551 F.2d 399 | D.C. Cir. | 1977
Opinion for the Court filed by Circuit Judge WILKEY.
The petitioners in this case are thirty-nine parties who invested $146,000 in various limited partnerships that were organized to purchase, hold or operate real estate in Puerto Rico. Without their knowledge or consent, these funds were diverted to the purchase of two parcels of real estate by Lela and Company, Inc., which has become insolvent. In March of 1975 the defrauded investors filed a petition in the District Court for involuntary reorganization of Lelá under Chapter X of the Bankruptcy Act.
The first ground of the dismissal was that the petitioners were not “creditors,” as defined by the Bankruptcy Act,
I
Because the facts of this unusual and tangled story are critical to a disposition of the issues, it is necessary to set them out in some detail. On 8 January 1971 Lela and Company, Inc. (Lela) was incorporated under the laws of Puerto Rico in order to engage, as its stated purpose, in the purchase, rent and sale of real estate. According to the person who has acted as the President of Lela,
On 27 January 1971 Lela purchased a parcel of land for $375,000; $30,000 was paid in cash at the time of sale and the balance was financed by a first and second mortgage.
In December of 1971 two limited partnerships were formed in Maryland into which the petitioners here paid their money. The agreements provided that the partnerships would purchase, hold or operate properties on the island of Puerto Rico,
In the years 1971 through 1973 regular payments were made on interest and principal for the two mortgages at the Hato Rey property. In 1973 Lela began to default on its payments and in 1974 the tenant on the property left. With regard to the Calle Arzuaga property as well, payments on the mortgage were made for about two years and then lapsed.
During this period Lela had no bank account or office in Puerto Rico but conducted its correspondence and business from the Washington, D.C., office of its acting president, William S. Tyson. This office was also listed as the principal place of business of the limited partnerships, although it does not appear that any business was ever transacted in their name. Tyson was General Partner of one of the partnerships, CAP Limited, and that partnership was General Partner of the other, CAPHato Rey Limited.
On its default the holder of the second mortgage on the Hato Rey property sued Lela for the full balance remaining and other costs, and received on 20 January 1975 a judgment of about $140,000 — without any appearance on the part of Lela. The holder of the Calle Arzuaga mortgage also sued Lela upon its default, and received a judgment in late 1974 of around $300,000, again without opposition. The petition to reorganize Lela under Chapter X was filed on 31 March 1975 when title to both properties still remained with Lela.
One of the major concerns of the petition was that the extensive funds, some $194,-000, that had been diverted from the part
Before continuing with our chronology it would be helpful to state more fully this central contention of the petitioners. Lela purchased the Hato Rey property for $375,-000 and made payments on both mortgages steadily for about two years, drawing substantially on the partnership funds. The balance owed is about $200,000 with about another $75,000 in accrued interest and unpaid taxes. A current appraisal of the property — the land alone — amounts to over $600,000.
The District Court referred the matter to a Bankruptcy Judge who conducted a hearing on 7 May 1975. No one appeared in opposition to the petitioners; indeed, Tyson consented to granting it. Petitioners and others testified that there were third parties interested in refinancing the debtor in a reorganization. On 16 May the District Court granted a stay of further proceedings, e.g., foreclosure, in lawsuits against Lela. As noted, the report of the Bankruptcy Judge, filed 6 June, urged that the petition be dismissed. Intervening in the oral argument of 23 October before the District Court was counsel for Dr. and Mrs. Pagan, the holders of the Calle Arzuaga mortgage. Soon thereafter the District Court issued a Memorandum and Order dismissing the petition. It later extended the stay on lawsuits for 10 days so that appeal could be had to the Court of Appeals. On 5 December a motions panel of this court denied a stay of lawsuits pending this appeal.
At oral argument counsel for the intervenor informed the court that both properties of Lela had been sold at public auction in the spring and summer of 1976. The Calle Arzuaga property was reacquired by the Pagans and the Hato Rey property by the holders of the second mortgage. Those foreclosure sales, however, despite their legality,
The Bankruptcy Act provides that the debtor corporation itself may file a petition, a “voluntary” petition, for reorganization under Chapter X.
