Petitioners Brief — National Surety Co. v. Coriell

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PETITIONERS’ REPLY BRIEF

“(of New York, N. ¥. i a

SAULS.MYERS

(of New York, N.Y.) 2

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INDEX.

PAGE

Petitioners’ Bently Brief .....iccccesccccccsones 1

T. No. 726. Order Making Receivership Perma.

UE girs ex aks OL eanea hase eens ee Matar eee 2

A. Concerning Petitioners’ Participation in

REPRE ate ep een KOR anc res 2

1. Petitioners Did Not Cooperate in

TRO TROCHRVOTENED. 6 ox cs iv cece vee 3

2. There Was No Consent Decree. ... 4

B. Defendant Corporation Insolvent With-

in the Meaning of the Bankruptey Act.. 4

C. Insolvency Within the Meaning of the

Bankruptey Act Precluded Equity Re-

a), ee ee ar re ere ener rey re 5)

1. Equity Had No Jurisdiction. ..... 6

2. Abuse of Discretion .........55+: 9

D. Receivership for the Benefit of the

Debtor, Not the Creditors ............ 11

I. Petitioners Deprived of Minimum Rights

Under Bankruptcy Act ............0.. 13

1. Safeguards for the Benefit of Cred-

1 re arn) ee mutate Pay ear 14

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2. Safeguards Absent in the Present

PRET RNUNE” cra ves ceivsh eee es 15

il

II. No. 727. Order Relating to the Reorganization

A. Bete Wee Be WAW .. «ov vccnc snstcesn

C. Petitioners Entitled to Cash Proceeds of

BR paper Mate an pylon shat Chae

Ill. Nos. 726 and 727.

A. Petitioners Waived No Rights ........

CRA iss a uae bere ee evn ee Eee

PAGE

ill

AvuruHorities CITED.

PAGE

B. Borchardt & Co. v. Yarnyal Naval Stores, 206

iin MN oak hae sae Canta Capa eK ee Re 24

Carr Vv. Zaja, 283 U.S. 32 66. eee eee eee 26

Chic. R. 1. & Pac. Ry. v. Lincoln, 284 Fed. 955.... 25

J.B. &J.M. Cornell Company, 186 Fed. 859 ...... 22

Gay v. Hudson River Electric Power Co., 184 Fed.

pS Se apn eee PON PO Ney vee re ie 23

Geddes v. Anaconda Co., 254 U. 8. 590 .......... 19

Harkin v. Brundage, 276 U.S. 36, 52 .......-...- 8, 27

Hollins v. Brierfield Coal & Iron Co., 150 U.S.

en ee cae ots s Nha Naw nek ek Ae ee 6, 138, 27

Kneeland vy. American Loan Company, 136 U.S. 89,

OF. a eRe deer ee ae +s REVS ES Cu ESR eee ee 23

L. & N.R. R. Co. v. Behlmer, 169 U.S., 644, 648. . 26

\

Matthews vy. Rodgers (No. 84, decided on Feb. 15,

Ss ee eres eer re eee rr ees ree 7

Merchants Loan & Trust Co. v. Chicago Railways

Co., 158 Ped. 922, 9269 . 2... oe wc n eres cen eens 23

In Re Metropolitan Ry. Receivership, 208 U.S. 90,

Gee hearer rent y rrr re ire te 8, 27

Municipal Financial Corporation v. Bankus Cor-

poration, 45 F. (2) 902, CR er rr e 8, 11

In Re Northampton Portland Cement Co., 185 Fed.

Ree eee a ee ey ees 22, 23

Northern Pacific Railway v. Boyd, 228 U.S. 482... 20, 27

Phipps v. Chic. R. 1. & Pac. Ry., 284 Fed. 945..... 25

Price, Receiver v. United States, 269 U.S. 492, 502 13

iv

PAGE

In Re Prudential Outfitting Company, 250 Fed. 504 22, 23

Pusey & Jones Co., v. Hanssen, 261 U.S. 491, 497,

SEELEY HORA Aeee alm et a 8, 27

Rock Island Cases, 284 Fed. 945 and 284 Fed. 955;

oie ee gle eee 25

In Re Sales of Assets of First National Bank of

Precwmce, Or. CBOE, SO oo... cc ccc cwces. 23

Simmons Co. v. Grier Bros., 258 U.S. 82 ......... 26

Stratton vy. St. Louis Southwestern Railway Com-

pany, (No. 178 Oct. Term 1931, decided Feb. 15,

1932) 284 U.S. 7

The Conqueror, 166 U.S. 110, 113 ............... 26

Toledo Co. v. Computing Co., 261 U.S. 399, 418... 26

United States v. Butterworth-Judson Co., 269 U.S.

A en ale te Oe ee ig a 8, 13, 27

Legislative Bases of ee Reorganizations,

gn een ee 25

White v. Coriell: A Recent Development in the Law

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2 of Corporate Reorganizations, 45 Harv. L. Rev.

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IN THE

Supreme Court of the United States,

OCTOBER TERM, 1931.

Nos. 726 anp 727.

NationaL Surety Company, et al.,

Petitioners

(Appellants Below),

vs.

Vaveria E. Corte.,

Respondent

(Appellee Below),

Morris Wuirte, Inc.,

Respondent

(Appellee Below),

v—

Irvine Trust Company, as Receiver

of Morris White, Inc.,

Respondent

(Appellee Below),

Micuart Hoivanper, et al., Constitut-

ing a Committee of Creditors of

Morris White, Inc.,

Respondents

(Appellees Below).

4

PETITIONERS’ REPLY BRIEF.

