320 F.2d 940 | 2d Cir. | 1963
Lead Opinion
The issue is the propriety of an order of Judge Edelstein, in the District Court for the Southern District of New York, denying a motion by the Securities and Exchange Commission (hereafter the SEC), to dismiss the petition of Grayson-Robinson Stores, Inc. (hereafter “Grayson” or “the debtor”), a large retail chain, for an arrangement under Chapter XI of the Bankruptcy Act unless the petition was amended or a new petition filed so that the proceedings would continue under Chapter X. The SEC’s motion was supported and its appeal has been joined by Katherine B. Ladd and Connecticut General Life Insurance Company (hereafter referred to collectively as a single landlord), who have filed a claim based on Grayson’s guarantee of a lease entered into by a subsidiary that has defaulted.
The facts have been so painstakingly stated in Judge Edelstein’s opinion, 215 F.Supp. 921, that we shall limit ourselves to the essentials:
Grayson, a California corporation, is a nation-wide chain selling women’s and children’s apparel. All the stores are separately incorporated, and many of them are operated under leases entered into by the subsidiary and guaranteed by the parent. Until October, 1962, Gray-son also owned and operated a “Peerless-Willoughby” division engaged in the retail sale of photographic and audio equipment. Prior to November, 1960, the controlling stock interest in Grayson, some 32%, was owned by Hyman P. Kuchai and Philip S. Harris, who also controlled the S. Klein department stores. Until 1956 Grayson owned all the stock of Klein; in that year 92% was distributed to the debtor’s stockholders.
On November 6, 1960, Kuchai and Harris entered into a contract to sell their stock in the debtor to Maxwell H. Gluck, who was and is sole owner of Darling Stores Corporation, another retail chain selling women’s apparel. The consideration was $2,467,500, of which $715,575 was payable in cash at the closing and the balance on January 5, 1961. Kuchai and Harris made it a condition that Grayson be released from a guarantee of a 4%% note of Klein to Prudential Insurance Company, then outstanding in the sum of $7,375,000, which imposed restrictions on both Klein and Grayson, with a breach by either working a default on both. This release was accomplished by a three-cornered transaction in which Grayson transferred to Klein the 8% of Klein stock (68,250 shares) owned by it, Prudential released Grayson from its guarantee, and Klein agreed to purchase the 4%,% $7,375,-000 note. It financed the purchase by paying $1,350,000 and issuing a new 5.7% note in the amount of $6,775,000 to Prudential, which credited Klein with $6,025,000 against the 4%,% note and delivered to Klein for cancellation another 5%% $750,000 note previously issued by Klein in place of a required prepayment on the 4%% note.
As a result of a study conducted by the well-known accounting firm, S. D. Leides-dorf & Co., a plan to that end was shortly evolved. Under this plan Grayson purchased all of Darling’s inventory, supplies, and New York office equipment at the lower of cost or market, and agreed to
The new management of Grayson embarked upon a substantial expansion program which took the form of opening leased departments to sell apparel in established discount stores — a method of operation in which Darling had already ■engaged and which was thought to have advantages in the way of lower capital and overhead costs more than compensating for the lower profit margin. This ■expansion imposed a severe strain on the ■debtor’s working capital. It sought to .alleviate this by increased loans from Bankers Trust Co., as security for which it pledged the stock and notes of its profitable photographic subsidiaries. In a further expansion move it agreed, on July 5, 1961, to buy from Shoe Corporation of America 51% of the stock of A. S. Beck Shoe. Corporation for $4,-900,000 of 5% convertible debentures (subordinated to bank and other borrowings but not to trade creditors), and to purchase Beck shares from other stockholders on the same terms. The Shoe Company shares were acquired on December 4, 1961, the Gluck management took control of Beck on December 15, and 33 shoe departments selling Beck shoes were later opened in Grayson or Darling locations.