The District Court gave essentially two reasons for considering these petitioners as shareholders. He said, first of all:
Their investment in the limited partnership was diverted to Lela and if Lela’s shares had issued the shares would be an asset of the partnership. Thus they are individuals who have an equitable interest in shares of Lela.23
To borrow from the language of the Bankruptcy Judge,
In any event, whatever petitioners’ status as shareholders, issuance of stock in Lela would immediately terminate any position they might have as creditors of the corporation25
Because a reorganization of Lela would “effectively convert the petitioners into shareholders,” the District Court believed that this would “abort further proceedings.” According to this second holding, even if petitioners could properly be classified as creditors, the petition should still be dismissed, as their prospective conversion to shareholders renders them ineligible to file at the outset. Let us consider this second holding first because, if it is correct, it obviates any reason to dispute the correctness of the initial characterization.
The Bankruptcy Act provides that a plan for reorganization under Chapter X “shall include in respect to creditors . provisions altering or modifying their rights, either through the issuance of new securities of any character or otherwise.”
The conversion of creditors to shareholders, moreover, does not have to block future proceedings because the Act allows for extensive shareholder participation once the petition is granted. See Price v. Gurney.
Returning to the first ground of the District Court, its position was that because the partnership funds had been wrongfully diverted to Lela the partnership would have had an “equitable interest” in any stock that Lela would have issued. Thus, the petitioners here who hold the partnership property are, in effect shareholders because that is what their status would have been if Lela had been a completely organized corporation. As we shall see, however, from an application of the principles of trust law, which govern this situation, the petitioners are not necessarily limited to interests in hypothetical stock but hold an equitable lien against the property of Lela, eg., the Hato Rey property, and can thus be characterized as secured creditors, eligible to file a petition.
It bears reminding at the outset that the definition of shareholder is set as an exception against a very “sweeping” view of what' constitutes a claim and, hence, a creditor.
A constructive trust is imposed where a person holding title to property is subject to an equitable duty to convey it to another person on the ground that he would be unjustly enriched if he were permitted to retain it. The duty to convey the property may arise because it was acquired . . . through wrongful disposition of another’s property.34
The Bankruptcy Judge also found that a constructive trust was imposed upon the partnership funds that were diverted to Lela.
What is the consequence of a constructive trust in these circumstances? What status does it afford the petitioners? In the analogous situation where a conventional trustee wrongfully uses trust money to acquire property, the Maryland Court of
If the equitable relief under a constructive trust were only to reach to the wrongdoer, then the petitioners here would probably be limited to an equitable interest in Lela itself, such as in any shares it might issue. But trust law allows the petitioners here to trace the path of their money to the property acquired and impose a lien upon it as a security for their claims of restitution against Lela. Hence, even if Lela had issued stock, petitioners would have had the option of pressing their lien against the property, like secured creditors, rather than seeking an interest in the stock, which would have cast them as stockholders. The Bankruptcy Act defines a creditor as one who holds a claim “against a debtor or its property.”
This result, that petitioners are not stockholders of Lela, probably also reflects the original understanding of the investors. They did not desire or intend to become stockholders, legal or equitable, in a corporation; they contributed their money to a limited partnership in which as partners they would hold title to real estate directly. This difference in title between their position as limited partners and their theoretical position as shareholders is significant. If title had been taken in the name of the partnership, then when the state foreclosure proceedings in Puerto Rico were undertaken, as named partners in a limited partnership they individually would have been entitled to notice at various points, certainly before the foreclosure sale. In contrast, as events developed, only Lela was given notice of the state proceedings against the Hato Rey property, and Lela failed to appear.
Even if it may have been envisioned that a corporation would hold title to the real estate, as may have been necessary under local law,
Finally, the result here does not appear to clash with the purpose behind the shareholder exclusion from filing. According to Price v. Gurney,
Ill
Provided that a petition meets the requirements of the Bankruptcy Act, the judge is directed to approve it “if satisfied that it . has been filed in good faith.”
Without making reference to any of the particular statutory reasons, the District Court found that the petitioners lacked “good faith” essentially because neither the purpose of the reorganization nor the structure of the corporation were congruent with Chapter X. As to the first of these reasons, he stated:
The purpose of this proceeding is to block the debtors [the mortgage holders] going to judgment and to arrange a sale of the property in the hope that an arm’s length transfer through a trustee will salvage some value for petitioners.47
Noting that a Puerto Rican court of equity would have authority to prevent the dissipation of corporate assets, the District Court concluded that this type of situation was not “amenable to Chapter X reorganization.”
It is certainly the case, as the District Court has intimated, that Chapter X is not to be invoked for petitioners who envision only that their plan will “accomplish a slow and orderly liquidation,” Fidelity Assurance Ass’n v. Sims.
