Amicus Curiae Brief — Consolidated Rock Products Co. v. Du Bois

Supreme Court brief1941

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NN il hdl or do aes & ip Wid we Oe Ww wr oo 8 ve tures

i Cd in sane udine de deedewecn oe ee bedobocdes

Statute involved... \__ Enea tad LEO, UC RU east BEN

ae el ved Gad neeiceboodne

I OF PEIN cicen wen wcwagesSccwecasewencusenes

Argu met: ,

The decision of tHe court below and the position of ;

* the Commission with respect thereto. ____._.____.

II. he findings of the district court are i: nsuffic ient to

permit determination that apy plan of. reorganiza-

tion is fair and equitable: fear sd okie el We ea sie io ta eae a

II}. The plan of reorganization now before the Court is

unfair to the bondholders of Union and Consumers_-

A. The treatment accorded to bondholders under

De Mieco cons oe. eck n eas pee fs

B. The treatment accorded to the bondholders

is ag fair and equitable__.___. a

, ‘ . The claims of Union and Consathere

against Consolidated... _-._,_.__-

‘2. The intermingling of the assets by

- Consolidated....3................

IV. A pian of reorganization is not unfair and inequitable

as a matter of law becgse classes of lienholders are

not given fully compefgatory treatment out of the

particular assets subj-ct to their respective liens, if

they are otherwise given sar corapensatory treat- .

Ne hae ee aCe ee a Pas be

SS A EA Ba en ere tae

REE a GRA on BSE IRONED Rie SRP aT Wea i

; CITATIONS .

Cases:

American en and Steel Mfg. Co. v. Seaboard Air Line Ry.,

fh | See as 3 Dare

Atlanta, B. & C. R. Co. v. United States; 296 U.S. 33.

Ealtimore & Ohio Tel. Co. v. Interstate Tel. Co., 54 Fed. 50-

-Barclay Park Corp., In re, 90 F. (2d) 595- slic

Case v. Los Angeles Lumber Products Co., Lid., 308 U. 8.

[tsctcnasceceensacddes Wy SGt Un wh, 04, O8, 41, 4, ©

Central-Republic Bank & Tr. Co. v. Caldwell, 58 F. (2d)

ee eee ca oe oe) Sateen

288614—41——_1 ie

50, g

‘48

_ Cases—Continued . , : Page.

Chicago Great Western Railroad Co., In re, 29 F. Supp. 149_ 34

Consolidation Coal Co., In re, if F. Supp. 594_._______. eR 27

Davis v. Alexander, 269 U. 8. 114_________ teeta. as ate * 46

Distilled Spirits/Fhe, 11 Wall. 356......_........ 45

Idaho, The, 93 U.S. 575.--._.....____. hemmed Poech tiene Siku 45

Intermingled Cotton Cases, 92 U.S. 65.__. Reeweubucaue ne . 45

Kansas City Terminal Ry. Co. v. Central Union Trust Cé.,

m8 2 Si eee eee RO ree 34

National Food Products Corporation, In re, 23 F. Supp. 979_ 34

National Surety Co. v. Coriell, 289 U. S. RE RAD 4]

Palmer v. Connecticut Ry. & Lighting Co., No. 38 this

. term, decided January 6, 1941__._...___..../. 27

Pennsylvania Canal Co. v. Brown, 235 Fed. 669, certiorari

denied, 242 U.S. 646.._______. Ante ix ad ema baetee wa i 46.

Pepper v.. Litton, 308 U. 8. MO ntsnnawcentiicnesecusux: ah.

Philadelphia Company v. Npple, Nos. 242, 243, present

_ term, decided Feb. 3, 1941__._____ __- ee kere 47

Pittsburgh Hotels Gorporation, In re, 17 F. Supp. 949____. 27 °

Standard Gas and Electric Company v. Deep Rock Oil Cor-

poration (C. CA, 10th), decided January 13, 1941__.__ 35

Trustees System Co. v. Payne, 65 F. (2d) 103.-.....____. 46

Utilities Power and Light Corp., In re, 29 F. Supp. 763,

appeal dismissed (C. C. A. 7th) March Wy ec espews 34

Union Naval Stores Co. v. United States, 240 U. 8. 284___. 45

Weekwire Spencer Steel Co., In re, 12 F. Supp. 528._____. 27.

The Willem Van Driel, Sr., 252 a Ne ee 46

Bankruptey Act: :

See. 57-th) (11 U.S. C. pee kee 43, 54

See. 57 (m) (11 U. S. C. SeeO3 | SERA eee 43, 54

Sec. 63 (a) (11 U. S. ©. See. 103 (8)).-.-.. Eran ae

Sec. 77 (e) (11 U. S.C. See. 205 EE Bar Sheek Ge 51, 55

Sec. 77B (b) (11 U. 8. C. See. 207 (b))_............. 43

' See. 77B (f) (11 U.S. C. Sec. 207 (f))....... 3,1, 55

See. 77B (k) (11 U. 8. C. See. 207 (k))_-......_._ 39, 43, 55

Chapter X, Secs. 174 and 221 (2) (11 U.'& C. Secs. 574

mw oy... “eee Ss

Chapter X, Secs. \208 and 276. c. (2) (ff U, S. C. See. .

we OO OS. 0. Sn 16

Chapter XT, See. 366 (3) (LI U. 8. C. Sec. 766 (d))____- 51

Chapter XII, Sec. 472 (3) (11 U.S. C. See. 872 (3)).... 51

‘Sec. 11 (b) (15 U.S. C. See. 79k Petacineecsacas cd 51

Sec. 11 (d) (15 U.S. C. Sec. 79k i ticemeccculceece. 51

See. 11 (e) (15 U. S. C. See. 79k i laadieacrwao an oes 51

‘ €

. oe. F

oo Ne

Miscellancous: }

Bonbright, Valuation of ‘aa (1987), Vol. 2, ‘pp. ee.

FP ididdta Che Khe oe ccesndanreusengeeewenene

' Dewing, The Financial Policy of Corporations (3d ed. ib

D, Peak was Abhi agen decawipesces Seeevdiguerorsesna

.. Finletter, The Law of*Bankruptey Regrganization (1939),

GR ekcneccachentetecesiecatbsnerhases a

Gilbert's Collier on ee (4th ed. 1937) sec. 1043-. -

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+ Inthe Supreme Court of the nied States :

OctoBER Term; 1940

’ No. 400 |

: Conso“ipaTED Rock Propvcts Co., anb Epwarp is, )

HATCH ET AL., COMPOSING THE PREFERRED STOCK-

_ HOLDERS. COMMITTEE OF CONSOLIDATED Rock Prop- *

UCTS Co., PETITIONERS

. ‘4,

I. Bios pu Bots -

No. 444 | =

¥. B, Bapaey ev AL., Composing THE UNIon Rock

CoMPANY BONDHOLDERS’ PROTECTIVE COMMITTEES,

ET AL., PETITIONERS |

VU.

K. Biois nu Bots

ON WRITS OF CERT'ORARI TO THE GNITED STATES CIRCUIT

COURT OF APPEALS POR THE NINTH CIRCUIT

BRIEF FOR THE SECURITIES AND EXCHANGE COMMISSION

AS AMICUS CURKIAE

OPENER S BELOW

The District Court rendered no opinion ; its find- —

ings. and conclusions appear at R. 219-265. The

(1) ,

opinion of the Circuit Court of Appeals (R. 365-

380), as modified (R. 382), directing reversal of the

order of the District Court is reported in 114 F.

(2d) 102. An earliat opinion of the Cireuit Court

of Appeals directing affirmance of the order of the

District Court ‘was withdrawn by the court (R.

364) ; that opinion is not a part of the record, but

‘“ it may be found in 107 F. (2d) 96, advance sheets,

JURISDICTION

The “decree of the Circuit Court of Appeals

reversing the order of the District Court was en- |

tered on June 49, 1940 (R. 381).. Petition for re-

hearing was denied. by the Circuit Court of Ap-

peals on August 5, 19TO\(R. 383). The petition

for a writ of certiorari in Ne. 400 was filed on Sep-

tember 6, 1940, and the petition fora writ of cer-

tiorari in No: 444 was filed on September 18, 1940. .

Certiorari was granted in both cases on October

28, 1940.. The jurisdiction of this Court rests upon

Section 240 (a) of the Judicial Code, as amended

by the Act of. February 13, 1925, ;

QUESTIONS PRESENTED

* The Circuit Court of Appeals reversed an order

of the District Court confirming a plan of reorgan-,

ization for Consolidated Rock Products Company

and its two wholly-owned subsidiari ies, Union Rock

C ‘company and Consumers Rock and Grav el Com-

pany, Ine. “The ere are: |

a. |

_ (1) Whether the court below correctly. held that

the findings of the District Court on the question

of the valuation of the properties of these com- —

‘panies were inadequate. .

(2) Whether under the rule enunciated in Case: '

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

U.S. 106, the plan of reorganization is unfair and °

inequitable to the bondholders of Union and .Con-

are permitted to participate although the bond-

holders do not: receive fully. compensatory treat-

' ment for their ‘claims. |

_(3) Whether the plan is, as a ic inattes of i un-

fair and inequitable to the bondholders of ‘Union ,

and Consumers inter sese on the ground that the

bondholders of each company are reqhired to share

’ the property securing their bonds with the bond-

holders of the other company, even though ‘they

receive. compensation in the form of interests in

other property. . . es |

STATUTE INVOLVED

The statute involved is Section 77B (f) of the

Bankruptey Act (11 U.S. C., See..207 (f)), the

pertinent portion of which is as follows:

-. After hearing such objections as may be

made to the. plan, the judge sliall confirm »

the ‘plan if satisfied that (1) it is fatr and

-_ equitable anid does not discriminate unfairly

in favor of any class of creditors or stock-

: es and is feisible * * *,

sumers because the stockholders of Consolidated - -

Other sections of the Bankruptcy Aci: herein-

after ea ta are printed In the Appendix, infra,

pp. maa | |

STATEMENE .

These proceedings were instituted on oe 24,

1935, by the filing of separate voluntary petitions

under Seetiori 77B of the Bankruptey Act by Con-

solidated Rock Products’ Company: (hereinafter

ealled Consolidated) and by its two wholly owned

subsidiaries, Union’ Rock Cothpany Chereinafter

cated Union) and Consumers Reck. and Gravel

Company,. Ine. (hereinafter ¢alled Consumers)

(R. 267). Consolidated has been i in possession of

. all the. pr operties of the three companies through-

~ out the proceedings (R. 267-268). No trustee

has been appointed for any of the « mpanies.

Capital Structure and Relation between Me

Com panies—Consolidated was organized in 1929 —

to acquire the. outstanding eapital stock of Union

and Consumers, , whigh were at that time competi-

tively engaged in’the business of mining, process-

ing. and marketing rock, sand, and gravel.’ in

southern CaNfornia. Both Union and Consumers

then had outstanding separate bond issues secured

by trust indentures on their respective properties

“(R. 235). There are now outstanding in the hands

of the publie-$1,877,000 of Union bonds on which

inteyést has been in default since March 1, 1934.

This interest aggregated $403,535 as of April 4,

_ 1987, the effective date of the plan. There are now

outstanding in the hands of the public $1, 137,000

of Consumers bonds, on which interest ets Deen

in default since July 1,4934.: This interest aggre- -

gated $221, 715 as of April 1, 1937. -(R. 189, 191- -

192.) <i :

To secure funds for the assis of Union’s

and Consumers” stocks, Consolidated issued its

own preferred, and common stock ”(R. 234).

Consolidated now has outstanding 285,947 shares

of preferred stock without par value but with a

liquidation preference’ of $25 per share plus ac-

cerned’ dividends, and 397,455 shares of common

stock without par value (R. 25, 136).

Upon acquiring control .of Union and Con-

suxaers, Consolidated designated their directors

and officers (R. 236). It-then caused the subsid-

iaries to execute an ‘operating agreement with it.

(R. 236) pursuant to which Consolidated took over

the possession, operation, management and fmane-

ing of their properties.t Under the terms of the

agreement, Consolidated undertook to majntain

.. the properties of the subsidiaries jn first class coi-

dition; to keep proper records of all transactions

between the parties, including proper entries con-

cerning depreciation, depletion, amortizatid n and

(obsolescence in compliance with the trust inden-

1 The nas also covered the properties of Reliance

’- Rock Company, a wholly owned subsidiary of Union (R. 236,

233-234). Legal title to all the properties of Union, Con-

sumers, and Reliance, except current assets, was for mally

retained by these companies. (KR. 164). a

288614—41-2

ioe | ;

tures of the subsidiaries ; to pay them the amounts

hecessary to enable them to meet the interest and

sinking fund provisions of their trust indentures ;

and to varry out the covenants of the trust inden-

tures (R. 165-168). Consolidated was to retain.

all the net revenues of the properties that might.

remain (R. 174). : ‘

Consolidated also agreed. to credit the current.

accouuts of the subsidiaries with items of deprecia-

tion, depletion, amortization and obsolescence

(R. 171}. Upon terminatioy of the agreement, the

properties were to“be returned and a final settle-

ment of accounts-made, including payment by Con-

_ Solidated of*the items of depreciation, depletion,

amortization, and obsolescence credited to the, sub-

sidiaries (R. i74). The agreement provided that

_ it was made for the mutual benefit of the parties

thereto and not made ‘for the benefit of any third

person as that term is used in Section 1559 of the

Civil Code of the State of Califernia” (R. 174- |

175). It further provided that any part might

withdraw from the agreement upon 30 days’ notice, -

and that the agreement was to terminate when such

notice was given by all of the subsidiaries to Con-

solidated or by Consolidated to all of the subsidi-

aries R. 173-174). ;

On. February 16, 1933, Consolidated accom-

plished. a purported modification of the operating

% .

