require the contractual subordination

provisions be disregarded and even that the subordinated

debentureholders be accorded a status prior to that of the

banks. These reasons, stated in detail in Judge Galgay’s

1, 1990 of the Company) of the Company for money borrowed

from Or guaranteed to persons, firms or corporations evidenced by

notes or similar obligations, (b) indebtedness of the Company

evidenced by notes or debentures (other than the Debentures and

the Convertible Subordinated Debentures due June |, 1990 of the

Company) issued under the provisions of an indenture or similar

instrument between the Company and a bank or trust company or

(c) purchase money indebtedness of the Company, in each case.

whether outstanding at the date of execution of this Indenture or

thereafter incurred; unless, in each case, by the terms of the

instrument by which the Company incurred, assumed Of guaranteed

such indebtedness, it is expressly provided that such indebtedness is

not superior in right of payment to the Debentures. As used in the

preceding sentence the term “purchase money indebtedness” shail

mean indebtedness evidenced by a note, debenture, bond or other

instrument (whether or not secured by any lien or other security

interest) issued or assumed as all or a part of the consideration for

the acquisition of property, whether by purchase, merger, consolida-

tion, or otherwise, provided, however, that such term shall not

include any account pavable or any other indebtedness created or

assumed by the Company in the Ordinary course of business in

connection with the obtaining of materials or services.

We reject the objectants’ assumption that the doctrine of equitable

subordination must invariably work to reverse the position’ of senior

and junior creditors. The equitable powers of the bankruptey court are

broad, Pepper v. Litton, 308 U.S. 295. 304-08 (1939), and it may

“adjust - equities among the creditors” in a flexible manner.

Herzog & Zweibel, The Equitable Subordination of Claims in Bank-

ruptcy, 15 Vand. L. Rev. 83, 87 (1961). Before considering a complete

reversal of priorities, the bankruptcy court would have been obliged to

weigh the less drastic remedy of placing a culpable senior creditor on a

plane of equality with junior creditors

1498

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Opinion approving the settlement, 4 B.R. at 60-61, were

as follows:

(a) At the time of the Initial Security Agreement of

September 16, 1974, the bank claimants knew or had

reasonable cause to believe that Grant was insolvent

and that the granting of security interests would

discourage further extensions of trade credit to Grant

and substantially reduce the flow of merchandise

into Grant stores, thereby impairing the prospects

for a successful reorganization of Grant.

(b) By forcing Grant into the Inventory Security

Agreement and Trade Subordination Agreement the

bank claimants increased the amount of Senior

Indebtedness to which the junior debentureholders

were subordinated.

(c) In the summer of 1974, the bank claimants

directed Grant not to proceed with a proposed sale of

$100,000,000 of customer accounts receivable to

Beneficial Finance Corporation and the use of some

undetermined portion of the proceeds to purchase

4°4% debentures at 25 cents on the dollar.

(d) The bank claimants used their position of control

Over Grant’s management to prevent Grant from

promptly seeking relief under the Bankruptcy Act,

feeding it just enough money to keep its head above

water while Strengthening their security position,

allowing the Passage of the four months period for

avoiding preferences under § 60a and hoping to al-

low the passage of the one year provision of § 67d(2)

for the avoidance of liens and fraudulent transfers.

The bank claimants made a variety of responses. They

denied having had any fiduciary relationship to Grant,

1499

l4a

asserted that they had made loans in the belief fostered by

Grant’s management that Grant remained viable, con-

tended that Grant’s management itself had abandoned

the proposed sale of accounts receivable, and denied that

they had prevented Grant from seeking rehabilitation

under the Bankruptcy Act. They asserted, moreover, that

as to many U.S. Trust’s claims, the remedy, even if the

claim were made out, would be invalidation of the banks’

security interests rather than subordination to the deben-

tureholders. U.S. Trust also raised claims of conflict of

interest and derelictions of duty against Chase, its prede-

cessor trustee, to which Chase answered.

The settlement originally provided for the payment of

14% of the claims of the accepting subordinated deben-

tureholders. All rights of non-acceptors were preserved,

and neither the offer nor the bank settlement agreement

was to have any effect in any proceeding brought by

them. The indenture trustees, U.S. Trust and Citibank,

were, however, to be released from all further obligations

to enforce the rights of debentureholders under their

respective indentures.

At a hearing before Judge Galgay objections were

made by eleven debentureholders, led by Victor Kurtz as

chairman of an “Ad Hoe Protective Committee of

Holders of 444% Debentures”, see note 5, supra, and

represented by I. Walton Bader. A group of Institutional

Investors also raised objections at the outset but have

played no subsequent role in the case. The Kurtz objec-

tors asserted principally that the Trustee had failed to

make a presentation of the facts and law adequate to

Support approval of the settlement, that the bank claims

should be equitably subordinated to the debentures be-

cause of the control and dominion over Grant allegedly

exercised by the banks, and that the Trustee, U.S. Trust

1500

l5a

and their respective counsel are subject to conflicts of

interest which require them to be disqualified. Acknowl-

edging the task imposed by Protective Committee for

Independent Stockholders of TMT Trailer Ferry, Inc. v.

Anderson, 390 U.S. 414, 424-25 (1968), Judge Galgay,

after 27 pages of discussion, 4 B.R. at 57-84, concluded

that the original settlement represented a fair compro-

mise, taking into account the strengths and weaknesses of

the claims of both sides and the delay and expense

incident to litigation,’ and approved it on February 20,

1980.

Timely appeals were taken to the District Court (Con-

ner, J.) by Kurtz and nine other debentureholders repre-

sented by Bader and Morton Robson (No. 80—Civ.

1857), and by debentureholder Levy and three others

« Initially we found it somewhat troubling that Judge Galgay applied

the language of Anderson to the Trustee, 4 B.R. at 69. rather than to

himself. While it is surely necessary that a trustee should perform these

duties, his having done so does not relieve the bankruptcy judge from

repeating the process, giving appropriate weight to the recommenda-

tions of the trustee and his counsel. However, Judge Galgay's opinion

shows that he thoroughly understood this.

9 There has been much to-do about how far Judge Galgay's opinion

represented his independent analysis as distinguished from a rubber-

stamping of the findings of fact and conclusions of law prepared by

counsel for the Trustee. Judge Galgay expressed, 4 B.R. at 57, his

awareness of the caution in United States v. El Paso Natural Gas Co..