Since the two eases are so interwoven that it is im-

possible to treat of one without touching on the facts and

points of law in the other, we thought it would be better

to reply to respondents’ statements and arguments in a

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single brief, answering first the points which relate to the

order making the receivership permanent (No. 726), then

the points with reference to the order of the Circuit Court

of Appeals on the reorganization plan (No. 727), and

finally the point raised with reference to both cases.

No. 726.

I. Order Making Receivership Permanent.

A. CoNcERNING PETITIONERS’ ParTICIPATION IN THE Case.

In this case respondents would make it appear that

petitioners have submitted to and acquiesced in the rul-

ings of the District Court and have, in fact, consented to

the decree making the receivership permanent.

Respondents’ development of the facts in this respect

is somewhat misleading. The record is replete with ob-

jections on the part of petitioners to the Equity Court’s

exercise of jurisdiction in the instant case. From the

very beginning petitioners maintained that since the de-

fendant corporation was insolvent within the meaning of

the Bankruptcy Act, the Equity Court should not exercise

jurisdiction to administer the estate, but should leave the

administration of such an estate to the Bankruptey Court.

The first opportunity petitioners had to object to the

receivership and to the so-called reorganization plan was

on the return to the rule to show cause why the offer of

Lily White should not be approved. That was on May

26,1931. Petitioners objected to the adoption of the offer

on the ground that there was no schedule of assets and

liabilities (R., 82) or of the net worth of the corporation

(R., 86); also on the ground that the facts disclosed a

bankruptcy ‘‘which is nearly 100 per cent.’’ (R., 86) and

that the entire plan was merely for the benefit of the sole

stockholder of the defendant corporation, to wit, Morris

White, husband of Lily White (R., 85).

3

On the next day, May 27th, petitioners sought an op-

portunity to examine the defendant, ‘‘in view of the fact

that this is a bankruptey’’ (R., 96). But petitioners’

counsel was at the same time engaged in an important

criminal trial and asked for a short postponement (R.,

97). Petitioners renewed their complaint that no adequate

statement of assets and liabilities had been furnished

(R., 156-7). The Court, after having intimated that it

would give petitioners a chance to examine Morris White,

the president of the defendant corporation, itself con-

ducted the examination (R., 173), despite the objections

of petitioners that they had no opportunity to examine

(R., 180-1). Immediately after the examination, of which

more will be said later, the Court announced that it would

approve the reorganization plan, granting an exception

to the dissenting creditors (R., 195).

On the next day, May 28th, counsel for petitioners

filed an affidavit (R., 198-202) praying that the plan be

rejected and disapproved and that the receivership be

vacated. Nothing further transpired until June 3, 1931,

when the Court rendered its decree making the receiver-

ship permanent (R., 209-218).

Respondents, however, would make it appear that pe-

titioners cooperated in the receivership and the reor-

ganization plan, that they consented to the decree making

the receivership permanent, and then for the first time

objected to that receivership.

1. Petitioners Did Not Cooperate In The Receivership.

Respondents go so far as to say (See p. 9 of their

brief) that a representative of the National Surety Com-

pany ‘became a member ex officio of the Creditors’ Com-

mittee (R., 110).’’ But page 110 of the record does not

bear out that statement. Instead, we find that a repre-

sentative of the National Surety Company requested not

to be put on the committee, although ‘‘the Committee re-

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quested him to come on, ez officio.’’ It would seem that

there is a difference between being a member of the com-

mittee and refusing to be a member.

2. There Was No Consent Decree.

Respondents also state that the decree sought to be

reviewed was entered on consent and was therefore not

subject to review (Respondents’ Brief, p. 7). We do not

understand the meaning of this statement, in view of the

fact that the record, as we have just shown, is replete with

objections on the part of petitioners to the Equity Court’s

exercise of power in this case. In view of the state of the

record, it is surprising that respondents should appear

in this Court and maintain that the decree of the District

Court was a consent decree not subject to review. We can

only say that this statement falls in the same category

with respondents’ statement (p. 9 of their brief) that

petitioners’ representative was a member ex officio of the

Creditors’ Committee.

Petitioners rely on the statement in the decree of June

3, 1931 that there was no opposition to the making of the

receivership permanent (R., 209). But that is in line

with the District Court’s statement that Lily White’s of-

fer was one to purchase the assets of Morris White, Ine.

(R., 227 in case No. 727). Suffice it to say that the Cir-

cuit Court of Appeals did not take either of those state-

ments seriously.

B. Derenpant Corporation INso_vent Wirnin' THe

MEANING OF THE Bankruptcy Act.

The two facts necessary for petitioners’ contention in

this case are undisputed and are brought out by the find-

ings of both the District Court and of the Cireuit Court

of Appeals. The findings are, and there is ample evidence

to support them, that the defendant corporation was in-

solvent and that it was not in a position to pay its cred-

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itors. A state of bankruptcy was admitted by counsel

for the defendant (R., 70), the District Court saw that

the defendant was insolvent (R., 74-5), it was apparent on

the face of the financial statement, such as was available

(R., 83-4), the defendant had no liquid assets with which

to satisfy any part of the debts (R., 74, 143). The Dis-

trict Court said (R., 191, 192):

‘“My view, stating it very shortly, is this:

“That if the estimate of value which has been

placed upon the assets of the defendant corpora-

tion is anvwheres near correct, it means, if this

concern goes into liquidation, that the general

ereditors will get little or nothing as a result, * * °

“T agree that the proposed reorganization is

more or less of an attempt by Mr. White to lift

himself by his bootstraps, in that there is here no

capital with which to finance the new concern, save

such as he thinks may be received on his business

record from others who are favorably disposed

toward him. All of us know, unfortunately too

well, the present condition of business.”’

