Petition for Writ of Certiorari — Taylor v. Standard Gas & Electric Co.

Supreme Court brief1939

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| SUPREME COURT OF THE UN(PED SAP RS"? &

OCTOBER TERM, 1938 es

) th

JOHN M. TAYLOR, OSCAR A. KENNEDY AND H. RUS-

SELL HASTINGS, as THE INDEPENDENT COMMITTEE FOR

THE PRoTEcTION OF THE HoLpERS OF PREFERRED STOCK OF

Deer Rock Or Corporation,

Petitioners,

vs.

;

STANDARD GAS AND ELECTRIC COMPANY, REOR-

GANIZATION COMMITTEE OF DEEP ROCK OIL

CORPORATION, H. N. GREIS, Truster or Deer Rock

i Om Corporation, anD DEEP ROCK OIL CORPORA-

TION.

| PETITION FOR WRIT OF CERTIORARI TO THE

UNITED STATES CIRCUIT COURT OF APPEALS

FOR THE TENTH CIRCUIT AND BRIEF IN SUP-

PORT THEREOF.

~ Jason L. Honicman,

Counsel for Petitioners.

“_,

i, i oe ee wile eee iia hee we lwee

a. Hearing on contest of claim.................

b. Nature of Standard claim..................

e. Fraudulent charges.............

f. Wrongful dividend withdrawals.............

g- Illegal compound interest and discount charges.

h. No proofs on fairness of Standard charges...

i. Standard treats open account as capital invest-

SE os nicca cat et neck RAT ee een hares

j. Standard’s manipulation of Deep Rock securi-

BR ere te ic ea dara Reina, nite pi ina

k. Summary of proofs on Standard claim a

4. Formation of respondent reorganization committee ..

5. First compromise proposa! for allowance of Standard

claim at five million dollars rejected...............

6. Second compromise and amended plan approved .._..

a. Terms of amended plan............... vet

b. Formation of petitioners’ committee...

ce. Petitioners’ objections to second compromise

and amended plan.................

Proofs show second compromise unfair. .

Proofs show amended plan unfair...

(1) Appraisal of debtor’s assets

f. District Court’s approval of second compro-

mise and amended plan

7. Decision of Cireuit Court of Appeals

B. Reasons for ——e certiorari

C. Relief )

Brief in support of petition for writ of certiorari

I. Gpinions of court below

II. Jurisdiction .....

ITI. Statement of the case

IV. Specifications of error

V. Summary of argument

—7123

°° &

eR RENEE O

RRER

SREERSS ESBS SBS

— a

ii INDEX

Ue ee ee et phan ie ens akleuee

1 Application of the Instrumentality Rule in 77-B

2. Unfair appraisal rial in 7-5 Proceting Bee

in 7/-B Proceedings............

3. Abuses of public utility holding companies........

4. Presumption of frand in dealings between common

directorates Fee ei eae Noe ta 2 Cia ila hae

trolled reorganization committees ............

. Bad faith offer and acceptance of plan..........

. Injustice of decision of Cireuit Court of Appeals. .

Tasiz or Cases Crrep.

Ahlenius v. Bunn Humphries, Inc., 358 Ill. 155, 192 N. E. 824

RA RRNA as hy Scenes ones a aoe As

Albert Richards Co. v. The Mayfaw, 287 Mass. 280, 191 N. E. 430

SS nn leh at asae eben bes ieaueraa ane dum ene bons

Allied Chemical & Dye Corp. v. Steel & Tube Co., 14 Del. Ch. 1,

CS ono hy ann Chants Pieaitnhicn wwrbde tesa)

Allied Chemical & Dye Corp. % v. _ Steel é Tube Co., 14 Del. Ch. 64,

ee es Enis ok awe chaevacand ious.

Baker Motor Vehicle Co. v. arenas 238 Fed. 894 (C. ¢. 2,

eee So

Borg v. International ‘Silver Co., . (2d) 147 (¢. C. A 2,

WI ito rce ccc alan Pou ea CA ech ue Bae toro,

Centmont Corp. v. Marsch, 68 F. (2d) 460 (C. C. A. 1, 1933).

Chicago, M. and St. P. Ry. v. Minn. Civic Ass’n, 247 U. S. 490,

ee es ee I ooo ola saebbitebe ee xs

Clere Clothing Co. v. Union Trust € Savings Bank, 224 Fed. 363

Uk, Oe is Oe I ne ets se wi sciowrs-s 4 cca

Corsicanna Nat. Rk. v. Johnson, 251 U. &. 68, 64 L. Ed. 141

8 NRE eer tabaaieg - Pacmag le. thgemlie Sepa

Downtown Inv. Ass’n v. Boston Met. Bidg., 81 Fr. (2a) 314

Pe ais ee ERS 5 Ses wera

Doyle Dry Goods Co. v. Lewia, 5 F. (2d) 918 (C. C. A. 8, 1925)

Edward Finch Co. v. Robie, 12 F. (2d) 360 (C. C. A. 8, 1926)

E. E. Gray Corp. v. Meehan, 54 F. (2d) 223 (C. C. A. 1, 1931)

Bshleman v. Keenan (Del. Ch. 1936), 187 Atl. 25

Farmers Loan € Trust Co. v. N. Y. d M. R. Co., 150 N. Y. 410,

44 N. E. 1043 (1906)

Forbush v. Bartley, 78 F. (2d) 805 (C. C. A. 10, 1935)

ay Bank v. Flershem, 290 U. S. 504, 78 L. Ed. 465

(1934)

28S 8 & 8B 88s a8

EF BEE28 & &

INDEX ll

Page

ge Anaconda Copper Min. Co., 254 U. S. 590, 65 L. Ed.

Se eS eee cree eae aoe 53, 55

Hart Steel Co. v. Railroad Sup. Co., 244 U. S. 294, 61 L. Ed. 1148

RT ead cares t rata senate sca ceavengacyas sss ses 47

Hyoms v. Calumet ¢ Hecla Min. Co., 221 Fed. 529 (C. C. A. 6,

eee tieaveetnceeneecsnsde-tcnesssccesess 54

In re Burntside Lodge, Inc., 7 Fed. Supp. 785 (D. C. Minn. 1934) .. 48

In re Kentucky Wagon Mfg. Co., 71 F. (2d) 802 (C. C. A. 6,

AR ALA Rg Eee Pee eee eee is 48

In ve 1775 Broadway Corp., 79 F. (2d) 108 (C. C. A. 2, 1935)... 62

In #e United Cigar Stores of America, 82 F. (2d) 247 (C. C. A.2,

es ta se awaswaseenes+seersessecees 56, 57

Int. Radio & Telephone Co. v. Atl. Communication Co., 290 Fed.

a Ae ee Bt

Jamieson v. Watters, 91 F. (2d) 61 (C. C. A. 4, 1937)..... woe 52

Lake St. El. R. Co. v. Ziegler, 99 Fed. 114 (C. C. A. 7, 1900). Ba aa 62

Langnes ¥. Green, 282 U. 8. 531, 75 L. Ed. 520 (1931)........... 63

Matter of Otsego Wazed Paper Co., 14 Fed. Supp. 15 (D. C.

ina sath Bin a Sata ee

McCaskill v. U. S., 216 U. S. 504, 54 L. Ed. 590 (1910)........... 47

National Surety Co. v. Coriell, 289 U. S. 426, 77 L. Ed. 1300

SE So fevask 51, 62

_Outwater v. Public Service Corp. of N. J., 103 N. J. Eq. 461, 143

ip ae a i See See iene

Penn. Canal Co. v. Brown, 235 Fed. 669 (C. C. A. 3, 1916). eae 54

8. G. V. Co. of Dela. v. S. G. V. Co. of Pa., 264 Pa. 265, 107 Atl.

721 (1919) oe ee ee ee epg ada e-e v 0 oe 48

U. S. v. Chicago, M. St. P. & P. R. Co., 282 U. S. 311, 75 L. Ed.

Ne oo oy ccs wate alee wees eter tse e recs se: 60

U. 8. v. Del. L. & W. Ry. Co., 238 U. S. 516, 59 L. Ed. 1438

(1915) _.. 47

U. 8. v. Lehigh Valley RB. RB. Co., 220 U. 8. 257, 55 L. Ed. 458

ll AE i Sys niga San eee 47

U. 8. v. Reading Co., 253 U. S. 26, 64 L. Ed. 760 (1920) reyes 47

Vallery v. Denver & R. G. R. R. Co., 236 Fed. 176 (C. C. A. 8,

1916) 54

Western Distributing Co. v. Public Service Commission, 285 U. S.

pe Ne eee 54

Srarutss Cirsp.

See. 240 (a), Judicial Code (28 U.S. C. A., See. 347) 44

See. 27, Bankruptey Act (11 U.S. C. A., See. 50) 38, 45, 55

Text Booxs Crrep.

Latty, Subsidiaries and Affiliated Corporations (1936)

Powell, Parent and Subsidiary Corporations (1931) __.

Securities and Exchange Commission, Report on the Study and

Investigation of the Work, Activities, Personnel, and Functions

of Protective and Reorganization Committees 59, 60

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 1938

No. 312

JOHN M. TAYLOR, OSCAR A. KENNEDY ann H. RUS:

SELL HASTINGS, as tHe InpEPENDENT CoMMITTEE FOR

THE ProrecTion oF THE HoupErs oF PREFERRED Stock oF

Deer Rock Or Corporation,

Petitioners,

vs.

STANDARD GAS AND ELECTRIC COMPANY, REOR-

GANIZATION COMMITTEE OF DEEP ROCK OIL

CORPORATION, H. N. GREIS, Trustee or Deep Rock

Om CorpPoratTion, anD DEEP ROCK OIL CORPORA-

TION.

PETITION FOR CERTIORARI.

Norre.—References to the Record are shown as to Volume,

by Roman numerals, and as to page, by Arabic

numbers, i. e. (11-300), is Volume Two, page 300.

To the Honorable the Chief Justice and the Associate

Justices of the Supreme Court of the United States:

Your petitioners, John M. Taylor, Oscar A. Kennedy, and

H. Russell Hastings, as the Independent Committee for the

Mar A IE TS

~ feo

Protection of the Holders of Preferred Stock of Deep Rock

Oil Corporation, by their counsel, Jason L. Honigman,

allege:

A. Statement of the Matter Involved.

1. Onpers Aprzatep From.

The instant petition seeks to review certain orders in 77-B

Bankruptcy proceedings for the reorganization of Deep

Rock Oil Corporation, a Delaware Corporation (herein-

after referred to as ‘‘Deep Rock’’ or ‘“‘Debtor’’). By these

orders, the District Court for the Northern District of Okla-

homa compromised and allowed in the amount of five mil-

lion dollars an alleged claim of Standard Gas and Electric

Company (hereinafter referred to as ‘‘Standard’’) against

Deep Rock, its subsidiary, and as part of the compromise of

this claim, confirmed a Plan of Reorganization for said

Debtor (1-363, 393). By these orders, Standard secured the

major portion of the equity in the Debtor’s assets at the

expense of a five million dollar class of public preferred

shareholders of the Debtor, who were thereby practically

eliminated.

From these orders, Petitioners, a committee of pfeferred

shareholders of the Debtor, appealed to the United States

Circuit Court of Appeals for the Tenth Circuit (I-1-15,

436-64), which affirmed said orders by a divided Court

(1-477-505). Circuit Judges Phillips and Williams each

wrote an opinion for affirmance and Circuit Judge Bratton

wrote a dissenting opiaion. The primary issues before the

District Court and the Circuit Conrt of Appeals revolved

about the validity cf the Standard claim, the propriety of

its compromise, and the unfairness of the allocation of the

Debtor’s assets under the Plan of Reorganization.

2. Desror’s Busuvess anp CaprraL STrRucrure.

The Debtor went into Federal Equity Receivership on

March 2, 1933 (I-23), which proceedings were transferred

into 77-B proceedings in June, 1934 (I-25). Deep Rock was

organized in 1919 by Standard and its affiliated interests

throngh the purchase of a going oil business (II-629,

635-43). Its original name, Shaffer Oil and Refining Com-

pany, was subsequently changed to its present name (II-629,

631).

The Debtor is engaged as an integrated unit in the oil

industry, preducing, refining and selling gasoline, oil and

other petroleum products (1-364, II-735). Ms principal

place of business is Tulsa, Oklahoma (I-36). It owns and

operates 488 producing oil wells, 44 gas wells and a large

refining plant (II-735). It owns or controls oil leases cover-

ing over 118,000 acres of oil lands located principally in

Oklahoma, Kansas, Texas and Arkansas (II-735). It has its

own pipe line gathering system totaling over 400 miles, and

owns and operates approximately 600 tank cars (II-735-6).

In addition, it distributes and sells its gasoline and other

oil products through approximately 700 filling stations

throughout the Midwest and Southwest territory (I1-21,

736). .

The capital structure of the Debtor consists of :

(1) Notes.—This is an issue of Ten Million Dollar Six

Per Cent Notes of Deep Rock which matured March 1,

1933, and upon which no interest has been-paid since that

date (II-722-3). Practically all of the notes were sold to

the public and except fér a few large holders are widely

spread among over four thousand small holders through-

out the country (1-328-9, IT-11, 420).

(2) Preferred Stock—The preferred stock of the Deb-

tor consists of fifty thousand shares of non-par stock which

is entitled on liquidation to $100.00 per share and accumu-

lated dividends of $7.00 per share per annum, unpaid since

1931 (II-114, 613, 631, 722-3, 821). Thus, as of the time of

confirmation of the Plan of Reorganization, the total right

—

SOs ta eB Ss ee Rs ce a es SE

of participation of the preferred shareholders in the assets

of the Debtor was approximately seven million dollars. All

of the preferred shares with but few exceptions were sold to

the public and are held among over fifteen hundred widely

scattered shareholders (II-114).