376 U.S. 651, 686-67 (1964), that trial courts should not Slavishly

follow one party's proposed findings of fact and conclusions of law

He acknowledged having “adopted findings of fact and conclusions of

law submitted by the Trustee for the reason that they accurately state

and reflect the true state of the record” so that “fijt would be a waste

of judicial time on my part merely to rephrase proposed findings and

conclusions so accurately stated.” /d. At our request the counsel for

the Trustee has made available his proposed findings and conclusions,

and we have compared them with Judge Galgay's. We find that while

Judge Galgay did adopt most of the Trustee’s proposed findings of

fact, especially as to the terms of the settlement. almost verbatim, he

Prepared his own legal discussion, and appellants’ charge that the

Opinion was that of counsel rather than of the judge is a grass

eXagegeration

1501

l6a

represented by Bader and Bradley R. Brewer. The latter

did not take an appeal on behalf of his present clients,

David Cosoff and Helen Finkelstein, who were not

named objectants but had asked Mr. Brewer to represent

them at the time of the hearings before the Bankruptcy

Judge. Before the appeals could be heard, negotiations

looking toward an improvement of the offer were begun.

Judge Conner stayed consideration of the appeals and

allowed negotiations to go forward under the Bankruptcy

Judge’s supervision. See In re WT Grant Co., 13 B.R.

1001, 1002 (S.D.N.Y. 1981). These resulted in an

amended offer. The amount payable to the debenture-

holders was raised from a floor of 14 cents on the dollar

to one of 19 cents on the dollar.’ Interest on the reserve

fund calculated from the date of approval by the bank-

ruptcy judge would run for the benefit of the debenture-

holders. Solicitation of acceptances could start

immediately. As soon as the tendering debentureholders

were paid, the banks could also draw down the remainder

of the $95,378,373 reserve fund set aside under the bank

settlement agreement.

A conference on certain details was held in Judge

Galgay’s chambers on April 16, 1981. The appearance list

shows Robson as appearing for “Kurtz et al.” and Bader

for “Bondholders”. There was much discussion of the

withdrawal of the appeals from Judge Galgay’s order of

February 20, 1980. Robson and Bader agreed that, sub-

ject to certain contingencies later worked Out, they would

withdraw their appeals with prejudice. Bader announced

that although he had brought Brewer into the case and

Brewer had signed his name on the briefs, Brewer was not

10 Additional amounts not in excess of 2 cents on the dollar might be

paid if allowed fees and expenses amount to less than 2% of the face

value of all debentures tendered

1502

l7a

the attorney for the Levy appellants, who were Bader’s

clients, and had not signed the notice of appeal. Robson’s

and Bader’s stipulations withdrawing appeals from the

February 20, 1980, order with prejudice and without costs

were signed and so ordered.

In the further proceedings before Judge Galgay relating

to the new settlement offer, objections had to be submit-

ted in writing by June 12, with a hearing to be held on

June 16. Brewer filed no written objections by June 12

because no one had authorized him to do so. A day later

appellant Cosoff retained him to oppose the settlement.

At the hearing on June 16 Judge Galgay gave him time to

argue; Brewer there objected Only to an alleged inade-

quacy of notice and to the Provisions concerning attor-

neys’ fees. By order dated June 23, 1981, Judge Galgay

approved the amended offer, which has now been ac-

cepted by some 80% of the debentureholders. On July 1,

1981, Cosoff and Finkelstein, represented by Brewer, and

Miller and McGinnis, Originally represented by Douglas

F. Eaton and now by Stuart E. Jackson, filed notices of

appeal, which on this occasion came before District Judge

Duffy. The grounds of appeal were largely those that had

been argued before Judge Galgay at the hearing on the

first settlement offer.'' On March 15, 1982, Judge Duffy

affirmed the order of the bankruptcy court, 20 B.R. 186

(S.D.N.Y. 1982), primarily on the ground that the dis-

missal of the appeals from the order of February 20,

1980, rendered that order res judicata. The instant ap-

peals are from Judge Duffy’s order.'?

i Judge Duffy noted, 20 B.R. at 189 n.4, that appellants had “ar-

guably failed to preserve their claims for appeal by not properly

articulating or presenting them in the bankruptcy court”, but did not

rely on this.

2 An appeal was also taken by a number of debentureholders, all

represented by Mr. Brewer, (No. 82-502]) which, because none of these

1503

18a

Discussion

Although the trustee in bankruptcy has not raised the

point and U.S. Trust Company has done so only feebly,

we begin by noting some concern whether appellants have

Standing to appeal in light of the fact that the settlement

leaves them free to pursue their remedies. We see nothing

in the argument of their counsel that they are entitled to

represent accepting debentureholders since a rejection of

the settlement would necessarily lead to a still further

improvement in the offer. There can be no such assur-

ance. Although the banks indeed moved rather quickly

from 14 cents to 19 cents, there must be a point at which

the banks would prefer to litigate rather than give up

more in settlement, and no one knows but the banks and

their counsel where that is. Beyond this there is no proot

that accepting debentureholders have authorized appel-

lants to appear for them. Appellants’ argument with

debentureholders had earlier appealed from the bankruptcy court to

the district court, was dismissed for lack of standing without prejudice

to later motions by these debentureholders for leave to intervene.

Seventeen of this group. led by Robert B. Yates. have been granted

perMission io intervene and have amplified appellants’ contention that

the bankruptcy Trustee's counsel should have been disqualified, infra,

pp. 26-28. Another nine, led by James Stephan, have been allowed to

intervene and have alleged conflicts of interest on the part of United

States Trust Co., successor indenture trustee for the 4% debentures,

and its counsel. In addition, leave to intervene was granted to a faction

ot debentureholders, led by John Masse and represented by |. Walton

Bader, who support the amended offer of settlement but oppose

United States Trust Co.'s application for fees pursuant to that offer

United States Trust Co. has also been permitted to intervene in support

of the amended offer and in defense of its own conduct and that of its

counsel

The Stephan intervenors point to alleged conflicts of interest arising

Out of United States Trust Co.'s desire to obtain fees for its services

and its potential liability for breaches of fiduciary duty committed by

its predecessor Chase. We see no basis for the charges of misconduct

leveled by the intervenors against United States Trust Co. and its

counsel

1504

19a

respect to standing must be rather that in a case of this

sort the right of an individual debentureholder or even of

a considerable group of such holders to assert their claims

against the embattled forces of ten of the country’s

largest banks, once deprived of the resources afforded in

the past by the bankruptcy trustee and the indenture

trustee, is more fiction than fact. With claims of 80% of

the debentures settled, the threat to the banks by a few

holdouts is not substantial. Bringing the bankruptcy trus-

tee, or the indenture trustee, or both, back to the nego-

tiating table or to court is the only realistic recourse to

preserve an opportunity for debentureholders who have

not yet accepted to achieve more. The situation is com-

parable to that of court-approved settlements of class

actions, in which “even where class members had the

right to exclude themselves from the class, they may

appeal from an order approving a settlement which they

deem unsatisfactory,” 3B Moore, Federal Practice

¢ 23.80[5] (2d ed. 1982), lest small claimants “be faced

with equally unpalatable alternatives—accept either

nothing at all or a possibly unfair settlement,” Ace

Heating & Plumbing Co. v. Crane Co., 453 F.2d 30, 33 (3

Cir. 1971).