This rapid expansion without increase of the equity base or other long-term financing proved to be unwise. As stated in Grayson’s Annual Report for the year ended July 28, 1962, early in 1962 “Pressure to liquidate the major bank loan developed. When knowledge of this pressure became public, serious limitations in trade credit resulted. The flow of merchandise, which is the life blood of the business, was gravely affected.” In an effort to meet its problems, Gray-son placed a $10,000,000 convertible debenture issue in registration with the SEC on January 26, 1962, and also a $4,702,500 issue of subordinated convertible debentures to be offered to the minority stockholders of Beck pursuant to the agreement with Shoe Corporation of America. However, the registrations had not been completed when the stock market experienced its radical decline in May, 1962, whereupon the underwriter of the $10,000,000 issue withdrew; both registration statements were subsequently withdrawn. Meanwhile, on March 14, 1962, Grayson secured a $2,500,000 six-month loan at 6% from Schroder Trust Company secured by pledge of the Beck stock and a personal guarantee of Gluck collateralized by deposit of $1,000,000 in other securities; on March 26 it borrowed another $2,500,000 for one year from James Talcott, Inc., at 1/30% per day, secured by customer accounts receivable of 130 stores. Despite all this, debts to trade creditors mounted to $10,000,000, and the flow of merchandise was drasti
On August 20 a Creditors’ Committee of 40 persons was elected at a creditors’ meeting. One of its co-chairmen represented American Credit Indemnity Co., with a claim of $350,000; the other members were merchandise suppliers with claims of varying amounts, and a representative of display fixture creditors, the total claims represented by committee members being some $2,381,000. At the suggestion of Referee Herzog, a sub-committee of 13 was chosen to act as the Official Creditors’ Committee under § 338 of the Bankruptcy Act. The Committee retained counsel and accountants to investigate the debtor’s affairs, and a merchandising subcommittee su^ pervised purchases to insure that the debtor did not over-commit itself. With the approval of the court the photographic subsidiaries were sold for approximately $5,800,000, an amount sufficient to liquidate the Bankers Trust Company loan, to discharge liens of more than $400,000 perfected by certain merchandise creditors, and to yield some surplus, in cash. The debtor also undertook a rehabilitation program estimated to produce annual savings of $4,000,000 through reducing home office expenses, store payrolls, and rentals, and through the closing of 30 unprofitable stores; further savings from rent reductions and store closings are anticipated.
On November 14 and 20, and December 3, 11 and 21, examinations under § 21(a)' of the Bankruptcy Act were held. Wood (treasurer of the debtor), Gluck, Sherman (the Leidesdorf partner who had advised as to the Operating Agreement) and Stanley Roth were examined. The examination, recorded in 377 pages of transcript, was conducted almost solely by counsel for the Creditors’ Committee under the supervision of Referee Herzog, but counsel for the appellant landlord was present on all but the first day’s examination,
In October, 1962, it became known that the SEC was considering the filing of an application under § 328 of the Bankruptcy Act, as amended, 1952, to require the debtor’s proceedings to be transferred to Chapter X. After various conferences, action by the SEC was postponed until after the Christmas season, the debtor assuring the SEC that no attempt would be made to rush through an arrangement before the SEC could move. Meanwhile negotiations with creditors with respect to an arrangement proceeded. On January 3, 1963, the SEC made its motion; a few days thereafter the proposed Plan of Arrangement was filed, to be followed on February 1 by an amended Plan.
The amended Plan provides for the payment of priority claims and also of interest due and unpaid on the subordinated convertible debentures held by Shoe Corporation of America, the latter payment being conditioned on the indenture trustee’s rescinding a declaration accelerating the principal.
The SEC’s motion was supported by an affidavit of one of its attorneys. After setting forth the recent history of the debtor, it alleged, as reasons for the relief requested, the “Financial Inadequacy of Chapter XI,” to wit, that successful reorganization would require the raising of new capital; “The Need for Investigation” of the transactions outlined above and other matters, particularly “the competency of management”; the desirability of bringing the debtor’s many subsidiaries into the reorganization, as could readily be done under Chapter X, § 129; and the various procedural and substantive safeguards provided by Chapter X but not by Chapter XI. See SEC v. United States Realty & Improvement Co., 310 U.S. 434, 448-455, 60 S.Ct. 1044, 84 L.Ed. 1293 (1940).