agrécitontt (R. 176, 237) through an fasbrament

signed by the president and secretary of Consoli-

dated; who also signed as preSident and secretary

of each of the subsidiaries (R. 182). This modi-

fication agreement provided that the depreciation

to be credited to thé subsidiaries by Consolidated

for the entire period of the operating agreement,

‘beginning retroactively as of the execution of the

original operating agreement, s should be er redited

only upon the termination of the agreement. The:

amount -of the credit was to be arrived at on. the

basis of retroactive appraisals, made after the ter-

‘mination of the agreement, of the value @f the

properties as of April 1 of each year. The pro-

vision of the original agreem vent for withdrawal of

any party upon 30 days’ notice, was eliminated and

it was provided instead that, except in the case of °

default, the agr ‘eement was +o run Yor five years

from the date of the modification, with-an option

in Consolidated fo. extend the agreement for a fur-

ther term of five’ years upon one year’s written

notice. In the event of default by Consolidated

as to any, subsidiar vy, that subsidiary could termi-

nate upon sixty days’ notice in w riting. Consoli-

dated was under no obligation to pay any amounts

for depreciation until términation of the agree- |

ment,, and then had’ the privilege, by paying an’

additional five per cent penalty, of paying 25 per.

cent of the amount of the depreciation credit in

Pe a

. : se

ten equal annual installments, and the remaining

7) per cent at the end of the tenth year from the

date of termination of the agreement. (R. 178-

181). Under the provisions of the modification

agreement, therefore, it was posstble for Consoli- _

dated: to avoid determination of the amount of the

depreciation credit until retroactive: appraisals

were made ten years s after execution of the agree-

mem, and to avoid payment of 75 per cent of the

amount so determined for 20 years: after execution

of the agreement,

After the execution of the original operating

agreement, Consolidated operated the properties

of all the companies as though there had been an

‘actual consolidation thereof under one owner-

Ship although the corporate existence of the sub-

sidiaries was maintained (R..140-141, 241). With

a decline in the volime of business and a conse-

quent contraction of operations, equipment and

material from noneperating properties were used

to supply shortages in operating properties without

regard to original ownership, so that, as the Dis-

triet Court found, it became impossrble to deter-

mine accurately what assets were. subject to the

indentures of each of thie subsidiaries (R. 241-242;

279-280). Consolidated’s own equipment pur-

chasedg both at the time of its organization,and

subsequently to replace worn-out eqydpment of all

the companies, was likewise intermingled with the

properties of the subsidiaries (R. 139-140, 149-150,

241-242, 316). Consolidated ’s s vice- president testi-

fied that the’ properties purchased by Consolic ated

“had an original cost of $860,007.39 arid a net ¥: alue,

as of September-20, 19: 37, of $296,465.58 GR. 286).

Consolidated has never undertaken to have the

subsidiaries’ properties app ‘aised, even thongh de-

faulis in the payment ef prineipal and interest on -

both Union and Consume rs bonds occurred in 192 3 =

and 1934 (R. 241), the companies have been in

reorganization since*May, 1935 .(R. 267), and the

Modification agreement: expired according to ‘its’

terms in February 1938.2 Consolidated’s books |

have been kept in accordance with the terms of the

original gperating agreement and no attempt has

been made to record any revised depreciation

enarges (R. 236, 280-1, 299). The show a- net

indebtedness to. Union and Consumers, as of June

30, 1938, of over $5,009,000 (R. 314-319).

Valuation. —The District Court did not find spe-

cifie values for the properties of either Consoli-

*'The modification agreement provided for earlier termi-

nation, in the event of default in any, of C ‘onsolidated’ s cove-

nants, including the covenant to pay the sums necessary to | +

ais a

meet. interest ang sinking fund requirements on the sub-

- sidiaries’ bonds (R. 167-168, 181). However, under the

terms of the agreement, termination could be effectgd only

‘by notice from the subsidiaries to Consolidated. The sub-

sidiar: ies were at all. times under the control of Consolidated,

and no such notice was given.

: | 10

dated, Union or Consumers or - for the properties,

of the ‘enterprise as a whole. The court did find,

generally, that the value of the assets of the com-

bined enterprise exceeded the aggregate claims of

the bondholders, including interest to April 1, 1937,

but was less than the amount of such claims plus

the claims of Consolidated’s preferred stockhold-

ers, including flividend accumulations (R. 245). °

The courtfurt er/found that the value of the as-

sets subject to the respective liens of the Union

and ConSumers bondholders was, in each ease; less

_than the principal and interest due on their bonds

- The-court below thought this finding

to be inconsistent with the finding’ that the assets

of the three companies have been so commingled

that identification thereof is impossible (R. 374).

Three witnesses testified concerning values, and.”

the valuations given by them are tabulated in the

opinion of the court below (R. 371). The average

of the valuatfous, which, is apparently accepted

as correct by petitioners (Br-31),° shows Union

with assets worth $2,202,733, as against a bonded

indebtedness, pail: interest, to April 1, 1937, of

* All references to petitioners: in this. brief; unless side

wise expressly stated, are to petitioners in No. 400. As

pointed out below (p. 16), the petitioners in No. 444 have

raised only the third of the questions presented and the

Commission is in agreement with their position on that

question. :

$2,280,555, and Consumers with assets worth $1,-

151,033, as against a bonded indebtedness, includ-

ing interest to April 1, 1937, of $1,358,715. On the

basis of similar averaging of the testimony of wit-

nesses (R. 281-282, 296), petitioners assert that the

value of Consolidated’s assets is $859,784 exclusive

of goodwill and trade names, which are arbitrarily

valued at $500,000 on the basis of the testimony of

Mitchell, Consolidated’s vice president (Br. 26, 27,

30; R. 282).

The testimony. upon. which petitioners rely in

these valuation. figures was- apparently based on-

physical factors, without reference to data concern-

“ing earning power. This testimony conflicts with

- the consolidated balance sheets furnished by Con-

-solidated, which show the enterprise to be insolvent —

in the bankruptcy sense (R, 214). It should also bé.

noted that,-except for the year 1929, Consolidated

showed no net operating profit, after bond interest —

and provision for depreciation and depletion, in

any year during the period from its organization

to the date of the hearings on thé plan’ (R. 190-

191). Considering the results of operations before

bond interest but after depreciation and depletion,

Consolidated liad a loss of $1,282,388 for the eight

and one-half years from April 1, 1929, the effective -

date of the operating agreement, to September 30, —

1937 (R. 183-191). Except for five quarterly divi-

dends in 192% and 1931 on the preferred stock of

Consolidated, no dividends have been paid on either

its preferred or common stock (R. 240, 280).

The Plan.—The District, Court accepted the con-

clusion of the parties, including the bondholders’

; committees, that it was viecessary and desirable to

aia i. maintain operations of the three companies on a:

unified basis (R. 226, 241-242, 244). Accordingly,

the plan.of reorganization, filed. for all three com-

panies, provides for the formation of a single eor-

poration to acquire all the prop erties of the com-

panies (R. 26). The secur ities of the new corpo-

ration are to be distributed to! existing claimants

as follows: Union and Consumers bondholders will

receive 50 percent of the principal-amounts of their

/ - glaims in 5 percent cumulative income bonds, se-

~ eured by a mortgage on all of the property of the

new corporation, and 56 percent in 5 percent $36

par value preferred stock. Thus, Union bondhold-

ers, for their claims of $2,280,595, will receive

i} $938,500 of new ineome bonds and the same

amount of new preferred stock, and Consumers -

bondholders, for tleir claims of $1,358,715, will

receive $568,500 of new income bonds and the

| same amount of new preferred stock (R. 27-

30). These securities will constitute all of the new

| bonds ‘and preferred stock to be issued, |

The new income bonds, which will mature in .

twenty years, will bear interest at the rate of 5

‘percent if earned, and cumulative if not paid .

tt ; _ (R. 35, 42-43). The new preferred stock will carry

| | a dividend of 5 percent per annim, noncumulative

ee ee ay 2

oe ae et

ca a i

. 13

until the retirement of the bonds except to the

extent that net income is available therefor, and

‘thereafter eumulative (R. 47).* In addition, each

share of new preferred stock will carry with it a

warrant for the- pure ‘hase of two shares of new $2

par value common stock at prices ranging

from $2 per share within six months after issuance

to $6 per share during the fifth year after issuance

(R. 28-30).- No further recognition is given to

the old bondholders for the principal and interest

of their. claims. :

_ The preferred stockholders of Consolidated will

receive one share of the new common stock for

each share of the old preferred, a total of 285,947

shares of the new common (R. 27, 31). A war-

_ vant to purchase one share of the new common at

$1 within three. months after issuance will be

isstied te the conmon stockholders of Cansolidated

for cach five shares of the old common (R21).

An aggregate of 79,491 shares of new common will —

be authorized and reserved for the exercise of the

a . ° we ¥

- «The bonds, and preferred stock to be issued to Union and

Consumers bondholders, respectively, will be in separate .

series designated as Series U and Series C (R. 25-30, 40-41).

The net income of the new corporation will be divided into

two equal parts. Each part will be used t6 pay successively, -

with respect.to the bonds-and preferred stock of each series,

interest on the bonds, sinking fund payments thereon, divi-

-dends on the preferred stock, and sinking fund pay ments

for the preferred; any ‘income remaining thereafter will be

available for general corporate purposes (R. 33-34). Pro-

ceeds from the sate of nonessential properties will bs used

to ) retire the bonds and preferred stock Sa 43).

2s861g--41—_3 ~~

_, warrants issued to the old common stockholders;

an additional 60,280 shares of new common will be.

authorized and reserved. for the exercise of- the

warrants to be attached to the new preferred stock

(R. 27). The total number of shares authorized

to be issued, therefore; is 425,718 (R. 27).

The new preferred stock, to be issued to the’

old bondholders, will be entitled to elect four of

‘the nine directors of the new corporation (R, 49).

The remaining five directors. will be elected by the

| nhew-common stock (R. 49), the majority of whieh |

will be held by the old preferred stockholders of

Consolidated even if all warrants are exercised.

Only upon the failure to pay interest on the bonds *

_ in prescribed amounts -will control of the new _

_ company pass to the old bondholders (R. 49).

The plan further provides for the cancelation

of $102, OO face amount of Union -bonds aid

$63,500 face amount of Consumers bonds held: by

Consolidated (R. 55). ‘The stock of the subsid-

iaries held. by Consolidated and the net claims of

the subsidiaries against Consolidated aggregating

- over $5,000,000 will also be cancelled. :

. None of the companies is indebted to genera}

_ereditors in any significant amount (R. 248, 314-

319) and the plan provides that the claims of such

creditors shall either be paid-in full or assumed by

the new corporation (R. 32:33).

The treatment to be accorded existing securities

Ba under the plan is shown in tabular form’ below.

The table does not list the warrants to be issued or

the intercompany claims to be cancelled.

sheers new securitigs

SSF BASSAS eaeres Firs | ;

Existing securities mtze. Pid. stock $50 | @oramon stock

ee ae - 2 | 8%cum.! par value 5% eo a vole

genre he income | nou-cum. % J > :

bonds | | wg?

. i i .

SERRE EE SERRE RERRRRRRE Simnenene Waceeee Caren SANNNeE anee

}- 4 Pat

| Par

- Union Ist Mortgage 6% © Serial H Shares | Par value | Shares | value ~

Bonds $1,877,000, 00 | $938, 500 | 18, 770 | $038, 500 | |.

Accrued Interest to April i, |

9370 $403, 555.00 |...-.-.---|

Consumers Ist Reitens age 64} - i H

Bonds ie $1, 137,000.00 | 568,500 |-11,370 | 568, 500. ,.. Seer

| 5 Hy

“ Acerued Interest te 1 Apel a, wl

1937! PRCTIRGEL oo sacch- Seo

i i

Consolidated $1. 75 Cum. Pfd. oy n | | |

nu par value, liquidation 1 1°

preference, $252 - -|. 9285, 047 =| 1285, 94% |$571, 804

Consolidated > Comagih no

par value. ong le 3207, 455 | |

‘ ot a = iT Re YORE EE Ra EIS

ckicsdabasayuddusstiakentinensacs 1, 507, 000) 30, 140 |1, 507, 000 285, v7 | 571, 804

a | |

1 The proposed effective date of the plan. ee F

1The liquidating preference of these shares aggregates Pad 148, 675, ex@sive of accumu-

lated and men dividends.

4 Shares.

Disposition of the Plan in the Lowey Courts.—

The plan was confirmed by the District Court on

September 8, 1938 (R. 231). ‘Respondent E. Blois

DuBois, a holder of both Union and Consumers

bonds, objected: to the plan and appealed from

the order of confirmation (R. 349). .On Novem;

ber 4, 1939, the court below rendered an opinic

affirming the action of the District ‘Cour (s

107 F. (2d) 96, advance sheets). After the Tei

sion of this Court in Case v, Los Angeles Lumber

Producis Co., Ltd., 308 U. 8., 106, the court below .

granted a.petition for rehearing and ordered its

)

Court.

[ee 16

‘

first opinion Withdrawn (R. 363 364), Upon the

v0 Apap the order of coneirmation Was reversed

(CR. 365, 381, 382).

3 Petitioner ‘sinthis Court, —The pe fitione ‘rs in No.

400 are Consolidated and a. cominittee 6f its pre-

ferred stockholders, They seék to have the.decree

of the court below reversed and the order of the

Digtriet Court confirming the plan affirmed. The

petitioners in No. 444 are the protective commit-

tees for the Union and ‘Consumer rs bondholders;

They seek reversal of the decree below only in so

far as it holds the plan to be unfair and inequitable

to the bondholders by reason of failure ‘to allot

them full prior ity in the particular assets subject

to their respee tive liens,"

Participation of the Securities ahd Erchange

Commission.—The Securities anid Exchange Com-

mission first appeared in the present case by filfie

a brief amicus curiae upon the rehearing in ‘the

court below.* After entry of the deeree of re-

versal, the Commission filed a notice of appearance

in the District Court pursuatito Sections 208 and

276. ¢. (2) of C hapter X of the Bankruptey Act,

as amended. The Coramission is now participat-

ing as.a par ty i in the proceeding before the District

SUMMARY Or ARGUMENT

1..The findings of the District Court are inade-

quate to pera a determination that any plan of

reorganization for the three companies here in-’

volved is fair and equitable. The-court left un-

determined the validity and value of the claims,

“ageregating over’ $5,000,000, of Union and Con-

sumers against’ Consolidated, and no precise ‘find-

ings were made as to th® value of the assets of any

of the companies, even apart from these claims,

or of the ente rprise as a whole. An examination

of the record reveals: that no ade ‘quate valuation

testimony was introduced upon which the necessary

findings could properly have been made. Accord-

ingly, the court below was clearly, correet in revers-

ing the or der of confirmation and directing that a

vethariy investigation of value be made. * ,

. Even on the present record, however, it is

hee that the plan of. reorganizagfion now be-

fore the Court is unfair and inequitable to the

Union and Consumers bondholders. On the basis

of petitioners’ valuation figures, the value of the

assets subject to the liens of the bondholders is

only about $300,000 less than the facé amount of

the bonds outstanding in the hands of the public,

plus interest accrued to April 1, 1937~— Yet. the

face amount of the new ine ome. bonds. and pre-

ferred stock which the bondholders aré to receive.

is $625,000 less than. their adinitted claims. More-

oyér, these new securities are of a definitely in-

Aevior grade. There is no reasonable prospect. that

- these securities will be of a. value equivalent to:

their face amount upon termination of the proceed-

ings or rea sonably soon thereafter, and they cannot,

therefore, ‘be regarded as satisfyi ing even pre tanto

the bondholders’ elaims.