(3) Standard’s Common Stock and Claim.—Standard is

the owner of practically all of the common stock of the Deb-

tor (1-260, I1-688-9). It also asserts a claim as a creditor

of Deep Rock in the amount of approximately $9,300,000

on the balance of an open account between itself and the

Debtor (I-23).

3. Stanparp Cam.

a. Hearing On Contest of Claim.

From the inception of the Debtor’s receivership, the

Standard claim as a creditor has been under attack as in-

valid in its entirety. Standard filed its claim in the equity

receivership and renewed it in the 77-B proceedings (I-23,

II-245, 266-276). The Receivers and the Trustee in Bank-

ruptcy filed objections to the allowance of this claim (II-

276-290, I-108-137). These objections were based primarily

on the ground that the claim includes fraudulent charges

by Standard against Deep Rock which should be eliminated

from the open account and which, if eliminated, would leave

no balance owing to Standard (II-283-288, I-108-132). The

objection was further made that by reason of the complete

and wrongful domination by Standard over the Debtor

throughout the entire period of/ the Debtor’s existence,

Standard should be denied a claim as a creditor as a mat-

ter of law through the application of the Instrumentality

Rule (11-290, 1-132).

Hearing on the claim and objections thereto were referred

by the District Court to a Special Master (1-65). Exten-

sive proofs for both Claimant and Trustee were taken and

completed during a period of many months (II-1-376, 592-

681, III-1-127). All of the witnesses who testified at these

hearings were officers, directors or agents of Standard or

its nffiliates, including the operating officers of the Debtor

(II-1, 19, 25, 31, 36, 55, 57, 62, 75, 100, 102, 107, 144, 145,

151, 223, 312-56, 606-8). None of the witnesses either ex-

pressed or indicated any hostility to Standard (II-377).

Many of the salient facts were agreed upon in a compre-

hensive stipulation of facts (II-242-376). Thusathe entire

evidence with reference to the Standard claim was substan-

tially uncontroverted.

b. Nature of Standard Claim.

From the inception of Deep Rock in 1919, up until the

time of ita receivership in 1933, Standard kept a so-cailed

open account with Deep Rock (1-61-63). This open account

consisted of book entries of debits and credits reflecting

thousands of transactions between Deep Rock and Stand-

ard throughout this period. This open account shows a

total of debit entries during this fourteen year period

charged by Standard against Deep Rock exceeding fifty-

two million dollars, offsetting which are credits totaling

approximately forty-three miilion dollars, leaving a net

debit balance of $9,342,642.37, which Standard claims to be

owing from the Debtor (1-61-63).

The transactions reflected by this open account range

from the expenditure of a few cents to transfers involving

millions of dollars at a time (1-61-63, III-27-53). It includes

thousands of charges for Deep Rock obligations and ex-

penses paid by Standard directly to third persons (II-42,

57-8, 61, 78-93, 114-15, 172, 179, 184, 195-6, II1-27-40, 41-53,

83-7). It also contains huge charges representing an ap-

portionment to Deep Rock of Standard’s business expenses,

including expenditures for office rentals, salaries, bookkeep-

wenee. oe geet

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bie? 5 TR SRS a st lk ld da he el lc oS RS

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ing charges, auditing services, stationery, telephone bills

and salaries and traveling expenses of various Standard

officers (III-27-53). The open account also includes entries

for some seventeen millions of dollars of cash advanced by

Standard to Deep Rock which from time to time were repaid

as shown by the credit entries (I-61-63).

However, by far the largest part of the open account con-

sists of charges arising out of intercompany transactions

between Standard and Deep Rock (1-61-63). Some twenty

million dollars of these charges are under attack in these

proceedings by reason of their fraudulent and wrongful

nature which, if eliminated from the open account, would

not only wipe out the entire Standard claim but leave

Standard indebted to Deep Rock (1-335-346). In addition,

it was urged that Standard had no right whatsoever to claim

as a creditor of the Debtor by reason of the applicability of

the Instrumentality Rule of law (1-328-30).

c. Stardard’s Domination of Debtor.

From this testimony, it appeared that Standard is one of

the large public utility holding companies of this country,

whose securities are listed on the New York Stock Exchange

(11-603, 688-9). It carries on no business of its own except

as it controls its subsidiary companies (II-7-8). Its pub-

lished statements show consolidated balance sheets of itself

and its subsidiary companies, in which total assets are listed

at over one billion dollars (II-603, 688-9). The only sub-

sidiary included in these consolidated statements that was

not engaged in the public utility business was Deep Rock

(II-602).

Standard incorporated the Debtor in 1919 and since early

1921, has owned between 95% and 98% of the common stock

of the Debtor (1-260, IT-635-41, 688-9). Standard has been

alone during that period in the election and appointment of

Deep Rock’s officers and directors and-in its control of the

Debtor, the common stock being the sole voting stock (II-

385, 422, 629-31). The public preferred shareholders have

had no voting rights and have at no time had any voice in

the management, control or appointment of officers or di-

rectors of the Debtor (II-385, 422, 427-8, 629-31). The

majority of the directors of Deep Rock were at all times

officers and directors of Standard, and the remaining di-

rectors were operating officers of Deep Ragk who were

chosen by Standar and were subordinate to Standard’s

officers (TI-325-56, 4-5, 9, 36, 41, 63, 70, 422, 427-8, 463).

The top officers of Standard received their sole salary from

Standard but at the same time acted as the top officers of

Deep Rock (II-325-56, 5, 8, 145, 147, 151). Thus, there was

complete interlocking of both officers and directors of the

two companies.

The uncontroverted testimony discloses that all of the

meetings and minute books of the Debtor’s Board of Di-

rectors were held in the offices of Standard at Chicago, al-

though the Debtor’s principal place of business was at

Tulsa (I-13, 37, 43, 162, 164-5, 178, 228, 240). At those

meetings, the majority of directors present were, at all

times, directors or officers of Standard and on rare occa-

sions there were present a few of the operating officials of

the Debtor (II-331-8, 608-629). Inasmuch as at all times

the same persons were the top officers of both Standard

and Deep Rock, the operating officers of the latter were

at all times subordinates of the Standard officials present

(II-312-359). Moreover, Deep Rock’s chief operating of-

ficers were hired directly by Standard (I1-4, 9, 63, 70, 36, 41).

With reference to the hiring of John L. Gray, Deep Rock’s

vice-president and general manager, the President of Stand-

ard testified :

‘‘As President of Standard, I contracted with Gray

as to the salary he was to receive as (Vice) President

(of Deep Rock)’’ (11-9).

a Sa SE SA et

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The uncontroverted evidence and written; admissions

herein, farther disclosed that many of the most important

transactions of the Debtor throughout the period of its

existence, were handled directly by Standard without even

the formality of approval by the Deep Rock Board and often

without even written agreements (II-42, 28, 30, 78-93, 98,

144-51, 161-2, 172-173, 184-5, 195-6, 244-5, ITI-27-53). The

uncontroverted testimony also disclosed that Standard

handled all of the numerous financing of the Debtor, di-

rectly supervised the latter’s accounting department, and

for practical purposes operated the Debtor as a department

of its own business (II-5-6, 9, 24, 26, 33, 37, 62, 69, 86, 233,

240, 380, 606-8, 652-76, 689).

The extent of Standard’s direct operation of.the Debtor

is again shown in the testimony of Standard’s officers that

in the operation of Deep Rock

no important moneys were spent or items

approved without the approval of this (Standard’s)

Chicago office’’ (11-6).

They also testified that Standard’s organization was ‘‘in

daily touch’’ with the affairs of Deep Rock (I-33, 62), and

‘‘could, at a moment’s notice, fill any executive capacity

of Deep Rock’’ (II-69).

Many officials of Standard were also dummy officials of

the Debtor although they were neither under salary nor

allegiance to the Debtor. These dummy officials signed for

the Debtor, checks for huge sums drawn on the Debtor’s

bank accounts but payable to Standard, notes for millions

of dollars payable to Standard, and contracts with Standard

involving many millions of dollars (II-42, 118-22, 144-51,

172-3, 179-80, 181-197, 201, ITI-1-5, 6-19). These dummy of-

ficials testified that they did not know why the contracts,

notes and checks were signed or what their purpose was or

whether there was any authorization therefor by the Deep

Rock Board of Directors (II-144-151). They testified that

they signed for Deep Rock whatever instruments their

superiors at Standard directed them to sign (II-144-151).

Typical of the testimony in this regard is the following

quotation from the testimony of one of the Standard of-

ficers who signed a $4,250,000 note payable to Standard in

his capacity as a dummy officer of Deep Rock: °

‘*Q. Do you have any recollection of that transaction?

‘*A. No, sir.

**Q. Do you know what the consideration for that

note was?

‘*A. No, sir.

**Q. Do you know what was done with the $4,250,000?

‘*A. No, sir.

‘*Q. Do you know whether or not (Deep Rock) re-

ceived that sum of money from the Standard Gas and

Electric Company?

‘*A. No, sir.

**Q. Did you know at that time?

‘*A. I don’t remember now.

‘*Q. By whose direction or authority did you sign the

name of (Deep Rock) to that $4,250,000 note?

‘*A. I don’t recall that, now’’ (II-148-49).

At a further point in his examination, this dummy official

admitted that in the signing of this note as well as many

other Deep Rock notes payable to Standard, he was acting

solely upon instructions from his superior officers at Stand-

ard (IJ-150-151). Other dummy officials of Deep Rock were

not put on the stand when Standard’s counsel conceded that

their testimony as to the circumstances under which they

signed Deep Rock notes, checks and contracts in transac-

tions with Standard would be to the same effect (II-151).

The manner of Standard’s operation of the Debtor is fur-

ther evidenced by the fact that the entire proceeds of both

a $7,500,000 and $10,000,000 Deep Rock note issue, sold to

the public by Standard’s affiliate and top-holding company,

TOE Sd et es eb Bh 8

Sa ISSR

H. M. Byllesby & Company, was pocketed directly by Stand-

ard (1-63, I1-60-61, 97). Standard merely credited the

Debtor’s open account with the proceeds so taken after de-

ducting heavy discount charges (I1-60-61, 97).

Standard, itself, considered Deep Rock as a department

of its own business (Ii-4, 5, 7, 10, 31). The Standard of-

ficials constantly referred in their testimony and documents

to Deep Rock as being a part of the so-called ‘‘Standard

System’’ or ‘“‘Byllesby Group”’ ({II-31, 62, 63, 87, 100-101,

156, 398). Standard’s President, in referring to the acqui-

sition of Deep Rock, testified :

‘**So we got into the oil business that way’’ (II-4).

At a further point, he referred to services rendered by

Standard for ‘‘all our properties, whether oil or public

utility’’ (II-7). Deep Rock’s assets and liabilities were

moreover included in Standard’s published reports as part

of its ‘‘Consolidated Balance Sheet’’ (I1-592-606). Deep

Rock earnings were likewise included as part of Standard’s

‘‘Consolidated Earning Statement”’’ (11-592-606).

The uncontroverted testimony further disclosed that the

Debtor was undercapitalized by Standard in the first in-

stance; that it was in dire need of money throughout the

entire period of its existence; and that it was in absolute

dependence upon Standard for financial aid (1-146, 260, I1-7,

16, 26, 30, 33, 35, 37, 41, 42, 73, 224, 229, 293, 405-6, 652-676,

677). The precariousness of the position of the Debtor

throughout its existence is described by Mr. O’Brien, Pres-

ident of Standard, Byllesby and Company and Deep Rock,

as a situation where the Debtor was constantly in danger

of receivership, and was most of the time ‘‘two steps in

front of the wolf’’ (II-16). Its utter financial dependence

upon Standard inevitably subjected the Debtor and its of-

ficers to complete subserviency in its dealings with

Standard.

d. Fraudulent Refining Compcny Transactions.

Deep Rock’s subserviency to Standar.’ was nowhere more

evident than in the course of the so-calicd Refining Com-

pany transactions. By these transactions, Standard by its

own fiat fraudulently divested Deep Rock of assets upon

which Deep Rock had spent millions of dollars gin acquisi-

tion, and at the same time foisted upon Deep Rock over

five million dollars of fraudulent charges, which are in-

cluded in Standard’s claim on the open account (1-62, II-

94-5, 130-3). ¥ ;

The uncontroverted testimony in this regard disclosed

that in February, 1923, Deep Rock purchased certain oil

properties known as the ‘‘ Bradstreet Properties’’, which it

continued to own and develop at its own cost and expense of

over $2,200,000 (II-34-6, 44-6, 128-9, 176-7, 194-5, 227). Deep

Rock operated these properties in the same manner as its

other producing properties, without accounting to anyone

for income therefrom and expending all sums necessary for

operation thereof without charge to any one (II-35-6, 45,

72, 226-7).

In 1922, Deep Rock constructed a cracking plant as a neces-

sary adjunct to its refinery to increase the production of its

gasoline products (II-19-24, 26, 108-9, 218-22). This crack-

ing plant was constructed on the refinery property of Deep

Rock and in fact and appearance was an integral part of its

refinery (II-108-9, 218-22, 226-7, ITI-148). It was operated

by Deep Rock in the same manner as the remainder of the

refinery (II-51, 108-9, 218-22). Its operation was entirely

by employes of Deep Rock, with all income therefrom

handled in the same manner as the income from the re-

mainder of Deep Rock’s refinery and all expenses therefor,

paid by Deep Rock (I-51, 108-9, 218-22). In the construc-

tion of this cracking plant and improvements thereto, over

$1,500,000 was expended by the Debtor (II-193).

ne ae Ae eee 2” cose

Salt toa 2

The title to the Bradstreet properties and the cracking

plant was nominally held by Deep Rock Oil and Refining

Company (herein referred to as the ‘‘Refining Company’’),

a purely inactive dummy corporation, all of whose stock was

owned by Deep Rock (1-113, II-36, 105-6, 191-2, 198, 294).

