In Re Standard Oil & Exploration of Delaware, Inc.
OPINION REGARDING DEBTOR’S MOTION TO OBTAIN CREDIT BY ISSUANCE OF NOTES EXEMPT FROM SECURITIES LAWS
I. ISSUES
Mаy a chapter 11 debtor in possession issue preconfirmation administrative priority notes to obtain fresh capital? If so, are such notes exempt from the registration and prospectus delivery requirements of federal and state securities laws pursuant to
II. PROCEDURAL BACKGROUND
Standard Oil & Exploration of Delaware, Inc. (“Debtor”) filed a voluntary petition for relief under chapter 11 of the Bankruptcy Code on April 12, 1991. No trustee has been aрpointed and the Debtor is acting as a debtor in possession.
The Debtor filed its Second Amended Motion to Incur Debt by Sale of Notes Exempt From Securities Laws and to Determine Factual and Legal Issues (“Amended Motion”) on December 31, 1991.
2
The Debtor requests the following relief: (1) an authorization to obtain credit, pursuant to
Notice of hearing of the Amended Motion was properly given to all interested parties, including the SEC and United States Trustee. The hearing was held on January 10, 1992. At the hearing, the court heard testimony from the Debtor’s President, Andrew J. Kacic (“Kacic”), and an expert on gas and oil wells, Paul D. McConnell (“McConnell”). The court found both witnesses’ testimony to be credible. The court has also reviewed and considered seven exhibits which were admitted into evidence.
The court has jurisdiction over the case pursuant to
III. FACTS
The Debtor is a publicly held corporation incorporated in 1970. 3 It is engaged in the business of developing and operating oil and gas wells in northern Michigan. The Debtor has 838 equity security holders. (See Debtor’s Exhibit 5, at 5.)
The Debtor’s assets include various interests in gas wells. Kacic testified that the Debtor’s principal asset is the Sand Lake Project. 4 The Debtor owns and operates 100% of the working interest in the Sand Lake Project which involves the drilling and completion of seventeen wells located in Antrim County, Michigan. (See Debtor’s Exhibit 5, at 44-45.) The Sand Lake Project consists of two phases. Phase I is comprised of twelve wells in various stages towards completion. Phase II envisions the addition of five new wells. Construction of the Phase II wells has not commenced. (See Debtor’s Exhibit 5, at 44-45.)
The Debtor asserts it needs additional funds to: (1) complete Sand Lake Project Phase I; (2) commence and complete Sand Lake Project Phase II; (3) pay chapter 11 administrative expenses; and (4) enter into a gas contract, acquire additional leased acreage, and construct additional pumping wells. (See Debtor’s Exhibit 3.) Kacic testified that he approаched two financial institutions to attempt to borrow the needed funds. Each financial institution declined to advance funds. Kacic testified the financial institutions did not want to loan money to an oil and gas company, especially one which is the subject of chapter 11 proceedings. Kacic and McConnell each testified that obtaining the additional funds is in the best interests of the Debtor and its estate. Assuming completion of the gas wells, entering into a proposed gas contract, and utilizing future revenues for operations and repayment of creditors, Kacic and McConnell opined that a meaningful distribution to unseсured creditors could be made — perhaps as much as a 100% dividend.
The Debtor proposes to issue 8% Promissory Notes (“8% notes”) and 13% Senior Subordinated Cumulative Notes (“13% notes”). Kacic believes there will be a market for the notes. When contacting prospective investors, the Debtor, or its agents, will use a Private Placement Memorandum which discloses the Debtor’s past business history, its future business plan, and the proposed chapter 11 plan of reorganization. Information regarding the notes, risk factors, various tax aspects, restrictions on transfer, and other important considerations, is also disclosed. (See Debtor’s Exhibit 5.) The Privatе Placement Memorandum contains information from the Debtor’s Disclosure Statement which has been approved by this court.
The Debtor seeks authorization to issue up to $6,500,000 in 8% and 13% notes. First, the Debtor intends to issue $650,000 in 8% notes. Second, contemporaneous with the issuance of the 8% notes, the Debtor will issue up to $6,500,000 in 13% notes (which amount will include the proceeds from the 8% notes). (See Debtor’s Exhibit 5, at 8-9.) The Debtor proposes that purchasers of the 8% and 13% notes shall be entitled to administrative priority pursuant to § 503(b)(1)(A). The 8% and 13% notes are different with respect to the Debtor’s intended use of proceeds and the proposed payment of рrincipal and interest on the notes.