Petitioners attempt to justify’ the participation

in the plan of Consolidated’s preferred stock-

holders, despite the reduction and impairment of

the rights of: the. bondholders, on the ground that

Consolidated has assets worth $859,000 which, they |

contend, are not subject to the bondholders’ claims.

The answer is twofold. In the first place, the

record clearly establishes that Union ahd-Cen-

sumers have valid and enforceable contractufai

-‘elaims against Consolidated which must be satisfied

‘out. of Congolidated’s assets before its stockholders

may participate at all, and that these claims are

inore than sufficient in amount to provide full com-

pensation for the bondholders. In- the second

place, in view of the intermingling of the properties:

by Consolidated itself ‘ahd the appropriation of the

income thereof by Consolidated under the - -oper-

ating agreement, the whole enterprise must ne 2CeS-

sarily be regarded as a unit. So regarded, it is

plain that the claims of the boridholders must re-

3 ceive full priority out of all the assets owned by the

enterprise before any interest therein is accerded

to the stockholders.

3. Although, for the reasons stated above, we

believe that the eourt below corregtly reversed the

“order of. the District Court tonfirming the plan,

we believe the court erred in its further holding

that the plan is unfair and inequitable as a matter

of law simply because it permits Union's -bond-

holders to share in Consumers’ assets and Con-

sumers’ bondholders to share in Union’s assets.

This holding was apparently founded on the view

that a class of claimants with a lien on particular

properties must receive fully compensatory treat-

"ment out of those properties and may not as a mat-

ter of law: receive less than’ fully compensatory

treatment out of those properties even: though it is

adequately compgnsated with an interest in other

properties., This ‘Tuling, unless reversed, will. .

-make impossible the formulation and consumma-

tion of a plan of reorganization w hich provides

for unified operation of all the properties by a new

_ corporation and for the satisfaction of the claims

of the boncsolders through their ‘participation in

securities covering all the — ties. of the new

corporation. .

The decision i in Case v. Les—Augeles Lumber Co.,

- Ltd., 308- U. ‘S.106,-furnishes no support for tee

‘declaian below in this regard. The rule of on

priority is not violated merely by the fact that

lienors surrender their priority to, or share it with,

persons Who contribute new funds to the enterprise.

The present situation is simfar, except that the

- contribution made by. each, group of lienors for the

right to share in th® assets contributed by the other

group is made in property rather than in money.

ARGUMENT

THE DECISION OF THE COURT BELOW AND THE POSITION

| OF THE COMMISSION WITH RESPECT THERETO

Upon. the reliearing in the court below, the Com- |

mussion contended that the order: of confirmation

should be reversed because the plan of reorganiza-

tion failed to meet the requirements of the rule

enunciated in Case v. Los Angeles Lumber Prod-

ucts Co., Ltd., supra, i he basis of the conten-

tion was that the plan did not provide fully com-

pensatory treatment for the bondholders of Union

and Consumers to thé extent 6f the value of the

assets subject to their claims, and yet allowed par-

ticipation in those assets by the preferred stock-

holders of Consolidated whose. position was junior

te that of the bondholders. . The court below held

that the findings of the District Court were inade-

quate to allow final disposition of this contention,

singe the findings failed to show the®value of dis-

puted claims, aggregating over $5,000,009, which

‘Union and Consumers had against Consolidated.

Moreoyer, the court held that judgment in this mat-

ter was hampered by the inadequacy and ineon-

‘sistency of the findings with respect to the values of

the properties subjeet to the lien of the bonds issued

by Union and Consumers, and the value of any

assets of Consolidated (R. 373-374, 382-383).

- The court might have stopped at this point and -

remanded the case to the District Court for further ;

- ai

findings. Instead of so doing, however, it simply

observed (R. 374) that ‘since the plan praposed,

we think, is unfair as a matter of law for reasons |

hereafter stated, We assume that both matters men-

tioned will be satisfactorily disposed of upon re-

mand of the cause.” eke

The reasons that the court believed the plan to

he unfair as a matter of law were tlien stated by it

in the following words (R. 377):

The trial court. found that the property of .

‘Union covered by the trust indenture was in-

sufficient to pay the principal and accrued

interest of the bonds issued by Union, yet

the Union bondholders are deprived of their

right.to full priority against Union’s assets,

since Consumers’ bondholders and debtor’s

preferred stockholders are given an inter-

est in Union’s .property. Likewise, the

trial court found that the property of Con-

sumers covered by the trust indenture was

insufficient to pay the principal and accrued

interest: of the bonds issued by Consumers, |

yet Consumers’ bondholders are deprived of

“their vight to full priority against Con-

sumers’ assets, since Union bondholders and.

debtor’s préferred \stockholders are: given,

; an interest in Consumers’ property. -Ex-

~ aetly in point, as to facts, is Case v. Los

Angeles Lumber Co., supra, Since the

order must be reversed on the ground that

the bondholders have not beep accorded full

priority, it is unnecessary to discuss other.

charges of unfairness in the plan, some of

which appear to be sound.

288614—41——4

As we understand this portion of the opinion, ©

the court below held that a class of claimants with —

a lien on particular properties must receive fully —

compensatory treatment out of those properties

and may not as a maiter of lai receive less than

fully compensatory treatment out of those prop-

erties even though it ‘is adequately compensated

: ° . ° ‘ F

with ari interest in properties subject ta the lien

of another class of claimants.’ |

* This portion of the opinion is not entirely clear insofar |

as it declares the-plan to be unfair to the bondholders because |

the preferred stockholders of Consolidated are ‘wiven an in- |

terest inthe assets securing the bonds. The court may have |

mearit simply that the participation of the preferred stock-)

holders in the plan was unfair to the bondholders because the

bondholders had‘ not received full priority; it may have

meant, on the other hand, that the preferred stockholders

should not have been allowed to share in the particular assets

securing the bonds because the bondholders had not received |

fully compensatory treatment out of those. assets.

But whatever the court may have meant by its reference

to the preferred stockholders, it. plainly intended to an}

nounce the principle of law stated in the text insofar ag

it held the plan unfair as a inatter of lay because each group

of bondholders was required to share its sectrity with the

other group of bondholders. - No other construction can be

given’ to the words (R. 377) that “the Union bondholders

are deprived of their right to full priority against Union’s

assets, since Consumers’ bondholders * * * are given an

_ interest:in Unioen’s property” and that’ “Consumers’ bond-

holders are deprived of their right to full priority against

Consumers’ assets, since Union bondholders * * * are

giyen an interest in Consumers’ property.”.. That the men- |

tion uf the interest given to each group of-vondholders in .

the assets of the other group was not inadvertent is shown

by the fact that the court below denied a motion, joined in

by all of the parties, to modify this paragraph of the opinion °

a ee

This holding we believe to be plainly erroneous

for the reasons stated in Point IV, infra, pp. 44-5Y. .

Consequently, although we urge affirmance of the

decree below, we also urge that the mandate of this »

- Court should issue in such form as to permit the

District ‘Court to proceed further-in the reorgan-_

ization witheut regard: ‘to this holding. —

. The grounds upoit which we urge affirmance of

the decree below are: (1) that the findings of the

District Court on. the question of valuation are in-

sufficient to per mit a deterfnination that any plan

of reorganization for thése companies is fair and

equitable; and (2) that, even on the basis of the

present record, it is evident that this plan of reor-

ganization is unfair and. inequitable to the Union

and Consumers bondholders. 7 ,

“Il

THE FINDINGS OF THE, DISTRICT COURT ARE INSUFFI-

CIENT TO PERMIT DETERMINATION THAT ANY PLAN

OF REORGANIZATION IS FATR AND EQUITABLE

‘It is manifest, we believe, that-before any plan

of reorganization for the three companies here in-

volved can properly be confirmed as fair and equi-

table, there must bé some adequate determination

of the value of the enterprise as a whole and of the

assets belonging to each company. If Censolidated

has no assets which are not subject to a valid claim

so as to delete references to the interest given to each group

of bondholders in the property ‘securing the claims of the .

other group o7. sic caeratatatais (R. 382-383).

of Union and Consumers, Consolidated’s stoek-

holders arg ebviously not entitled &o participate *

iit the reorg anization unless Consolidated, as holder |

of all the stock of Union and Consumers, has an

“equity in fheir assets remaining after full priority

is accorded to the Union and Consumers bond-

holders. “The existence or nonexistence of such.

equity cannot be determined without ascertaining

the value of the business as a going concern.

‘Similarly, if Consolidated has assets which are not |

subject to a valid claim qf Union and Consumers,

those assets must be valued in order to determine

the extent to-which their existence may justify

participation in any plan‘by Consolidated’s stock- |”

: holders. ' And in either situation, it is necessary

to value Union’ s and Consumers’ assets in order

to determine whether the: treatment accorded to

the bendholders of each eompany is fair to them

rnter sese.

As the court below held, the findings of the Dis-

trict Court are totally inadequate on these funda-

mental issues. Not only did the court leave

undetermined the validity and value of. elainis,

aggregating over $5,000,000, which Union and Con-

sumers have against Consolidated, but it made no -

findings concerning the value of the assets of the

companies apart from these claims. ‘And exami-

nation of the record reveals that no adequate valua-

tion testimony was introduced upon which the

necessary findings could properly have been, made.

1- With respect to Union and Consumers, the

| District Court found merely that the present fair .

value of all of the assets ‘‘admittedly”’ srbject to

the trust inderitures securing their respective bond

issues ‘‘is insufficient to pay the par value of the

bonds, plus acerucd interest’? (R. 245). Myis find-

‘ing, as the court below pointed out (R. 374), is

not easy to reconcile with the further finding that

the assets of the three companies have. been so com-

: ¢ : ° “2 eee 2 : °

mingled that identification of the assets belongmg

to each is impossible (R. 241-242). Moreover, the

District ‘Court failed to find the extent to which _

the bonded indebtedness of each company, plus ac-

eryed inter est, excseded the value of the mortgaged

assets, and it fatled-to determine ,whether or not

Union and Consumers had any assets not subject

to the trust indentures, and, if so, the value of such

assets. Had such a determination been made, as —

it should have: been, it weuld necessarily have in-

volved.a determination of the validity and value

of the claims ‘of Union and Consumers against

same suansigs

. So far as = Dsaaclidated is concerned, there 3

ae no finding whatever as to the value, if any, of ’

its assets. Instead of: making such a determina-

tion, the District Court found only that the valtie

of the assets of all three companies, if operated

‘ aS a unit, was in excess of the total bonded in-

debtednéss, plus accrued interest, although not in ~

exeess of the ‘bonded indebtedness, plus accrued

interest, and the liquidation preferences on Con-

solidated’s preferred stock, including accrued divi--

- 26

dends ( R. 245), It should be noted that this

general findjng’ of the solvency of the enterprise.

as a Whole is ‘inconsistent with the consolidated

balance-sheet filed by Consolidated itself (R. 314),

which shows the enterprise to.bé insolvent. In any .

event,-a mere conclusion that the enterprise as a-

whole is worth.more than the amount of the mort-

gage debts is not sufficient.; a more precise detér- |

mination of value must be made so that a conekusion

may be reached as to the proper allocation of

‘securities between bondholders and stockholdefs.

3. In our view, the present record does not con-.

‘tain sufficient evidence upon which adequate valu-

ation findings could have © been | made. Three —

valuation witnesses were “talled ; ‘of these ‘three

witnesses, referred to -by. the petitioners as ‘‘in-

dependent’? (Br. 19), two are present officers of

Consolidated, and the other is a. former employee

of Union €&, 279, 290-291). It is apparent that

all three-reached their: conclusions as to .value

on the basis of physical valuations of the assets’

_ (R. 281-282, 290, 291-292), :

_ The record contains ‘no testimony concerning

- the estimated prospective earnings ‘of the oa

prise and no attempt was made to value en-

terprise by the capitalization of such prospective

, earnings.’ The absence of such evidencg, in and .

* . “

: Rogers testified that Union could earn interest on‘a valua-

tion of $7,000,000, although the present value of its ph Lyi ical

properties was $2,318,000. As to this $7,000,000 figure, the

. Special Master said, “The evidence Goes not war rant a finding ©

‘of this valuation” (R. 151).

ieee | a7

of itself, makes the record inadequate for any

determination as to-the fairness of any plan

that may. be presented. This is so because the

- proper method for estimating the value of any

going concern is to capitalize prospective earnings

, | cat a rate appropriate in viey of the risks inherent

imsthe business. This was recently recognized: by

this Court in Palmer v. Connecticut Ry. & Light-

ing Co., No. 38, this Term, decided January 6,

1941; it has similarly been recognized by the lower.

| federal eourts and by the leading text writers on

_ valuation problems.’ . :

- The necessity for a thorough inquiry into fe ;

prospective earning power of the enterprise in-

volved in the present case is emphasized by its poor ;

earnings record in the past, which ‘the valuation |

| ‘witnesses appear to have entirely disregarded. —

The recerd shows that the business has lost money

and allowance for depreciation and depletion ex-

_ pense and taxes. Considering the results of oper-

> ation before bond ‘interest but after allowance

for depreciation and depletion, the business lost

$1, 282, 288 in the eight and one-half ‘years from

™In re Wickwire Spencer Steel Co., 12 F. Supp. 528, 533

(W. D. N. Y.}5 Jn re Consolidation Coal Co., 11 F. Supp.