Where the financial picture of the debtor does provide a prospect of successful reorganization, however, it is not an impermissible purpose that the reorganization seeks to avoid “the harsh consequences of liquidation.”
If there were a showing, for example, that the property was worth more than*223 the amount of the first mortgage indebtedness and it appeared that that excess value would be lost to the junior interests in the state proceedings . . . approval of the petition clearly would be justified . . ..51
In this case, as noted, there has been an appraisal of the Hato Rey property at over $600,000, more than the total mortgage indebtedness of about $200,000 against the land. Considerable loss of value could be expected from the forced sale since its full value was conditioned on a sale over a reasonable time. It also does not appear that the reorganization plan would have to constitute a “liquidation proceeding at the outset,” as Sims warns us is inappropriate. Petitioners have identified third parties willing to refinance Lela; a trustee would undoubtedly seek a profitable re-leasing of the land and a sound new management. Indeed, after reorganization, eventual liquidation for the satisfaction of petitioners’ claims, may become only one of several possibilities, particularly if petitioners are converted to shareholders.
As his second basis for finding no “good faith,” the District Court turned to Lela’s lack of structure. He wrote:
Lela is not a going concern. The company has no employees or on-going activity. It has no management, no cash or liquid assets, no public debts, and no widespread group of investors.52
Characterizing the reorganization as “an attempt to protect investments by creating a functional corporation in which the partnership would hold shares,” the District Court concluded that Chapter X was not available for this purpose. The District Court’s statement appears to reflect two separate apprehensions: the first is that given the lack of structure it may not be possible to have an effective reorganization, and the second is that even admitting the possibility of reorganization the small and private nature of Lela make it inappropriate for Chapter X.
As quoted earlier, the Bankruptcy Act provides that a judge may find no “good faith” where “it is unreasonable to expect that a plan of reorganization can be effected.” The case law on this ground demonstrates a marked judicial disposition to resolving doubts about whether a plan can be effected in favor of the petition.
The fact that Lela may now be largely a “paper company,” as the District Court viewed it, does not by itself mean that its vitalization is impossible. The corporate existence does continue, with the full range of corporate structure and activity available for whatever new management is selected. And, moreover, Lela has not always been entirely dormant; for two years rents were collected from the properties and mortgage payments were made to its credit. Ordinarily, as in Sims,
Two of the factors listed by the District Court as significant in his dismissal were that Lela had “no public debts” and that it had “no widespread group of investors.” Even if the District Court regarded effective reorganization as possible, it appears, from the traits listed, that he simply considered Chapter X inappropriate, for these particular factors have been recognized by the Supreme Court as figuring in such a determination. According to SEC v. American Trailer Rentals,
In the course of deciding which corporate reorderings should proceed under Chapter X and which under Chapter XI, a series of Supreme Court opinions has established the approach to determining the appropriateness of Chapter X.
The advantage of a Chapter X proceeding is the extensive reorganization that a disinterested trustee can implement under the supervision of the court and with the advice of the SEC.
*225 These controls are essential both where a complicated debt structure must be readjusted and where a sound discretion indicates either that there must be an accounting from the management or that a new management is necessary.64
While the usual rehabilitation of an insolvent corporation entails largely a careful resettlement and redirection of its finances, another primary purpose of Chapter X may be the installation of new management. Speaking realistically, “[wjithout a new management today’s readjustment may be a temporary moratorium before a major collapse.”
With regard to Lela, of course, the installation of vigorous new management is indispensable, as it will be challenged with the need to vitalize the corporate form as well as to structure the new financing and operation. With the competing claims of the mortgage holders and the petitioners, the oversight and approval of the court provides important assurance that the trustee acts with disinterest. In addition, it may be that a trustee under court supervision may seek to investigate and account for past mismanagement, for whatever benefit might accrue to Lela.
The case is remanded to the District Court for further proceedings under Chapter X.'' As noted earlier, the court should promptly assure that the interest of Lela in the two properties is not further impaired pending the reorganization.
. 11 U.S.C. §§ 501 et seq.
. Report of Special Master, 9 June 1975, Appendix (App.) at 68.
. Memorandum and Order, 29 October 1975, App. at 86.
. 11 U.S.C. § 506(1, 4).
. See 11 U.S.C. § 526.
. 11 U.S.C. § 546.
. Affidavit of William S. Tyson (filed with petition), App. at 18.