In commenting on the financial condition of the de-

fendant corporation, and after stating the various esti-

mates of its assets and liabilities (R., 234) the Circuit

Court of Appeals said (R., 238):

‘« Assets of an insolvent commercial corporation

have long been recognized as a trust fund for the

payment of its creditors.”’

C. Ixsotvency WITHIN THE MEANING OF THE BANKRUPTCY

Act Prectupep Equity RECEIVERSHIP.

With both courts finding the defendant corporation

insolvent within the meaning of the Bankruptey Act, we

maintain that the Equity Court should not have continued

the receivership, should not have approved the reorgan-

ization plan and should not have made the receivership

permanent.

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1. Equity Had No Jurisdiction.

The petition for the appointment of a receiver was

filed by a simple contract creditor, alleging that the de-

fendant corporation was solvent, but financially embar-

rassed and not able to pay its debts; and that if all of

the creditors should pursue their remedies against the

defendant and levy upon its assets, there would not be

enough with which to pay the debt owed to the plaintiff.

These allegations were by way of showing that the Equity

Court had jurisdiction in the case to appoint a receiver

and conserve the assets for the benefit of the creditors,

and that the plaintiff had no adequate remedy at law.

The receiver, however, could not be appointed upon

application of the simple contract creditor without the

consent of the defendant.

Hollins v. Brierfield Coal &€ Tron Co., 150 U.S.

371.

It could defeat the application either by denying that the

plaintiff had no adequate remedy at law, or by denying

that the defendant was solvent.

The denial of ‘‘no adequate remedy at law’’ would

have required the plaintiff to exhaust her remedies at

law by obtaining a judgment on her contract. If the exe-

eution were returned nulla bona, then the Equity Court

would be in a position to proceed with the receivership,

provided the defendant were solvent. If the defendant

denied that it was solvent, then it would become apparent

that the plaintiff’s remedy was under the Bankruptey

Act.

For this reason it has been held that a receiver can

not be appointed upon application of a simple contract

creditor, unless there is consent on the part of the de-

fendant corporation, which admits that there is no ade-

quate remedy at law, and also that it is solvent.

In view of the recent decisions of the Supreme Court,

with reference to equity jurisdiction, the following ques-

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tion arises: If, upon the admission of the defendant that

the plaintiff has no adequate remedy at law, the Equity

Court appoints a temporary receiver, and then it appears

that the defendant at the time of the application was in-

colvent within the meaning of the Bankruptcy Act, should

the Equity Court continue the receivership?

The cases we refer to are Stratton v. St. Louis South-

western Railway Company (No. 178 Oct. Term 1931, de-

cided Feb. 15, 1932) and Matthews v. Rodgers (No. 84,

decided on the same day).

The first of these presents the stronger case. There,

the railroad company brought suit to enjoin the collec-

tion of a tax, stating that it had no adequate remedy at

law. The Secretary of State of Tlinois, being anxious

to have the constitutionality of the tax settled, and not

realizing that the plaintiff had an adequate remedy at

law by paying the tax and suing to recover the same, ad-

mitted the allegation.

Both the District Court and the Cireuit Court of Ap-

peals in the first proceeding and then the statutory three

judge District Court in the second proceeding accepted

the admission of the allegation, which gave the Equity

Court jurisdiction, and enjoined the collection of the tax.

After the case was argued in this Court four times, it

was held that the plaintiff did have an adequate remedy

at law. The decree was reversed, and the cause remanded

with directions to dismiss the complaint for lack of juris-

diction. That case stands for the proposition that the

jurisdictional requirement of a lack of an adequate

remedy at law cannot be waived by the defendant, and

that as soon as the equity court finds that there is an

adequate remedy at law, it must cease entertaining juris-

diction in the case.

Does the same rule apply in these friendly equity re-

ceiverships where the plaintiff alleges and the defendant

admits that the defendant is solvent, but in the course

of the proceedings it appears that the defendant was at

all times insolvent within the meaning of the Bankruptey

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Act? What should the Equity Court do? Should it dis-

miss the case and relegate the plaintiff to his remedy at

law provided by the Bankruptey Act, as was done by

Judge Woolsey in the case of Municipal Financial Cor-

poration vy. Bankus Corporation, 45 F. (2) 902, or should

the Equity Court continue to exercise jurisdiction in an

equity receivership and usurp the functions of the Bank-

ruptey Court, as was done in the present case?

This court has lone looked with disfavor on

‘*friendly’’ receiverships, in which the jurisdiction of

the Equity Courts is invoked for the purpose of hinder-

ing creditors and of enabling the defendant in receiver-

ship to eseape its obligations. In the ease of Harkin v.

Brundage, 276 U .S. 36, this Court, in an opinion by Chief

Justice Taft, said (p. 52):

‘*We do not wish what we have said to be taken

as a general approval of the appointment of a re-

ceiver under the prayer of a bill brought by a sim-

ple contract creditor simply because it is consented

to at the time by a defendant corporation. The

true rule in equity is that under usual cireum-

stances a creditor’s bill may not be brought except

by a judgment creditor after a return of ‘nulla

bona’ on execution. Whena receiver has been thus

irregularly appointed on such a bill without ob-

jection, and the administration has proceeded to

such a point that it would be detrimental to all

concerned to discharge the receiver, the receiver-

ship has been permitted to continue because not

seasonably objected to (Pusey d Jones Co. v.

Hanssen, 261 U.S. 491, 497, 500; Re Metropolitan

Ry. Receivership, 208 U. S. 90, 109, 111; United

States v. Butterworth-Judson Corp, 269 U.S. 504,

513).”’