In connection with the 8% notes, the Debtor requests that: (1) the proceeds may be used immediately to complete Sand Lake Project Phases I & II, pay reasonable and necessary postpetition operating expenses, and pay chapter 11 administrative ex
With respect to the 13% notes, the Debt- or proposes that: (1) commencing on the date the issuance of the notes is authorized by the court and ending before the confirmation hearing date of a chapter 11 plan 5 , the Debtor will offer for sale a minimum of $1,284,000 and maximum of $6,500,000 in 13% notes (these amounts include proceeds from the 8% notes); (2) the proceeds shall be held in escrow pending the receipt of the minimum amount of $1,284,000 and confirmation of the Debtor’s chapter 11 plan or further court order after notice to all interested parties including the noteholders; (3) the principal and interest on the notes shall be repaid to the noteholders on the confirmation date of Debtor’s chapter 11 plan by issuing one share of common stock for each dollar of the administrative claim; and (4) if the plan is not confirmed within one year and there is no preconfirmation court order authorizing the Debtor to use the funds in the escrow account, then any funds received will be returned to each noteholder with interest. {See Debtor’s Exhibits 2 & 5.)
IV. DISCUSSION
A. Issuance of Administrative Priority Notes Outside the Ordinary Course of Business.
As Kacic's testimony demonstrates, the Debtor needs the additional funds to have any likelihood of reorganizing. The Debtor unsucсessfully attempted to obtain the necessary funds through traditional lending from financial institutions. Because of the lack of interest from the financial institutions, the Debtor’s only method of obtaining the additional funds appears to be through the unconventional method of issuing exempt notes. This court finds that, under these facts, the issuance of the notes is necessary and outside the ordinary course of business. Therefore, under
B.
Issuance of Notes Under
The Debtor requests the court to authorize it to obtain credit by the issuance of the 8% and 13% notes. The Debtоr asserts that, pursuant to
1. Analysis of
Except with respect to an entity that is an underwriter as defined in section 1145(b) of this title, section 5 of the Securities Act of 1933 (15 USC 77e), the Trust Indenture Act of 1939 (15 USC 77aaa et seq.), and any State or local law requiring registration for offer or sale of a security or registration or licensing of an issuer of, underwriter of, or broker or dealer in, a security does not apply to the offer or sale under this section of a security that is not an equity security.
[Section] 364(f) exempts (except with respect to any entity that is an underwriter under Code § 1145(b)) the offer or sale of nonequity securities under Code § 364 from § 5 of the 1933 Act, from the 1939 Act and from any state or local law requiring registration of such nonequity securities, or registration or licensing of the issuer or underwriter of, or a broker or dealer in, such securities.
3 NORTON BANKRUPTCY LAW & PRACTICE § 57.13 (1991) (emphasis added). See also Morgan, Application of the Securities Laws in Chapter 11 Reorganizations Under the Bankruptcy Reform Act of 1978, 1983 U.ILL.L.REV. 861,, 878-79 (1983). For the exemption to apply, the debtor in possession must satisfy the other requirements of § 364. 3 NORTON BANKRUPTCY LAW & PRACTICE § 57.13 (1991); Morgan, supra, at 879. Specifically, there must be notice and a hearing and the debtor in possession must demonstrate that it is proper to obtain credit pursuant to one of the prior subsections of § 364. 11 3 NORTON BANKRUPTCY LAW & PRACTICE § 57.13 (1991).
The legislative history and the commentators support the conclusion that § 364(f) is intended to allow the issuance of debt
Fresh capital securities are securities issued by a debtor to raise money for working capital or to fund a plan. 3 NORTON BANKRUPTCY LAW & PRACTICE § 57.15 (1991); Morgan,
supra,
at 881; Mitchell,
supra,
at 118. As a general rule, the issuance of fresh capital securities must meet the registration and prospectus delivery requirements of the 1933 Act unless there is an exemption for the particular issuance. 3 NORTON BANKRUPTCY LAW & PRACTICE § 57.15 (1991); Morgan,
supra,
at 881-82; Mitchell,
supra,
at 118;
cf. S.E.C. v. Granco Prods., Inc.,
2. Application of § 364(f).
a. Definition of “Underwriter”.
The Debtor must demonstrate that it is not an underwriter pursuant to § 1145(b). Section 1145(b) states, in pertinent part:
(1) ... an entity is an underwriter under section 2(11) of the [1933 Act], if such entity—
(A) purchases a claim against, interest in, or claim for an administrative expense in the case concerning, the debtor, if such purchase is with a view to distribution of any security received ...;
(B) offers to sell securities offered or sold under the plan for the holders of such securities;
(C) offers to buy securities offered or sold under the plan from the holders of such securities ...
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(D) is an issuеr, as used in such section 2(11) [of the 1933 Act] with respect to such securities.
Because the Debtor is, (1) not a purchaser of the notes with a view to distribution, (2) not offering to sell the notes for the noteholders under a plan, or (3) not offering to buy the notes from the noteholders under a plan, the Debtor is not an underwriter pursuant to § 1145(b)(1)(A), (B) & (C). See 3 NORTON BANKRUPTCY LAW & PRACTICE §§ 57.07-57.09 (1991).