L. =. ~—-BO4, 597 (Mad.); Jn re Pittsburgh Hotels Corporation, 17:

F. Supp. 949, 951 (W. D. Pa.) ; Bonbright, Valiatton of

Property (1987), Vol. 2, pp. 875-881, 883-893; Dewing, The

Financial Policy of Corporations ed. 1934), p. 140; Fin-

Le . letter, The Law of Bankruptcy feo ganization: (1939), pp.’ ‘

557-568; cf. Atlanta, B. & C. R. Co. v. United States, 296 .

iw. S. 33, 38. ;

. . rg

in every year from 1930 through 1937 after interest .

+ ~ ‘

April 1, 1929 to September 30, 1937 (BR. 183-191).*

In the light of this poor earnings récord, it seems

- difficult to justify the value of over $4,000,000

ascribed to the properties by petitioners,.on the

‘basis of the testimony of the valuation witnesses

(Pet. Br., pp. 26-27, 30-31) ; to. justify such a

valuation on the. basis of a capitalization of earn-

ings, the enterprise would have to have an operat-

- ing profit, after all expenses except bond interest,

of over $400, 000 a year, even assuming the applica-

tion of a 10% capitalization, rfte.” |

4. In this state of the record, we believe that the

court below correctly held that ‘‘precise findings as

to values must be made’’ for ‘‘a complete deter-

- mination as to the fairness of any plan’’ (R. 380).-’"~

We also believe that the court below properly left

to the discretion of the District Court the question |

of whether an ‘‘appraisal’’ of the properties should

_be made for this purpose (R. 380). Certainly

there is no place in most reorganization cases for

an ‘appraisal’? of a going concern consisting

merely of the sum of values assigned to individual ;

assets of the concern without regard to the earning

power of the enterprise as.a whole. But: ‘‘ap-

-praisal’’ in the sense of a critical consideration of -

——

the nature and condition of these assets is, of .

course, an essential part of an enterprise valuation

based on prospective earnings. In our view,. no

Iti ts impossible in the present state of the record to deter-

mine what allowances for depreciation and depletion must

be made in the future.

(

Lf adequate judgment-may be formed on the present °

record as to the degree of inquiry necessary into

‘the nature and condition of the assets in this case

in connection with a valuation based on ners tf

and the question of an’ ‘‘appraisal”’ 3 in this respect ‘

was, therefore, properly et ‘for. decision by the — cae

District Court’ . .

THE PLAN OF REORGANIZATION NOW BEFORE THE COURT

1S UNFAIR TO THE BONDHOLDERS OF UNION AND

CONSUMERS Be STE ores 2 pean

- Although, for the reasons stated above, we

believe the court bel ow correctly held that the find- .

ings of the District Court as to the valuation of the

properties are inadequate affirmatively toestablish |».

the fairness of any .plan of reorganization that

might be proposed for these companies, we think -

it plain, even on the basis of the present record, -

that this plan of reorganization does not comply

with the requirements of the statute.

* There would remain also to be considered in the District

Court an appropriate formula for the ascertainment’ and -

valuation of the respective assets of Union and Consumers,

in order to determine the fairness of thestreatmentt afforded?

thei? bondholders énxter sese. Unlike the valuation of the

enterprise as a whole, the valuation of Union and Con- »

sumers primarily on an, earnings, basis presents difficulties

because of the manner in which these.companies have been e

operated since 1929 (R. 238), the commingling of their

assets,-and the fact they have no inciviges! earnings record.

380

A. Tite TREATMENT ACOORDED TO BONDHQLDERS UNDER THE PLAN

In order to make the-followirg discussion. spe-

cific we shall use the values for tahgible assets

used. in petitioners’ brief. Based woon the aver:

age of the estimates contained i

» petitioners treat Union’s assets): |

_, $2,202,733, Consumers’ assets as worth $1,151,033

_ and Conisolidated’s tangible assets (including all

current assets of th enterprise) as worth $859, 784

(Br. pp. 26-27, 30-31 )> This gives a total vakue

for the enterprise of app¥aximately $4, 213,000.*”

We do not concede by using théye figures that the

- record contains satisfactory evil ence from which

such values can be found to éxist. We emphasize,

too, that the following discussion of the unfairness

‘ of the plan does not depend on any exact assump-

; tions as to value, for the unfairness rests in the

inadequacy of the securities given to the bond- —

we a

In the>following discussion we , disregand the value of

$500,000 ascribed by Mitehell to the good will of the enter-

prise (R. 282). This figure appears to be wholly arbitrary,

_ particularly in the light of the earnings record (see pp. 11, 27,

-supra), the fact that only five quarterly dividends on ‘the

: preferred stock were ever paid (in. 1929 and 1931), that no

dividends have ever been paid ‘on the common stock, and

that the bonds oF tl the subsidiaries have been in default since .

1933 and . Inany event, for the reasons discussed below

at pages 43-4€, we believe that, if good will is to be separately

included as an element of value in determining the value of

the properties, it shoyld be apportioned among the several

. companies constituting the enterprise rather than be consid-

ered as an asset of Consolidated alone. See i in this connection

R147, sais ‘ae

es 31

holders. Such seaiieiniaion — exist irrespective

of the precise values which the assets of any of the

eompanies may..be found to have. _

Against the assets thus valued at’ $4,213,000 stand

prior claims of the bondholders aggregating: $3,-

640:000, representing the principal and interest

of their claims as of April

elaims, amounting to 000: or about 17% of

; ‘the bondholders’ tota claims, are entitled to the

same priority as~ :

Park Corp., 90 F. (2d) 595 (C.

- American Tron and Steel Mfg. Co. v. Seaboard Air | |

Line Ry., 233 U. S. 261, 266-267 ; Case v. Los An-—

geles Lumber Products Co., Ltd. ,|308 U. S. 106.

All of the bondholders’ claims are now due and

owing. They constitute first_liens against all of

the assets except those of Consolidated, which on — |

petitioners’ assumptions are about 20% of the

assets of the combined enterprise. The bonds bear

fixed interest rates of 6% and afford the borid-

holders the ‘customary remedies in the event of

default.

In exchange for their dil of $3,640,000, the

plan offers the bondholders new income bonds and

preferred stock of an aggregate face amount of

only $3,015,000. Thus, even if the new securities

be considered as worth their face amount, they are

inadequate by $625,000 to satisfy the bondholders’

admitted claims. 'Bhis is the precise amount of the

accrued interest obligation, the effect of the plan’

/ being to cancel this obligation. -

» Vow

-1937. The interest:

. ba , “

coioaied dhenrimengenmamgnseeng aetry

Not ‘ite da the bondholders lose their interest

~ claim, bit the new securities offered-them are of a .

definitely inferior grade. ‘The new bonds and pte-

ferred tock will bear interest and dividend rates,

respectively, at the reduced rate of 57oy88 com- |

eke ce pared with the 6% rate on the present b nds. The :

_-—~ + new bonds will be on an income basis With matu-

__. + pity extended for 20 years. The definition of de- — -|

fault. is extremely lenient and the remedies upones~ —

default are severely restricted (R. 39, 42-43). The ‘

. .. preferred stock, of cou.se, will have no maturity. -

‘It will be on a noncumulative income basis, except

to the extent of available earnings, until all bonds ~

are retired. - -This means, of course, that a distri-.

-bution to common stockholders may be made in any

year, after ajl charges on the preferred stock have..

been met for that year, even-though dividends

had not been earned and paid on the preferred

_ stock in prior years. |

As further emphasizing the obvious failure of

— these securities to constitute full compensation for

_* the creditors’ claimg, even to the extent of their

, face amount, it should be notéd that the securities a

ay _ isstied to the bondholders do not carry with them ;

a, A control of the new company. Consolidated’s pre. -—

ferred stockholders, who receive all of the new com-

mon stock initially to: ‘be issued, will retain control

even though all the proposed warrants are exer/ —

ised. Only in the event of a failure to pay certain

‘minima of interest.on the new bonds will control

pass to the bondholders. (R. 49.) |

“a,

The | eumilative rect ofthe, fonégting dine:

acteristics: of the new “securities “compels the con-"

clusion that they do not ‘constitute full eompen-

| ‘sation to the bondholders -even to the extent ~

of their. face amount. On the contrary, there is

- plainly no reasonable prospect that, upon termina-

tion of the reorganization or: reasonably soon. there-

after, thése securities will be of a value equivalent .

to their face amount, and, consequently, they can- ,

not be regarded as satisfying even pro tanto the -

~ bondholders’ elaims.

“The warrants attached’ to the new preférred

stock are not compensating factors of-conse:;uence.

To make ‘the bondholders wholé merely for. the

cancellation of their accrued interest of $625,000, :

. the 60,280 shares of new common ‘to which they

would be entitled upon exercise of the warrants ©

would have to attain a value exceeding the war-

-yant price by $625,000. This would. require yalues |

ranging -from. $12.40per share .(if the wardgnts

were exercised within the first. sfx months) to

vy °

$16.40 per share (if the warrants were exercised ee

* during the fifth year after issuance). On the

other hand, petitioners’ own..estimates, which as-

sume a maximum valite of about $1,300,000 for the

equity in the new company after deducting the face

amoimt of the new “ponds ' ‘and preferred’ stock,

indicate a value per share of approximiately

- $4.50.. It is plain, ‘therefore, that’ the warfants —

‘represenj no material. fheasure of compensatory

treatment for the bondholders.

ont

: oe

An this connection it should be noted that Consoli-. -

dated’s common stockholders, who were found ‘to

_ have no ‘equity whatsoever (R. 245), are given war-

rants to purchase the same class of stock-as the

bondholders, and at a lower price. Thus every ex-

. ercise of a warrant by-a bondholder would imme-

‘diately enhance the book value of new common

stock purchased by the old common stoafiolders, ie

" and conversely, every exercise of a.warrant by the

old’ comman stockholders would dilute the book —

value of new common stock purchased by: the old

bondholders.”

The foregoing discussion demonstrates the dras-

tic reduction and impairment of the bondholders’

claims‘tontemplated by the plan and the resulting

benefit & the Consolidated preferred stockholders, —

The ‘bondholders: receive nothing for their i interest

‘elaims, and for their principal claims they receive

inferior securities which are not full. compensation

The very issuance of warrants to the common stockhold- .

~ ers makes the plan unfair as a matter of law, in the absence

of circumstances makirig necessary the tender to them of a

. right to subscribe. Kansas City. Terminal R. Co. v. Central

Onion Trust Co., 271 U. S. 445, 455-456 ; Case v. Los Angeles

Lumber Products Co., Ltd., 308 U.'S. 106, 117, 121-122. The

allotment of subscription warrants to a class of common stock

for which there is no equity, in the absence of the necessary

justification, violates the“fair and equitable” standard. Cf.

In re Utilities Power and Light Corp., 29°F. Supp. 763

(N: D-Ill), appeal dismissed, C. G.-A; 7th, March 9, 19405 .

In re Chicago Great Western Railroad Co., 29 F. Supp. 149

(N. D. Ill.) ; see also Jn re National Food Products Oonene

tion., 23 F. Supp. 979 (D. Md.).

dhierefor. It i is not our position that under a re-

organization “plan bondholders cannot be given

securities with characteristics inferior to those of

the securities formerly held.. Feasibility may. 80 -

require, and the rule of full priority does not ren-

~ der a feasible” reorganization impossible. But to

the extent, that the requirements | of a financially

sound reorganization make necessary the cutting

‘ down,of bondholders’ rights, adequate compensa-

tion must be given before junior classes may be

_ permitted to participate. Cf. Standafd Gas and

Electric Co. v. Deep Rock Oul Corp. (C: CA. 10th),.

decided January ‘18, 1941. Stated otherwise, the

rule of full compensation cannot be satisfied merely

face amount; but, if junior cla are to partici-

pate, the package of new securiti which is offered

to the bondholders must possess such protective

provisions, security and rate of return.as to. make

the securities of a value equal to = bondholders’

claims. —

by the: issuance of securities in fe appropriate

B. THE TREATMENT ACCORDED TO THE BONDHOLDERS IS NOT FAIR

AND EQUITABLE

Petitioners attempt to justify the participation

in the plan of Consolidated’s preferred. stockhold- - _

ers; despite the reduction and impairment of the

rights of Union’s and Consumers’ bondholders, on

the ground. that Consolidated has assets worth by i

$859, 000 which, they contend, are not subject to te

bondholders’ claims."* The answer is twofold, In-

- the first place, the record clearly establishes that

Union and Consumers have valid and enforceable

contractual’ claims against Consolidated which |

must be satisfied: out of Consolidated’s assets be-

fore its stockholders: may participate at all. In

the second place, in view of the intermingling of

the properties of the three companies by~Consoi-

idated itself and the appropriation of the income

thereof by Consolidated under the operating agree-

ment, we believe that the whole enterprise must

necessarily be regarded as a unit and that the

claims of the bondholders must receive full prior- —

ity out of all the assets ovried by the enterprise

before any interest therein is accorded the stock-

holders. When such right to fall priority is rec-

ognized, it is clear that the plan is unfair to the |.

bondholders. P

1. The claims of Union and Consumers siiaee

Consolidated.—The bodks of Consolidated, as well

as those of Unicon and Consumers, show an indebt-

edness of Consolidated to its subsidiaries of over

$5,000,000. The books of the subsidiaries show a

_ 2 Petitioners advanced the additional contention in the

court below and in their petition for a writ of certiorari that

the rule of fuli priority enunciated in Case v. Los Angeles

Lumber Co., Ltd., 308 U. S. 106, is not applicable to a solvent

enterprise. . This contention has now apparently been aban-

doned. For the reasons pointed out in the Memorandum

for the Securities and Exchange Commission as Amicus

Curiae, filed in connection with the. petition for certiorari,

the contention is plainly Without merit.

as a

. total net claim of $5138,141:34, of which $291,331.69

. - represents net current receivables, exclusive of

depreciation, ‘depletion, and amortization, and the

remainder represents accumulated depreciation,

depletion, and amortization (R. 317-319). Con-

solidated’s own balance sheet shows a net liability

to its subsidiaries of $5,321,998.37, of which $256,-

598.56 represents net cutrent liabilities (R. 316).”°

These records have been kept in accordance with

‘the requirements of the. original operating -agree-

ment (R. 236-237, 280-281, 299).