Tn the cases cited by the Court in Harkin v. Brundage,

this Court did not order the termination of the friendly

receiverships, because those receiverships had not been

seasonably objected to, and after the receiverships con-

tinued for considerable time without objection, it would

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have been detrimental to all concerned to discharge the

receivers.

In this case the objection to the receivership was sea-

sonably made (See pp. 2-8, supra). The receivership was

continued by the equity court, despite the continuous ob-

jections on the part of the non-assenting creditors. Fur-

thermore, there would be nothing lost by terminating the

receivership, for the only changes which had taken place

were in form, not in substance. (See the reorganization

plan, p. 10, infra). Therefore, the present case does

not fall within the class of cases in which the friendly re-

ceiverships were permitted to continue.

It will also be remembered that those cases were de-

cided before the decision of this Court in Stratton v. St.

Louis Southwestern Railway Company; that is to say,

before this Court had put a stop to the practice of in-

voking the jurisdiction of equity courts in cases where

equity courts had no jurisdiction. Those cases permitt-

ting the receiverships to continue were rendered at a time

when there were also suits to enjoin the collection of

taxes, and the jurisdiction of the equity courts was not

disturbed, although the plaintiffs had an adequate remedy

at law. The question presented here is one of the funda-

mental jurisdiction of the courts of equity as applied to

what it generally termed as equity receiverships.

2, Abuse of Discretion.

If, however, the continuance of the equity receivership

is still within the sound diseretion of the court, despite

the insolvency of the defendant, then we submit the dis-

trict court abused its diseretion. In this connection we

again stress the salient facts concerning the offer of Lily

White to ‘‘purchase’’ the property of Morris White, Ine.

Morris White, according to his own testimony, was

the alter ego of Morris White, Inc. (R., 181). Mrs. White,

in her offer to purchase, contributed no cash or any other

assets, or any security (R., 82), and so far as it appears,

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after having made the offer, vanished from the picture

entirely. The common stock, that is, the voting stock of

the new corporation to be organized under this offer, was

to be held by Morris White himself (R., 235).

Stripped of all fiction and camouflage, the ‘‘purchase”’

approved by the District Court sitting as a Court of

Equity, amounts to this: that Morris White, having debts

aggregating $1,072,000, would first undertake to pay

$158,000 owed in taxes, would pay the sum of $50,000 in

administration expenses, and also an indeterminate fee

for counsel for the friendly creditors, receiver and him-

self, and then would deal with his creditors by giving

them unsecured, unindorsed, non-interest bearing notes

for 20% of their claims, while the remainder, 80%, would

be wiped out by an issue of preferred non-voting stock ;

the business, if any, would be carried on as heretofore,

except that Morris White would be assured of $60,000 per

year and nothing further would be said about the $2,000,-

000 he had diverted from the corporate funds.

Practically all of the assenting creditors either gained,

else did not lose anything by this arrangement. The fed-

eral and state governments were to be paid outright;

Vincent Astor, the landlord, was interested in keeping the

premises occupied (R., 191-2); others had a different axe

to grind (R., 152). It would seem that such an offer of

‘*purchase’’ with a view of paying off creditors, would

shock the conscience of any Chancellor. Instead of seek-

ing an equitable distribution of the assets of the corpora-

tion among the creditors, it appears that a fraud* was

sought to be perpetrated upon the court and upon the

dissenting creditors. Yet the District Court approved the

plan over the objections of those creditors, whose claims

aggregated over $120,000 (R., 198-201).

*It appears that after the case was remanded to the District

Court, a new claim for $1,025,000 suddenly came to light. This

probably explains why petitioners’ repeated demands for a certi-

fied statement of the assets and liabilities were not complied with.

We are filing with the Clerk a certified copy of the claim and of

the rule to show cause issued by the District Court.

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The function of an equity receivership is to preserve

the assets of a solvent corporation, so that all the eredi-

tors, rather than some of them, might be paid. In grant-

ing a receivership, an equity court in effect prevents each

of the creditors from exercising his legal rights and de-

celares a moratorium for the purpose of conducting the

business of defendant for the benefit of all the creditors.

In granting such relief, the probabilities must be that the

creditors will be paid in full. For if the probabilities are

that the creditors will not be paid in full, then the equity

court would usurp the functions granted by law to the

bankruptey courts.

This test for continuing the receivership fails in the

present case, There was nothing in the record to point

to any condition which would lead to the conclusion that

the creditors would be paid within a reasonable time.

When asked whether any cash at all could be paid to the

creditors at this time, counsel for the defendant answered

that that would be impossible (R., 143). The District

Court did not arrive at the conclusion that the plan showed

promise of success so far as creditors were concerned.

On the contrary, the court treated the entire matter as

a hopeless proposition (R., 192).

D. Recerversuip ror THE Benerir or THE Depror, Nor

THE CREDITORS.

While an Equity Court may declare a moratorium for

the purpose of safeguarding the interests of all creditors,

it may not keep the defendant in receivership for its own

benefit at the expense of the creditors. ‘‘There is not any

right of sanctuary in an equity receivership in the Fed-

eral court’’, said Judge Woolsey in Municipal Financial

Corporation v. Bankus Corporation, 45 F. (2) 902, 906.

Yet, that is just what the entire reorganization plan

amounts to. It is a plan to relieve Morris White of a

great part of his indebtedness.

12

Much was said by the friendly creditors pointing out

Morris White as a philanthropist and benefactor of

humanity in order to influence the equity court to give

White another chance, or, as one of the creditors put it,

‘*to see that justice to Morris White is done’? (R., 104).

After dwelling at length on the fine qualities of Morris

White, which we do not need to dispute because the entire

matter was irrelevant, this same creditor said; ‘** * *

if this man is given an opportunity to come back and put

three or four thousand* people to work, not a cent will

be lost to anyone; everyone will receive their money back”?