In opposition there were submitted an affidavit of Stanley Roth accompanied by numerous exhibits relating to the debt- or's recent history and future prospects, affidavits of counsel for the Creditors’ Committee and of a co-chairman and a member of that body, and an affidavit of David Dubinsky, President of the International Ladies’ Garment Workers’ Un
With this background of fact we turn to the applicable law. Chapter X of the Chandler Act of 1938, as is well known, finds its source in § 77B, which was added to the Bankruptcy Act of 1898 in 1934, 48 Stat. 911, as Congress’ response to dicta of the Supreme Court casting doubt on the validity of the consent equity receivership;
In 1952 Congress altered Chapter XI in two respects relevant here. It added § 328, providing that “The judge may, upon application of the Securities and Exchange Commission or any party in interest, * * * if he finds that the proceedings should have been brought under chapter X of this Act, enter an order dismissing the proceedings under-this chapter,” unless the debtor amends, its petition to seek Chapter X relief or a creditors’ petition under that chapter be-filed.
It is difficult to extract much in the way of clear principle from these decisions, as indeed would be expected when Congress has authorized a corporate debtor seeking rehabilitation to follow either of two roads but has provided that a court “may” — surely not the strongest auxiliary verb known to our language— direct dismissal of a proceeding taken on one road if the debtor “should have” taken the other. Although there are some points of similarity between this case and the cases in which dismissal has been directed, there are points of difference which we think more important.
Insofar as the United States Realty decision rested on the impossibility of the debtor’s meeting the “fair and equitable” test without sacrifices by the publicly held stock that were impossible to enforce under Chapter XI, 310 U.S. at 452-454, 60 S.Ct. at 1051-1052, one would suppose it to have been considerably affected by the 1952 amendment eliminating the “fair and equitable” requirement from Chapter XI. This was the view of the minority in General Stores, 350 U.S. at 471-472, 76 S.Ct. at 521-522 and the position of the majority, 350 U.S. at 466 and 467, 76 S.Ct. at 519, is not altogether clear to us.
However we might decide the case if the record contained no more than this, we do not feel warranted in upsetting the judge’s exercise of discretion when there is added to the scales the evidence as to the drastic financial consequences of transfer to Chapter X. This point was not made at all in United States Realty, Mecca Temple, or Liberty Baking, and was not urged in General Stores with anything like the same seriousness and specific evidentiary support as here. However much we as judges might be inclined to join in the SEC’s queries why businessmen who have given credit to a debtor in possession under Chapter XI would refuse to do the same to a Chapter X trustee who had retained the debtor’s management, the affidavits before the District Judge stated with particularity that this was indeed the case. It was open to the SEC to contradict this by factual evidence from suppliers, credit men, or expert witnesses, but it did not do so. The Commission is no more relieved from the need of producing evidence on such a factual issue than are other litigants; the willingness of Seventh Avenue garment makers to sell on credit is not a subject on which the SEC is so expert that arguments may be accepted as the equivalent of proof.
Affirmed.
. The question whether Grayson’s guarantees of leases entered into by its subsidiaries are “executory contracts” that may be rejected under § 313 of the Bank-ruptey Act is at issue in Docket No. 28167, which is to be heard by another panel of this Court. We intimate no views on that question or, in general,
. The transfer of the 68,250 shares of Klein stock in this transaction for an allegedly inadequate consideration is the subject of two pending suits by Grayson stockholders in the Supreme Court of New York.
. The following table of receipts of merchandise illustrates this:
1961 1962
June........,$8,010,000 $4,580,000
July ........ 5,800,000 2,700,000
August ...... 8,070,000 960,000
. The examinations on December 11 and 21 were also attended by an attorney for two other creditors.
. The debentures are payable December 31, 1985; they are entitled to sinking fund pajonents of $200,000 a year beginning on December 1, 1965.