After three years of operation of these properties by the

Debtor as its own, the stock of the Refining Company was

suddenly transferred to Standard solely upon directions

of the General Auditor of Standard to his subordinates at

Deep Rock (II-48-50, 128, 188, 606-8) with provisions made

for crediting Deep Rock’s open account with the latter’s

cost of acquisition (I1-48-50, 128).

At the same time, a five year lease of these properties

from the Refinig Company to the Debtor was drawn by

Standard officials and signed at Chicago by Standard offi-

cials in their capacity as dummy officials of Deep Rock

(1-134-5, TI-52, 148, 167, 230, 308, 606-8). Neither of the

two officials who signed this lease in behalf of Deep Rock

was under salary to Deep Rock and the only one of these

officials who testified, stated that he knew nothing of this

lease agreement nor why it was signed, except as it was com-

mon for him to sign Deep Rock instruments at the direction

of his superior officers at Standard (II-148, 151).

This lease, so executed by the Standard officials in their

capacity as dummy officers of the Debtor was, on March 19,

1926, mailed to Tulsa from Standard’s office in Chicago with

instructions from the Standard Auditor that it should be

signed under date of October 1, 1925, by two of the operating

officers of Deep Rock in their capacity as dummy officers of

the Refinmg Company (II-52).

By this lease, it was provided that Deep Rock was leasing

from the Refining Company these very assets which Deep

Rock had owned and operated for over three years and pur-

chased, constructed and developed with its own funds

(1-134-5). The lease furthermore provided that Deep Rock

should pay a rental to the Refining Company of $600,000 per

year (1-134-5). These rentals were admittedly grossly ex-

orbitant (II-391, 429-32). It is admitted that Deep Rock

paid these rentals not to the Refmimg Company, but directly

to Standard (II-94-5, 152-3). In addition, Standard charged

Deep Rock some $190,000 for Federal Income, Taxes on

Standard’s profits from these rentals on the wholly fraudu-

lent assumption that that was another Deep Rock obligation

under this lease (II-81-2).

The lease further provided that Deep Rock should pay all

costs of operation and acquisition of new properties and ad-

ditions which would then belong to the Lessor (I-134-5).

After the making of the lease, Deep Rock spent several mil-

lion dollars more of its own money in acquiring new prop-

erties which Standard now claims to be the property of the

Refining Company (1-134-5, I1-176-7, 192-3, 391). Despite

Deep Rock’s tremendous losses on this deai during the five

years of this lease, the lease was renewed at its expiration

for another five years on the same terms and through the

medium of the same dummy officials (1-136-7, I1-229-30, 244,

429-32, ITI-23-4).

It ‘s admitted by Stipulation of Standard that neither

this lease nor its renewal of October 1, 1930, was ever ap-

proved by or even submitted to the Deep Rock Board of

Directors (11-244). It is further admitted by Standard

that, although two-thirds of the rental charged under this

lease was attributable to the leasing of the cracking plant

to Deep Rock, the written instrument itself completely omit-

ted any mention or description of the cracking plant (ITJ-23-

24, I1-244).

By these Refining Company transactions, Standard stole

from the Debtor assets on which the Debtor has spent over

four million dollars of its own funds (IJ-176-7), leased them

back to the Debtor, the owner of the assets, and by this lease,

foisted on Deep Rock about five and one-half million dollars

50 2. ee

fe al BS ERS SOS 2 er

CSE Be ae

of fraudulent rental, income taxes and interest charges which

are part of the open account on which Standard’s claim is

based (1-62, [1-81-2, 131-133).

demned in the dissenting opinion of Circuit Judge Bratton

(1-504) but were likewise recognized in the Majority opin-

ion of Cireuit Judge Phillips as transactions in which

‘‘Standard exercised its control to the benefit of Standard

and to the detriment of Deep Rock’? (1-482). These trans-

actions were likewise characterized by the Attorney for the

Trustee as ‘‘unconscionable’’ and ‘‘frandulent’’ (11-391).

The significance of this unanimous version of the fraudn-

lent nature of the Refining Company transactions lies in

the fact that these were not merely isolated or insignificant

instances of Standard’s abuse of its control over the Debtor.

@n the contrary, these transactions were an aggregate of

major period of the Debtor’s existence. Moreover, these

admittedly fraudulent transactions account for over five

milhon dollars of the debit charges that are included in

Standard’s open account as the basis for its claim against

Deep Rock (1-62, IT-81-2, 131-3).

The unanimous finding by the Circuit Court of Appeals

of the wrongfulness of the Refining Company transactions

is of itself, we submit, an irrefutable adjudication that in

its operation of the Debtor, Standard grossly and fraudu-

lently abused its power of control over its instrumentality

subsidiary. It is submitted that this finding of fact calls

as a matter of law for the application of the Instrumen-

tality Rule, as recognized by this Court and by the weight

of authority, in denial of Standard’s entire claim as a credi-

tor of Deep Rock.

e. Fraudulent Management Charges.

The uncontroverted testimony further disclosed that over

$1,200,000 of the Standard claim against Deep Rock is

TTT EN SES

based upon charges by Standard’s wholly owned affiliate,

Byllesby Engineering and Management Corporation, for

supervision and management of the Debtor, by the same

officials who, at the same time, were also the top officers

of Standard and the Debtor (1-62, I/-3, 7-8, 28-9, 55, 101,

239, 433-4). These officials admitted that they kgew noth-

ing about the oil business and claimed to know nothing and,

in fact, performed no services other than advice on the

financial difficulties of the Debtor (IT-4, 5, 7, 9-10, 14-16, 27,

29, 40, 41, 55-59, 227-8, 239). :

It is admitted by Standard that no contract for these

charges was ever made, either orally or in writing, and

that the matter was never submitted to the Deep Rock

Board (I-28, 244). The charges were entirely dictated and

directed by the Standard officials in their capacity as offi-

cers of the said Management Company (II-28). None of

the witnesses could give any basis for the making of these

charges or how the amounts were arrived at (II-7, 25-26,

27, 239). It was admitted by the Vice-President of Stand-

ard’s own affiliate and top holding company that these

charges were made for services that were never rendered

and were unwarranted in their entirety (11-4334). These

Management Company charges were likewise characterized

by the Attorney for the Trustee as a ‘‘frand’’ and as

‘‘wholly unjustified’’, after the close of the proofs on the

Standard claim (II-391).

f. Wrongful Dividend Withdrawals.

Over four million dollars in Deep Rock dividends were

declared to Standard (I-61, I1-88-9). Although the books

of the Debtor showed a surplus by reason of earnings

(11-649-50), nevertheless, it is admitted that the records

of Deep Rock’s income and earnings filed with the Federal

Government as part of Standard’s consolidated income tax

return disclosed that, in fact, Deep Rock had neither sur-

SSF a ee, We es eee 2

plus nor earnings from which to pay any dividends

(III-90-93). It is also shown by the uncontroverted evi-

dence that Deep Rock never had the cash to pay these divi-

dends to Standard, and had to borrow from Standard

throngh the medium of the open account in order to pay

them (I-61, IT-7, 16, 26, 35, 37, 88-9, 224). This open account

indebtedness for dividend charges was, we submit, clearly

illegal and unwarranted.

g. [legal Compound Interest and Discount Charges.

The uncontroverted testimony further disclosed that, in-

eluded in the Standard Claim is $4,819,222.07 of interest,

chatged by Standard against Deep Rock on the average

daily balances of this open account at the rate of seven per

cent per annum (I-61). These interest charges were added

at the end of each month to the open account as an

additional indebtedness on which interest was thereafter

charged, thereby resulting in illegal compounding of that

interest (I-61, II-86-7). Moreover, the major part of these

interest charges arose out of Deep Rock’s indebtedness on

the many wrongful and fraudulent charges imposed by

Standard and included in the open account. Were it not

for these fraudulent and wrongful charges, there would

have been no balance owing to Standard and hence no

interest to be charged.

It is admitted by Standard that there was no written

agreement covering the charging of this interest and that

the matter of the making of these charges was never sub-

mitted to or approved by the Deep Rock Board of Directors

(II-86-88, 161-2). In addition, millions of dollars of under-

writing fees and discounts were charged by Standard

against the Debtor without any written agreement or au-

thorization by the Deep Rock Board of Directors (1-61-3,

447-8, I-60, 87-8, 143, 148-151). The total of these illegal

and extortionate interest and discount charges contained in

the Standard claim is well over six million dollars (I-61,

447-8).

h. No Proofs on Fairness of Standard Charges.

The undisputed testimony further disclosed many other

instances of wrongful charges and unconscionable transac-

tions included in Standard’s charges against Deep Rock,

as well as the manner and method of Standard’s handling

of the Debtor as a department of its own business and to

suit its own ends unmindful of the best interests of Deep

Rock’s security holders. In presenting its claim, Standard

made no attempt at proving the fairness of the charges

against Deep Rock included in the open account but con-

tented itself with showing that the charges so made were

shown on the books of both Standard and Deep Rock

(11-59-61, 267, 437, 543-7).

It is admitted that the entries on Deep Rock’s books were

directed by Standard’s Auditing Department (II-62, 240).

It would indeed be surprising if the two sets of books did

not agree (II-545-6). It is also conceded that there were

many large transactions between Deep Rock and Standard

and its affiliates that did not clear through the open account

and the propriety of which has never been exposed to in-

quiry (II-74-5, 89, 123).

We submit that the existence of the many fraudulent

transactions brought to light in the course of this hearing,

and the admittedly interlocking nature of the relationship

between Standard and Deep Rock, should have at least re-

quired the submission of an impartial and competent audit

of all of Standard’s dealings with Deep Rock. It is admit-

ted, however, that no independent audit has ever been made

of the transactions between Deep Rock and Standard and

its affiliates (11-525, 437).

aoe ee ep

i. Standard Treats Open Account as Capital Investment.

Although Standard now urges that it is a creditor of Deep

Rock by virtue of this open account, the fact is that, prior

to Debtor’s receivership, Standard itself treated this open

account as merely a part of its capital investment in Deep

Rock. Standard’s entire treatment of the open account and

the unusual nature of the transactions reflected therein bore

none of the usual attributes of a debtor-creditor relation-

ship.

It is admitted, for instance, that Deep Rock never entered

into any agreement for the repayment of these open ac-

count balances, nor was any time of repayment even dis-

cussed (II-65, 241). The fact is that Standard distinctly

recognized these open account balances as part of its capi-

tal investment in Deep Rock when, in 1928, it cancelled ap-

proximately eleven million dollars of open account balances

for which it took additional common stock of Deep Rock,

although at the time, it already owned practically all of

the Debtor’s common stock and hence was not increasing its

ownerghip in the Debtor’s assets (I1-624, 1-59-60). Other

instances of Standard’s treatment of this account as a part

of its capital investment in the Debtor appear in the Rec-

ord (11-89, 273-5, ITI-105, 118, 120, 127).

3. Standard’s Manipulation of Deep Rock Securities.

The uncontroverted evidence further discloses that the

notes and preferred stock of the Debtor were sold to the

public by Standard und its top-holding Company, Byllesby

& Company (II-11, 114, 420). Byllesby & Company acted

as both principal and agent in its dealings with the public

in the sale and purchase of Deep Rock notes and preferred

stock (II-421). From the outset it maintained a controlled

market for these securities and uncontradicted evidence

points to fraudulent manipulation of the prices (II-421,

508-11, 642).

The evidence further discloses that in selling Deep Rock

securities to the public, representations as to the valuations

of the Debtor’s assets showed amounts that were far in

excess of the true valuati were four times the valua-

tion now claimed by Standard . the appraiéal of these

assets in the instant case (II-254, 297, 593-605, ITI-103-114).

The undisputed testimony further discloses that in the sale

of these securities representations were made as to the tre-

mendous earnings by the Debtor at a time when its Federal

income tax reports were disclosing heavy losses (II-254-62,

297-301, 593-605, ITI-103-114, 90-93). Similarly, the annual

reports to the Deep Rock security holders, published by

Standard, grossly and unconscionably misrepresented the

valuations of the Debtor’s assets, as well as the amount of

its earnings (II-593-605, ITI-103-114).

The further uncontroverted evidence discloses that the

prospectuses prepared and circulated by Standard, upon

which the Deep Rock notes were sold to the public by Stand-

ard and by Byllesby & Company, both in 1926 and 1928, set

forth that the Cracking Plaut was owned by Deep Rock, al-

though Standard, as a part of its claim herein, maintains now

that the Cracking Plant was at that time owned by itself,

as sole owner of the Refining Company’s stock (II-258, 297).

We submit that under the undisputed evidence, there is

no room for doubt that throughout the entire history of

Deep Rock, Deep Rock’s security holders were preyed upon

by Standard, not only by its fraudulent looting of Deep

Rock’s assets, but further by its fraudulent manipulation of

the market values of these securities.

k. Summary of Proofs on Standard Claim.