(R., 105). Another creditor frankly admitted that his

interest in the case was not so much to save the $20,000

owed to him by Morris White, Inc., as it was to put Morris

White back into business so that he, the creditor, might

profit by selling metal parts to the new corporation (R.,

152).

In short, in this receivership proceeding, the friends

of Morris White sought to put him back into business

without the burden of his obligations. That was the es-

sence of the reorganization.

If the plan was not to benefit Morris White, what need

was there for the organization of a new corporation, an-

other name for Morris White?) What need was there for

the issuance of preferred stock? The court itself treated

this plan as one to benefit Morris White, although it did

not take seriously his claim of ability to rehabilitate him-

self. The court naively permitted such reorganization,

because it knew of no ‘‘wrongdoing on the part of Mr.

White in the management of his business, save and except

the freedom that he exercised in taking assets (about

$2,000,000!) of this corporation and devoting them to his

other business ventures’’—the stock market, real estate

(R., 102) and a directorship in the Bank of United States

(R., 176). The Court told him that he must not do that

during the receivership (R., 192).

* Ile must have meant four or five hundred. See R., 166,

13

Since the plan was not one for relief of creditors, but

for relief of the stockholder of the defendant corporation,

we submit that the district court abused its discretion in

making the receivership permanent.

Kk. Peririoners Derrivep or Minimum Ricuts UNver

Bankruvrey Acr.

We have stated in our petition and brief that the mak-

ing of the receivership permanent deprived petitioners

of rights under the Bankruptey Act. To this the respond-

ents have answered (Resp. Brief, pp. 11-12) that the peti-

tioners were not deprived of their right to file a petition

in bankruptcy. We admit respondents’ statement, but

that is not our contention. If we have not made ourselves

sufficiently clear, we beg leave to do so now.

Our argument is not that the filing of the receivership

proceeding deprived the petitioners of their right to file

a petition in bankruptcy, but that the administration of

the estate in the Equity Court, together with the fictitious

sale of the property of the defendant corporation to Lily

White, operated to deprive petitioners of certain mini-

mum rights which are contained in the Bankruptcy Act.

Had there been no consent to the receivership, it could

not have taken place on petition of a simple contract

creditor.

Hollins v. Brierfield Coal & Iron Co., 150 U.S.

371,

This was therefore a consent receivership, equivalent to

an assignment of the assets for the benefit of creditors.

Price, Receiver v. United States, 269 U.S. 492,

502;

United States v. Butterworth-Judson Co., 269

U. S. 504, 513-4.

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This means that if the defendant was solvent, as was al-

leged in the petition for receivership, then the creditors

were entitled to payment in full. If, on the other hand,

the corporation was insolvent, then the assets of the cor-

poration became a trust fund to be distributed among

the creditors according to their rights and priorities

under the Bankruptcy Act. But if the latter is the case,

then the Bankruptcy Act provides many safeguards pre-

venting the diminution of the portion recoverable by the

creditors.

1. Safeguards for the Benefit of Creditors.

Among the safeguards provided by the Bankruptey

Act are: (1) Preferential payments are prohibited, (2)

The charges on the administration of the bankrupt estate

and for counsel fees are carefully supervised and are sub-

ject to objection on part of the creditors, (3) The bank-

rupt estate must be appraised by disinterested ap-

praisers; the appraisals must be made available to eredi-

tors, (4) A bona fide sale of the property must be made

prior to distribution, (5) If a ‘‘composition”’ is allowed,

then the bankrupt must be examined at a meeting of credi-

tors, and he must file a schedule of assets and liabilities,

(6) Compositions must be accepted by a majority of eredi-

tors in number and amount, (7) Security must be fur-

nished by the bankrupt for the discharge of obligations

assumed in a composition, (8) No composition may be ap-

proved, if the bankrupt was guilty of acts of commission

or omission which would be a bar to his discharge in

bankruptcy, (9) In ease of composition, non-assenting

creditors must be paid in money at least a portion of

their claims.

-

15

2. Safeguards Absent In the Present Receivership.

Of these advantages, or safeguards, petitioners are

being deprived by the permanent receivership and by

the transfer of the assets of the defendant corporation to

a new corporation, under the guise of a sale:

(1) In the present case the District Court permitted,

nay directed, a preferential payment to a judgment cred-

itor (R. 65-6, 72-75), and immediately after the reorgan-

ization order was approved, but before the decree was

rendered, the court approved the payment in full to a

large number of small creditors (R. 194-5).

(2) The administration expenses during the first

seven weeks of the receivership were estimated at $50,-

000 over and above an indeterminate amount to be paid

to counsel for the Creditors’ Committee (R., 149-50). In

addition the estate would be subject to an annual charge

of $60,000 in the form of a salary for White himself

(R. 168).

(3) No inventory was ever given to the court, nor

was a judicial appraisal made. The objecting creditors

have demanded a certified statement of the assets and

liabilities of the defendant corporation, but none was

forthcoming (R. 180-4).

(4) Although the offer of Lily White was one of

**purchase’’, there was really no purchase or sale in-

volved. (See p. 10, supra.)

(5) There was no examination similar to that con-

ducted under See. 21-A of the Bankruptey Act. The

District Court having been requested to grant peti-

tioners an opportunity to examine Morris White under

oath, intimated that it would appoint a Special Master

to take testimony (R. 97). But then the court undertook

to examine Morris White, without giving petitioners an

opportunity for cross-examination. For all of the evi-

16

dence was in possession of the defendant and the receiver,

and it was not made available to petitioners. The exam-

ination conducted by the Court (R. 173-179) was more in

the nature of a friendly chat in which Mr. White informed

the Court that his failure in business was not due to any

mismanagement of the corporation (R. 176), but only to

the fact that he ‘‘took’’ the corporation’s money and

lost it in other enterprises. (R. 176).