. The first mortgage amounted to $180,000 and the second, which was taken from the seller, to $165,000. The deed to the real estate as well as the second mortgage were not recorded in the Puerto Rico land records, although received, apparently because no corporate resolution attesting to the authority of the purchaser for Lela was submitted.
. The one with this general purpose was the Caribbean Auto Park Limited Partnership (CAP) which raised about $169,000 over the course of a year.
. This one was named the CAP-Hato Rey Limited Partnership. It raised about $25,000 in 1972.
. This was the Calle Arzuaga Limited Partnership; its General Partner was listed as the CAP Limited Partnership.
. Tyson has been sued by the SEC for his involvement in the organization of a number of fraudulent limited partnerships. A consent decree has been entered enjoining him and other defendants from engaging in similar promotional arrangements.
. Affidavit of Tyson, App. at 20.
. Letter of 5 May 1975 from Puerto Rico Department of State. Lela had not filed annual reports for 1971, 1972 and 1973, however, and was considered “not in good standing” by the Department. App. at 27.
. Creditor’s Petition Under Chapter X, App. at 11.
. This appraisal was conducted by an independent firm but was conditioned upon exposure for sale “in the open market allowing a reasonable time to find a purchaser. . . . ” Appellants’ Br. at 9.
. The District Court has exclusive jurisdiction over the debtor’s property upon the filing of a petition, 11 U.S.C. § 511, and is expressly empowered to stay a mortgage foreclosure “upon cause shown” prior to the approval of a petition, 11 U.S.C. § 513. Presumably, a stay of foreclosures pending the appeal of a dismissal will be also granted only “upon cause shown.” The provision for an automatic stay on foreclosures after a petition is approved, 11 U.S.C. § 548, further demonstrates that the issuance of any stay prior to approval is discretionary. See In re Long Island Properties, Inc., 42 F.Supp. 323 (S.D.N.Y.1941) (Rifkind, J.).
. 11 U.S.C. § 586. See also 11 U.S.C. § 110(a).
. See 11 U.S.C. § 110(d).
. 11 U.S.C. § 526.
. Ibid
. 11 U.S.C. § 506(1, 4) (emphasis added.)
. Memorandum and Order, App. at 87.
. Report of Special Master at 10.
. Memorandum and Order, App. at 87.
. 11 U.S.C. § 616(1).
. 6A Collier on Bankruptcy § 10.03 at 427 (14th ed.).
. 312 U.S. 510, 528-530, 61 S.Ct. 675, 85 L.Ed. 982 (1941).
. 324 U.S. 100, 103-104, 65 S.Ct. 513, 89 L.Ed. 776 (1945).
. 11 U.S.C. § 606.
. “The word ‘claims’ as defined in § 106(1) [11 U.S.C. § 506(1)] is sweeping in scope. . [It] is, of course, a more inclusive definition than that applicable in ordinary bankruptcy, and it should be given a broad construction with respect to claims and creditors in order to dispose of all liabilities of the debtor in reorganization.” 6 Collier on Bankruptcy § 2.05 at 311-312 (14th ed.).
. 11 U.S.C. § 506(12).
. Price v. Gurney, 324 U.S. 100, 106, 65 S.Ct. 513, 89 L.Ed. 776 (1945).
. Carter v. Abramo, 201 Md. 339, 343, 93 A.2d 546, 548 (1953). See also Maryland National Bank v. Tower, 374 F.2d 381 (4th Cir. 1967) (statement of Maryland law in diversity case).
. Report of Special Master at 10.
. V Scott on Trusts § 508.1 at 3579 (3rd ed.).
. 73 Md.Ann.Code § 20 (1970).
. Restatement of Trusts § 202 (1935). This section was retained in the Restatement (Second) of Trusts (1959).
. Corbett v. Hospelhorn, 172 Md. 257, 191 A. 691, 699 (1937).
. V Scott on Trusts § 463 at 3425 (3rd ed.).
. 11 U.S.C. § 506(1) (emphasis added).
. William Tyson testified before the Bankruptcy Judge that.Lela was created because he was told, “right or not, I don’t know,” that a limited partnership could not hold property in its name in Puerto Rico. App. at 55.
. 324 U.S. 100, 104, 65 S.Ct. 513, 515, 89 L.Ed. 776 (1945).
. 11 U.S.C. § 541.