Thus, we submit, the uncontroverted facts in the trial

on the merits of the Standard claim disclose that Deep Rock

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was completely dominated by Standard throughout its ex-

istence ; that it was operated as a department of Standard;

that Standard grossly abused its control over the Debtor;

that Standard fraudulently manipulated the Debtor’s se-

mere instrumentality of Standard. It is submitted that, as

a matter of law, those facts call for the application of the In-

strumentality Rule in denial of Standard’s entire claim as

a creditor of Deep Rock. (See Brief herein for citations of

authority. )

We further submit that the uncontroverted testimony dis-

closes that aside from the application of the Instrumentality

Rule, Standard has no valid claim because the specific

items of wrongful and fraudulent charges included in Stand-

ard’s claim against Deep Rock total over twenty million dol-

lars (1-335-47). If but half of those wrongful charges are

eliminated from the open account, the claimed indebtedness

of the Debtor to Standard is entirely wiped out.

The facts hereinabove discussed were developed in the

trial before the Special Master on the merits of the Standard

claim. All proofs at that trial were closed on February 13,

1935, when both the Trustee and Standard rested their case

(IT-241-2). No decision was rendered, however, either at

that time or at any time since.

4. Formation or RESPONDENT REORGANIZATION ComMITrTeE.

Meanwhile, immediately after the inception of the re-

ceivership of the Debtor, Byliesby and Company, top-hold-

ing company controlling Standard, initiated the Respondent

Reorganization Committee ty represent holders of both

notes and preferred stock (11-312, 395, 423-4, 465, 717).

This Committee was and is headed by John J. Shinners, as

Chairman (II-717, 819). Mr. Shinner: is a Vice-President

of Byllesby and Company and testified that Byllesby and

Company picked the entire personnel of the Reorganization

Committee (I1-423-4).

A Plan of Reorganization was first promulgated by the

Reorganization Committee in August, 1934, hereinafter re-

ferred to as the ‘‘First Plan’’ (II-819) and requisite con-

sents therefor were-obtained by January, 1935 ( 1-138-42).

Under this First Plan, Deep Rock’s preferred shareholders

were to be wiped out, and a new two and one-half million

dollar issue of preferred stock was allocated entirely to

Standard (II-823). In addition, Standard was to receive

seventy-five per cent of the new common stock of the reor-

ganized Company, with a little less than ten per cent of-the

common stock to be allocated to the preierred shareholders

of the Debtor in full satisfaction of their rights (II-823).

The Plan provided that the allocation to Standard was

predicated on the assumption that Standard would succeed

in establishing its claim as a creditor of the Debtor in the

amount of at least five million dollars (11-824-5). Prior to

presentation of this First Plan for confirmation, it was there-

fore necessary for Standard to secure allowance of a five

million dollar claim.

5. Fist Compromise PRopPosaL For ALLOWANCE OF STANDARD

Cram at Five Mrmuorn Do.uars Resectep.

On February 21, 1935, John M. Taylor and Wm. H.

Taylor, holders cf five hundred and fifty shares of preferred

stock intervened in the 77-B proceedings (I-99-102). The

Taylors, who were the predecessors of petitioners, had pur-

chased these shares in 1928 on the recommendation of

Byllesby & Company at a cost of forty-eight thousand dol-

lars (I-316, II-510). Upon their intervention, they filed ob-

jections in behalf of themselves, as well as the holders of

preferred shares as a class, to the allowance of the Standard

oper Tee

ee sine

ee Se ee

claim in any amount whatsoever for the reasons herein.

before set forth (1-96-99, 335-447).

Special Master who had heard the completed proofs on the

merits ot the Standard claim but had not yet filed his find-

ings of fact and law (I-107 ). At the hearing before the

Special Master, acceptance of the compromise proposal was

recommended and urged by the Trustee of the Debtor, by

Standard, and by the Reorganization Committee (I1-376-

400, 380, 400, I-200). The Taylors, alone, opposed its ap-

provail (1-200). At the close of this hearing, the Special

Master recommended acceptance of this first compromise

proposal (I-201-2).

The matter then came on before the District Judge on

September 23, 1935, for hearing on the Taylors’ Exceptions

to the Special Master’s Report (I-211, II-400). During the

course of this hearing, J udge Ramsey, Attorney for the

Trustee, although he recommended the approval of this

compromise (I-105-107, 11-380), admitted to the Court what

had been disclosed by the uncontroverted testimony in the

course of the hearing on the merits of the Standard claim

(II-403-6). He stated in part:

‘*Now there isn’t any doubt that the Standard has

manhandled this Deep Rock. As Lord Brougham once

said : ‘It was the proud boast of Augustus that he found

a Rome of brick and left it of marble.’ The Standard

found the Deep Rock an unsophisticated country maiden

and left it a harlot. There isn’t any doubt but what

the Standard has absolutely manhandled the Deep

Rock. * * * This Deep Rock Company made one hun-

dred and ninety-two million and some odd dollars in

thirteen years, and its net profit was a little over ten

milion. Now that on its face shows that it has been

manhandled. Talk about a corporation making one

hundred ninety-two million plus in ten years and having

only ten million dollars plus in net profits. That on its

face shows it has been run in a harum scarum way”’

(II-403-406). ‘

At the conclusion of this hearing, the District Judge set

aside the Special Master’s findings and completely rejected

this first compromise proposal, on the basis that the objec-

tions of the Taylors urging the disallowance of the entire

Standard claim were ‘‘sustained”’ ( 1-244-5). In the course

of his opinion rendered in open Court, the District J udge

said, in part:

“The Court: Here is the situation. You cannot get

$10,000,000 noteholders and $5,000,000 worth of pre-

ferred stockholders, it is hard to get them to concentrate

in a unified fight for their interest, whatever it may be.

They are scattered all over the country. ° * *

*“‘Now there is no need to go any further with this

argument. I am thoroughly convinced. I have been

studying this case, and that is the reason I had it set

down for further argument, my conscience wouldn’t

let me approve this compromise from just hearing the

arguments. Here is $5,000,000 worth of stock outstand-

ing; somebody got that money from the public. Now

under this settlement if I was to approve it, and in

approving the plan of reorganization I would just as

well say to the (preferred) stockholders, you are wiped

out ; you get a little piece of paper called common stock

that I wouldn’t give one cent for. * * *

“The evidence is overwhelming the Standard ran this

company ; they officered it ; they capitalized it; it is just

a child in their hands, and if there ever was a case the

law ts clear on, it is nothing in the world but an instru-

mentality, according to the admissions, * * *

2 eee a

- 336 2 Mare CSUR ae

that the Standard claim be allowed at five million dollars,

although exactly such an allowance had already been re.

jected in the first compromise proposal (I-105-7 IT-731-4).

a. Terms of Amended Plan.

Under the Amended Plan, the Debtorié to have a new

capital structure of ten million dollars of notes and 520,000

shares of common stock, allocated as follows (II-722) :

(1) Norzxotpers are allotted all of a new issue of ten

million dollar six per cent income debentures in lieu of the

present issue in the same principal amount. For interest

accumulated to January 1, 1937, in the total amount of

$2,300,000, the noteholders are to receive $1,200,000 in cash

and 40,000 shares of the new common stock. All interest

subsequent to January 1, 1937, is to be paid in cash (1-378).

(2) Prererren SHaneHoupers are eliminated from their

preferred position and in full satisfaction of their present

seven million dollar right of participation in the Debtor’s

assets, they are allotted one hundred thousand shares of

the new common stock.

(3) Sranwpagp receives, for its five million dollar claim,

three hundred and eighty thousand shares of the new com-

mon stock. It receives presumably nothing for its owner-

ship of the present common stock of the Debtor.

Thus, Standard is allocated approximately seventy-three

per cent of the new common stock, as against nineteen per

cent to the preferred shareholders, with the remaining

eight per cent allocated to the noteholders.

b. Formation of Petitioners’ Committee.

This Second Compromise Proposal and Amended Plan

was set for hearing before the District J udge on December

12, 1936 (1-288, 299). In the meantime, about the middle

of 1936, the Taylors had caused the formation of the Inde-

pendent Committee for the Protection of the Holders of

Preferred Stock of Deep Rock, petitioners herein, who

A ek | he ls ea.

preferred shareholders as a class (I-33-4, 328-54, 420-24).

c. Petitioners’ Objections tu Second Compromise and

Amended Plan.

The objections of petitioners to the Amended Plan and

Second Compromise were substantially as follows (1-328-54,

420-24) :

(1) That the compromise allowance of the Standard

claim at five million dellars was unwarranted inasmuch as

the Standard claim was invalid in its entirety as disclosed

by the substantially uncontroverted evidence in the com.

pleted hearings on the merits of this claim.

(2) That the District Court had already adjudicated the

invalidity of the entire Standard claim at the time of the

rejection of the first compromise proposal, and in any event

had adjudicated that a compromise allowance of that claim

at five million dollars was unwarranted.

(3) That the compromise Proposal was contrary to the

best interests of the preferred shareholders and was unduly

favorable to Standard.

(4) That the Plan of Reorganization was based on an

unfairly low appraisal of the Debtor’s assets, which re-

sulted in an unfair and inequitable discrimination in favor

of Standard at the expense of the preferred shareholders,

in the allocation of the equity in the Debtor’s assets.

(5) That the offer and acceptance of the Plan was in

bad faith for the purpose of enhancing Standard’s interests

at the expense of the preferred shareholders.

d. Proofs Show Second Compromise Unfair.

At the hearing, Standard and the Reorganization Com-

mittee urged acceptance of the Amended and Second

Compromise proposal but produced no proofs in justifica-

tion of the compromise allowance of Standard’s claim at

five million dollars. The Chairman of the Reorganization

Committee, Mr. John J. Shinners, Vice-President of Byl-

lesby & Company, admitted that the Reorganization Com-

mittee knew nothing of and did not concern itself with the

propriety of the compromise proposal (II-446, 448, 449,

451).

He stated that the Reorganization Committee urged ac-

ceptance of the compromise solely in reliance on the recom-

mendation and approval of the Trustee (11-448). It ap-

peared moreover that, prior to the hearing, a letter had

been sent to the security holders by the Reorganization

Committee urging them to refrain from joining with peti-

tioners in opposing the compromise proposal. This letter

read in part:

**The Trustee of Deep Rock and his Counsel have

approved the new compromise’’ (II-683).

The Trustee and his counsel, however, specifically belied

the testimony of Mr. Shinners and the representation made

in this letter when they stated in open court that they were

making : |

**No recommendations here on behalf of the Trustee

to either accept or reject the compromise’’ (II-524).

Thus, neither the Reorganization Committee nor the

Trustee attempted to justify the fairness or propriety of

‘hy

SO AE Se

this compromise allowance of Standard’s claim. Standard

alone urged the acceptance of this compromise allowance of

its claim. However, even Standard offered no testimony

The only proofs with reference to the propriety of the

compromise allowance were those offered by petitioners in

Opposition to it. Petitioners offered in evidence the entire

record in the completed hearing on the merits of the Stand-

the Record in this case on appeal (IT-556-7). In addition,

petitioners produced additional testimony, including a full

cross-examination of the Chairman of the Reorganization

Committee, supplementing the Record on which the District

Court had rejected the first compromise proposal (IT-419,

469, 508-514, 542-555).

proximately seventeen million dollars on the Debtor’s as-

sets (I-359-61). There being some twelve million dollars

owing to the noteholders for principal and interest, there

was .eft only a five million dollar equity to be shared by

Standard and the preferred shareholders. With Standard

being allowed a claim for five million dollars, no equity was

left for the preferred shareholders. Thus, the preferred

shareholders were as completely eliminated by the com-

promise allowance of the Standard claim at five million dol-

lars as they would be by the allowance of the entire Stand-

ard claim at some nine million dollars. The compromise

was thus clearly contrary to the best interests of the pre-

ferred shareholders and was beneficial only to Standard.

At the close of this hearing, the District J udge approved

the compromise but rendered no opinion, either written or

oral in support of his adjudication (1-393-6). Nor did he

make any attempt to explain or reconcile his approval of

this compromise in the face of his former rejection of ex-

actly the same compromise amount, and particularly in the

face of his own finding that the entire Standard claim was

invalid.

e. Proofs Show Amended Plan Unfair.

On the fairness of the Plan as a whole, the only testimony

offered by its proponents was that of Mr. Shinners, Vice-

President of Byllesby & Company and Chairman of the Re-

organization Committee ( II-411-19). He admitted that the

same Standard officials, who were also the top officers of the

Debtor, are his superior officers at Byllesby and Company

(IT-422-3, 433). The extent of his partisanship for Standard

was shown during the course of his entire cross-examination

at this hearing ( I1-419-467, 508-514). At one point he was

asked whether he knew that the testimony on the Standard

claim showed gross misrepresentations by Standard to Deep

Rock security holders. Mr. Shinners characteristically

replied :

‘If you are asking me to impeach and try my asso-

ciates with respect to their integrity, Mr. Honigman, I

am not going to do it’’ (IJ-462).

On the whole his testimony disclosed many evasions and

contradictions. His entire basis for supporting the fairness

of the Plan was his explanation that the Plan was fair pro-

vided that Standard had a valid claim for five million dol-

lars and provided that the appraisal of the Debtor’s assets

was a fair one (I]1-444-453). At best, his testimony merely

begged the basic questions in issue.