. The Minimum Obligatory Fixed Annual Payments are 10% of the full original amount of the General Debentures payable on January 31, 1905, 1966 and 1967 and $500,000 on each January 31 thereafter. In addition, beginning January 31, 1965, the debtor is to pay any excess of two-thirds of net profits after taxes for the fiscal year ended in July of the preceding calendar year over the Minimum Obligatory Fixed Annual Payments, -but not if such payment would reduce working capital below the lower of $10,000,000 or tlie working capital for the end of the fiscal year in which the Plan is confirmed. The Official Creditors’ Committee is empowered to defer not more than one-half of any of these required payments for not more than one year.
The principal of the General Debentures is to be accelerated on any default or, at the option of the Official Creditors’ Committee, if the debtor has suffered specified losses or if the trustee under the indenture covering the Subordinated Convertible Debentures has accelerated their principal.
. Harkin v. Brundage, 276 U.S. 36, 52, 48 S.Ct. 268, 72 L.Ed. 457 (1928) ; Shapiro v. Wilgus, 287 U.S. 348, 355-356, 53 S.Ct. 142, 77 L.Ed. 355 (1932) ; First Nat’l Bank v. Flershem, 290 U.S. 504, 515-516, 54 S.Ct. 298, 78 L.Ed. 465
. House Report No. 2320, 82d Cong. 2d Sess. (1952), at 19, U.S.Code Congressional and Administrative News 1952, p. 1980, states that the amendment “codifies the law of the United States Realty & Improvement case, and adopts the procedure of section 147 for transferring the proceeding to chapter X.” The important benefit of this amendment was in avoiding the need for starting a new proceeding if Chapter X was found the apprepriate vehicle after a Chapter XI petition had been filed.
. The House Report stated that “the fair and equitable rule, as interpreted in Northern Pacific Railway Co. v. Boyd, 228 U.S. 482, 33 S.Ct. 554, 57 L.Ed. 931 (1913), and Case v. Los Angeles Lumber Products Co., Ltd., 308 U.S. 106, 60 S.Ct. 1, 84 L.Ed. 110 (1939), cannot realistically be-applied” in a Chapter XI proceeding. House Report No. 2320, note 8 supra, at 21, U.S.Code Congressional and Administrative News 1952, p. 1981.
. The developments are reviewed in a series of articles, Weintraub, Levin, and Noviek, Chapter X or Chapter XI: Coexistence for the Middle-Sized Corporation, 24 Fordham L.Rev. 616 (1956) ; Weinti’aub and Levin, A Sequel to Chapter X or Chapter XI: Co-existence for the Middle-Sized Corporation, 26 Ford-ham L.Rev. 292 (1957) ; Weintraub and Levin, Availability of Bankruptcy Rehabilitation to the Middle-Sized Corporation: The Third Circuit’s Interpretation, 14 Rutgers L.Rev. 564 (1960).
. In SEC v. Liberty Baking Corp., supra, 240 F.2d at 515 n. 4b, Judge Frank said as to this point that assuming, arguendo, that, if a plan is properly within Chapter XI, it need no longer measure up to that [“fair and equitable”] standard or to anything equivalent, nevertheless “in determining whether a proceeding properly comes within that Chapter, it is necessary * * * to determine, among other things, whether the proposed arrangement contains features which bring it within Chapter X where the ‘fair-and-equitable’ standard is applicable and where alone the facts relevant thereto will be fully investigated.”
. In this respect the case differs sharply from Liberty Baking, where no § 21(a) examination had been conducted.
. The questioning at the § 21(a) examination covered such matters as the circumstances, motives and method of Gluck’s purchase of Grayson stock, the transfer of Klein stock to Klein in connection with the release of the guarantee of the Prudential loan, the economic strength of Grayson and Darling, the fairness of the Operating Agreement, the various charges of self-dealing, the losses incurred by Gray-son immediately after the change of management, and the acquisition of the Beck stock. The questioning was done under the close surveillance of the experienced Referee. Although, as the SEO says, a party urging investigation cannot fairly
. The SEC’s affidavit (p. 85) tells us that such suits are pending also with respect to the purchase of the Darling operation and the Operating Agreement.