(6) Instead of holding Morris White liable to the

creditors for the corporate fund diverted by him, which

together with the other assets would have been sufficient

to pay all of the debts of the corporation, Morris White

was permitted to get away with a promise or fond hope

that, within less than four or five months, he would give

his 150 creditors and five bankers ‘‘a nice little dinner,

and have a check to go in full right on the plate, on the

20% of notes.’’ (R., 175). The time has passed, and the

creditors saw neither the check nor the dinner. And

many a dinne: will be missed by creditors if the Equity

Courts throughout the country will undertake to condone

diversion of corporate funds at the expense of creditors.

(7) Throughout the proceedings, the Creditors’ Com-

mittee claimed to represent the majority of creditors,

both in number and amount. But though this claim was

challenged (R. 101), no proof to that effect was submitted

to or required by the Court.

(8) In fine, no security was offered to guarantee the

payment of the claims; and no cash was offered to pay

the creditors in whole or in part.

No doubt respondents are right in saying that bank-

ruptey supersedes receivership and that the jurisdiction

of the Bankruptcy Court within its proper sphere is es-

sentially exclusive. But unless the decree of the District

Court making the receivership permanent is set aside,

the creditors will find no assets of the bankrupt from

17

which they may expect payment of the bankrupt’s lia-

bilities. By the magic change in the corporate name,

the defendant corporation becomes an empty shell with

no assets to be reached by the creditors. The exercise of

rights in bankruptcy, to be effective, must be predicated

on the assumption that the Bankruptey Court will undo

all that the Equity Court has done. A Court of Equity

should not put itself in such a position.

That is why we maintain that under the receiver-

ship in the present case, petitioners were deprived of

certain minimum rights which they had under the Bank-

ruptey Act; that is a situation which is likely to result

whenever an Equity Court undertakes to administer

property of an insolvent corporation; and that is why it

has been repeatedly held that when it appears that a

defendant in a receivership proceeding is insolvent with-

in the meaning of the Bankruptcy Act, the Equity Court

should not proceed to administer a bankrupt estate under

the guise of an equity receivership.

18

No. 727.

Il. Order Relating to the Reorganization.

The order sought to be reviewed in this ease is the

one modifying the order of the District Court rendered

June 15, 1931, approving an offer of Lily White, the

wife of Morris White, to ‘‘ purchase’’ the assets of Morris

White, Ine.

A. Tuere Was No Sate.

We do not agree with respondents that the fairness

of the reorganization plan approved by the District

Court is not before this Court. That would have been

so, if petitioners were given an aliquot share of the pro-

ceeds of a public sale, or of a bona fide private sale,

conceded to vield as much as could be realized at a public

sale. Here, however, as the court below said (p. 263):

‘*There was no public sale and therefore no

competitive bidding. Apparently what took place

helow was that an offer was made by Mrs. White

for all the assets. The creditors’ rights thereto

were wiped out. They were directed to take pre-

ferred stock and notes. By the acceptance of the

offer, the new corporation obtained the assets of

the old Morris White, Inc. No new money or as-

sets were provided. Jf the transaction be termed

a sale, it was not a publie sale.’’ (Italics supplied.)

That there was really no sale, publie or private, has al-

ready been demonstrated (pp. 9-10, supra).

The Cireuit Court of Appeals could not sustain such

a departure from law and equity. It held that whatever

may be the rights of assenting creditors to enter upon

a joint business career with Morris White, the District

Court was without authority so to dispose of the con-

tractual rights of the objecting creditors. It therefore

19

reversed the order of the District Court and held that

the objecting creditors were entitled to payment in cash.

The propositions of law, on which this judgment was

based, are well recognized and are the very propositions

of law on which petitioners rely in their claim that the

Cireuit Court of Appeals did not go far enough in re-

versing the decree of the District Court. The court be-

low said (R. 258, 263, 264) :

‘Assets of an insolvent commercial corpora-

tion have long been recognized as a trust fund for

the payment to its creditors. It has likewise long

been recognized that contract obligations may not

be impaired by the courts. * * * Private property

may not be taken in violation of contract obliga-

tions. * * * The assets of the corporation may not

be used as a fund for the benefit of the debtor

rather than a creditor. * * *

‘*We are unable to find authority for the claim

of the appellees that the court has power to com-

pel a creditor of any kind to accept stocks or

promises to pay in the future in full extinguish-

ment of his claim, without being afforded the

alternative of receiving his proportionate share of

the proceeds of the conventional sale of the prop-

erty in cash. * * *

“Their rights must be protected. They are

ordinarily entitled to a public sale with competi-

tive bidding, the assets to be sold to the highest

bidder.”’

B. Estimate Versvs Actua Sate.

But the court did not order a sale of the property

in order to protect those rights of the objecting creditors.

It merely ordered that an estimate be made of the assets

of the defendant corporation, and that the objecting credi-

tors be paid an aliquot share of the estimate.

In ordering that the value of the corporation’s assets

be estimated, the court below relied on the case of Geddes

v. Anaconda Co., 254 U.S. 590. We submit that neither

that case, nor the others mentioned in the opinion, sup-

20

port the ruling of the Cireuit Court of Appeals. In

that case the conflict was not between the interests of

the stockholders and those of creditors, but a conflict

among stockholders themselves. Yet, even there, this

Court held that the reorganization could be effected by

the exchange of the properties of the corporation for the

stock of another corporation only because the stock re-

ceived in exchange had a definite and ready market value.