& eS MY eB

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(1) Appraisal of Debtor’s Assets.

various departments of the Debtor (11-526, 484). These

operating heads had\been hired originally by Standard (II-

519). Under the Proposed plan, they would again find them-

assets (1-359-361). Admittedly, however, it did not take

the earnings or earning power of the Debtor into consid-

eration (II-501, 504, 528-9, 566). The earnings of the

Debtor have been very substantial, amounting to over one

hundred ninety-two million dollars of gross earnings in the

fourteen year period of its existence prior to its receiver-

ship (II-649). Since receivership, the Debtor has accumnu-

lated from earnings over four million dollars in cash, as

well as millions of dollars in additions and improvements

This Trustee’s appraisal was by far the lowest appraisal

ever submitted of the Debtor’s fixed assets. It was but a

fraction of the values arrived at in former appraisals by

the same Standard employes (II-102, 193, 534-5, ITT-125)

(1-43, TI-595-605) (II-676-9). The last statement published

by Standard for distribution to Deep Rock’s public secu-

rity holders showed a book valuation for the fixed assets of

Deep Rock in excess of forty-four million dollars (11-113),

as contrasted with the present Trustee’s appraisal of nine

and one-half million dollars for these same assets after

admittedly substantial improvements since receivership.

Moreover, the Trustee of the Debtor had admittedly made

an appraisal in 1933, subsequent to receivership, in which

he evaluated the Debtor’s fixed assets at approximately

thirteen million dollars (IT-412-14, IT-146). In the course

of his testimony, the Trustee admitted under cross-exami-

nation that the fixed assets of the Debtor were now worth

between three and four million dollars more than they were

at the time of his 1933 appraisal (II-519). Based on the

Trustee’s former appraisal, the present value of the fixed

assets would be at least sixteen million dollars, instead of the

nine and one-half million dollars now claimed. Although his

former appraisal was put into evidence at this hearing, the

Trustee offered no explanation for this gross discrepancy.

The only witness who appraised the fixed assets of the

Debtor in the light of its earnings and earnings power was

the expert witness produced by petitioners (II-551-555).

He appraised the fixed assets at thirteen million six hundred

thousand doilars (I1-554). That this appraisal was a con-

servative one, is evidenced by the fact that it was far lower

than any appraisal ever made of the Debtor’s assets with

the single exception of the present Trustee’s Appraisal

(I1T-125, IT-102, 193, 534-5) (1-43, II-595-605) (II-676-9)

(IIT-130) (ITI-146, II-519, 512-14) (II-781-2, 537-40).

Petitioners’ appraisal showed a total value of the Deb-

tor’s current and fixed assets at $21,600,000 (11-554). On

petitioners’ appraisal, there is sufficient value in the Deb-

tor’s assets to pay $12,300,000 for principal and interest

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O_O rr er i a ie a i

in full to the noteholders, as well as $5,000,000 to Standard,

assuming it has a valid claim in that amount, and still leave

an equity of approximately $4,000,000 for the preferred

shareholders.

The proponents of the Plan justify the practical elimi-

nation of preferred shareholders from participation in the

assets of the Debtor by claiming that under the present

seventeen million dollar ““Trustee ’s Appraisal’’, there is

ers and Standard’s five million dollar claim are taken care

of. Thus, through the device of an unfairly low appraisal,

that admittedly omits all consideration of earning power,

Nevertheless, the District Judge accepted this palpably low

and unfair appraisal, without any opinion or explanation

sider the Debtor’s earnings (IT-566).

Respondent Reorganization Committee voted in approval

of the Amended Plan approximately 83% of the notes and

58% of the preferred stock of the Debtor (II-579). The

testimony in the hearing before the District Court developed

that the largest individual preferred shareholders of the

Debtor had joined in acceptance of the Plan for selfish

reasons of their own, and were ‘not concerned with the best

interests of the preferred shareholders as a class. A dis-

cussion of the facts in this regard appears in the Brief

accompanying this Petition.

f. District Court’s Approval of Second Compromise and

Amended Plan.

At the conclusion of this hearing, the District J udge, with-

out written or oral opinion, entered orders approving the

compromise allowance of the Standard claim at five million

dollars and confirming the Amended Plan of Reorganiza-

tion (1-363, 393). Petitioners appealed from these orders

to the Tenth Circuit Court of Appeals under both Sections

25 and 24-B of the Bankruptcy Act (I-1-15, 436-64). These

appeals were there consolidated (1-17-21).

7. Decision of Circuit Court of Appeals.

The Circuit Court of Appeals affirmed the decision of the

District Court by a divided Court (1-477-505). Sepa-

rate opinions for the majority were rendered by Cir-

cuit Judges Orie L. Phillips and Robert L. Williams (1-477,

499). A dissenting opinion was rendered by Circuit Judge

Sam G. Bratton (1-500-505).

Both majority opinions refused to pass upon the va-

lidity of the Standard claim on its merits (I-492, 499). The

gist of both majority opinions is that they saw no reason to

disturb the discretion of the District J udge in approving

the compromise allowance of the Standard claim, and con-

firming the Plan of Reorganization of which it was a part.

Both majority opinions, and particularly the opinion of

Circuit Judge Williams, place great reliance upon off-the-

record evaluations of local counsel, the attorney for the

Trustee and the Special Master, both of whom had recom-

mended the first compromise proposal for the allowance of

the Standard claim at five million dollars (1-490, 499). The

fact is, however, that neither of these Attorneys had made

any recommendations whatsoever on the Second Compro-

mise Proposal. The latter compromise was never submitted

to the Special Master, and the Attorney for the Trustee ad-

nitted in open court that he was making no recommenda-

tions (II-524). Moreover, no explanation is made in either

of the majority opinions as to why the earlier recommenda-

tions of those individuals should be given any weight, when

the District Judge had already rejected those recommenda-

tions at the hearing on the first compromise proposal, in

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language so strong as to characterize the rejection as one im-

pelled by the District Judge’s “conscience”? (IT-406).

The opinion of Circuit J udge Williams makes no attempt

to analyze the facts of the instant case. The opinion of Cir-

cuit Judge Phillips, however, goes into a lengthy discussion

of the facts, but, we submit, it shows a grave misconception

of the facts on some of the basic points in issue and also

fails to mention many salient facts that appear from un-

disputed testimony. For example, the opinion of Circuit

Judge Phillips omits all mention of the fraudulent Manage-

ment Corporation fees, the illegal and extortionate com-

pound interest and discount charges, Standard’s fraudulent

manipulation of the Debtor’s securities, and the many bad

faith practices of the Respondent Reorganization Committee.

Then, too, Circuit J udge Phillips finds that in the Refining

Company transactions, ‘‘Standard exercised its control to

the benefit of Standard and to the detriment of Deep Rock’’

(1-482). We submit, however, that his opinion fails to recog-

nize the significance of that finding. As we have hereinbe-

fore pointed out, the Refining Company transactions were

not isolated or insignificant instances of the abuse of Stand-

ard’s control over the Debtor. On the contrary, they repre-

sent a major portion of Standard’s dealings with the Debtor

over the greater part of the latter’s existence. These trans-

_ actions were a continvous series of dealings, whereby Stand-

ard, over a period of ten years constantly imposed on Deep

Rock many millions of dollars of fraudulent charges, and

diverted assets belonging to Deep Rock running into millions

of dollars. In the face of such an admitted situation, it is

merely giving lip-service to the Instrumentality Rule to

recognize its existence and at the same time to refuse to

apply it in denial of Standard’s claim as a creditor in the

instant case.

Another important misconception of the facts appears

in Cirenit Judge Phillips’ opinion in the course of discus-

sion of the appraisal, upon which his approval of the Plan

is predicated. He says (1-498) :

‘There was no showing that in making the appraisal

any pertinent factor was disregarded. Due considera-

tion was given to going concern value.”’

The record itself clearly contradicts this finding. The

sole expert witness produced by the proponents of the Plan

in support of this appraisal, testified under ¢ross-examina-

tion:

“‘Q. But the net earning power of the whole picture

has not been taken into account, has it?

‘*A. Not by me.

“*Q. Did they produce any figures to you on which you

could take it into account?

‘*A. No, sir.

‘*Q. So that that element, which to a purchaser would

be one of the chief elements in purchasing, is not re-

flected in the appraisal on file here?

‘‘A. That is true.’’ (II-504).

The Trustee of the Debtor likewise acknowledged that no

consideration had been given to earnings or earning power

of the Debtor in the computation of this appraisal (II-528-9).

Moreover, the District Judge himself, at the close of the

proofs on this appraisal, stated in open Court:

‘*The Court: There is no doubt you have a low ap-

praisement. It is a very conservative appraisement,

because your testimony established you didn’t pay any

attention to the earning power’’ (II-566).

Thus, Circuit Judge Phillips’ findings concerning this

appraisal are clearly contrary to the undisputed facts. In

the face of those undisputed facts, the Trustee’s appraisal

was, we submit, an improper one under the decisions of this

Court and the decided weight of authority, discussion of

which is contained in the Brief presented herewith.

Sth2 otis

SR re ee:

® 36

Circuit Judge Bratton, in his dissenting opinion, un-

equivocally held that the Standard claim as a creditor was

invalid in its entirety by reason of the applicability of the

Instrumentality Rule (1-504). He further held that in view

of the invalidity of the Standard claim, the Plan of Re-

The decree of the Circuit Court of Appeals affirming the

District Court’s orders was entered on April-27, 1938 (I-

505). Petition for rehearing was filed by petitioners on

May 25, 1938 (1-507) and was denied on June 6, 1938 (I-

527). From the decision of the Circuit Court of Appeals,

this Petition for Certiorari is taken.

B. Reasons for Granting Certiorari.

1. Application of the Instrumentality Rule in 77-B

Proceedings.

calling for application of the Instrumentality Rule in the in-

stant case are substantially uncontroverted, leaving for de-

cision only the legal question of the applicability of the In-

strumentality Rule to those facts. The Instrumentality

Rule is a highly important rule of law that is far-reaching in

its application to intercorporate relationships. It is of par-

ticularly widespread importance and Significance in view

of the very many large corporations of this country that seek

reorganization in 77-B proceedings under circumstances

where, as in the instant case, participation in the reorganiza-

tion plan is predicated upon the establishment of large

claims between interrelated corporations. By reason of the

expanding importance of the Instrumentality Rule, the fur-

ther delineation of its applicability in reorganization pro-

ceedings is worthy of consideration by this Court.

2. Unfair Appraisal in 77-B Proceedings.

The decision of the Circuit Court of Appeals is in conflict

with the applicable decisions of this Court and the decided

weight of authority in confirming a plan of meorganization

which is based on an unfair and prejudiced appraisal of the

Debtor’s assets which admittedly omits all consideration of

earnings or earning power of the Debtor. By means of such

unfair appraisal, the equity of a five million dollar class of

public preferred shareholders has been eliminated. The im-

portance of a fair, disinterested and proper appraisal in ar-

riving at a fair plan of reorganization can scarcely be over-

estimated and has often been acknowledged by this Court

in equity receiverships. It is a matter of great public im-

portance that this Court define the requirements of a fair

and proper appraisal in reorganizations under Section 77-B.

3. Abuses oj F ublic Utility Holding Companies.

This Court should undertake to pass upon the highly im-

portant public question of the practices of many public

utility holding companies in looting the earnings and assets

of their subsidiaries by foisting upon them illegal and un-

warranted charges. The uncontroverted facts in this Rec-

ord disclose a series of fraudulent deals and practices by

Standard, a public utility holding company, in its self-

dictated dealings with its subsidiary, the Debtor. The legis-

lative and executive branches of our Government have al-

ready taken steps to cure the evil practices prevalent among

public utility holding companies. This Court should un-

dertake in the instan‘ case to place the judicial stamp of re-

jection on such practices.

Hei NE cial, See AAs ERE i lt a i

4. Presumption of Fraud in Dealings Between Common

Directorates.

weight of authority in refusing to apply the rule of law

that a presumption of frand attaches to dealings between

common directorates of affiliated companies. The entire

Standard claim arises out of such dealings. Under this

rule, Standard was bound to undertake the burden of over-

coming the presumption of fraud and proving the fairness

of its self-dictated dealings with the Debtor. Throngh the

device of a compromise of its claim, Standard has entirely

avoided that burden. Publié’ interest requires that this

Court undertake to establish that this highly important rule

of law cannot be circumvented in this way.

5. Compromise Powers in 77-B Proceedings.

The Circuit Court of Appeals has erroneously decided an

important question of Federal law which has not been, but

should be settled by this Court, in its adjudication on the

scope of a District Court’s powers in 77-B proceedings to

compromise claims under Section 27 of the Bankruptcy Act

(11-U. 8. C. A., See. 50). By its decision, the Circuit Court

of Appeals held that the District Court had the power in

77-B proceedings to allow a claim by compromise, without

regard to the best interests of a five million dollar class of

public preferred shareholders which is being wiped out by

the compromise. In former decisions under Section 27, the

Bankrupt was always insolvent and thus, only the interests

of creditors had to be taken into account. Since the enact-

ment of 77-B, it is submitted that this Court should require

that in the making of a compromise, the interests of stock-

holders having an equity in the Debtor’s assets must also

be given adequate consideration.

6. Impropriety of Majority’s Refusal to Adjudicate

Standard Claim.

The two majority members of the Circuit Court of Ap-

peals expressly refused to pass upon the validity of the

Standard claim. Nevertheless, they approved its compro-

mise allowance in the amount of five million dollars, thereby

wiping out the entire equity of the public preferred share-

holders of the Debtor, without even an adjudicgtion that that

elimination was a meritorious one. This compromise, thus

approved, gave no regard to the legal requirement for the

actual existence of a valid claim. Moreover, on the only two

occastons when the question of the validity of the claim was

ever passed on, separate opinions of two Federal Judges

(dissenting opinion of Circuit Judge Bratton and opinion

of District Judge) have held that the claim was invalid in

its entirety. Under these circumstances, the refusal by the

majority of the Circuit Court of Appeals to adjudicate the

validity of the Standard claim must be deemed so great a

departure from the accepted and usual course of judicial

proceedings as to call for the exercise of this Court’s power

of supervision.