. Thus, it was not an adequate factual answer to argue that in the past some similar chains have been rehabilitated under Chapter X and that some Chapter XI arrangements have gone awry.
. Of course, the arrangement must be accepted by creditors representing a majority in both number and amount, § 362.
. Stanley Roth’s affidavit states that a position on the Committee was offered to counsel for the landlord appealing here but that he declined to serve. The district court might well consider whether the committee that is to exercise important functions under the arrangement ought not contain representatives of landlords. See §§ 363 and 364.
Dissenting Opinion
(dissenting).
The present petition would seem to present an a fortiori situation for a rehearing by the full court under any and all of the principles heretofore suggested for in banc hearings. See Walters v. Moore-McCormack Lines, 2 Cir., 312 F.2d 893, 894. The decision itself, which appears to be contrary to decisions of this court and of the Supreme Court, affects a great number of persons interested in this far-flung corporate empire. But further, it puts in jeopardy practically all attempts by the SEC to execute its statutory responsibility to investigate and supervise the reorganization of large corporations in this circuit, since the denial of such power in a case with the complexity of corporate relations here shown presages a potential battle in practically all such cases in the future. And the disagreement with previous precedents is highlighted by an interpretation of statutory amendments of 1952 at variance with our previous views. The confusion in legal principle thus engendered in the circuit having traditionally the greatest number of corporate reorganizations of the country seems to me thus quite obvious and to merit consideration by the full court.
To particularize further, it should first be noted that we have here all the criteria emphasized by the Supreme Court in the leading decisions of Securities and Exchange Commission v. United States Realty & Improvement Co., 310 U.S. 434, 60 S.Ct. 1044, 84 L.Ed. 1293, and General Stores Corp. v. Shlensky, 350
Furthermore, the possibility that new management is sorely needed is suggested from the fact that until November 1960, when the present management gained control of Grayson, the debtor had enjoyed many consecutive years of profitable operation. It had a good ratio of ■current assets to current liabilities; and with but one minor exception, its assets were free from liens. The expansion program undertaken by the debtor’s pres•ent management proved disastrous. As the Supreme Court noted in General Stores Corp. v. Shlensky, supra, 350 U.S. 462, 76 S.Ct. 516, 100 L.Ed. 550, the need for an accounting by the management for misdeeds which caused the debacle ■ and the need for new management are ■ sure indicators of the desirability of a Chapter X proceeding, rather than one under Chapter XI.
The “Plan of Arrangement” — accepted by the district court and our panel here— .also presents curiosities which would appear to require SEC expertise for its proper evaluation. It calls for no sacrifices from the stockholders, save only the surrender by Gluck, the chairman of the debtor’s board of directors, of part of his Grayson stock holdings, with the right to repurchase any time in the next three years. Since, on its face, this aspect of the plan appears to be the necessary cost to Gluck of prolonging his management which heretofore has been so disastrous for the debtor, independent appraisal of whether Grayson got the better end of the bargain would seem imperative. Essentially the plan is but a long moratorium on any collection of the debtor’s heavy liabilities. For the unsecured debts, including claims arising from the rejection, prior to confirmation, of execu-tory leases and contracts, are to become “General Debentures” payable only in minimum fixed annual installments beginning in January 1965 and continuing for eleven years from the date of confirmation. There are no changes proposed in the debtor’s structural ties with its related and subsidiary corporations; and while some safeguards are placed on further outlays of funds, raises in compensation of certain executives, and the like, it would seem that future financial exigencies, of the kind which are thought to call for hurried action here, may well lead to recurrent crises.
In other words, the optimistic predictions of management which has shown itself at the very least inept in the past do not deserve to be taken at face value, as is being done here and below. Indeed, as a practical and common-sense matter, the situation would seem compelling to call for that careful investigation which is the SEC’s reason for existence. It parallels very closely the General Stores case, as well as Securities and Exchange Commission v. Liberty Baking Corp., 2 Cir., 240 F.2d 511, cert. denied 353 U.S. 930, 77 S.Ct. 719, 1 L.Ed.2d 723, and Mecca Temple of Ancient Arabic Order of Nobles of Mystic Shrine v. Darrock, 2 Cir., 142 F.2d 869, cert. denied 323 U.S. 784, 65 S.Ct. 271, 89 L.Ed. 626.