As we understand petitioners’ argument, no con-

tention is advanced that Consumers and Union do

- not have a valid claim against Consolidated to the

extent, at least, of the net current liabilities, aggre-

gating more than $250,000, showfon Consolidated’ 8

books. Nor can there be any valid cuntenti on that"

Consolidated is not undér some liability with re-

«pect to the depreciation, depletion, and amortiza-

tion items. Even overlooking the serious doubts.

_ as to the validity of the modification agreement and

treating that agreement as determining the rights

of the parties, Consolidated is Hable to its subsid-

_ jaries for depreciation, depletion, and amortization

in amounts to be determined. by ‘retroactive ap-

-praisals made after termination of the operating

agreement. The modification agreement expired —

*?The variations in the figures shown by the books of

- Union and Consumers and of Consolidated may possibly be

explained by the inclusion in the latter of accounts with

other subsidiat aries of Consolidated (R. 286-287, 316).

pursuént to its terms before the plan of reorgan-

ization in this ease was confirmed. ‘The record

- does not show that the one-year notice required for .

renewal (R. 180-181) was ever. given. Thus it

would have béen entirely possible for the appraisal

‘to have been made. _Certairily Consolidated, which ° |

has been in possession. of fhe subsidiari ies’ proper-,

ties thYoughout the proceedings and controlled

their directorates (R. 236), cannot advance the

failure to have the appraisal made, and hence the

extent of its liability determined, as Justification

for entirely negating hability.

Petitioners argue that there is no present claim

by the subsidiaries ‘against Consolidated, because

under the modification no claim exists until the ter-

mination of the operating agreement. “But the

operating agreement, as modified, terminated on

February 16, 1938. Although petitioners speak of

‘a right of f renewal (Brief, p. 28), the record does

not show “the exercise of the right, nor do peti-

tioners assért that it was exercised.

Petitioners argue further. that even after the _

claim is detexmined the subsidiaries cannot reach

the assets of Consolidated, because Consolidated - ‘

has the option to pay the claim in ten annual in-

stallments. But. this optio: relates only, to the

amounts due ‘for depreciation (R. 178-9), not to

, the $250,000 or more due on current account.

over, the fact that payment of the remainder

“@of the debt may be made in installments (which

——* 39

bear interest) (i. 179) does not affect the prova-

bility of the debt under the broad definition of

‘“‘claims’’ and ‘‘ereditors’’ in Section T7B: (b).

Claims are there defined to mnelude ‘‘debts, securi-

- ties, other than stock, liens, or other interests of

whatever character’’; creditors are defined to in-.

clude all holdeys of such claims’‘‘including claims

~ under executory contracts, whether_-or not such

claims would otherwise constitute provable claims

under this Act.’’ Compare Section 62 (a) (1),

which permits proof of fixed liabilities ‘“whether

thew payable or not,’’ and Section 63 (a) (4),

which permits proof of debts on open account, or on

a contract express or implied, with no limitation

_as to maturity. The. proof would be made by the

trustees of the subsidiaries. Bankeoptey Act, See-

tions 57 (m), 77B.(k).

Since liability* does in fact exist, it is imma-

terial whether the “amount due is around $5,000,-

000, as the books show, or some lesser amount de-

termined on the basis of an appraisal made

_under the modification agreement. In gvhatever

amount liability exists, to that extent it subjects

the assets of Consolidated to thé prior claims of

.the bondholders. According to petitioners’ valua-

tion figures, the bondholders’ claims held by the —

_ public exceed the value of the assets securing their

liens by only $300,000. To this may be added the

- $200,000, priritipal and - interest, of ‘Union and

Consumers bonds whichs Consolidated owns, and

—wT

which for present purposes we may assume con-

stitutes a valid claim of Consolidated. against

Union and Consuniers. It is therefore necessary

to show liability only in the &mount of $500,000

from Consolidated to.the subsidiaries in order to

establish the bondholders’ right. to full compensa- -

tion for the face amount of their claims. Of this

$500,000, at least $250,000 is due on current ac-

counts. Petitioners are therefore required to main-

tain that the liability for depreciation, depletion, ©

and amortization, set out on the books of the

companies at morethan $5,000,000, in fact amounts

to no moré ‘than $250,000. The record furnishes

no ‘support for any such propos ition. To the con- .

trary, as pointed out in respondent’ s brief (p. 19),

even accepting the modification agreement as valid,

depreciation, depletion, and amortization charges

would be approximately $1,250,000 on the basis

of a $3,300,000 valuation for Union’s and Con-

~ gumers’ properties.

Petitioners seek to avoid the force of this posi-

tion by contending that the provisions of the plan

_ constitute a compromise of Consolidated’s liability.

The contention is completely without merit. It.was

_ first advanted upon the rehearing in the court be-

_ low after the decision of this Court in the Los

_ Angeles Lumber ease; prior to that time, neither

in the District Court nor in the Cireuit Court of

‘Appeals, did petitioners urge that participation in

the plan by Consolidated’s stockholders was to be.

Ben

ie g |! . '

acai witli i

aa ‘

‘justified en the basis of a compromise. Upon the

rehearing, the Circuit Court of Appeals expressly

refused.to treat the plan as embodying such a ee

- promise, stating that no plan of reorganization for.

the companies could be held to be fair and equitable

“until the claim is settled, either voluntarily or

by litigation” (R. 374).

Certainly, if the plan was in fact intended as a

compromise of lability, there isa complete failure

of proof to that effect. A plan embodying a com-

x promise should be presented to the court in such

»fashion as to indicate ‘clearly the nature of the pro-

posed compromise, the extent to which liability i 1s

recognized, and the allocation of securities based

- on the settlement. In the present ease these stand-

ards. have not been met; the alleged compromise

- has-been presente? to the court with its terms so

obscured as not to afford to the court an oppor-

. tunity to exercise the “informed, independent .

judgment’’ which the statute requires. National —

Surety Co. v. Coriell, 289 U. 8. 426, 436; Case v.

Los Angeles Lumber Products Co., Ltd, supra, at

114-115.

But apart from these considerations, it/is plain *

that any compromise in fact embodied in this.plan

of reorganization would have ‘to be rejected on

the merits. In the Los Angeles Lumber case, this

~. Court recognized that although conflicting claims

to specific assets might sometimes be settled, such

settlement would be ‘‘in the discretion of the

. -

- 4

court’” (308 U.S. at 130). Ajppfoval' of this plan

on the basis of the asserted compromise would, we

submit, be a gross abuse of discretion. , :

As pointed out above, on the basis of nitiivaiios

own valuation figures, a liability of only $500,000° .

on the part of Consolidated would have to be shown

in order to establish the right of the bondholders to _

fully compensatory treatment~for the face amount

of their claims. Of this $500 ,000, at least $250, 000

is due on current atcounts——Consequently, in

‘order to-support the plan. on the basis of an al-

’ leged compromise, petitioners must establish that

Consolidated has such substantial defenses against

the claims of the subidiaries for depreciation, de-

pletion, and amortization as to justify. settlement

of those claim§, carried on Consolidated’s own

books at more than $5,000,000, for less than :

-» $250,000. In this respect, petitioners’ case is en-

tirely deficient; the defenses they assert for Con-

_solidated are flimsy, if not captious.

The first of these alleged defenses is that, al-

though Consolidated may be liable to Union and

Consumers, it is not liable to their bondholders

because of the provision in the operating agree-—

ment that that agreement was not made for the

_ benefit of, any third person. But the question at ~

this point is not whether the bontlholders may

directly. enforce the liability against “onsolidated ;

the question is only whether and to what extent

. that liability exists. To-the-extent that it does

exist, the claims of Union and Consumers against

~ F

an Consolidated are. valuable assets of ie subisidi-

- aries which are subject to the claims of the bond-

‘

_. holders. : The normal procedure for adjudication

of the existence and amount df Consolidated’s:

liability would be for trustees of the subsidiaries _

to’ file claims against Consolidated’s estate and

for the bank#uptey court to decide the validity

and amount of those claims. Section 57 (Qn);

Section 77B (k). Cf. Pepper v. Litton, 308

U. S. 295. Contrary to petitioners’ contention

(Br. 29), there would be no necessity for fore-

closure of the trust indentures under the law of ©

_ California. The.effect of the enforcement of the

claim under the operating agreement would be to

draw the assets of Consolidated into the subsidi«

arias’ estates. ‘The bondholdérs could then either

. have their security valued under section 57 (h)

. of the Bankruptcy Act (see sec. 77B.(b)) and |

prove a general claim for the deficiency, or they.

-could prove their entire claims as general claims,

waiving their security. Gilbert’s Collier on Bank-

ruptey (4th ed., 1937Y see. 1043. In either case,

- since the bondholders are the only significant credi- -

tors of Union and Consumers (R. 248, 317-319),

their claims would have to be satisfied in full out of

_. » any assets in the estates before Consolidated, as

stockholder - of the subsidiaries, could share.

The other alleged. justification for the compro-

mise is that without the compromise the bondhold-

“ers would be faced with extensive progedural

obetacles before they could realize upon/the claims.

‘e

t / . 44

If this means ‘that the compromise avoids fore- -

closure and sale, the answer is, as we liave stated,

_ that no foreclosurais‘neeessary. If it means that ‘

the compromise avokde obstructive litigation, the

answer is that a compromise for this purpose alone

is not justified. .In the [os Angeles Lumber case,

this Court stated (pp. 129-130): .

The conclusion of the District Court that:

avoidance of litigafjon with the stockholders

gave validity to their claim for recognition -

in the plan involves a misconception of the

duties and responsibilities of the court in

these proceedings. Whatever might be the

_ strategie or nuisanée value of such parties.

_ outside of § 77B is irrelevant to the duties of

| the court in confirming or disapproving a

r plan under that section. In these proceed-

ings there is no occasion for the court to

yield to such pressures. If the priorities

of creditors which the law protects are not, -

to be diluted, it is the clear duty of the court

to’ resist all such assertions.

- We believe it is evident, therefore, that the as-

serted compromise iz no justification for the par-.

ticipation in the plan hy Consolidated’s preferred

stockholders,. that sufficient (if not all) of Consol-

idated’s‘ssets are subject. to the claims of Union .

aud Consumers to provide fully ‘¢ompensatory

treatment for the bondholders, and that zonse-

, quently the failure of the plan to accord them such

\ treatment renders the plan unfair and inequitable

as a matter of law.

a i a 9 =

om sa

Ln en Pee

® ’

. The ‘ications of the assets by .Consoli-

Paes assets allegedly, belonging to Con-

_ solidated-“are subject to the claims of the bond-

holders even apart from the contractual liability

of Consolidated to Union and Consumers.

Under the: operating. ‘agreement, Consolidated

completely dominated the subsidiaries. It took

possession of their properties and operated them —

in connection with its ea though all-the prop-

-“erties.were consolidated: upder a single ownership,

and it commingled the assets of each so that sep-

arate identification thereof has become impossible.

This commingling -alone should throw upon Con- p

solidated the burden of identifying its own assets

> in order ‘to assert a claini to osany. Union Naval

Stores Co. v. United States, 240 U. 8. 284,291; The —

= 93 U. S. 575; Intermingled Cotton Cases, —

. 8. 65; The Distilled Spirits, 11: Wall. 356.

as ae Consolidated exerted its control over the sub- _

sidiaries todo more than commingle the assets. On °

the one hand, it took possession of the subsidiariés’

_ properties through the operating agreement and’

appropriated for itself.all revenues from opera-,.

tions (R.\170-171), thus disabling the subsidiaries

from per forming the covenants of their indenture

agreements, including ‘particularly the .interest, .

sinking fund and depreciation.and depletion provi-

sions. On the other hand, it violated its own cove- ,

nant: to supply the subsidiaries. with the necessary

funds to meet interest and sinking fund require-

\ .

“~

MM.

a ee

ie:

ments (R. 167-168). In all respects, except for

some bookkeeping purposes and the failure ex-

pressly to assume the subsidiaries’ mortgage debis,

_ it treated the enterprise as a‘unit and the subsid-

iaries ’ properties as its own.

Under these circumstances, we believe that the

__ bankruptey court, as a eourt.of equity, is not re-

quired to pay regard to the separate corporate

entities of the subsidiaries, which Consolidated

itself has so consistently disregarded. Rather, it

is called upon to treat the enterprise as though the

properties of ‘the different companies were actually

held under single ownership by a corporation liable

for all the debts. Compare Davis v. Alexander,

269 U.‘®. 114; Baltimore & Ohio Tel. Co. .v. Inter-

state Tel. Co., 54 Fed. 50 (C. C. A. 4th); Pennsyl-

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

3d), certiorari denied, 242 U. 8. 646; Fhe Willem

Van Driel, Sr., 252 Fed. 35 (C. ©. A. 4th); certio-

rari denied, 248 U. S. 566; Trustees System Co. v.

Payne, 65 F. (2d) 103 (C. C. A. 3d); Central Re-

public Bank & Tr. Co. v. Caldwell, 56 F. (2d) 721

—“(C. CLA. 8th). .

So considered, of course, all the assets of the ’

enterprise would be subject to the full amount of

the bondholders’ claims and the stockholdérs would

. be entitled to participate only to the extent of any

remaining balance after fully compensatory provi-

sion is made for such claims, As we have shown,

the plan fails to accord such full compensation to

the bondholders.