Here the objectors to the reorganization plan are not

stockholders, but creditors, whose interests are apt to

be sacrificed in an effort to reestablish the sole stockhold-

er in the business. It is a settled proposition of law that

any reorganization which recognizes and preserves the

interests of the stockholders at the expense of creditors

is invalid.

Northern Pacific Railway v. Boyd, 228 U.S. 482.

And the plan adopted by the Cireuit Court of Appeals did

not give sufficient protection to the creditors, from being

subordinated to the interests of the stockholder.

Looking into the assets of this corporation, including

the debt of about $2,000,000 owed by Morris White to

the defendant corporation, it is submitted that the order

of the court below is too indefinite and is impossible of

performance.

It is not humanly possible for a Special Master in

April, 1932, to determine what would have been real-

ized for the assets, if sold at publie auction in April, 1931.

It is impossible to reconstruct the situation as it existed

a year ago. Furthermore, the record shows that no

inventory had been taken at the time of the appointment

of the receiver nor at the time of the so-called ‘‘sale”’ of

the property to Lily White; and there is no way of

telling now what persons would have bid at the public

auction for the property in April, 1931, and what would

have actuated their bids.

21

Assuming that the estimate is to be made of a highest

bid, not as of April 1931, but as of the present time, the

order is still too indefinite and uncertain to safeguard

the rights of creditors. This is not like estimating the

value of a life estate based upon mortality and probabil-

itv tables, where, after a tremendous amount of actuarial

research, the probable error is reduced to a minimum.

It is also unlike an estimate of the value of a particular

piece of property which also may be determined with

some degree of certainty. Here the problem is to estimate

the amount of a highest bid at a public sale, and it is a

matter of common knowledge that the variations are

very wide among highest bids on the same type of prop-

erty.

Assuming that an estimate is to be made, not of a

highest bid at a public sale, either as of April, 1931, or

as of the present, but of the value of the property itself,

what should be the basis for valuation? If the valuation

is to proceed upon the allegation in the complaint and

the admission in the answer that the corporation was

solvent, then there is no need for an estimate. The value

of the notes and of the preferred shares is then at least

the full amount of the debt. If the estimate is to proceed

on the assumption that the corporation is insolvent, then

should the valuation proceed on the reproduction cost

theory, on the value of the assets to Morris White him-

self, on the prudent investment theory, or on the book

value of the assets of the corporation? Should each item

of the assets be valued separately or should the business

be valued as a whole? What consideration should be

given to such intangible items as ‘‘good will’’, ‘‘going

concern value’’, ‘‘trade names’’ and ‘‘echoses in action’’?

What, for example, should be done about the preferences

allowed by the District Court? At last, the additional

question arises, if the aliquot interest is less than the

amounts of the debt owed to each creditor, by what right

will the stockholder retain an interest in the property?

wal MOR PSE.

WRI TAL ob met

22

These are but a few of the difficulties which present

themselves in connection with the modification of the re-

organization plan ordered by the Circuit Court of Ap-

peals.

C. Peririoners Entirtep to Caso PRocEEpvS or ACTUAL

SALE.

For this reason, petitioners maintain that nothing

short of a public sale would adequately determine their

share in the assets of the corporation.

We have referred this Court to a number of authori-

ties sustaining our contention. To this respondents an-

swered that the authorities cited were not in point (Re-

spondents’ Brief, p. 9), without, however, disclosing

their reason for saying so. An examination of those

cases will disclose that the authorities cited are in point.

In re Prudential Outfitting Company, 250 Fed. 504,

is a decision holding that a creditor cannot be compelled

to accept an aliquot interest in the assets of a corpora-

tion under the guise of a sale. In that case there was a

reorganization plan somewhat similar to the one in-

volved here, and the court held that such plan could not

be forced upon a dissenting creditor. An actual sale had

to take place even in the event of a reorganization, and,

the court added: ‘‘the dissenting creditors must be paid

their own proportion of the bid, which is their inviolable

right.’’ (p. 507).

In the case of J. B. & J. M. Cornell Company, 186

Fed. 859, the same court refused to confirm a sale solely

for the reason that the bid required non-assenting eredi-

tors to accept a percentage of their claims payable in

the future—a much less drastie provision than the one

in the present case.

To the same effect is In Re Northampton Portland

Cement Co., 185 Fed. 542, 543, where the court thought

that the proposed plan offered the creditors their only

23

opportunity of obtaining any payment upon their claims.

But the court said:

‘*Assuming the plan to be judicious, the ques-

tion remains: Has the District Court any author-

ity to enforce it?) The fact that it has been ap-

proved by a iarge majority of the creditors is not

decisive.’’

And the court then set aside the reorganization plan.

We cited some cases for the purpose of showing that

this rule applies not only to private corporations, but

also to quasi-public corporations, like national banks,

In ve Sales of Assets of First National Bank of

Florence, 6 F. (2) 905, 910,

railroads,

Kueeland vy. American Loan Company, 136 U.S.

89, 97,

and other public utilities,

Merchants Loan & Trust Co. v. Chicago Rail-

ways Co., 158 Fed., 923, 928-9,

Gay v. Hudson River Electric Power Co., 184

Fed. 689, 693-4.

Perhaps respondents mean that the cases were not in

point, because in some of them the attempts to force an

aliquot interest on the dissenting creditors were made in

bankruptcy proceedings. If so, note that Judge Learned

Hand, delivering the opinion in the Prudential Outfitting

Company case, supra, said:

‘‘Bankruptey does not change the character of

the creditors’ claims, which are measured by, and

collectible in money.’’