7. Impropriety of Inserting Compromise In Plan of

Reorgamization.

The Circuit Court of Appeals has erroneously decided an

important question of Federal Law affecting 77-B proceed-

ings which has not been, but should be settled by this Court.

By its decision, the Court upholds the propriety of compro-

mising a litigated claim as part of a Plan of Reorganization,

contrary to the provisions and intent of the 77-B Act.

8. Unfatr Practices of Banker and Management Controlled

Reorganization Committees.

This Court should undertake to establish its views on the

highly important public question of the propriety of Banker

i Se ore ae See ce

and Management controlled Reorganization Committees

and their prevalent practices as developed by the Record

in the instant case. In this case, the Reorganization Com-

mittee, representing a majority of the securityholders, was

admittedly formed and actually controlled by the Standard

interests. It undertook as its major task the allowance

of the Standard claim as part of the Plan of Reorganization.

In so doing, its fiduciary obligation to the public security-

holders was adverse to the interests of Standard. Such

conflict of interest could only result, as it did in the instant

case, in flagrant abuse of its fiduciary obligations to the

detriment of the public securityholders. The prevalence

of such abuses in major reorganizations throughout the

country calls for corrective measures by this Court, in addi-

tion to the steps recently taken by the Legislative and Ex-

ecutive Branches of our Government.

9. Bad Faith Offer and Acceptance of Plan.

The decision of the Cirenit Court of Appeals is in conflict

with the applicable decisions of this Court and the decided

weight of authority in confirming a plan of reorganization

offered and accepted in bad faith by a majority of security-

holders. This Court has recognized in its consideration of

equity receiverships the Rule that acceptances by a majority

of a class of securityholders are not controlling, where, as

here, the majority has se!4ish interests that are not common

to the securityholders as a class. The importance of this

Rule of law for maintaining equality and fairness in reor-

ganization proceedings-should warrant this Court in affirm-

ing the applicability of this Rule to 77-B proceedings.

10. Injustice of Decision of Circuit Court of Appeals.

A grave injustice has been done to a five million dollar

class of public security-holders who have been deprived of

practically their entire investment by the unwarranted

approval of the instant compromise and plan of reorganiza-

tion. It is submitted that in the interests of justice, this

Court should exercise its power of supervision to correct

that error.

C. Relief.

WHEREFORE your petitioners respectfully pray that a writ

of certiorari may be issued out of and under the seal of this

Court, directed to the United States Cirewt Court of

Appea!s for the Tenth Circuit, commanding that court to

certify and send to this Court for its review and determina-

tion on a day certain to be therein designated, a full and

complete transcript of the record and all proceedings of the

case, and that your petitioners may have such other or fur-

ther relief in the premises as to this Court may seem just and

proper, and that the said decree of the said Circuit Court

of Appeals in the said case, and every part thereof, may be

reversed by this Honorable Court.

JASON L. HONIGMAN,

Attorney for Petitioners,

2003 Dime Savings Bank Building,

Detroit, Michigan.

Dated August 24, 1938.

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 1938

No. 312 ’

JOHN M. TAYLOR, OSCAR A. KENNEDY ann H. RUS.

SELL HASTINGS, as tHe Inpepenpent ComMMITTEE FOR

THE PROTECTION oF THE HoLpErs oF PREFERRED Stock oF

Deep Rock Or Corporation,

Petitioners,

vs.

STANDARD GAS AND ELECTRIC COMPANY, REOR-

GANIZATION COMMITTEE OF DEEP ROCK OI,

CORPORATION, H. N. GREIS, Trusrez or Deep Rock

Om Corporation, ayD DEEP ROCK OIL CORPORA-

TION.

BRIEF IN SUPPORT OF PETITION FOR WRIT OF

CERTIORARI.

I. Opinions of Court Below.

The District Court rendered no opinion in the instant case.

The opinions of the Circuit Court of Appeals for the Tenth

Circuit are officially reported in 96 F. (2d) 693-710 and in

this Record at I-477-505.

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;

Il. Jurisdiction.

The decree of the Circuit Court of Appeals was entered on

April 27, 1938 (I-505). A petition for rehearing was filed on

the twenty-fifth day of May, 1938, and was denied on the

sixth day of June, 1938 (1-507, 526, 527). The statutory

provision which is believed to sustain the jurisdiction of

this Court is Section 240(a) of the Judicial Code as Amended

(28 U.S. C. A., See. 347).

HI. Statement of the Case.

The essential facts of the instant case have been stated

in the foregoing petition, reference to which is prayed.

IV. Specifications of Error.

The District Court erred in its orders of December 22,

1936, and February 3, 1937, and the Circuit Court of Appeals

for the Tenth Circuit erred in affirming them, because

1. Under the substantially undisputed facts of the instant

case and as a matter of law, Standard was entitled to no

claim as a creditor of Deep Rock, by reason of the appli-

cability of the Instrumentality Rule.

_ 2. Under the uncontradicted and overwhelming weight of

the evidence, a’ total of $20,000,000 of specific items of

charges included in Standard’s account against the Debtor

are invalid and unsustainable. (See specific items listed in

Record at I-338-345.) If only one-half of these wrongful

charges are eliminated, it requires the complete disallow-

ance of the entire Standard claim.

3. The validity of the Standard claim should have been

adjudicated on its merits.

4. The compromise was contrary to the best interests of

the preferred shareholders of the Debtor and was unwar-

ranted under all of the circumstances of the instant case.

5. The instant compromise was precluded by reason of

res adjudicata resulting from the District Court’s rejection

of the first compromise proposal.

6. The compromise proposal was not presented or recom-

mended by the Trustee, nor was there any proof of fairness

thereof, contrary to the provisions of Section 27 of the

Bankruptcy Act and General Order in Bankruptcy No. 33

(11 U. S. C. A., Secs. 50 and 53).

7. The compromise proposal was a fraudulent device to

release Standard from its burden of proving the fairness

of the transactions with Deep Rock upon which the open

account is based, contrary to the rule of law that attaches

a presumption of fraud to dealings between common direc-

torates.

8. The compromise was inserted as part of the Plan of

Reorganization, contrary to the provisions and intent of

the 77-B Act.

9. The Plan was unfair in that it unfairly allocated the

major portion of the Debtor’s assets to Standard at the

expense of the public preferred shareholders of the Debtor.

10. The Plan was unfair in that it was wrongfully predi-

cated on the assumption that Standard has a valid claim

as a creditor of Deep Rock in the amount of five million

dollars.

11. The Plan was unfair in that it was wrongfully predi-

cated on the so-called Trustee’s Appraisal of the Debtor’s

fixed assets, which appraisal was unfairly low, was not

made by disinterested persons, and failed to take into

account the earnings or earning power of the Debtor as

a going-concern.

12. The compromise and Plan were offered and accepted

in bad faith by Standard, the Debtor, the Respondent Re-

MO ke ee le ee ee

ae tele Rhee Pentllh e

eds) acct, hoeh,

organization Committee, and by the largest individual

holders of preferred stock.

13. The District Court and the Circuit Court of Appeals

should have refused to approve and confirm the compro-

mise and Plan and should, instead, have denied the allow-

ance of any claim to Standard by an adjudication on the

merits of the Standard claim and should have adjudicated

that the Debtor was the owner of all of the assets of the

Refining Company, free of any claims on the part of Stand-

ard or its nominees.

V. Summary of Argument.

For the sake of brevity, reference is prayed to the ‘‘Rea-

sons for Granting Certiorari,’’ contained in the foregoing

petition for certiorari.

VI. Argument.

1. AppLicaTion oF THE InstTRUMENTALITY RULE IN 77-B

PROCEEDINGS.

The applicability of the Instrumentality Rule in the in-

stant case is entirely a matter of law, the facts being sub-

stantially undisputed. Petitioners have claimed through-

out, and were sustained by Circuit Judge Bratton ( 1-504)

in their contentions, that the Instrumentality Rule of law

should be applied in denying Standard’s claim as a creditor

against Deep Rock, its instrumentality subsidiary. If Stand-

ard has no valid claim, then, we submit, that the approval of

the compromise allowance of that claim at five million dol-

lars was erroneous as a matter of law. In refusing to

apply the Instrumentality Rule in the instant case, the deci-

sion of the majority members of the Circuit Court of

Appeals is clearly in conflict with the decisions of this

Court and the decided weight of authority.

The Instrumentality Rule is a fairly recent development

of the law. This Court was among the first to blaze the trail

in the recognition and development of this Rule. The Rule

has been stated by this Court to be a broad equitable rule of

law, that separate corporate entities of a parent and sub-

sidiary will be disregarded by the courts

‘ce * * where stock ownership has been resorted

to, not for the purpose of participating in the affairs of

a corporation in the normal and usual manner, but for

the purpose * * ®* of controlling a subsidiary so

that it may be used as a mere agency or instrumentality

of the owning company. * * °* In such a case the

courts will not permit themselves to be blinded or de-

ceived by mere forms of law but, regardless of fictions,

will deal with the substance of the transaction involved

as if the corporate agency did not exist and as the justice

of the case may require.’’ (From the opinion of Mr.,

Justice Clarke in Chicago, M. é St. P. Ry. v. Minn

Civic. Assn., 247 U. S. 490, 501, 62 L. Ed. 1229.)

This rule has often been applied by this Court in piercing

the forms of separate corporate entities ‘‘as the justice of

the case may require.’’ /Under the decisions of this Court,

the parent company has been held liable for the obligations

of its ‘‘instrumentality’’ subsidiary on contracts and torts

and also as the real offender in statutory violations com-

mitted through its ‘‘instrumentality’’ subsidiary.

McCaskill v. U. 8., 216 U. 8. 504, 54 L. Ed. 590 (1910) ;

U.S. v. Lehigh Valley R. R. Co., 220 U. S. 257, 55 L. Ed.

458 (1911);

U.8. v. Del., L. d W. R. R. Co., 238 U. 8. 516, 59 L. Ed.

1438 (1915) ;

Hart Steel Co, v. Railroad Sup. Co., 244 U.S. 294, 61 L.

Ed. 1148 (1917) ;

U.S. v. Reading Co., 253 U. S. 26, 64 L. Ed. 760 (1920).

¥ \wue

The Instrumentality Rule has likewise been applied to

deny the parent company’s claim as a creditor upon the re-

ceiwvership or bankrugtcy of its ‘‘instrumentality’’ subsidary.

Centmont Corp v. Marsch, 68 F. (2d) 460 (C. C. A. 1,

1933) ;

E. E. Gray Corp. v. Meehan, 54 F. (2d) 223 (C. C. A. 1,

1931) ;

Clere Clothing Co. v. Union Trust & Savings Bank, 224

Fed. 363 (C. C. A. 9, 1915) ;

In re Kentucky Wagon Manufacturing Co., 71 F. (2d)

802 (C. C. A. 6, 1934) ;

Edzard Finch Co. v. Robie, 12 F. (2d) 360 (C. C. A. 8,

1926) ;

Baker Motor Vehicle Co. v. Hunter, 238 Fed. 894 (C. C.

A. 2, 1916) ;

In re Burntside Lodge, Inc., 7 Fed. Supp. 785 (D. C.

Minn. 1934) ;

Matter of Otsego Waxed Paper Co., 14 Fed. Supp. 15

(D. C. Mich. 1935) ;

Albert Richards Co. v. The Mayfair, 287 Mass. 280, 191

N. E. 430 (1934) ;

S.G.V. Co. of Dela. v. S.G. V. Co. of Pa., 264 Pa. 265,

107 Atl. 721 (1919) ;

Powell, Parent and Subsidiary Corporation (1931)

pp. 112-114;

Latty, Subsidiaries and Affiliated Corporations (1936)

NPP. 151-153.

We submit that in not one of these cases has there been

nearly as many factors calling for the application of the

Instrumertality Rule as appear in the instant case and as

set forth in the petition herein. We have seen that Stand-

ard had complete control over the Debtor and its manage-

ment; that it ran the Debtor’s affairs to suit its own ends

and without any regard for the interests of the Debtor or the

latter’s public securityholders ; that the operating officers of

the Debtor were at all times completely subservient to Stand-

ard’s top-officers who, at the same time, were also the top-

officers of the Debtor; that through dummy officials and by

direct intervention, Standard dictated, without restraint,

the many fraudulent transactions which form the basis of its

claim as a creditor of the Debtor; that Standard misled the

Debtor’s securityholders through misrepresentations and

market manipulations of the Debtor’s securities ; that Stand-

ard exercised all the attributes of a sole owner of the

Debtor’s assets, yet upon bankruptcy of the Debtor, it seeks

to share as a creditor rather than as an owner of those assets.

We submit that within the principles laid down by this Court,

the interests of justice require the denial of Standard’s claim

to share as a creditor of the Debtor at the expense of the pub-

lie securityholders whose rights have throughout been

flaunted. The majority’s decision in the instant case was,

we submit, merely giving lip-service to the Instrumentality

Rule, when it recognized its existence while, at the same time,

it refused to apply the Rule to deny Standard’s claim.