Finally the action of the panel in employing the 1952 amendments to Chapter XI as a means of substantially nullifying the United States Realty case requires the most careful review by the entire court. Actually the stated purpose of the legislators was to codify the holding of the United States Realty case. See H. R. 2320, 82d Cong., 2d Sess. 2, 3, 19; S.Rep. No. 1395, 82d Cong., 2d Sess. 20, U. S. Code Congressional and Administrative News 1952, p. 1960. Thus the addition of § 328 to Ch. XI provided an effective means of shifting a case from Ch. XI to Ch. X, the procedure here sought by the SEC. The amendment to § 366 so relied on had nothing whatsoever • to do with the question of which procedure was to be required in a particular case; it dealt only with the confirmation of an arrangement after that procedure had been decided upon and substantially completed. Our understanding that no change in the criteria stated in the United States Realty case had been made by this amendment is clearly shown in our reference to it in General Stores Corp. v. Shlensky, 2 Cir., 222 F.2d 234, and in Securities and Exchange Commission v. Liberty Baking Corp., supra, 2 Cir., 240 F.2d 511, cert. denied 353 U.S. 930, 77 S.Ct. 719, 1 L.Ed.2d 723. The Supreme Court’s affirmance of our holding in the General Stores case, in General Stores Corp. v. Shlensky, 350 U.S. 462, 76 S.Ct. 516, 100 L.Ed. 550, without questioning this conclusion, though the amendment was heavily relied on by the two dissenting justices (350 U.S. 468, 471-472, 76 S.Ct. 520, 521-522, 100 L.Ed. 550), shows that our view was approved. Both in view of the statutory terms and of this background the panel repudiation of the conclusion appears doubtful.
The trend of the law as shown by this case fills me with a deep sense of nostalgia. When I came to the court a quarter century ago I was faced almost at once with the determination of my colleagues to reverse a district court decision that the United States Realty & Improvement Co. could not seek an arrangement under Ch. XI, but was limited to reorganization with SEC intervention under Ch. X. The arguments then made seem substantially those repeated in the panel opinion herewith. But we had the background of the monumental study conducted by Professor (later Mr. Justice) Douglas on the gross evils of the traditional equity reorganization of corporations, culminating in the extensive report of the Securities and Exchange Commission (pursuant to the direction of Congress), which sparked the Chandler Act revision of the Bankruptcy Act to
So it would have seemed that these principles had been so firmly set that they could not be rejected in the summary and almost casual fashion as they are here disposed of. Now it appears that the battle for public supervision won in 1940 has all to be done again— if it can be rewon after this setback. It has been vigorously asserted that the regulatory agencies have been grievously at fault in not announcing rules and principles upon which they act. As concerns this agency, however, it would seem that it has had to expend so much of its time and energy in even maintaining a foothold on that regulation for which Congress had created it that it has little opportunity to build much beyond this. ■Compare Securities and Exchange Commission v. Capital Gains Research Bureau, 2 Cir., 300 F.2d 745, 751-754; ;s.c., 306 F.2d 606, 611-620, cert. granted 371 U.S. 967, 83 S.Ct. 550, 9 L.Ed.2d 538. So I hold that before we require such extensive refighting of old battles won, we should take time for a resurvey by the full court.
I dissent from the denial of a rehearing in banc.
Rehearing
On Petition for Rehearing in Banc
Before LUMBARD, Chief Judge, and CLARK, WATERMAN, MOORE, FRIENDLY, SMITH, KAUFMAN, HAYS and MARSHALL, Circuit Judges.
The petition of the Securities and Exchange Commission for rehearing in banc is denied.
CLARK, Circuit Judge, dissents from such denial with an opinion.
SMITH and HAYS, Circuit Judges, dissent from such denial without opinion.
Rehearing
On Petition for Rehearing
Considering the petition for rehearing as addressed to the panel, as required by Rule 25(b) of this Court, the petition is denied.