We have little doubt as to the correctness of Judge

Duffy’s observations about res judicata in the usual case

or even in most cases of the approval of settlements in

bankruptcy. An appeal by one creditor will not save the

situation for another if the first withdraws his appeal—if

for no other reason than that the time for the other to

take an appeal will generally have expired. See 9 Moore.

Federal Practice € 204.11[4] (2d ed. 1982). Here the latter

Obstacle does not exist. The operative order was Judge

Galgay’s order of June 23, 1981, approving the revised

settlement and ihe Cosoff-Finkelstein and Miller-McGin-

1505

29a

nis appeals were timely. By the time the Kurtz and Levy

appeals from the February 20, 1980, order were with-

drawn the amended offer had been made public and, if

the appeals had not been formally withdrawn, Judge

Conner would surely have found some way of getting rid

of them rather than devote his time to hearing appeals

from an order that was about to be Superseded. Ap-

parently the reason why withdrawal of the appeals was

sought was to permit speedy dissemination of the new

offer without having to await the the district court's

decision as to the superseded offer, see 20 B.R. at 188;

that purpose was accomplished. We see no indication that

anyone thought at the time that the withdrawal of the

appeals from the February 20, 1980, order with prejudice

would deprive objectors to the new offer of a right to

appeal on the merits if Judge Galgay were to approve

this. Beyond all this, policy considerations weigh against

a rigid application of res judicata when such serious

attacks have been made upon the bankruptcy trustee and

his counsel, the present and former indenture trustees for

the 4%4% debentures, and the bankruptcy judge. We

therefore proceed to Judge Duffy's alternative ground of

decision, on which he did not elaborate, that the appeals

are lacking in merit. 20 B.R. at 190. While we could

remand the case to him to perform the task of a detailed

analysis of the settlement and ordinarily would do so,

nearly three years have elapsed since the initial approval

of the settlement, and a remand and subsequent appeal

would doubtless add nearly another year.

In undertaking an examination of the settlement, we

emphasize that this responsibility of the bankruptcy

judge, and ours upon review, is not to decide the numer-

Ous questions of law and fact raised by appellants but

rather to canvass the issues and see whether the settlement

1506

2la

“fall[s] below the lowest point in the range of reasonable-

ness”, Newman vy. Stein, 464 F.2d 689, 693 (2 Cir.), cert.

denied sub nom. Benson y. Newman, 409 U.S. 1039

(1972). We shall not attempt to deal with every argument

advanced by appellants but will concentrate on what seem

the most near!y persuasive.

We start with appellants’ argument that, quite apart

from the banks’ conduct, part or all of the banks’ claims

are not “Senior Indebtedness”, see note 6, supra, to

which alone the claims of debentureholders are subordi-

nated. We can pass over the frivolous argument that the

language does not cover further borrowings, to which

Judge Galgay gave the treatment it deserved, 4 B.R. at

70-72. Appellants next argue that until Grant's guaranty

of August 21, 1974, the banks’ claims did not qualify as

Senior Indebtedness of Grant since their loans were not to

Grant but to Grant Financial. Judge Galgay thought a

sufficient answer to be that Grant's indebtedness to Grant

Financial was evidenced at the time of the filing of the

Chapter XI petition by an Intercorporate Demand Note

in the amount of $819,887,663, more than the amount of

the banks’ loans to Grant Financial. and that this would

qualify as Senior Indebtedness if the corporate entities are

respected; if they are not, as well might be proper, the

loans to Grant Financial, all evidenced by notes, would

qualify even more directly. Beyond this. the $15,000,000

Secured Demand Loans of August 1974 were originally

made directly to Grant, and the $44,000,000 loaned under

the Interim Loan and Guaranty Agreement of August 21,

1974, was guaranteed by Grant. Finally, under the Loan

and Guaranty Agreement all loans by Grant Financial

were guaranteed by Grant. While this did not become

effective until October 8, 1974, which fell 6 days short of

a year of the Chapter XI petition, there is no showing

1507

22a

that the trustee could have established lack of fair consid-

eration for the guaranty under § 67(d). The legal standard

in a situation such as this, which is governed by

§ 67(d)(1)(e) of the Bankruptcy Act, is whether “the

economic benefit. . . that accrued to [the] bankrupt as a

result of the third person's indebtedness” was “ ‘dispro-

portionately small’ when compared to the size of the

security that that bankrupt gave and the obligations that

it incurred,” Rubin y. Manufacturers Hanover Trust Co.,

661 F.2d 979, 993 (2 Cir. 1981). See also Klein v. Tabatch-

nick, 610 F.2d 1043, 1047 (2 Cir. 1979). Through its

subsidiary, Grant received the full benefit of the extended

maturity of some $490,000,000 in short-term loans and

additional loans up to the total amount of $600,000 ,000

in return for its guaranty and for security interests, see

note 4, supra, estimated by the Bankruptcy Judge to

amount to $288,000,000, 4 Bankr. Ct. Dec. at 606. We

thus conclude that while the subordinated debenture-

holders have some arguments that the larger part of the

bank debt would not qualify as Senior Indebtedness

because the loans initially were made to Grant Financial

rather than to Grant, these did not have much chance of

prevailing.

Appellants contend that, however things might

otherwise stand, the banks are estopped from claiming

that Grant's indebtedness to Grant Financial constituted

Senior Indebtedness because the prospectus under which

the 444% Debentures were issued showed Senior Indebt-

edness of only $28,775,000 whereas Grant then owed

Grant Financial $246,420,216. The Bankruptcy Judge

accepted the Trustee's answer that where there is a con-

flict between a prospectus and the language of an inden-

ture, the latter controls, citing Jn re Discon Corp., 346 F.