. 11 U.S.C. § 546 provides, in full:
Without limiting the generality of the meaning of the term “good faith”, a petition shall be deemed not to be filed in good faith if—
(1) the petitioning creditors have acquired their claims for the purpose of filing the petition; or
(2) adequate relief would be obtainable by a debtor’s petition under the provisions of chapter 11 of this title; or
(3) it is unreasonable to expect that a plan of reorganization can be effected; or
(4)a prior proceeding is pending in any court and it appears that the interests of creditors and stockholders would be best subserved in such prior proceeding.
. 6 Collier on Bankruptcy § 6.07 at 1019 (14th ed.).
. Memorandum and Order, App. at 88.
. 318 U.S. 608, 617, 63 S.Ct. 807, 811, 87 L.Ed. 1032 (1943).
. Sims, supra at 622, 63 S.Ct. at 814.
. In re Southern Land Title Corporation, 301 F.Supp. 379, 409 (E.D.La.1968).
. Marine Properties v. Trust Co., 317 U.S. 78, 86, 63 S.Ct. 93, 97, 87 L.Ed. 64 (1942).
. Memorandum and Order, App. at 88.
. “The whole scheme of Chapter X indicates that this test should not bar approval of a petition unless it is abundantly clear that there is no possibility that a plan of reorganization can be effected,” A-Cos Leasing Corporation v. Wheless, 422 F.2d 522, 524-525 (5th Cir. 1970). See also In re Bermec Corporation, 445 F.2d 367 (2d Cir. 1971).
. See 11 U.S.C. § 574.
. In re Business Finance Corporation, 451 F.2d 829, 835 (1971).
. 318 U.S. 608, 616-618, 63 S.Ct. 807, 87 L.Ed. 1032 (1943).
. 379 U.S. 594, 613, 615, 85 S.Ct. 513, 524, 13 L.Ed.2d 510 (1965).
. SEC v. United States Realty Co., 310 U.S. 434, 60 S.Ct. 1044, 84 L.Ed. 1293 (1940); General Stores v. Shlensky, 350 U.S. 462, 76 S.Ct. 516, 100 L.Ed. 550 (1956); SEC v. American Trailer Rentals, supra.
. Chapter XI generally, seeks an “arrangement” for the “settlement, satisfaction, or extension of the time of payment of [the] unsecured debts” of the debtor. 8 Collier on Bankruptcy, § 401 at 343 (14th ed.). The petition must be filed by the debtor itself, which may retain possession of its property. See 11 U.S.C. § 732. The Creditors’ Petition stated that reorganization would be possible only under Chapter X because Lela would be unable to file a Chapter XI petition, there being no internal corporate organization. The petition also recited that charges against Lela’s property would have to be adjusted, which presumably would be impossible since Chapter XI reaches only unsecured debts. These allegations of unavailability of Chapter XI have not been disputed by the Bankruptcy Judge, the District Court, or the intervenor and also appear sound to us.
. 350 U.S. 462, 465-466, 76 S.Ct. 516, 100 L.Ed. 550 (1956).
. 310 U.S. 434, 60 S.Ct. 1044, 84 L.Ed. 1293 (1940).
. Shlensky, supra, 350 U.S. at 466, 76 S.Ct. at 519.
. If the scheduled indebtedness of the debtor is below $3 million, the judge may, at his discretion, submit the proposed plan to the SEC for an examination and advisory report. 11 U.S.C. § 572.
. 350 U.S. at 467, 76 S.Ct. at 519. See also American Trailer Rentals, supra, 379 U.S. at 616-617, 85 S.Ct. 513.
. Shlensky supra, 350 U.S. at 466, 76 S.Ct. at 519.
. The file's of Lela were seized by the SEC in early 1974, Affidavit of Tyson, App. at 20, and are apparently now in the custody of the U. S. Attorney for the District of Columbia, Appellant’s Br. at 4.
. The determination of “good faith” rests with the District Court in the first instance and should not be set aside unless clearly erroneous. In re Bermec Corporation, 445 F.2d 367, 368-69 (2d Cir. 1971). The reason that the brief (three-page) Memorandum of the District Court has been analyzed at such length herein is to demonstrate that the District Court in the fair exercise of his discretion should have found “good faith.”
. See, e. g., In re Equity Co. of America, 115 F.2d 570 (7th Cir. 1940) (assets of debtor were two adjacent lots with $20,000 in mortgages; debtor’s total liabilities exceeded $100,000); In re Agregados de Manati, Inc., 357 F.Supp. 1263 (D.P.R.1973) (solely owned corporation which operated sand and gravel processing plant).
. 6 Collier on Bankruptcy § 4.14 at 843 (14th ed.).