OIE ae eat

~\Philadelphia Company v. Dipple, Nos. 242, 243,

present Term, decided February 3, 1941, is not op-

posed to our contention. Although in that case

’ this Court refused to disregard the corporate enti-

ties of various companies which had been operated

as a unit, the relationship of the operating com- .

pany to the underlying companies was there merely

a ereditor-debtor relationship under a -lease; and

| ‘not, as here, the relationship of parent and sub- -

-sidiary. Moreover, as the Court pointed out, to ..

ignore the separate corporate entities in the Dipple ©

case might have affected the claims of other credi-

tors adverse!y.. No such consideration is involved

in the present case. mies

No serious consideration need be given peti-

tioners’ contention (Br. pp. 30-31) that even if

Consolidated’s assets are subject to the debts, the

plan is fair.. As we have shown, the bondholders

are not fully compensated for their prior claims,

and no plan can be fair which does not provide full

compensation. The: assertion that the preferred

stockholders are ‘‘contributing’’ 22% of the assets,

ignores the fact that the assets must be applied

to full compensation for the bondholders before —

- the preferred stockholders can “‘contribute’”’ the

residue, and that in ‘‘accepting’’ a junior. position

the preferred stockholders give up nothing to which

they are entitled. Moreover, petitioners’ assertion

rests on assumptions as to the value of the physical

assets and the good will which we believe to be

unsupported by satisfactory evidence (supra, pp.

_ 26-28). Finally, we think it too clear for discus-

ee -

sion that a plan which gives the preferred stock-

holders ‘‘the right to elect only 5 out of 9 direc-

tors’? (Pet, Br., p. 31) ini return for their alleged

22% ‘‘coutribution” unduly favors them and dis-

criminates against the bondholders.

eet

A PLAN OF REORGANIZATION IS NOT UNFAIR AND IN-

EQUITABLE AS A MATTER OF LAW BECAUSE CLASSES

OF LIENHOLDERS ARE NOT GIVEN FULLY COMPENSA-

TORY TREATMENT OUT OF THE PARTICULAR ASSETS

‘SUBJECT TO THEIR RESPECTIVE LIENS, IF THEY ARE

OTHERWISE GIVEN FULLY COMPENSATORY TREATMENT

The court below appears to have assumed that it

was bound by the Los Angeles Lumber decision to —

hold that the plan of reorganization is unfair be-

cause it permits Union’s bondholders to share in :

Consumer’s assets and Consumer’s bondholders to

share in Union’s assets. In other words, the court

-below apparently held that a class of claimants

with a lien on particular properties must ‘receive °

fully compensatory treatment out of those prop-

erties and.imay not as a matter of law receive less

than fully compensatory treatment out of those

properties even though it is adequately compen-

sated with an interest in other properties. Sucha

ruling would make impossible thé formulation and

consummation of a plan of reorganization which

| ‘provides for unified operation of all the properties

by a new corporation and for the satisfaction of the

claims of the bondholders through their narticina-

a ee

tion in securities covering all of the properties of .

. the new corporation. The proposal of such a plan

here resulted largely from the manner in which the

enterprise had been pai in the past and the

conclusion of the parties, accepted by the Special

- Master and the District Court, that it was desirable

that the separate liens be displaced and that the -

properties be operated’ as a unit in the future

(R. 147-148, 261, 271). The Cireuit Court of Ap-

peals did not question this assumption.

We believe it plain that the Los Angeles Lumber

decision doés not require that a plan be held un-

fair aud inequitable, as a matter of law, where

bondholders receive less than full compensation out —

_of the assets on which they have a lien, provided

that they are adequately compensated for the loss

of their prior claims by interests in other assets.

The respondent has not questioned this. He &x-

pressly disclaims any contention to the contrary

in his brief (p. 26).

Obviously, lienors may have to surrender their

priority to, or share.it with, persons who contribute

new funds to the enterprise ; in such-case their com-:

pensation ‘vill consist in the acquisition by their

corporation of the new funds. The present situa-

tion is similar, except that the contribution made

by each group of lienholders for the right to share

in the assets contributed by the other group is

made in- property rather than in money. Con-

‘ sumers’ bondholders share their priority with per-

sons who contribute property nbcessary for the

succéss of the enterprise as a Whole, namely, the

Union bondholders; the obverse is ‘likewise true.

So long as each group shares on an equitable basis

in the securities of the combined enterprise, the

plan of reorganization satisfies the requirements

of the Los Angeles Lwmber ruie.*

Furthermore, to read: into the rule of the. ye

' Angeles Lumber case a requirement that fully com-

. pensatory treatment for liens must be given out of

the assets: subject to the liens would have disastr®us

practical consequences. The elimination of divi-

sional liens in the reorganizai on of corperations

is frequently necessary and desirable. The prob-

lem arises in many industrial and railroad reor-

14 Because of the inadequacy of the record, w ‘not now

express an opinion as to whether the plan of reorganization

is fair in its treat.nent of the two groups of bondholders with

respéct to each other. We do, however, disagree with the

suggestion of petitioners in No. 444 (Br., p. 18) and of peti-

_tioners in No. 400 (Br., p. 18) that no more precise findings

of,value than those which have been made are necessary in ,

order to reach a conclusion as to the fairness of the treatment

of ‘the bondholders inter sese. The statement of petitioners

in No. 444 (Br., p. 11) that new bonds of one issue equal in

amount to the aggregate of the two old issues, and secured.

by both properties, would be reasonably compensatory ex-

pressly assumes that. the ratios of the values of the respective

_properties to the debts which they respectively secure are

the same. The accuracy of this assumption cannot be deter-

mined without more precise conclusions as to the values of

the respective properties. |

° lott]

_ e

- ,

> = a . e . ; y

_ ol

ganizations where it is necessary or desirable to

maintain: unified operation of properties mortgaged

to secure separate bond issues and where a simpli-

fied capital structure is required. The problem

may also arise, even in the absence of liens, with

respect to the treatment of the Securities of any

two or more corporations the properties of which

should be combined in a single reorganized « cor-

poration. a

Reorganization in some typ pes of cases might be.

impossible under the holding of the court below.

The reorganization provisions of the Bankruptcy

Act,” and comparable provisions of other statutes,”

require that a plan of reorganization be feasible as_

well as fair and equitable. If the holding of the

court: below is correct, a plan. of reorganization

- on 77 (e), 11 ;U. S.C. § 205 (e); Sec. 77 B (f), WW

U.S. C. § 207 (f); Chane X, Sees. 174 and*221 (2), 11

U. S. C. §3 574 and 621 (2); Chapter XI, Sec. 366 (3), 11

U.S. C. § 766 (d); Chapter XIT, Sec. 472 (3), 11 U. S.C

§ 872 (3) ; Chapter XITI, Sec. 656 (3),11 U.S. G. § 1056.(3).

_ 8 Sections 11 (d) and 11 (e) of the Public Utility Hold-

in& Company Act of 1935, 15 U. S. C. § 79k (d) and (e),

authorize the Securities and Exchange Commission to ap-

prove, andsto take steps to enforce, plans of reorganization

of registered public-utility — companies or 7 ir-sub- ~

sidiaries;which must be both “ d equitable” and “neces-

sary to effectuate the provisions of subsection (b).” * Among

other things, Sec. 11 (b) requires the Commission to direct

each registered holding company and subsidiary thereof to

take steps to insure that its cor porate str ucture 1 is not unduly

or unnecessarily complicated.

~~ .

og :

;

which: fails to preserve priorities of separate . b

_lienors against the properties securing their re- :

spective claims cannot be fair. Yet in many cases .

any plan attempting to preserve separate liens

would necessitate so complicated a capital strue-

ture that it would not be feasible. Consequently,

in some Cases, no plan of reorganization complying |

with the statutory standards would be possible.

We submit that the Los Angeles case compels no

such result. | es,

The decision below ‘in this regard is opposed in -

principle to a number of degisions of the lower

federal courts and of the ~~. Commerce

Commission in comparable reorganization. cases.

These authorities are collected in the brief filed on

behalf of the petitioners in No. 444 (pp. 11-13) and

" eonsequently will not be further discussed in this

brief. :

| CONCLUSION

_ We submit that the decision of the court below

reversing the order confirming’ the plan of reorgan-

ization should be affirmed, but that the mandate of.

this Court should issue in such form that the Dis-

trict Court may, upon proper findings of the neces-

sity or desirability of unification, approve a plan

_.of reorganization providing for unified operation

of the enterprise by a single reorganized corpora-

tion, without any. requirement that the full com-

pensation which-each class of security holders is to *

be accorded for.the value of its interests be given |

_ (88

out of the particular assets subject to ‘its claims.

Respectfully submitted,

/ FRANCIS Bwo1e, |

Solicitor General.

/ Ricwarp H. DEMUTH, -

Special Assistant, to the Attorney Geveral.

J Cuester T. LANE,

General Counsel,

Securities and Exchange Commission.

* Martin RIGER,

. GeorGE Roster,

HoMER KRIPKE, i

IRVING S. RoGERs,

Attorneys,

Securities and Exchange Commission.

. a “ ‘

a .

3 .

. , .

APPENDIX™

The applicable provisions of the Bankruptcy

Act, as they existed prior to the 1938 amendments

(11 U.S: C. Supp. V, § 1 et seg.), are as follows:

Sec,

Sec.

The value of securities held by secured

creditors shall be determined by converting

the same into money according to the terms

of the agreement pursuant to which such

securities were delivered to such creditors or

by such creditors and the trustee, by agree-

ment, arbitration, compromise, or litigation,

as the court may direct, and the amount of

such value shall be credited upon such claims,

and a dividend shall be paid only on the un-

paid balance. .

The elaim of any estate which is being

administered in bankruptey against any like

estate may be proved by the trustee and

allowed by the court in the same manner

and_upon like terms as the claims of other

ereditors. '

63 (a) (11 U.S. 0.§103(a)):

Debts of the bankrupt may be proved and

‘ allowed against his estate which are (1) a

fixed liability, as evidenced by a judgment

’ *- or an instrument in writing, absolutely

‘owing at the time of the filing of the petition

against him, whether then payable or hot,

. With any interest thereon which would have ~

been recoverable at that date or with a rebate

(54) -

of interest upon such as were not th2n pay-

able and not bear interest; * * * (4)

founded u an open account, or upon a

contract express or implied ; */

See.

* The term “creditors” shall in- .

a e i all purposes of this section and of —

reorganization plan; its acceptance and

po ht rs all holders of claims of what-

ever character against the debtor or its

property, including claims under executory

contracts, wheth?r or not such claims would

otherwise constitute provable claims under

this Act. The term ‘‘claims”’ includes debts,

securities, other than stock, liens, or other

interests of whatever. character. * * *

In the case of secured claims entitled to the

provisions of clause, (5) of this subdivision *

(b), the value of the security shall be deter-

mined in the manner provided in section 57,

clause (h) of this Act, and if the amount: of

such value shall be less than the amount of

the claim, the excess may | be classified as-an

unsecured claim. * *

After hearing such objections as may. be

“made to the plan, the judge shall confirm

the plan if satisfied that (1) it is fair and

- equitable and does not discriminate unfairly

See,

in favor of any class of creditors or stock-

holders, and i is feasible’ * * *,.

T7B (1) (1 U. 8. C. § 207 (k)):

If an order is entered directing the trustee

or trustees to liquidate the estate pursuant

to the provisions of.clause (8) of subdivision

referred to a referee as provided in section

oe:

_ provable under section 63 may be proved as

‘directing the trustee or trustees to liquidate - }

such order shall have the same consequences

vided in section 44, and be compensated as 4

. expire until six months after the date of the |

_ last publication of the notice of the first. 7

‘ority as provided in section 64; (6) sales 4

' Shall be made as provided in subdivision (b)., q

22, who shall be compensated as provided in 4

section 40; (2) the first meeting of creditors —

shall be held as provided in section.55, upon 7

notice as provided in section 58; (3) a trus- —

tee or trustees shall be appointed as pro- 7

provided ‘in section 57, except that the time 4

within which proof may bé made shall not +

meeting; (5) debts shall be entitled to pri-

of section 70; (7) dividends may be declared *

and paid as provided in ‘section 65. None

of the sections enumerated in this ‘subdivi- 4

sion (k), except subdivision (g), (i), (j), 7

and (m) of section 57,and ‘subdivisions (a) . |

and (e) of section 70, shall apply to pro-

ceedings instituteg under this section 77B

unléss and until an order has been entered 7

eos

the estate. All other provisions’of this Act, . |

except such as are inconsistent With the pro- |

visions of this section 77B, shall-apply to, |

proceedings instituted under this section, 4

whether or not an order to liquidate the ~

estate has been entered. For the purposes. |

of such application, provisions relating to

‘‘bankrupts”’ shall be deemed to relate also

to ‘‘debtors’’; ‘‘bankruptcy proceedings” or

‘proceedings in bankruptcy’? shall be ~

deemed te include proceedings under this ~

section ; the date of the order approving the =

petition or answer under this‘section shall be —

taken to be the date of adjudication, and

and effect as an order of adjudication.

U.S. GOVERNMENT PRINTING OFFICE: 1941

“SUPREME COURT OF THE UNITED STATES.

«+ Nos. 400 and 444.—OcToBER Term, 1940.

' Consolidated Rock Products Co., et al.,)

‘ Petitioners, "

> 400 “9. : On Writs of Certiorari, to

3 E. Blois du Bois. | the United States Circuit

i : . ar Court of Appeals for the

_» F. D. Badgley, et al., Petitioners, Ninth Circuit.

44 U8. | a aa

R _° E. Blois du Bois. ' - |

[March 3, 1941.]

Mr. Justice Dovauas delivered the opinion of the Court.

This case involves questions as to the fairness under § 77B of the

Bankruptcy Act (48 Stat. 912) of a plan of reorganization for a

parent corporation (Consolidated Rock Products Co.) and its two

wholly owned subsidiaries'\—Uniwn Rock Co. and Consumers Rock

and Gravel Co., Inc. The District Court confirmed the plan; the

Cireuit Court of Appeals reversed. 114° F. (2d) 162. We granted

_ the’petitions? for certiorari because of the importance in the admin-

istration.of the reorganization provisions of the Act of certain prin-

ciples enunciated by the Circuit Court of Appeals.

The stock of Union and Consumers is held by Consolidated.