Supp. 839, 844 (S.D. Fla. 1971). Appellants’ argument,

1508

23a

however, is not really one of construction: they say that

even if the words are sufficient, Grant, allegedly with the

banks’ knowledge, acted in such a way as to make it

inequitable for the banks to rely on the words. Yet even if

this were upheld—and we find no proof of the banks’

complicity in Grant’s prospectus, the point remains that

the prospectus goes on to define Senior Indebtedness as,

inter alia, “indebtedness . . . for money borrowed from

Or guaranteed to persons, firms or corporations evidenced

by notes or similar obligations” (emphasis supplied).

Grant’s fresh guaranty of the indebtedness of Grant

Financial to the banks in 1975 would itself therefore

qualify as Senior Indebtedness even if some principle of

estoppel were to prevent the banks from claiming that the

unguaranteed intercorporate loans from Grant Financial

would not have done so in 197].

Once it is concluded that there was a strong probability

that all of the bank debt would be deemed Senior Indebt-

edness and a certainty that some of it would be, appel-

lants’ other claims lose much of their force. It is true, as

appellants urge, that the contractual subordination of the

debentures to the bank debt would not prevent the bank-

ruptcy court, as a court of equity, from placing the

debentures on a plane of equality with or even, although

this is harder to envision, see note 7, supra, of superiority

to all or part of the Senior Indebtedness if the banks had

engaged in inequitable conduct. However, what appel-

lants disregard is that in judging the equity of the banks’

conduct their position as creditors prima facie senior to

the debentureholders must be taken into account. We see

no reason to quarrel with the substance of Judge Galgay’s

summary of the law of equitable subordination, 4 B.R. at

74-75, although every judge would probably state his own

version differently. We entirely agree with his conclusion

1S09

24a

that “[a] creditor is under no fiduciary obligation to its

debtor or to other creditors of the debtor in the collection

of its claim”, 4 B.R. at 75, and cases there cited. See

Weinberger v. Kendrick, 81-7317, slip ops. at 3923, 3957

(2 Cir. July 14, 1982). The permissible parameters of a

creditor’s efforts to seek collection from a debtor are

generally those with respect to voidable preferences and

fraudulent conveyances proscribed by the Bankruptcy

Act; apart from these there is generally no objection to a

creditor’s using his bargaining position, including his

ability to refuse to make further loans needed by the

debtor, to improve the status of his existing claims.

Returning to the four principal points raised by objec-

tors, see pp. 8-9, supra, we thus think the bankruptcy

judge was warranted in giving relatively little weight to

those labeled as (a) and (b). The premise of both argu-

ments is that sometime between September of 1974 and

May of 1975 the banks knew or had reasonable grounds

to believe that Grant was insolvent. Although the Trustee

had alleged this in his answer to the banks’ claims, we

have been cited to no evidence that would support this.

To the contrary there was much testimony that Grant

continued showing a substantial net worth and that the

banks considered it viable almost to the end.

Taking up next the objection lettered (d), the gravamen

of this charge is that Grant management, apparently in

the summer of 1974, contemplated taking action to place

Grant in a Chapter XI proceeding, which might have

enabled Grant to survive as a reduced Operation with

lower administrative expenses, but that the banks pre-

vented this, making specious explanations but acting in

reality to improve their preferred position. For this appel-

lants cited pasages from two depositions neither of which

supports the contention they advance. In the first of

1510

25a

appellants’ references, John P. Schroeder, Morgan

Guaranty’s officer in charge of the Grant credit, merely

agreed with questions suggesting that in the late summer

of 1974 the banks wished “to recoup the most amount of

money as possible on the Grant loans”, an understand-

able and permissible desire, and that for this reason they

“did not opt for liquidation at that time”. In the second

passage cited, Robert Dannenbaum of the Bank of New

York stated that at some unspecified time the banks

would have liked an “unofficial reorganization pro-

gram”, by which he meant not a Chapter XI proceeding

but rather nothing more than “general monitoring of the

Company’s affairs by the banks”. No suggestion is found

in any passage of these witnesses’ testimony reproduced

by appellants that Grant itself actively contemplated un-

dergoing voluntary liquidation or reorganization under

the Bankruptcy Act in the summer of 1974. We also note

that after July, 1974, the banks increased their loans by

$44,000,000 in August, 1974, and by another $66,587,500

in October, 1974, and on September 15, 1975, subordi-

nated $300,000,000 of their debt to trade obligations.

While a sinister interpretation is possible, this is not

demanded; considering that the fresh money provided by

the banks after July, 1974, amounted to some

$226,000,000 as against $95,378,373 principal amount of

the debentures, the banks would have been paying a

rather high price to obtain whatever legal advantages the

various arrangements of July, 1974, through September,

1975, would yield in the event of Grant’s invoking the

Bankruptcy Act.

With respect to objection (d), the Bankruptcy Judge

was warranted in attaching little importance to general

Statements by Grant officials that the banks were “run-

ning” Grant. There is no doubt that, at least from March

1S11

26a

of 1974, the banks kept careful watch on what was going

on at Grant; they would have been derelict in their duty

to their own creditors and stockholders if they had not. It

is not uncommon in such situations for officers whose

companies have been brought to the verge of disaster to

think that they still have better answers than do the

Outsiders. In order to establish their claims the appellants

must show not simply that the banks proffered advice to

Grant that was unpalatable to management, even advice

gloved with an implicit threat that, unless it were taken,

further loans would not be forthcoming. They must show

at least that the banks acted solely for their own benefit,

taking into account their reasonable belief that their

claims constituted Senior Indebtedness vis-a-vis the de-

bentureholders, and adversely to the interest of others.

The allegation most discussed by appellants is that

lettered (c). With respect to this the record, along with

materials submitted in Support of and in response to the

petition for rehearing in Weinberger v. Kendrick, supra,

enable us to piece out the story. Harry Pierson, the acting

president of Grant and Robert Luckett, the controller,

made a report to a meeting of the Grant board of

directors in June of 1974 Proposing a transaction wherein

$100,000,000 of customer accounts receivable would be

sold to Beneficial Finance Company (Beneficial) at a

discount of up to 27% and some undetermined portion of

the proceeds'’ would be used to purchase on the market

4%s% subordinated debentures which were then selling at

about 25 cents on the dollar. Pierson reported that two of

13 As the transaction was conceived, Grant would use for repurchase of

subordinated debentures so much of the proceeds as was needed to

have the resulting Paper reduction in subordinated debt On the right

hand side of Grant's balance sheet offset the loss of assets on the left

hand side engendered by the discounted sale of the accounts receivahle

1512

27a

the major banks, Morgan Guaranty and Chase, were

Opposed to the transaction until some time after the

completion of the proposed bank loan commitment, pre-

sumably the Loan and Guaranty Agreement executed on

October 8, 1974. Their reasons were that proceeds of one

of Grant’s most valuable assets would be used to pay

junior debt and that trade creditors would be upset.