The ratio decidendi was that such are the rights of eredi-

tors without bankruptcy, and that the bankruptey did not

affect those rights.

24

Respondents are not satisfied with stating that the

authorities cited by petitioners do not support their con-

tention. They state further (page 9) ‘‘None can be

cited.”’

We therefore respectfully refer this Honorable Court

to the case of

B. Borchardt & Co. v. Yarnyal Naval Stores,

206 Fed. 366,

for the proposition that, if an actual sale is not had, the

only way of satisfying an objecting creditor is by paying

him off in full.

D. THe Question 1s New 1n Tuts Court.

If all the above points are resolved in favor of the

respondents, the question in this case reduces itself to

this: Granting that dissenting creditors are entitled to

their proportionate share of the assets of the defendant

corporation, must the court order a sale, or may it cause

an estimate to be made of the assets and allow to each

creditor his aliquot part of the estimate? This question

has never been decided by this Court.

The decree of the court below has been treated as

a radical departure from the accepted rules concerning

the rights of creditors in corporate reorganizations, in

an article entitled:

White v. Coriell: A Recent Development in the

Law of Corporate Reorganizations, 45 Harv.

L. Rev. 697.

It is an able discussion of the subject, though we do not

agree with its author that such development is desirable,

or that the estimates would give less difficulty than a

judicial sale.

25

Another illuminating article on the same subject ap-

pears in the February, 1932, issue of the Pennsylvania

Law Review and is entitled:

Legislative Bases of Corporate Reorganizations,

80 Penn. Law Rev., 579.

This article also takes the position that such a departure

from the accepted course of corporate reorganizations

would be desirable, but it rightly maintains that equity

courts have no power to make such departure without

legislation authorizing it.

The author also takes the position that even if the

courts had the power so to override the will of dissent-

ing creditors, it would not be advisable to exercise such

power without express legislative sanction.

As to the power of the equity courts to dispose of the

rights of creditors on the basis of an estimate, rather

than on the basis of an actual sale of the properties,

the author of the latter article says:

‘*In America, the right of the court so to act,

in the absence of enabling legislation is evidenced

only by the Rock Island cases. Thus it would seem

that those decisions are at best questionable. It

is greatly to be regretted that the Supreme Court

was not given the opportunity to review them’? (p.

584).

In the Rock Island cases, 284 Fed. 945 and 284 Fed.

959, involving a reorganization of a public utility, the

unsecured creditors were allowed an aliquot part of the

assets in stock which had a ready market value in eash.

This Court granted a writ of certiorari in the case,

261 U. S. 611, but afterwards the case was dismissed

per stipulation of counsel, 262 U. S. 762.

26

Ill. Nos. 726 and 727.

A. Petitioners Watvep No Ricuts.

In the preliminary statements of both cases, re-

spondents would make it appear that petitioners had

waived all right to object to either of the orders sought

to be reviewed, because they participated in hearings be-

fore the Special Master after the case was remanded by

the Cireuit Court of Appeals. Our answer is that there

is nothing in the record in these cases concerning any

hearings before a Special Master, and the respendents’

statement that in the future a motion would be made to

dismiss the petitions on the ground that petitioners had

waived all right of review, is not properly before the

Court at the present time.

Furthermore, the fact that the Cireuit Court of Ap-

peals did not stay its mandate does not deprive this Court

of jurisdiction to issue a writ directing the Cireuit Court

of Appeals to certify the case, so long as the case has

not become moot.

The Conqueror, 166 U.S. 110, 113.

L. dé N.R.R. Co. v. Behlmer, 169 U.S. 644, 648.

Carr v. Zaja, 283 U.S. 52.

The fact that the decision of the Cirenit Court of Appeals

is not ‘‘final’’, in the sense of the term used concerning

the finality of judgments of state courts, likewise does

not affect this Court’s jurisdiction.

Simmons Co. v. Grier Bros., 258 U.S. 82:

Toledo Co. v. Computing Co., 261 U.S. 399, 418.

ee |

27

Conclusion.

In so far as the Equity Court was permitted to con-

tinne jurisdiction despite the insolvency of the defen-

dant, the decision of the court below is contrary to the

general rule laid down by this Court in

Stratton v. St. Louis Southwestern Ry. Co.,

284 U. S. —.

2. If the continuance of the jurisdiction was within the

discretion of the District Court, then that court abused

its discretion, and the Cireuit Court of Appeals in

affirming the order making the receivership per-

manent, permitted such a departure from the accepted

and usual course of judicial proceeding, as to call for

an exercise of this Court's power of supervision.

3. In so far as the receivership was continued despite

insolvency, the decision of the court below is in eon-

flict with the principle* announced by this Court in

Harkin vy. Brundage, 276 U.S. 36, 52;

United States v. Butterworth-Judson Co., 269

U.S. 504, 513;

Hollins v. Brierfield Coal & Iron Co., 150 U. S.

371;

Pusey & Jones Co. v. Hanssen, 261 U.S. 491, 497,

500;

Inve: Metropolitan Ry. Receivership, 208 U. 8.

90, 109, 111.

4. In so far as the receivership was continued for the

benefit of Morris White and not for the benefit of

the creditors, the decision of the court below is eon-

trary to the principle laid down by this Court in

Northern Pac. Ry. v. Boyd, 228 U.S. 482.

* On the facts the cases are distinguishable.

28

In so far as the court below held that, in the absence

& of a bona fide sale, non-assenting creditors may be

& paid an aliquot part of the estimated assets of the

corporation, it has decided an important question of

law, which has never been, but should be, settled by

: this Court.

Respectfully submitted,

Grecory Hankin,

Cuarves H. Turrre,

Sau. S. Myers,

Counsel.

Dated, April 25, 1982.