_ Uni has outstanding in the hands of the public® $1,877,000 of

6% bonds secured by an indenture on its property, with accrued

’ ana unpaid interest* thereon of $403,555—a total mortgage indebt-

1The proceed’ ys under §77B were instituted in 1935 by the filing of

separate voluntary petitions by Consolidated, Union and Consumers. No

_ trustees have been appointed, Consolidated remaining in possession,

2 The petition in No. 400 raises all of the questions discussed herein, while

_ the petition in No. 444 raises only the question as to the authority of the

reorganization court to approve a plan which substitutes one mortgage cover-

' imtg all of the property for so-called divisional mortgages on separate units

of that property. The Interstate Commerce Commission and the Securi-'

ties and Exchange Commission filed memoranda urging that the petition in

No, 444 be granted and that the petition in No. 400 be granted to the extent

that it raised the same question as that presented by the petition in. No, 444.

8 $102,500 face amount of Union’s bonds are held by Consolidated.

‘As of April 1, 1937, the effective date of the plan. Interest on Union

bonds has been in default since March 1, 1934. .

2 Consolidated Rock Products Co, vs. du Bois.

edness of $2,280,555. Consumers has outstanding in the hands of

the public® $1,137,000 of 6% bonds secured by an indenture on its

property, with accrued and unpaid interest*® thereon of $221,715~

. a total mortgage indebtedness of $1,358,715. Consolidated has out: |

“standing 285,947 shares of no par value preferred stock’ and 397,

455 shares of no par common stock.

. The plan of reorganization calls for the formation of a new cor.

poration to which will be transferred all of the assets of Consoli-

dated, Union,* and Consumers free of all ciaims.® ‘The securities of

the new corporation are to be distributed as follows:

Union and Consumers bonds heid by the public will be exchanged

for income honds! and preferred stock" of the new company. For

50 per cent of the prinsipal amounts of their claims, those bond.

holders will receive income bonds secured by a mortgage on all of

.the property of the new eompany;-for the balance they will receive

an equal amount of par value preferred stock Their claims to

issued therefor. Thus Union bondholders for their claims of

$2,280,555 will receive income bonds and preferred stock in the .

fare-amount of $1,877,000; Consumers bondholders for their

’ claims of $1,358,715 will receive income bonds and preferred stock!2

5 $63, 500 face amount of Consumer’s bonds are. held by Consolidated.

6 Interest has been in default since July 1, 1934.

7 With 4 preference on liquidation of $25 per share plus accrued dividends,

‘8 Reliance Rock Co, is a wholly owned subsidiary of Union whose properties

also were to be transferred ta the new company.

® The claims of general creditois will be paid in full or assumed by the new

comphny.

10 These bonds will mature in 20 years and will bear interest at the*rate of

5 per cent if earned. The interest will be cumulative if not paid. The bonds,

as well as the preferred stock, to be issued to Union and Consumers bond-”

holders will be in separate series. The net income of the new company is to

be divided into two equal parts: each part to be used*to pay, with respect to

; bonds and preferred stock of each series, first, interest and sinking fund pay-

ments on the bonds; second, dividends and sinking: fund payments on the pre-

BK, stock, Income remaining will be available for general corporate

: 11 The new preferred stock will have a par wales of $50 and will carry 8

j dividend of 5 per cent. It will be noncumulative until the retirement of the

bonds of the same series except to the extent that net income. is available for

ré dividends. Thereafter it will be cumulative.

. 12 All of the new income bonds and preferred stock are to be venridh to the

public holders of Union and Consumers bonds.

——— oo

Consolidated Rock Products Co. vs. du Bois 3

in the face amount of $1,137,000. Each share of new preferred

stock will have a warrant for the purchase of two shares of new $2"

par value common stock at prices ranging from $2 per share within

six months of issuance, to $6 per share during the fifth year after .

issuance.

Preferred stockholders of Consolidated will receive one share of

new common stock (¢2 par value) for each share of old preferred

or an aggregate of 285,947 shares of new common. ,

A warrant to purchase one share of new common for $1 within

three months of issuance will be given to the common stockholders

of Consolidated for each five shares of old common.™ '

The new preferred. stock, to be received by the old vondholders,

will elect four out of nine directors of the new company; the new

common stock will elect the remainder.’4 But on designated d’

_linquencies in payment of interest on the new bonds, the old bond-

holders -would be entitled to elect six of the nine directors.

The bonds of Union and Consumers held by Consolidated,’ the

stock of those companies held by Consolidated, and the inter-

company claims (discussed hereafter) will be cancelled. . ‘

In .1929 when Consolidated acquired control of these various

properties, they were appraised in exeess of $16,000,000 and it

was estimated that their annual net earnings would be $500,000.

In 1931 they were appraised’ by officers at about $4,400,000,

“exclusive of going concern, good will and current assets.’’? The

- District Court did not find specific values for the separate proper-

ties of Consolidated, Union, or Consumers, or for the properties

of the enterprise as a unit. The average of the valuations (ap-

parently based on physical factors) given by three witnesses’® at

the hearing before the master were $2,202,733 for Union as against

. &@ mortgage indebtedness cf $2,280,555 ; $1,151,033 for Consumers

as against a mortgage indebtedness of $1,358,715. Relying on simi-

lar testimony, Consolidated argues that the value of its property, to

13 79,491 shares of new common will be reserved for the exercise of warrants

issued to. old common stockholders; an additional 60,280 shares of new common,

for the exercise of warrants attached to the new preferred.

14 It is apparent that the majority of the new common will 7 held by the

old preferred stockholders even if all warrants are’ exercised,

‘15 See notes 3.and 5, supra.

16 Two officers and one ex-employee. These valuation figures included the

properties of Reliunce. See note 8, supra.

4 Consolidated Rock Products Co. vs. du Bois.

be contributed to the new company, is. over $1, 359 ,000, or exclusive

of an alleged good will of $500,000, $859,784. “These estimated

~ yalues somewhat conflict with the consolidated balance sheet (as:

at June 30, 1938) which shows assets of $3,723,738.15 and liabilities

(exclusive of capital and surplus) of $4,253,224.41.. More im-

portant, the earnings record of the enterprise casts grave doubts on

the soundness of the estimated values. No dividends were ever

paid on Consolidated’s common stock ; and except for five quarterly

dividends i in 1929 and 1931, none on its preferred stock. For the .}

eight afida half years from April 1, 1929, to September 30, 1937, .

Consolidated had a loss of about $1,200,000 before bond interest but

after depreciation and depletion. And except for the year 1929,

‘Consolidated had no net operating profit, after hond interest and

amortization, depreciation and depletion, in any year down to Sep. .

tember 30, 1937.17 ;Yet on this record the District Court found that

the. present fair value of all the assets of the severe! companies, ex- |

clusive of good will and going corfcern value, was in excess ofsthe *

total bonded indebtedness, plus accrued and unpaid interest. And

it also found that such yalue, including good will and going concern

value, was insufficient to pay the bonded indebtedness plus accrued

and unpaid interest and the liquidation preferences and accrued

dividends on Consolidated preferred stock. it further found that

the present fair value of the assets admittedly subject to the trust

indentures of Union and Consumers was insufficient to pay the face

amount, plus accrued and unpaid interest of the respective bond

issues. In spite of that finding, the District Court also found-that

‘it would be physically impossible to determine and segregate with

any degree of accuracy or fairness properties which originally be-

longed to the companies separately’’; that as a result of unified

operation properties of every character ‘‘have been commingled

and are now in the main held by Consolidated without any way of

ascertaining what part, if any thereof, belongs to each or any of the_

companieseparately’’; and that, as a consequence, an appraisal

‘‘would be of such an an renee and unsatisfactory nature as to |

produce further confusion.’

The unified operation which resulted in that commingling of

assets was pursuant to an-operating agreement which Consolidated

”

’ & §

- .17The hearings on the plan’ were held before a master during November,

1937 5

a y hs,

’

Consolidated Rock Products Co. vs. di Beis. “5

eaused its wholly owned subsidiaries'® to execute in 1929. Under

that agreement the subsidiaries ceased all operating functions and

the entire management, operation and financing of the business and

properties of the subsidiaries were undertaken by Consolidated.

The corporate existence of the subsidiaries, however, was maintained

and certain separate accounts were kept. Under this agreement Con-

solidated undertook, inter alia, to pay the subsidiaries the amounts

necessary for the interest and sinking fund provisions of the inden-

_ tures and to credit their, current accounts: with items of deprecia-

tion, depletion, amortization and obsolescence.® Upon termination

of the agreement the properties were to be returned and a final

settlement of accounts made, Consolidated meanwhile to retain all

net revenues after its obligations thereunder to the subsidiaries had

been met. It was specifically provided that the agreement was made

for the benefit of the parties, not ‘‘for the benefit of any third per-

son.’’ Consolidated’s books’ as at June 30, 1938, showed a net in-

debtedness under that agreement to Union and Consumers of some-

what over $5,000,000. That claim was cancelled by the plan of re- |

organization, no securities being issued to the creditors of the sub-

sidiaries therefor. The District Court made no findings as respects

the amount or validity of that intercompany claim; it summarily

disposed of it by concluding that any liability under the operating

agreement was ‘‘not made for the benefit of any third parties and

the bondholders are included in that category.’’ /

We agree with the Circuit Court of Appeals that it was error to

confirm this plan of reorganization. ;

I. On this record no determination of the fairness of any plan

of reorganization could be made, Absent the requisite valuation

data, the court was in no position to exercise the-‘‘informed, inde- -

4 7

18 This agreement covered the properties of Reliance as well as Union and

Consumers; By a modification made in 1933 the agreement was: to expire in

February, 1938, Consolidated having an option to extend the agreement for

another five years on specified notice.

' 19The agreement was modified in 1933 ¢by two officers acting for each

of the four companies)’ whereby the depreciation to be credited to the

subsidiaries should ‘be ‘credited only on termination of the agreement. At

that time Consolidated was to have the right by paying a five per cent

penalty, to pay twenty-five per cent of the amount of the depreciation credit .

in ten annual installments and the balance at the end of ten years from the

date of termination. Some question has been raised as to the propriety of

that modification, a question on which we express no opinion.

. - hondholders emphasizes its necessity and importance. According ]

: 6 Consolidated Rock Products Co. vs. du Bois.

pendent judgment’’ (National Surety Co. v. Coriell, 289 U. 8.426,

- 436) which appraisal of the fairness of a plan of reorganization

entails, Case v. Los Angeles Lumber Products Co., 308 U. S. 106,

- And see First National Bank v. Flershem, 290 U. S. 504, 525,

There are two aspects of that valuation problem, ?

In the first place, there must be a determination of what assets .

are subjeCt to the payment. of the respective claims. This obvious

requirement was not-met, The status of the Union and Consumers

to the District Court the mortgaged assgts are insufficient to pay

_ the mortgage debt. There is-no finding, however, as to the extent

of the deficiency or the amount of unmortgaged.assets and their

value. It is plain that the bondhoiders would have, as against

Consolidated and its &tockhoiders, prior recourse against any un-

mortgaged assets of Union and Consumers. The full and absolute }

priority rule of Northern Pacific Railway Co. v. Boyd, 228 U. §..

482, and Case v. Los Angeles Lumber Products Co., supra, would

preclude participation by the equity interests in any of those assets

until the bondholders had been made wl®le. Here there are some

unmortgaged assets, for there is a claim of Union and Consumers

against Consolidated—a claim which according to the books of Con-

\golidated is over $5,000,000 in amount. If that claim is valid,” ;

or even if it were allowed only to the extent of 25% of its face

amount,”! then the entire assets of Consolidated would be drawn

down into the estates of the subsidiaries. In that event Union and

Consumers might or might not be solvent in the bankruptcy sense.

But certainly it would render untenable the present contention of

- Consolidated and the preferred stockholders that they are con- }

tributing all of the assets of Consolidated to the new company in

éxchange for which they are entitled to new securities. On that

theory of the case they would be making a contribution of only

such assets of Consolidated, if any, as remained after any de- .

ficiency of the bondholders had been wholly satisfied.

20 Consolidatéd seems to admit that that claim is valid, at least to the extent

of net current liabilities aggregaiing more than $250,000 as of June 30, 1938.

21 Respondent points out that even on the basis of a $3,300,000 valuation of

the properties of Union and Consumers depreciation, depletion and obsoles-

cence charges would be approximately $1,250,000. é

hen

Consolidated Rock Products Co. vs. du Bois. . ° 7

There are no barriers to a valuation and enforcement of that

claim. If as Consolidated maintains the subsidiaries have no-

present claim against it,** the claim can readily be discounted to

present worth. It is provable by trustees of the subsidiaries,

for the term ‘‘ereditors’’. under §77B(b) includes ‘‘holders 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.’3 Consolidated makes some point of the difficulty and ex-

pense of determining the exterit of its liability under the operating

agreement and of the necessity to abide by the technical terms of

that agreement** in ascertaining that liability. But equity will not .

permit a holding company, which has dominated and contru'l 2 its -

subsidiaries, to escape or reduce its liability to those subs: . tries

by ‘reliance upon self-serving contracts which it has imposed on

them. A holding company, as well as others in dominating or con-

trolling positions (Pepper v. Litton, 308 U. S: 295), has fiduciary

* forced. See Taylor v. Standard Gas & Elecéric Co., 806 U. S. 307.

In this connection Consolidated cannot défeat or postpone the ac-.

counting because of the clause in the operating agreement that it

was not made for the benefit of any third person. The question

here is not a technical one as to who may sue to enforce that lia-

bility. It is merely a question as to the amount by which Consoli-

dated is indebted to the subsidiaries and the proof and allowance

of that claim. The subsidiaries need not be sent into state courts '

to have that, liability determined. The bankruptcy court having’

exclusive jurisdiction over the holding company and the subsidi-

aries has plenary power. to adjudicate all the issues pertaining to

22 Consolidated maintains that there is no present claim against it because

no claim exists until termination of the operating agreement which ran until

February 1938, with an option in Consolidated to extend it for fivé years.

But it does not assert, nor does th record show, that the option was exercised.