According to Luckett, Pierson had nevertheless deter-

mined to sign the contract with Beneficial and apparently

persisted in that intention after a meeting at Morgan

Guaranty where the banks’ Opposition was strongly con-

veyed. However, when Grant’s attorneys received the

documents from Beneficial, they found, as often happens

iN negotiations of this sort, that the provisions were

distinctly more onerous than the Grant officers had

supposed. For example, Beneficial reserved the right to

cull the accounts tendered, would make no payment until

30 days elapsed, and could put back to Grant any ac-

counts that it found difficult to collect. These and numer-

Ous Other snags in the draft agreement led Charles A.

Doyle, then an attorney in Grant’s Legal Department, to

report to Robert Kelly, his superior, that “it would be

legally unwise and unsound tO execute any of these

agreements in their present form.” This view was shared

by Kelly, as well as by John Sundman, Grant’s new

Financial Vice President and its closest link with the

banking community.

It would seem a sufficient answer to the objectors that

the Beneficial deal was abardoned for reasons relating to

its terms that were entirely independent of the banks’

Opposition. Beyond that we think it would have been

Surprising if the banks had not objected to the portion of

the transaction which involved use of proceeds of quick

assets to purchase long-term subordinated debt. The

1513

28a

banks reasonably thought that their claims were senior to

the debentures. True, the purchase of debentures at 25

cents on the dollar would have meant a Saving of interest

of some 19% on the purchase price. But Grant’s immedi-

ate problem was short term; what it needed was to

conserve resources and obtain short-term loans in order

to stay afloat until the tide turned. Even if we should

assume the evidence went so far, we see nothing inequita-

ble in the banks taking the position that if Grant wished

use quick assets to redeem subordinated long-term debt,

even On an advantageous basis, it could expect no further

help from them.

The appellants raise a special point concerning Chase.

As previously stated, Chase, one of the three lead banks,

had been Indenture Trustee for the 434% debenture-

holders until August, 1974, when it resigned and was

succeeded by U.S. Trust. A debentureholder accepting the

offer of settlement releases his claim against both.'* De-

spite the limited duties of a trustee for debentureholders,

as distinguished from a trustee holding property as secu-

rity, it is settled in this circuit that he owes a duty “not to

profit at the expense of his beneficiary”, Dabney v. Chase

Nat'l Bank, 196 F.2d 668, 670 (2 Cir. 1952) (L. Hand, J.),

as supplemented, 201 F.2d 635 (2 Cir.), cert. dismissed per

stipulation, 346 U.S. 863 (1953). See also United States

Trust Co. v. First National City Bank, §7 A.D.2d 285,

296, 394 N.Y.S.2d 653, 660-61 (Ist Dep’t 1977), aff'd, 45

N.Y.2d 869, 410 N.Y.S.2d 580 (1978): Broad vy. Rockwell

Int'l Corp., 642 F.2d 929, 959-60 (5 Cir.) (en banc)

(construing New York law), cert. denied, 454 U.S. 965

(1981); Morris v. Cantor, 390 F.Supp. 817, 824 (S.D.N.Y.

14 We see no basis whatever for any claims against U.S. Trust or its

counsel, supra, note 12

1514

29a

1975). When an indenture trustee assumes the role of a

lender, it takes the risk that, in the event of insolvency of

the issuer, its acts will be subject to special scrutiny. Here

the Bankruptcy Trustee conducted an examination of

Chase’s files covering its activities as indenture trustee,

and objector Kurtz deposed a Chase vice president con-

cerning its decision to resign as indenture trustee and

other matters. Neither the deposition nor any of the

exhibits marked thereat were offered in evidence at the

hearing on objections. In their briefs in this court objec-

tors rely on Chase’s having played a principal role in the

opposition to the sale of accounts receivable to Beneficial

Finance Co. and having participated in the negotiation

and drafting of the agreements of the summer and fall of

1974.

At first blush the argument that Chase helped to thwart

a plan whereby at least some of the debentureholders

would have received partial payment might seem to have

possible merit. However, it falls on the rock of so much

of our previous discussion as shows that Grant would not

have consummated the Beneficial deal apart from the

banks’ opposition. The second argument falters on the

fact that the $44,000,000 of secured loans covered by the

Interim Loan and Guaranty Agreement were new money,

$12,480,000 of which was supplied by Chase. Even if the

facts showed that Chase participated in negotiation of the

October 8, 1974, Loan and Guaranty Agreement while

still indenture trustee, which is not at all clear, this also

involved $66,587,500 of new money, $17,973,000 of

which was supplied by Chase. This is some distance from

the acts of “[a] creditor who accepts payment of part of a

loan before it is due, from a debtor known to be ‘fighting

for its life’, and who insists upon security for the balance

{of unsecured debt] when it is due”, of which Judge Hand

1515

30a

wrote in Dabney, supra, 196 F.2d at 672. As the Fifth

Circuit en banc recently concluded, New York authority

runs contrary to the assertion “that an indenture trustee

has a duty, fiduciary or otherwise, to seek for the holders

of debentures any benefits that are greater than those

contractually due them,” Broad v. Rockwell Int’! C Orp.,

supra, 642 F.2d at 959 (emphasis in Original). In short,

while Chase might have been better advised to resign at

an earlier date we see little prospect of a recovery against

it as indenture trustee on the facts before us.

The only other contention of appellants we deem

worthy of discussion is their position that Weil, Gotshal &

Manges (WGM) should have been disqualified as attor-

neys for the Bankruptcy Trustee. Although their argu-

ment is cast in terms of disqualification, what appellants

are really saying is that WGM’s allegiance to the banks

led the firm to make an inadequate investigation of the

claims of preferences, fraudulent conveyances, and so

forth, raised in the Trustee’s answer in the adversary

proceeding initiated by the banks and, in part because of

this lack of investigation, to recommend a settlement too

favorable to the banks. The claimed bases for “disqualifi-

cation” are that:

(1) WGM acted as counsel for the bank claimants

for five days after the initiation of the Chapter

XI proceeding and before it was retained as

co-counsel by a creditors’ committee representing

both the bank and other claimants:

(2) WGM was one of two co-counsel representing

the creditors committee throughout the Chapter

XI proceeding and until its engagement as coun-

sel for the Trustee in liquidation:

1516

3la

(3) From February, 1975, until April, 1977, WGM

acted as counsel for Morgan Guaranty in connec-

tion with a $9,000,000 claim against Bowmar

Instrument Corp. in a Chapter XI proceeding;

(4) Until 1975, WGM was counsel for Shapiro

Brothers Factors Corp., a wholly owned subsidi-

ary of Chase, and it now represents Chase

Manhattan Mortgage and Realty Trust, a pub-

licly owned real estate investment trust with ties

to Chase.