The decisions that have thus far applied the Instrumen-

tality Rule in denial of a parent company’s claim as a

creditor against its instrumentality subsidiary have relied

upon the principles laid down by this Court. This Court,

as yet, however, has never decided a case involving the ap-

plication of the Instrumentality Rule to deny a parent com-

pany’s claim as a creditor upon receivership or bankruptcy

of its ‘‘instrumentality”’ subsidiary. This phase of the In-

strumentality Rule is of particular public importance in view

of the advent of 77-B proceedings for corporate reorganiza-

tion. The reorganization of many of the largest corpora-

tions of this country involve the disposition of large claims

between interrelated corporations, under circumstances

necessarily involving the applicability of the Instrumentality

Rule. By this Court’s delineation of the applicability of the

ELLE LILLE LIL SPLECLE LL ADL

Instrumentality Rule to such situations, a great service will

have been performed for thousands of public security-

holders whose rights, as in the instant case, are dependent

upon the application of that Rule.

2. Unvam Apprawat rx 77-B Procezpi.gs.

As we have hereinbefore seen, a fair appraisal of the

Debtor’s assets would leave a substantial equity for the

preferred shareholders, even assuming that Standard has a

valid claim of five million dollars. The importance of a

fair and disinterested appraisal has long been recognized

; by this Court. The appraisal accepted by the District

2 Court, however, was neither fair nor disinterested.

“i It was to Standard’s interest to arrive at a low valuation

| of the Debtor’s assets in order to justify the elimination of

| the preferred shareholders from any equity in the Debtor’s

assets. It is undisputed that the instant appraisal was prv-

; i) pared by employes having a primary allegiance to Standard

| (II-v26, 484). These same employes were originally hired

O- Ne cehe ieenan ewes os ~ 2 + pects waa

by Standard and under the Plan of Reorganization they

would again be in Standard’s employ (II-519, 463). These

same employes had previously submitted appraisals of the

Debtor’s fixed assets in an amount four times higher than

now claimed when it suited Standard’s needs in the manipu-

| lation of the Debtor’s securities (ITI-113, 125, II-102, 193,

534-5). It is little wonder that they submitted the instant

appraisal to again suit Standard’s needs, although it was by

‘ar the lowest appraisal ever made of the Debtor’s fixed

assets (III-125, II-102, 193, 5345) (1-43, I1-595-605)

(II-676-9) (III-130) (ITI-146, I1-519, 512-14) (II-781-2,

537-40).

Moreover, as we have seen, the Trustee who lent his name

to this appraisal had already made a substantially higher

appraisal of these same fixed assets which was some seven

million dollars more than his present appraisal (I1-512-14,

| RB OT CRO TT atts ne

ae Se

;

Bere oe were

519). This gross discrepancy, the Trustee did not even

attempt to explain.

Furthermore, the instant appraisal admittedly gave no

consideration to the tremendous earnings and earning power

of the Debtor as a going concern (II-501, 504, 528-9, 566).

No appraisal can be deemed a fair one that disregards this

important factor.

This Court, through the opinion of Mr. Justice’Brandeis,

in the case of National Surety Co. v. Coriell, 289 U. S.

426, 77 L. Ed. 1300 (1933), reversed the confirmation of a

plan of reorganization in a Federal Equity Receivership.

In so doing, the opinion pointed out that ‘‘a trustworthy

appraisal’’ by ‘‘a disinterested appraiser’’ was a necessary

prerequisite to a fair reorganization. This Court there

pointed out further that a fair appraisal must take into

account ‘‘results of the operation of the business’’.

These requirements were further stressed by this Court

in the subsequent case of First National Bank v. Flershem,

290 U. 8. 504, 78 L. Ed. 465 (1934), wherein this Court, after

granting certiorari, reversed the decision of the Circuit

Court of Appeals entirely by reason of an inadequate ap-

praisal of the assets. In that case, Mr. Justice Brandeis

again pointed out the indispensability of an appraisal ‘‘by

independent experts’’ and the requirement that a fair valua-

tion of the business of a corporation must take into account

its value ‘‘as an entirety as a going concern’”’.

The requirement that the earning power of a corporation

must be taken into account in any fair valuation of the

assets of a going concern has been recognized on every

occasion that it has come before the courts. Some of these

decisions are:

Borg v. International Silver Co.,-11 F. (2d) 147 (C.

C. A. 2, 19-5);

Doyle Dry Goods Co. v. Lewis, 5 F. (2d) 918 (C. C. A.

8, 1925);

Allied Chem. & Dye Corp. v. Steel & Tube Co., 14 Del.

Ch. 64, 122 Atl. 142 (1923) ;

Ahlenius v. Bunn Humphries, Inc., 358 Tl. 155, 192

N. E. 824 (1934).

In 77-B proceedings, the importance of a fair and disin-

terested appraisal can scarcely be overestimated. See

Jamieson v. Watters, 91 F. (2d) 61 (C. C. A. 4, 1937).

Section 77-B, unlike bankruptcy, contemplates the contin-

uation of the Debtor as a going concern. To value the

assets of the Debtor in 77-B proceedings without giving

consideration to its earning power as a going concern ig-

nores the basic nature of the 77-B Act. It is respectfully

submitted that this Court, by its decision in the instant

case, should propound the rule that an appraisal in 77-B

proceedings must take into account the earnings of the

Debtor as a going concern and must comply with the same

principles of fairness which this Court has already laid

down for equity receiverships.

3. ABusEs of Pusiic Utitiry Hoipine Compantzs.

The fraudulent charges which Standard, a billion dollar

public utility holding company, foisted upon its subsidiary,

the Debtor, are typical of the abuses by many public utility

holding companies which have brought upon them both pub-

lic and legislative condemnation. In the instant case, peti-

tioners have urged that the Standard claim includes some

twenty million dcllars of fraudulent and unsustainable

charges which it imposed on Deep Rock (1-335-346).

Typical among these are the charges of $1,200,000 for

management fees for services which in fact were never ren-

dered (II-4-5, 7, 9-10, 14-16, 27-29, 40, 41, 55-59, 227-8, 229).

Standard imposed these latter charges through the medium

of its wholly owned subsidiary, the Byllesby Engineering

and Management Corporation as part of its general policy

Reioe.

of imposing such charges on its various public utility sub-

sidiaries (II-3, 7-8, 100-1, 359, 691). The fraudulent nature

of these charges was reluctantly conceded by the Vice-

President of Byllesby and Company (I1-433-4) and was

further acknowledged by the Attorney for the Trustee, who

stated :

‘This Management Corporation, that is the same

thing Congress has had in this Holding Company Bill.

* * * Just like all these other public utilities were

doing, the purpose is to make a fictitious overhead

charge on public utilities in order to maintain their

rates. Now this Management Corporation, the Stand-

ard owned all of its stock, said so in its annual reports.

It received from that Company over $23,000,000 in divi-

dends, and they (Management Corporation) never had

any assets except pencils and drawing tools’’ (II-405).

Legislative and Executive action has already been taken

to curb the prevalent abuses committed by public utility

holding companies. It is respectfully submitted that this

Court, by its decision in this case, can aid in correcting a

situation which has become a national problem.

4. PresuMPTION oF Fraup 1n DEaLines BETWEEN COMMON

DrImECTORATES.

All of the dealings upon which Standard’s claim against

Deep Rock is based are admittedly dealings between a com-

mon directorate and interlocking officers (II-324-56). This

Court, as well as the decided weight of authority, has estab-

lished the Rule that such transactions are presumptively

fraudulent.

Corsicanna Nat. Bk. v. Johnson, 251 U. S. 68, 64 L. Ed.

141 (1919) ;

Geddes v. Anaconda Copper Mining Co., 254 U. S. 590,

65 L. Ed. 425 (1921) ;

Lo Ne Ll aS I

Western Distributing Co. v. Public Service Commission,

285 U. 8. 119, 76 L. Ed. 655 (1932) ;

Hyams v. Calumet & Hecla Mining Co., 221 Fed. 529

(C. C. A. 6, 1915) ;

International Radio & Telephone Co. v. Atlantique

Communication Co., 290 Fed. 698 (C. C. A. 2, 1923) ;

Vallery v. Denver & R. G. R. R. Co., 236 Fed. 176 (C. C.

A. 8, 1916) ;

Penn. Canal Co. v. Brown, 235 Fed. 669 (C. C. A. 3,

1916) ;

Forbush Co. v. Bartley, 78 F. (2d) 805 (C. C. A. 10,

1935) ;

Farmers Loan & Trust Co. v. N. Y. é M. R. Co., 150

N. Y. 410, 44 N. E. 1043 (1906) ;

Allied Chemical Dye Corp. v. Steel & Tube Co., 14 Dela.

Ch. 1, 120 Atl. 486 (1923).

Speaking of the basis for this rule, this Court has held:

‘‘The relation of directors to corporations is of such

a fiduciary nature that transactions between boards

having common members are regarded as jealously by

the law as are personal dealings between a director and

his corporation; and where the fairness of such trans-

actions is challenged, the burden is upon those who

would maintain them to show their entire fairness ; and

where a sale is involved, the full adequacy of the con-

sideration. Especially is this true where a common

director is dominating in influence and character. This

court has been consistently emphatic in the application

of this rule, which, it has declared, is founded in the

soundest morality, and we now add, in the soundest

business policy. Twin Lick Oil Company v. Marbury,

91 U. S. 587, 588; 23 L. Ed. 329, 330; Thomas v. Brown-

ville, Ft. K. & P. R. Co., 109 U. 8. 522, 27 L. Ed. 1018, 3

Sup. Ct. Rep. 315; Wardell v. Union P. R. Co., 103 TU. S.

651, 658, 26 L. Ed. 509, 511; Corsicanna Nat. Bank v.

Johnson, 251 U. S. 68, 90, 64 L. Ed. 141, 155, 40 Sup.

Ct. Rep. 82. * * *’’ (From the opinion of Mr. Justice

Clarke in Gddes v. Anaconda Copper Min. Co., 254

U. 8. 590, 599, 65 L. Ed. 425 (1921.)

In the instant case, Standard had the burden of proving

the fairness of its dealings with Deep Rock as a condition

precedent to the establishment of its claim. Through the

device of a compromise proposal, Standard has established

its claim without being required to overcome the presump-

tion of fraud which this Rule attaches to its dealings with

Deep Rock. Thus, a way has been opened to avoid the rigid

judicial scrutiny of such transactions required by this long

established Rule.

‘‘Soundest morality’? and ‘‘soundest business policy’’

require that this Court undertake by its decision in the

instant case to prohibit the evasion of this salutary rule of

law.

5. ComproMIsE Powers 1n 77-B PROCEEDINGS.

In the instant case, the District Court invoked the powers

of Section 27 of the Bankruptcy Act (11 U.S. C. A. See. 50)

in the compromise of a claim in 77-B proceedings. By its

terms, Section 27 authorizes the compromise of a claim in

bankruptcy when it is ‘‘for the best interests of the estate’’.

In the instant case, this Act was applied in compromising

the Standard claim in disregard of the ‘‘best interests’’ of

the public preferred shareholders of the Debtor. Under the

appraisal accepted by the Court there was only a five million

dollar equity in the Debtor’s assets for satisfaction of the

claims of both Standard and the preferred shareholders.

The preferred shareholders gained nothing by the compro-

mise inasmuch as their equity was as completely eliminated

by the compromise allowance of Standard’s claim at five

million dollars as it could be by the allowance of the Stand-

ard claim at its full amount of some nine million dollars.

Standard, on the other hand vained as complete a victory

an en ene ee

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by the compromise as it could possibly gain by a victory in

the trial on the merits of its claim. Thus, the compromise

was clearly contrary to the ‘‘best interests’’ of the pre-

ferred shareholders.

Prior to the 77-B act, the only concern of the Bankruptcy

courts was with the ‘‘best interests’’ of the creditors of the

estate. The instant case, however, presents the question of

whether in 77-B proceedings the compromise of a claim

must also consider the ‘‘best interests’’ of stockholders

who have an equity in the Debtor’s assets. It is respectfully

submitted that by its decision in the instant case, this Court

should lay down the proper limitations of compromise pow-

ers in 77-B proceedings.

6. Impropriety oF Magority’s RerusaL to ADJUDICATE

STanDARD CLAIM.

Both Majority opinions of the Circuit Court of Appeals

refused to pass on the merits of the Standard claim. Circuit

Judge Phillips states in his opinion:

‘‘Clearly whether Standard was entitled to whe allow-

ance of its claim on the merits is not the issue here pre-

sented’’ (1-492).

Circuit Judge Williams likewise asserts in his opinion:

‘*Tt is not to be understood that I express any opinion

as to whether the Deep Rock Oil Corporation was an

instrumentality of the Standard Gas and Electric Com-

pany’’ (1-499). .

These holdings are in direct conflict with the basic require-

ment for the provability of a claim in bankruptcy. The test

of provability of a claim in 77-B proceedings is stated in the

opinion of Circuit Judge Chase in the recent case of In re

United Cigar Stores Co. of America, 82 F. (2d) 247 (C.C. A.

2, 1936) :

nl — _ — ——

‘‘Section 77-B of the Act (11 U. S. C. A. Section 207

(B) permits the filing of ‘claims of whatever character

against the debtor or its property, including claims

under executory contracts, whether or not such claims

would otherwise constitute provable claims under this

Act (Title).’ So here the test of provability is the

actual existence of a valid claim.”’ (Italics ours.)

By its refusal to adjudicate the validity of the Standard

claim, the majority of the Court failed to apply the test of

‘Sactual existence of a valid claim.”’ °

The Court’s refusal to adjudicate the validity of the

Standard claim is, moreover, paradoxical in that, by approv-

ing the compromise, the Court indirectly does adjudicate

that Standard has a valid claim of five million dollars. Such

a highly incongruous result is particularly unwarranted

where, as here, the validity of the claim is so seriously open

to question. On the only two occasions when the validity of

the Standard claim has judicially been passed on, it has been

held that the Standard claim is valid m its entirety. The

District Judge so held in his opinion stated in open court

at the time of the rejection of the First Compromise Pro-

posal (II-406-7)._ Circuit Judge Bratton likewise so held

in his dissenting opinion (1-505).