*But even if it had been, only the time when the amounts accrued were payable

would be affected. ' F

23 For an equally broad defin‘tion of ‘‘creditor’’ under Ch. X of the Chaxd-

ler Act (52 Stat. 840) soe § 1(6(1) and (4). | . |

_ 4 Thus Consolidated argues that under the operating agreement the machin-

ery for an appraisal provided therein must be employed. Yet assuming

erguendo thut that is true, Consolidated which has been in posseasion and con-

trol throughout, cannot rely on the failure to have an appraisal as a reason for

‘ blocking or delaying its duty to account. ‘

* ing & a condition precedent to approval of any plan.of reorgani-.

8 Consolidated an Products Co. vs. du Bois.

the claim. The intimations of Consolidated that Siew must be ,

foreclosure proceedings and protracted litigatior. ‘in state courts

involve a misconception of the duties and powers of the bankruptey

court, The fact that Consolidated might have a strategie or

- @uisance value outside of § 77B does not detract from or impair the

power and duty of the bankruptey court to require a full account. '

zation. The fact that the claim might be settled; with the approval

of the Court after full disclosure and notice to interested parties,

does not justify the concealed compromise effected here through the

simple expedient of extinguishing the claim.

So far as the ability of the bondholders of Union and Consumers

to reach’ the assets of Consolidated on claims of the kind covered

by the operation agreement: is concerned, there is another and

more direct route which reaches the same end. There has been

a unified operation of those several properties by Consolidated pur.

suant to the operating agreement. That operation not only resulted

in extensive commingling of assets. All management functions of |

the several companies were assumed by Consolidated. The sub- /

sidiaries abdicated. Consolidated operated them as mere depart- |”

ments of ‘its own business. Not even the formalities of. separate .

- corporate organizations were observed, except in-minor particulars

such as the maintenance of certain separate accounts. In view of

these facts, Consolidated is in no position to claim that its assets

are insulated from such claims of creditors of the subsidiaries. To

the contrary, it is well settled that where a holding company di-

rectly intervenes in the management of its subsidiaries so as te -

treat them as’ mere departments of its own enterprise, it is rm )

responsible for the obligations of those subsidiaries incurred or

arising during.its mapagement. Davis v. Alerander, 269 U. Sm1l4.

117; Joseph R. Foard Co. v. State of Maryland, 319 Fed... 82%

829; Stark Electric R. Ce. v. M’Ginty Contracting Co., 238 Fed.

657, 661-663; The Willem Van Driel, Sr., 252 Fed. 35, 37-39; '

“Luckenbach S.S. Co. x. W. R. Grace t Co., 267 Fed. 676, 681:

Costan v. Manila Electric Co., 24 F. (2a) 383; Kingston Dry Dock |

Co. v. Lake Champlain Transp. Co., 31 F. (2d) 265, 267; Dillard

& Coffin Co. v. Richmond Cotton Oil Co., 140 Tenn. 290. We are

ret dealing here with a situation where other creditors of a parent | ,

company are competing with creditors of its subsidiaries. . If me

POO Sate SSO ATL)

» Consolidated Rock Products Co. vs. du-Bois. g¢ 9

tictlous regard to corporate forms, which Consolidated has long ig-

nored, is now observed, the stockholders of Consolidated nfhy be the

direct beneficiaries. Equity will not countenance such a result. A

holding company which assumes to treat the properties of its sub-

‘ gidiaries as its own cannot take the benefits of direct management |

without the burdens.

_We have already noted that no adequate finding was s made as to

the value of the assets of Consolidated. In view of what we have

said, it is apparent that a dei.:: mination of that value must be made

so that,criteria will be available: to determine an appropriate allo-.,

cation of new securities between bondholders and stockholders in’

case there is an equity remaining after the bondholders have been

made whole..

There is another reason why the failure to ascertain What assets

are subject to the payment of the Union and Consumers bonds is

fatal. There is a question raised as to the fairness of the plan as

respects the bondholders inter sese. While the totad mortgage. debt

of Consumers is less than that of Union, the net income of the new

company, as we have seen,*° is to be divided into two equal parts,

one to service the new securities issued to Consumers bondhelders,

the other to service those issued to Union bondholders. That allo-

cation is attacked here by respondent as discriminatory against

Union, on the ground’ that the assets of Union are much greater

in volumerand in value than those of Consumers. It does not ap-

pear from this record that Union and Consumers have individual

earnings records. If they do not, some appropriate formula for at

least an approximate ‘ascertainment of their respective assets must :

be designed. in spite of the difficulties oceasioned by the com-

mingling. Otherwise the issue of fairness of any plan of reorgani-

zation as between Union and Consumers bondholders cannot. be in-

telligently resolved. |

In the second place, there is the question of the method of valua-

tion. From this record it is apparent that little, if any, effort was

made to value the whole enterprise by a capitalization of prospec-

tive earnings. The necessity for such an inquiry is emphasized

by the poor earnings record of this enterp ise in the past. Findings

as to the earning capacity of an enterprise are essential to a deter-

mination of thé feasibility as well as the fairness of a plan of re-

25 Supra, note 10.

10 . Consolidated Rack Products Co, vs. du Bois.

organization. Whether or not the-earnings may reasonably be

expected to meet the interest and dividend requirements of the

new securities is a sine qua non to a deterptination of the integrity

and practicability of-the new capital structure. It is also essential

for satisfaction of the absolute priority rule of Case v. Los Angeles

Lumber Products Co., supra. Unless meticulous regard for earn-

ing capacity be had, indefensible participation of junior securities

in plans of reorganization may result.

As Mr. Justice Holmes said in Galveston, Harrisburg & San |

Antonio Ry. Co. v. Texas, 210 U. 8. 217, 226, ‘‘the commercial

value of property consists in the expectation of income from it.”’

And see Cleveland, Cincinnati, Zhicago & St. Lowis Ry. Co. v.

Backus, 154 U. 8. 489, 445. Such criterion is the appropriate one.

here, since we are dealing with the issue of solvency arising in con-

nection with reorganization plans involving productive properties.

It is/plain that valuations for other purposes are not relevant to or

helpful in a determination of that issue, except as they may in-

dirgetly bear on earning capacity. Temmer v. Denver Tramway

Co. 18 F. (2d) 226, 229; New York Trust Co. v. Continental &

Commercial Trust & Sav. Bank, 26 F. (2d) 872, 874. The criterion

of earning capacity is the essential one if the enterprise is to be

freed from the heavy hand of past errors, miscalculations or dis-

-aster, and if the allocation of securities among the various claimants

is to be fair and equitable. In re Wickwire Spencer Steel Co.,,

12 F. Supp. 528, 533; 2 Bonbright, Valuation of Property, pp.

870-881, 884-893. Since its application requires a prediction as

to what will occur in the future, an estimate, as.distinguished from

mathematical certitude, is all that can be made. But that estimate |

must be based on an informed judgment which embraces all facts

relevant to future earning capacity and hence to present worth,

including, of course, the nature and condition: of the properties,

the past earnings record, and all circumstances which indicate

whether or not that record is a reliable criterion of future per-

formance. A gum of values based on physiéal factors and assigned

to separate units of the property without regard to the earning

capacity of the whole enterprise is plainly inadequate. See Fin-

letter, The Law of Bankruptcy Reorganization, pp,/ 557 et seq.

But hardly more than that was done here. The Circuit Court of

Appeals correctly left the matter of a formal appraisal to the —

Consolidated Rock Products Co. vs. du Bois. di

diseretion of the District Court. The extent and method of in-

- quiry necessary for a valuation based on earning oemy are

necessarily dependent on thé facts of each case. -

Il, The Cireuit Court of Appeals held that the absolute priority

rule of Northern Pacific Railway Co. v. Boyd, supra, and Case v.

Los Angeles Lumber Products Co., supra, applied to reorganizations

of solvent as Ww ell as insolvent companies. That is true. Whether

a company is sivent or insolvent’ in either the equity or the

bankruptcy. sense, ‘‘any arrangement of the parties by which the

| sybordinated rights and interests of the stoekholders are attempted

to be secured at the expense of the prior rights’’ of creditors ‘‘comes

within judicial denunciation”’. Louisville Trust Co. v. Louisville,

New Albany & Chicago Ry. Co., 174 U. S. 674, 684. And we indi-

cated in Case v. Los Angeles Lumber Products Co., supra, that that

tule was not satisfied even ‘though the ‘‘relative priorities’’. of

creditors and stockholders were maintained (pp. 119-120).

The instant plan runs afoul of that principle. In the first place,

no provision is made for the acerued interest on the bonds. This

interest is entitled. to the same priority as the principal. See Amer-

ican Iron & Steel Mfg. Co. v. Seaboard Air Line Ry., 233 U. S.

261, 266-267; Ticonic National Bank v. Sprague, 303 U.'S. 406.

In the second place, and apart from the ca ellation of in-

terest, the plan does not satisfy the fixed principle of the Boyd

case even on the assumption that the enterprise as a whole is solvent

in the bankruptcy sense. The bondholders for the principal amount

_ of their 6% bonds receive an equal face amount of new 5% income

bonds and preferred stock, while the preferred stockholders re-

ceive new common stock. True, the relative priorities are main-

tained. But the bondholders have not been made whole. They

have received an inferior grade of securities, inferior in the sense

that the interest rate has been reduced, a contingent return has

been substituted for a fixed one, the maturities have been in part

extended and in part eliminated by the substitution of preferred

stock, and their former. strategic position has been weakened.

Those lost rights are of value. Full compensatory provision must

be made for the entire bundle of rights wah the creditors sur-

render,

The absolute priority rule does not mean that bondholders cannot

be given inferior grades of securities, or even securities of the same

12. ~— Consolidated Rock Products Co. vs. du Bois.

grade as are received by junior interests. Requirements of feasi-. '

bility?* of reorganization plans frequently necessitate it in the in.

terests of simpler and more conservative capital structures. And

. standards of fairness permit it. This\ was recognized in Kansas

City Terminal Ry. Co. v. Central Union Trust Co., 271 U. S. 445,

‘This Court there said (p. 455) that though ‘‘to the extent of their

debts creditors are entitled to priority over stockholders against all

thesproperty:’’ of the debtor company, ‘‘it, does not follow that in

every reorganization the securities offered to general creditors must

be superior in rank or grade to any which stockholders may obtain.

It is not impossible to accord to the creditor his superior rights in

other ways.’’ And the Court went on to say (p. 456), ‘‘No offer is

fair which does not recognize the prior rights of creditors. . :;

but circumstances may. justify an offer of different amounts of the

same grade of securities to both creditors and stockholders.’’ Thus

it is plain that while creditors may be given inferior grades of secu-

rities, their ‘‘superior rights’? must be recognized. Clearly, those

prior rights are not recognized, in cases where stockholders are

participating in the plan, if creditors are given only a face amount

of inferior securities equal to the face amouxt “f their claims. They .

must receive, in addition, -compensation for the senior rights which

they are to surrender. If they receive less than that full compensa-

tory treatment, some of their property rights will be appropriated

for the benefit of stockholders without compensation. That is mot

a permissible. The plan then comes within judicial denunciation

because it does not recognize the creditors’ ‘‘equitable right to be

preferred to stockholders against the full value of all property be-

longing to the debtor corporation’’, Kansas City Terminal Ry. Co.

v. Central Union Trust Co., supra, p. 454.

Practical adjustments, sother than a rigid formula, are neces-

sary. The method of effecting full compensation for senior claim-

ants will vary from case to case. As indicated in’ the Boyd case

(228 U. S. at p. 508) the creditors are entitled to have the full

value of the property, whether ‘‘

dends or only for purposes of control’’, first appropriated to pay-

- ment of their claims. But whether in case of a solvent company

the creditors should be made whole for the change in or loss of |.

their seniority by an increased participation in assets, in earnings

or in control, or in any combination thereof, will be dependent on

26 See. 77B(f) (1).

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present or prospective, for divi- -

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Consolidated Rock Products Co. vs. du Bois. — 13

the facts and requirements, of each case.27 So long as the new

securities offered-are of a value equal to the creditors’ claims, the

appropriateness of the formula employed rests in the informed

discretion of the court. ;

The Circuit Court of Appeals, however, made certain statements

which if taken literally do not comport with the requirements of

the absolute priority rule. It apparently ruled that a class of

claimants with a lien on specific properties must receive: full com-

’ pensation out of those properties, and that a plan of reorganization

js per se, unfair and inequitable if it substitutes for several old

bond issues, separately secured, new securities ¢onstituting an in-

terest in all of the properties. That does not follow from Case v.

Los Angeles Lumber Products Co., supra. If the creditors are ade-

quately compensated for the loss of their prior claims, it is not

material out of what assets they are.paid. So long-as they receive

full compensatory treatment and so long as each group shares in

the secuvities of the whole enterprise on an equitable basis, the re-

quirements of ‘‘fair and equitahle’’ are satisfied. ?

“Any other standard might well place insuperable obstacles in the

way of feasible plans of reorganization. Certainly where unified —

operations of separate properties are. deemed’ advisable and essen-

tial, as they were in this case, the ¢limination of divisional mort-

gages may be necessary as well ‘as wise: Moreover, the substitution

of a simple, conservative capital structure for a highly complicated

one may be a primary requirement of any reorganization plan. .

There is no necessity to construct the new capital structure on the

framework of the old. __- ae :

See ° Affirmed.

27In view of the condition of the record remtive to the value of the proper-

- ties and the fact that the accrued interest is cancelled by the plan, it is ‘not

profitable to attempt a detailed discussion of the deficiencies in the alleged’

compensatory treatment of the bondholders. It: should, however, be noted as

respects the warrants issued to the old common stockholders that they ad-

mittediy have no equity imthe enterprise. Accordingly, it should have been

shown that there was a necessity of secking new money from them and that

the participation accorded them, was not more than reasonably equivalent to

their contribution.- Kansas Cit Terminal Ry. v, Central Union Trust

Co., supra; Case v. Los Angeles Lumber Products Co., supra, pp. 121-122. In

the latter case we warned against the dilution of creditors’ rights by inade- -

quate contributions by stockholders. Here that dilvtion, takes a rather obvious

form in view of the lower price at which the stockholders may exercise the

warrants. Warrants exercised by them would dilute the value of common

stock purchased. by bondholders during the same period. Furthermore, on

Consolidated ’s estimate of the equity in the enterprise, the values of the new

common would have fo increase many fold to reach a value which exceeds the

warrant price by the amount of the accrued interest.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.