Judge Galgay overruled this claim, 4 B.R. at 82, partly in

reliance on § 44c¢ of the Bankruptcy Act, which provides:

An attorney shall not be disqualified to act as attor-

ney for the receiver or trustee merely by reason of his

representation of a general creditor.

Appellants answer that their objection goes to WGM’s

affiliations not with general creditors but with institutions

claiming to be lien creditors.

However, we do not find that any of the relationships

charged by appellants were disqualifying. The five days

of representation of the bank claimants were de minimis:

appellants point to no action taken during that period on

WGM!'s advice which figured in the later investigation or

negotiations. We likewise have been pointed to no dis-

qualifying action taken while WGM was co-counsel for

the creditors’ committee in the Chapter XI proceeding.

Although appellants allege it was understood that WGM

: It would appear that the bank claumants had already acted to set-off

$94,$23.110 of Grant’s funds on deposit with them and to advance

,

back $90,300,000 of thi amount to Grant as debtorin possession by

October 2, 1978, prior to the start of WGM's challenged five-day

representation of the bank claimants

1$17

32a

was representing the banks and the co-counsel, Ballon,

Stoll & Itzler, were representing other creditors, we have

been shown nothing to substantiate this or to show that

WGM was advancing the cause of the banks in this case.

We see no reason to disagree with Judge Galgay’s reaffir-

mation, 4 B.R. at 83, of his conclusion in Jn re REA

Holding Corp., 4 Bankr. Ct. Dec. 1249, 1253 (Bankr.

S.D.N.Y. 1979), vacated and remanded on other grounds,

2 B.R. 733 (S.D.N.Y. 1980), that “[t]he role of counsel to

an official creditors’ committee is not adverse to or in

conflict with the role of counsel to a bankruptcy trustee if

liquidation should subsequently ensue.” WGM's previous

representation of one or more of the banks or their

subsidiaries in unrelated matters is scarcely a ground for

disqualification. There is no contention that WGM regu-

larly served any of the banks in bankruptcy cases, and

their having done so in one or more unrelated cases would

not prevent a vigorous assertion of the claims of the

subordinated debentureholders against the banks. On an

issue of this sort particular weight should be given to the

conclusion of the Bankruptcy Judge, who had abundant

Opportunities to observe the activities of WGM over

many months and concluded “that the Trustee’s attorneys

have served him and the creditors of the bankrupt estate

with vigor, objectivity and independence.”

We conclude by reemphasizing that the task of the

bankruptcy judge was not to determine whether the

settlement was the best that could have been obtained,

something that neither he nor we can ever know, but

whether it “fall[s] below the lowest point in the range of

reasonableness”, Newman v. Stein, Supra, 464 F.2d at

693. If we take the Trustee’s estimated realization of

$600,000,000, and deduct the estimated $143,000,000 of

administration and § 64a priority claims, the $76,000,000

1518

33a

owing to secured suppliers, and the $24,000,000 owing

to senior debentureholders, there would be a balance

of $357,000,000 available for distribution among

$650,000,000 of bank claims, $95,000,000 of Subordi-

nated Debentures and $82,000,000 of general unsecured

claims, 4 Bankr. Ci. Dec. at 606. If the banks could

sustain their claims of subordination, let alone their

claims of lien protection for $288,000,000 of their debt,

the subordinated debentureholders would take nothing.

Even if the banks’ claims to secured creditor status and

subordination of the debentures were rejected but the

banks were not subordinated to them, all of which was

highly problematical, the debentureholders would receive

only 43 cents on the dollar, after much further expense.

After considering the strengths and weaknesses of the

claims of the debentureholders a settlement assuring them

of 19 cents can hardly be regarded as below the lowest

point in the range of reasonableness.

We therefore affirm the judgment of the district court

on the merits.

1S$19

34a

UNITED STATES DISTRICT COURT

SOUTHERN DISTRICT OF NEW YORK

A A a ee tt ts ts te tl. le te le ‘tl t,t ta » 4

In re :

W.T. GRANT COMPANY, :

Bankrupt. : 2 Civ.

SLL LL SS OO a ae a X 5996 (KTD)

DAVID COSOFF, HELEN FINKEL-

STEIN, EILEEN MCGINNIS, JAY :

MILLER, OPINION

Appellants,

- against -

CHARLES G. RODMAN,

Trustee-

Appellee. :

Se ee eS ee ee ee ee ee ee ne ae ae ee ee ee ee ee ee es p 4

APPEARANCES:

WEIL, GOTSHAL & MANGES

Attorney for the Trustee

767 Fifth Avenue

New York, New York

Of Counsel: Harvey Miller, Esq.

Richard Krasnow, Esq.

BREWER & SOEIRO

799 Broadway

New York, New York

Of Counsel: Bradley R. Brewer, Esq.

DOUGLAS F. EATON, ESQ.

Attorney for Appellants

Eileen McGinnis and Jay Miller

598 Madison Avenue

New York, New York

Of Counsel: Joanne C. Eaton, Esq.

35a

KEVIN THOMAS DUFFY, D.J.:

David Cosoff, Helen Finkelstein,

Eileen McGinnis and Jay Miller appeal pur-

Suant to Bankr.R.P. 801 from Bankruptcy Judge

Galgay's order approvidng a settlement be-

tween banks and subordinated debenturehold-

ers of bankruptcy W.T. Grant Company ("Grant").

The settlement offers debentureholders 19

1/

cents on the collar.= Appellants argue

that Judge Glagay committed errors of law

and fact in approving the settlement and in

providing notice to debentureholders. It is

unnecessary, however, to address these argu-

ments. Appellants’ claims were litigated to

a final judgment in bankruptcy court two

years ago, and are thus res judicata.