It is, we submit, exceedingly unfair that, without even

taking issue with these holdings that the Standard claim

is actually invalid in its entirety, the Majority nevertheless

approve the compromise allowance of that claim at five mil-

lion dollars. By its refusal to adjudicate the merits of the

Standard claim, the Circuit Court of Appeals effectively

eliminated the preferred shareholders without even an ad-

judication that that elimination is a meritorious one. It

effectually deprived the preferred shareholders of their day

in Court under circumstances that are clearly contrary to

any basic notions of fair play. Under these circumstances,

the refusal of the Court to adjudicate the Standard claim

on its merits is, we submit, a gross injustice calling for ,

supervisory correction by this Court.

7. Inepropriery or Insertinc ComPrRoMIsE Inv PLAN oF

REORGANIZATION.

In the instant case, the Plan of Reorganization and the

Compromise allowance of the Standard claim are made a

part of each other (1I-381-2, 393-5). In this way, the Stand-

ard claim is allowed for the first time in the Plan of Reor-

ganization itself.

In order to arrive at fair and equitable plans of reorgani-

zation, it is necessary that the amount and priority of claims

and securityholders should be established prior to the pro-

mulgation of a plan of reorganization. Unless that is first

determined, the fairness of the participation granted to the

different classes of securityholders under the plan of reor-

ganization can scarcely be judged.

This was admitted by the attorney for the Respondent

Reorganization Committee at the close of the hearing on

the first compromise proposal. He told the District Judge /

that the adjudication of the Standard claim was

“eo * * ‘a primary step precedent to the submission

of the plan (of reorganization) tothe Court * * * I

cannot see the possibility of preparing a Plan of Reor-

ganization which has as one of its (conditions) the com-

promise or disposition of a claim’’ (II-409-10).

Despite this view conceded by the attorney for the Respond-

ent Reorganization Committee, the Amended Plan of Re-

organization combined the Compromise of the Standard

claim with the Plan of Reorganization.

There is no express provision in the 77-B Act which per-

mits such a combination. As a matter of principle, the basic

objection to such combination is that, where, as here, the

Plan of Reorganization itself first establishes the propriety

and amount of the claimant’s claim, the inquiry as to the

fairness of the Plan is so highiy interwoven with the inquiry

as to the propriety of the claim as to befog both issues. Such

a result is clearly contrary to the spirit and intent of the

77-B Act. It is the aim of 77-B proceedings to to light

all of the basic problems incident to the reor ization of a

particular debtor. This Court should undertake to prohibit

the use of methods which, as in the instant case, becloud the

issues and result in unfair and inequitable plans ofreorgani-

zation.

8. Unrarr Practices or BANKER AND ManaGEMENT Coyn-

TROLLED REORGANIZATION COMMITTEES.

The Reorganization Committee in the instant case was

admittedly organided by Byllesby & Company, the top hold-

ing company controlling Standard and the Committee there-

after constantly favored Standard as against the interests

of the public preferred shareholders whom it purported to

represent (II-312, 399, 423-4, 465, 717).

Gross abuses of such reorganization committees have al-

ready subjected them to remedial legislation. A compre-

hensive study of the activities of such reorganization com-

mittees is contained in a published report by the Securities

and Exchange Commission, dated May 10, 1937, written pur-

suant to an Act of Congress (Section 211 of the Securities

Exchange Act of 1934). This report is entitled ‘‘Report on

the Study and Investigation of the Work, Activities, Per-

sonnel, and a of Protective and Reorganization

Committees.’’ submit that there is hardly a single trick

that is employed by unscrupulous reorganization committees

as disclosed by that report that cannot be found in the Rec-

ord of the mstant case.

The reeord of the Reorganization Committee in the instant

case well justifies the conclusions of the Securities and Ex-

change Commission, as expressed by its one time Chairman.

The Honorable Joseph. P. Kennedy when he said (S. E. C.

Report, Part IT, page 509) : /

‘‘The activities of Protective Committees constitutes

one of the most dismal chapters in the annals of Ameri-

can finance. * * * The investment banker, except in

rare cases, organizes these Committees for selfish pur-

poses, and the interests of the securityholders are a

secondary consideration at best. * * *

“In many instances the bankers organized a commit-

tee for the express purpose of taking command of the

reorganization and, by covering up the evidence of their

past wrongdoings, insulating themselves against lia-

bility. In practically every case, the bankers were moti-

vated by a greedy desire to preserve or secure control,

so that they might enjoy the perquisites thereof. This

is the equivalent of what we call ‘graft’ in public life.’’

See, also, dissenting opinion of Mr. Justice Stone in U. S.

v. Chicago, M. St. P. € P. R. Co., 282 U.S. 311, 331, 75 L. Ed.

359.

In the instant case, the Record discloses that the Re-

organization Committee has'used many of the artifices con-

denined in that report in aiding Standard to accomplish its

aim of wiping out the preferred shareholders of the Debtor.

It is respectfully submitted that this Court by its decision

in the instant case should enunciate the principles by which

reorganization committees should be bound in their repre-

sentation of public securityholders.

9. Bap Farrag Orrer anp ACCEPTANCE OF PLAN.

The instant Record discloses that the offer and acceptance

of the Plan was in bad faith. The offer of the Plan was

made by Standard through its instrumentality, the Respond-

ent Reorganization Committee (1-276, Ii-717). From the

outset, they sought to eliminate the preferred shareholders

from their equity in the Debtor’s assets’by the offer of the

First Plan of Reorganization (11-819, 406), which was

defeated by the Taylors.

tt Oe

The offer and acceptance of the Amended Plan was

equally in bad faith. The instant Record discloses that the

public preferred shareholders represented by the Reorgani-

zation Committee were misled in their acceptance of the Plan

by the misrepresentations and artifices of the Reorganiza-

tion Committee (II-682-4, 444, 451-2).

Moreover, the largest individual holder of preferred

shares of Deep Rock, holding 6,000 shares, is Utility and In-

_dustrial Corporation, a wholly controlled subsidiary of

Byllesby & Company (II-580-4, 715-16). Its acceptance of

the Plan was purely at the dictation of its masters, Byllesby

7 and Company and Standard.

The Pitcairn interests, the second largest preferred share-

holder, hold 2,350 shares. Prior to the hearing on the

Amended Plan, they had joined with petitioners in opposing

the Plan and Compromise (I-33). A few days before the

hearing, they suddenly withdrew their powers of attorney

from petitioners (I-33-4) and joined with the Reorganiza-

tion Committee in accepting the Plan and Compromise (II-

872). At the hearing, it developed that their change of posi-

tion was actuated by reason of their ownership of a large

block of Deep Rock notes (1-309). Prior to the hearing, the

Reorganization Committee had agreed to double the amount

of cash that was to be distributed to noteholders under the

Ameuded Plan as then promulgated (I-302-11). In return

for this and other concessions to their position as notehold-

ers, the Pitcairn interests voted their preferred stock in sup-

port of fhe Amended Plan (1-33-4, I1-463-4).

The Reorganization Committee further represents 969

shares of Deep Rock’s preferred stock owned by Standard

(11-583-4). Thus, three of the largest holders of preferred

stock, holding a total of 9,319 shares out of the 29,144

shares voting for acceptance, accepted the Plan by reason

of special interests not common to the entire class of pre-

ferred shareholders.

@ t The basic rights of minority securityholders to be secure

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against oppression by the majority is a fundamental prin-

ciple of law long recognized in receivership cases.

Lake St. El. R. Co. v. Ziegler, 99 Fed. 114 (C. C. A. 7,

1900) ;

Eshleman v. Keenan (Del. Ch. 1936), 187 Atl 25; _

Outwater v. Public Service Corp. of N. J., 103 N. J.

Eq. 461, 143 Atl 729 (1928),

Hamilton-Brown Shoe Co. v. Ben L. Berwald Shoe Co.,

10 F. (2d) 275 (C. C. A. 5, 1926).

In National Surety Co. v. Coriell, 289 U. 8. 426, 77 L. Ed.

1300 (1933), this Court rejected a plan of reorganization

upon complaint by minority securityholders. In so doing,

Mr. Justice Brandeis said (437):

‘‘The creditors who approved of the Plan of Reor-

ganization appeared to be actuated in their recommen-

dations and desires by considerations not applicable to

the dissenting creditors.’’ -

This rule is of particular importance in 77-B proceedings

for the protection of minority securityholders where, as

here, acceptances by the*majority are heavily relied upon

as evidence of the fairness of a proposed Plan of Reorgan-

ization.

Downtown Investr:ent Assn. v. Boston Metropolitan

Building, 81 F. (2d) 314 (C. C. A. 1,-1936) ;

In re 1775 Broadway Corp., 79 F. (2d) 108 (C. C. A.

2, 1935). /

We submit that the instant Record discloses a situation

where the offer and acceptances of the Plan were clearly

in bad faith and should not be made binding on the minor-

ity securityholders.

It is respectfully submitted that this Court, by its deci-

sion in the instant case, should uphold the rights of minority

securityholders to be protected by the requirements of good

faith in the majority’s offer and acceptance of plans of re-

organization in 77-R proceedings.

10. Insustice or Decision oF Crscurt Court oF APPEALS.

By its decision in the instant case, the Circuit Court of

Appeals affirmed the elimination of a five million dollar

class of public preferred shareholders. This was ac-

complished, we submit, through the medium of an unfair

compromise and plan of reorganization.

It is true, of course, that the matter of the compromise

allowance of a claim is basically a matter of sound discre-

tion of the court. It is clear, however, that such discretion

must be exercised within the limits of fairness. In Langnes

vy. Green, 282.U. 8. 531, 541, 75 L. Ed. 520, 526 (1931), Mr.

Justice Sutherland held:

‘<The term discretion denotes the absence of a hard

and fast rule. The Styria v. Morgan, 186 U. 8. 1, 9,

46 L. Ed. 1027, 1033, 22 Sup. Ct. 731. When invoked

as a guide to judicial action, it means a sound discre-

tion, that is to say, a discretion exercised not arbitrar-

ily or wilfully, but with regard to what is right and

equitable under the circumstances and the law, and

directed by the reason and conscience of the judge to

a just result.”’

It is submitted that in no reported case has the compro-

mise allowance of a claim been permitted under circum-

stances comparable to the instant case. In no case has a

claim been allowed by compromise where, as here, the fol-

lowing circumstances were present:

(1) Full proofs in a trial on the merits of the claim had

already been completed (II-241-2) ;

Pao

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(2) The proofs on the claim were substantially undis-

puted, making the issue of the validity of the clai:n basic-

ally an issue of law;

(3) The claim is not such as appears in the usual course

of business but, on the contrary, involves intercorporate

dealings between a parent company and its subsidiary, with

debits and credits running over a period of many years sup-

ported by nothing more than the self-serving dictations of a

single management ;

(4) The uncontroverted facts disclose a situation calling

for the application of the Instrumentality Rule of law in

denial of the parent company’s right to a claim as a credi-

tor against its ‘‘instrumentality’’ subsidiary.

(5) The common directorate of the parent claimant and

the Debtor requires as a matter of law the application of

the rule that the claim is presumptively a fraudulent one.

Tkrough the compromise, the claimant sought to avoid its

burden of proving the fairness of its self-dictated dealings

with Debtor.

(6) The admitted facts disclose that the claim includes

huge charges arisiug out of a series of actually fraudulent

transactions imposed on the Debtor for the benefit of the

parent claimant ;

(7) An opinion had already been expressed by the Dis-

trict Judge that the claim was invalid in its entirety by

reason of the applicability of the Instrumentality Rule to

the undisputed facts (I1-406-7).

(8) The compromise was clearly contrary to the best in-

terests of a five million dollar class of public preferred

shareholders.

(9) No time or expense could conceivably be saved by

compromising the claim as against adjudicating it on its

merits. The claim had already been tried on its merits and

petitioners’ active objection to this compromise was known

} 65

by its proponents prior to its submission (I1-449-50). Thus,

it was known that the compromise could not end the litiga-

tion and that no time or expense could be saved by the

compromise as against an adjudication on the merits.

(10) The compromise was made a part of an unfair plan

of reorganization.

It is respectfully submitted that no conceivable scope of

judicial discretion could warrant the approéal of a com-

promise under all of these circumstances.

Moreover, the Circuit Court of Appeals, by its decision,

confirmed an unfair and inequitable Plan of Reorganiza-

tion. The Plan of Reorganization is basically unfair be-

cause its allotment of the Debtor’s assets to Standard at

the expense of the preferred shareholders ig erroneously

predicated on the assumption that Standard has a valid

claim as a creditor in the amount of five million dollars.

The Plan is further basically unfair in being predicated

upon an unfairly low appraisal of the Debtor’s assets.

This appraisal, as we have seen, was neither disinterested

nor did it take into account the earning power of the Debter

as a going concern. Such an appraisal cannot be accepted

as a fair one within the principles enunciated by this Court.

Conclusion.

We submit that the decision of the Circuit Court of Ap-

peals is erroneous as a matter of law. It is respectfully

submitted that the grave injustice of this erroneous deci-

sion to a five million dollar class of public securityholders,

as well as the importance of the many problems of public

concern presented by this case, should warrant this Court

in granting certiorari in the instant case.

Respectfully submitted,

Jason L. Honteman,

Attorney for Petitioners.

Dated August 24th, 1938.

ot (7123)

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