This matter arises out of the attempt

of Grant's bank creditors to collect some

$657,000,000 by enforcing liens and guaran-

tees after the company was adjudicated a

bankrupt on April 13, 1976. Appellee Charles

G. Rodman, bankruptcy trustee, challenged

the validity of the liens and guarantees on

36a

the ground that the banks had obtained their

sureties by dominating Grant management to

the prejudice of the company in the eighteen

months before bankruptcy. Chase Manhattan

Bank, N.A., and Citibank, N.A., had been both

Grant lenders and indenture trustees for the

debentureholders~’ during the events in ques-

tion, so these banks appeared to have a con-

flict of interest. Rodman argued that under

the doctrine of equitable subordination the

$94,000,000 in subordinated debentures should

be paid in full before the banks received any

money from the bankrupt's estate. See Pepper

v. Litton, 308 U.S. 295-307-310 (1939).

The trustee accumulated about $700,000-

000 by liquidating the estate. Some $94,000-

000 was set aside to meet the debenturehold-

ers' claims in case they won; otherwise the

money would go to the banks as senior cred-

itors. The trustee litigated against the

banks for about one year. He deposed more

than twenty-five witnesses and took more than

10,000 pages of testimony. Settlement nego-

» Sa

37a

tiations began in late 1977 or early 1978.

The trustee recommended a settlement for 14

cents on the dollar, and after five days of

hearings in May, 1979, Judge Galgay approved

the settlement on February 20, 1980. in re

W.T. Grant, 4 Bankr. 53 (Bankr. S.D.N.Y.

1980). The settlement provided that debenture-

holders would accept a cash payment of 14 cents

on the dollar by tendering their securities and

waiving all claims against the banks.>/ Funds

would be disbursed out of the $94,000,000 re-

Serve fund only after 90 percent of the deben-

tureholders (or such lower percentage as the

banks would choose) had accepted the offer.

The trustee would retain funds sufficient to

cover 100 percent of the principal and accrued

interest on claims of debentureholders who re-

fused the settlement. The settlement offer

would not be distributed to the debenturehold-

ers, and no money would be paid out, until ap-

peals of the settlement were exhausted.

Eleven debentureholders appealed from

Judge Galgay's order to the district court.

=~ 2 «

38a

Cosoff, Finkelstein, McGinnis and Miller were

not among them. Cosoff and Finkelstein had ob-

jected to the settlement in bankruptcy court

and had been represented by their present at-

torney Bradley R. Brewer. Brewer participat-

ed in the appeal of Judge Galgay's order, but

in his brief he admits that he did not appeal

on behalf of Cosoff and Finkelstein because he

did not think it necessary to protect their

rights.

Negotiations continued while the ap-

peal was pending, and the district court is-

sued a limited remand so that Judge Galgay

could supervise the negotiations. On April

1, 1981, the parties reached a compromise; the

banks raised their settlement offer to 19 cents

on the dollar. In return, the objectants a-

greed to dismiss their appeal with prejudice.

Lawyers for the banks worried that parties not

present might try to block the settlement, but

Harvey Miller, counsel to the trustee, observed

that withdrawal of the appeal would make Judge

Galgay's decision final and allow the parties

39a

to disseminate the settlement offer.

Mr. Brewer participated in the settle-

ment conference in Judge Galgay's chambers, but

he was unable to state for the record exactly

who he was representing. He made no effort to

contact his clients to intervene in the appeal

or otherwise keep it alive. Mr. Brewer knew of

the 19-cent settlement on April 1, 1981, but

he received no objection from any client tothe

offer by June 8, when he was informed that all

objections to the new settlement had to be sub-

mitted to the bankruptcy court in writing by

June 12. Mr. Brewer submitted no written ob-

jections because he had received none by that

date. Judge Galgay approved the 19-cent set-

tlement on June 16. Mr. Brewer appeared at

the hearing on June 16, but he was still un-

certain as to who he represented. Only Mr.

Cosoff had retained him to oppose the settle-

ment, and Mr. Cosoff had acted on June 13, one

day after the deadline for submitting objec-

tions. Judge Galgay gave Mr. Brewer a limit-

ed time to argue in court against the settle-

40a

ment. Mr. Brewer chose to object only to the

adequacy of notice--he claimed the June 8-12

interval was too little time, and he claimed

the notice of settlement was confusing--and

to attorneys’ fees incorporated in the settle-

4/

ment.-—

The settlement offer was distributed,

and about $79,300,000 or 80 percent of the de-

bentures have been exchanged in acceptance of

the settlement. The banks approved disburse-

ment of cash pursuant to the settlement.2/ it

is this executed settlement’ that appellants,

again represented by Brewer ,— seek to undo.

Two years after the bankruptcy court

approved the 1l14-cent settlement, appellants

here raise only the same claims that were li-

tigated before Judge Galgay. Judge Galgay's

decision was res judicata. Katchen v. Landy,

382 U.S. 323, 334 (1966). Even though the

bankruptcy proceeding continued, appellants

could attack the decision only by direct ap-

peal. In re Abilene Flour Mills Co., 439 F.2d

S37, 939 (10th Cir. i371): Kimm v. Con, 1307.

a ee

4la

721, 736-37 (8th Cir. 1942).This they failed

to do. Therefore, they may not litigate their

claims a second time through this appeal.

Appellants argue that Judge Galgay's

decision was challenged on appeal by the orig-

inal objectants. They reason that because they

were not parties to the first appeal, the dis-

missal of the appeal does not bind them and in

some way reopens Judge Galgay's decision to

their attack. This argument mistakes the ef-

fect of res judicata in bankruptcy.

A bankruptcy is essentially an in rem

proceeding of an equitable nature. Local Loan

Co. v. Hunt, 292 U.S. 234, 241 (1934); Moore,

Res Judicata and Collateral Estoppel in Bank-

ruptcy, 66 Yale L.J. 1, 1 (1958); 1 Collier on

bankruptcy, 92.09, at 173 & n.3 (3. Moore & &.

King 14th ed. 1974). The bankruptcy court ad-

judicates interests in the res, which is the

bankrupt's estate in general and the $34,000,000

reserve fund in this particular case. A judg-

ment in rem binds all parties in the world who

have notice of the proceeding as to their in-

terests in the res.o' Restatement of Judgments

42a

Section 73(1) (1942); Restatement (Second) of

Judgments, Section 73(a) & Comment (a) at 192

i7Tent. Dratt Wo. 1 1973).

In Stoll v. Gottlieb, 305 U.S. 165

(1938), the bankruptcy court approved over cre-

ditor Gottlieb's protests a reorganization

plan which required Gottlieb and other credi-

tors to give up their claims against guaran-

tors of the debtor. Gottlieb did not appeal

the bankruptcy court's decision that it had

jurisdiction to bind Gottlieb as against the

guarantor, and the Supreme Court held the de-

cision res judicata against Gottlieb when he

sued the guarantor in state court.

In Chicot County Drainage Dist. v.

Baxter State Bank, 308 U.S. 371 (1940), the

bondholders with notice of a municipal bank-

ruptcy proceeding but who never participated

in the proceeding challenged the bankruptcy

court’s adjudication after the Supreme Court,

in another case, held the municipal bankrupt-

cy law unconstitutional. The bondholders ar-

gued the bankruptcy court lacked subject mat-

43a

ter jurisdiction. Even though the bondholders

never participated in the proceeding, the Court

held the decision of the bankruptcy court res

Sudicata. Id. at 375. See Moore, Supra, 68

Yale L.J. at 7-10.

The cases as analyzed above indicate

that a creditor with notice may not contest a

decision of the bankruptcy court once that de-

cision has become final, whether or not the

creditor appeared before the bankruptcy judge.

It would seem to follow that a creditor may

not contest a decision of the bankruptcy court

On appeal after a first appeal has been with-

drawn and the time to join in that appeal has

expired. See Bankr.R.P. 802(a) .2/ It is not

the capitulation of the original appellants

which binds the appellants here. See Robin-

son v. First Nat'l City Bank, 482 F. Supp. 92

(S.D.N.Y. 1979) (litigating creditors in bank-

ruptcy are not class representatives and do

not bind fellow creditors). It is instead ap-

pellants' own failure to join in the original

appeal.

44a

To allow appellants a second chance at

review would permit yet a third appeal should

these appellants settle with the banks. A de-

cision permitting such a result would disserve

the goal of finality in litigation which is

the purpose of res judicata. See Federated

Department Stores, Inc. v. Moitie, 49 U.S.L.W.

4687 (1981) (where five of six plaintiffs dis-

missed by the same judge won on appeal because

of an intervening change in law, the district

court decision remained res judicata against

the non-appealing plaintiff). Moreover, ap-

pellants present no good reason for relief

from res judicata. The first appeal was not

0/

a sham; no procedural inequity is apparent.—

Nor will any substantive injustice result from

this application of res judicata. The settle-

ment appellants seek so hard to upset expli-

citly preserves to them and all other dissent-

ing debentureholders both their cause of ac-

tion against the banks and a reserve fund from

which to collect. In any event, this appeal

is totally devoid of merit. Judge Galgay care-

» il «

45a

fully considered the settlement over six days

of hearings, and the opinion of the court,

though drawn from the statement of the trustee,

contains no error sufficient to constitute an

abuse of discretion.

The order of the bankruptcy court is

affirmed and costs will be assessed against

the appellants.

SO ORDERED.

Dated: New York, New York

March 15, 1982

/s/ KEVIN THOMAS DUFFY, U.S.D.J.

1.

46a

FOOTNOTES

The settlement actually provides for a gross payment

of 21 cents on the dollar; it provides that no more

than 2 cents on the dollar will go towards attor-

neys' fees, leaving debentureholders with a net set-

tlement of at least 19 cents on the dollar.

There are actually two different groups of debenture-

holders in this proceeding: those holding 4.75 per

cent subordinated debentures totalling $92,507,000,

and those holding 4 percent subordinated debentures

totalling $834,000. Citibank was the indenture trust-

ee for the 4-percent debenture holders; Chase Manhat-

tan was the indenture trustee for the 4.75 percent de-

bentureholders until August 14, 1974, when it resigned

and was replaced by the United States Trust Company

of New York. Appellants here hold only 4.75 subordi-

nated debentures. Because I hold that Judge Galgay's

1980 decision is res judicata against all subordinat-

ed debentureholders. I do not consider appellee's ar-

gument that appellants cannot affect the validity of

the settlement on behalf of the 4-percent holders.

The first settlement provided for a gross payment of

15 cents on the dollar, with no more than 1 cent go-

ing towards attorneys’ fees.

Appellants arguably failed to preserve their claims

for appeal by not properly articulating or presenting

them in the bankruptcy court. In re REA Holding Corp.,

2 Bankr. 733, 737 (S.D.N.Y. 1980); In re Bildisco, 11]

Bankr. 1019, 1020 (D.N.J. 1981). Appellee in turn

first presented his res judicata argument in this ap-

peal. However- neither side contends here that the

other has waived a claim or defense by failing to pre-

sent it to the bankruptcy court. Omission of res ju-

dicata arguments below is understandable: Mr. Brewer's

failure to comply with the bankruptcy court's proce-

dures deprived the trustee of notice that a res judi-

cata defense would be necessary. For this reason, and

in the absence of any waiver argument by appellants, I

think appellee's res judicata argument is properly be-

fore this Court. To rule otherwise would reward appel-

lants for their failure to comply with procedures below.

10.

47a

Appellants tried and failed to obtain a stay of the

cash disbursement. The banks guaranteed return of

the case should this appeal go against them.

Cf. Bankr.R.P. 805 (Unless an order approving sale

of property is stayed pending appeal, a good faith

purchaser of the property shall not be affected by

reversal or modification of the order).

The notice of appeal was filed by Mr. Brewer. Mr. Ea-

ton later appeared as co-counsel for the appellants.

The appellants do not claim that they lacked notice

of the bankruptcy proceeding.

See 9 Moore's Federal Practice, %204.11[4] at 4-54-

55 (J. Moore, B. Ward & J. Lucas 2d ed. 1980) (though

parties may have identical interests, one who appeals

under Fed.R.App.P. 4(a) does not stand as surrogate

for one who does not, and those failing to appeal may

not challenge judgment of the trial court). Bankr.

R.P. 802(a) is modeled after Fed.R.App. 4(a). Bankr.

R.P. 802 advisory committee note.

Appellants complaint that they recieved no notice of

the original appellants’ decision to withdraw their

appeal with prejudice. This argument contains neith-

er legal nor factual merit. The present appellants

had knowledge of the original order and could have

joined in the original appeal. Withdrawal of the ap-

peal occurred long after the appellants’ time to join

the appeal had lapsed. It as settled law that appel-

lants were owed no notice of the order from which ap-

peal was taken. See In re General Insecticide Co.,

403 F.2d 629, 630 (2d Cir. 1968); In re St. Cloud

Tool & Die Co., 533 F.2d 387, 390 (8th Cir. 1976).

It is difficult to see how appellants were owed no-

tice of a withdrawal of an appeal if they were not

owed notice of the original order. Finally, Mr. Brew-

er, who admits in his brief that he represented ap-

pellants before the bankruptcy court, did have notice

of the decision to withdraw the first appeal.

+ hw