However the Debtor may be an “underwriter” if it is an “issuer” under § 1145(b)(1)(D). Section 2(11) of the 1933 Act, which is incorporated by reference in § 1145(b) of the Bankruptcy Code, defines “underwriter” and states, in pertinent part:
As used in this paragraph the term “issuer” shall include in addition to an issuer, any person directly or indirectly controlling or controlled by the issuer, or any person under direct or indirect common control with the issuer.
Courts and commentators have refused to interpret § 1145(b)(1)(D) as the literal reading of the statute would seem to suggest.
Considering section 1145(b)(1)(D) in terms of its legislative history, it is submitted that thе reference to “issuer,” as used in section 2(11) of the [1933] Act, was intended to pick up only the latter portion of the definition [involving control persons],...
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Thus, section 1145(b)(1)(D) brings “controlling persons” within the ambit of section 1145(b)(1) “underwriter” status but does not affect the “issuer” exemption contained in section 1145(a). A contrary construction could be interpreted as rendering sections 1145(a) and 364(f) meaningless.
5 COLLIER ON BANKRUPTCY 111145.02, at 1145-33 to 1145-34 (15th ed. 1991) (emphasis added).
See In re Stanley Hotel, Inc.,
This court recognizes that its first focus must be on the statutory language in § 1145(b)(1)(D). If the statutory language is unambiguous, its plain meaning must be enforced.
See United States v. Ron Pair Enter., Inc.,
The literal interpretation of the words of an act should not prevail if it creates a result contrary to the apparent intention of the legislature and if the words are sufficiently flexible to allow a construction which will effectuate the legislative intention. The intention prevails over the letter, and the letter must if possible be read to conform to the spirit of the act. “While the intention of the legislature must be ascertained from the words used to express it, the manifest reason and obvious purpose of the law should not be sacrificed to a literal interpretation of such words.”
2A N. SINGER, SUTHERLAND STATUTORY CONSTRUCTION § 46.07 (5th ed. 1992) (citing
Pierce v. Van Dusen,
This court agrees with those cases which hold that § 1145(b)(1)(D) is intended to include as its definition of “issuer” only the “control persons” language of § 2(11) of the 1933 Act.
See Frontier Airlines, supra; Amarex, supra; Stanley Hotel, supra.
Section 1145(b)(1)(D) therefore does not totally encompass the broad definition of “issuer” under § 2(4) of the 1933 Act. If § 1145(b)(1)(D) was so construed,
The court concludes the Debtor is not an “issuer” pursuant to § 1145(b)(1)(AHD). Therefore, the Debtor is not an underwriter pursuant to § 1145(b).
b. Definition of “Equity Security”.
The second element of § 364(f) is satisfied if the Debtor can demonstrate that the notes are nonequity securities. Examples of nonequity securities include bonds, debentures, promissory notes, and certificates of indebtedness. 3 NORTON BANKRUPTCY LAW & PRACTICE § 57.12 (1991). These types of instruments are debt securities which document a loan of funds to a debtor. Id.
Section 101(16) of the Bankruptcy Code defines an “equity security” as a:
(A) share in a corporation, whether or not transferable or denominated “stock”, or similar security;
(B) interest of a limited partner in a limited partnership; or
(C) warrant or right, other than a right to convert, to purchase, sell, or subscribe to a share, security, or interest of a kind subparagraph (A) or (B) of this paragraph[.]
The notes to be issued may be subsequently exchanged for stock in the reorganized Debtor if the proposed plan is confirmed. On the other hand, if the plan is not confirmed, (1) the 8% and 13% notehold-ers will remain entitled to administrative priority distribution, or (2) to the extent that the proceeds from the 13% notes are not released from the escrow account pursuant to court order, those noteholders will be repaid with interest. The 8% and 13% notes, although convertible to stock if the plan is confirmed, are not included within the parameter of the definition of an “equity security” under the Bankruptcy Code. The court determines the 8% and 13% notes that the Debtor now proposеs to issue are therefore “nonequity securities” as required by § 364(f).
Summarizing, because the Debtor is not an underwriter, as defined by § 1145(b), and the 8% and 13% notes are not equity securities, as defined by
3. Other Securities Law Considerations,
a. Adequate Disclosure.
A fundamental premise of the 1933 Act is that potential investors are entitled
Adequate information is also a fundamental requirement of a chapter 11 plan of reorganization.
See
On January 10, 1992, this court approved the Debtor’s First Amended Disclosure Statement. The disclosure statement contained adequate information regarding the Debtor, the 8% and 13% notes, the Debtor’s proposed reorganization plan, securities laws considerations, and other important information. As was the case with the hearing regarding the Amended Motion, the SEC was given proper notice of the disclosure statement hearing and did not appear. As an exhibit to the Amended Motion, the Debtor submitted a Private Placement Memorandum which will be distributed to potential investors.
(See
Debt- or’s Exhibit 5). The Private Placement Memorandum contains selected portions of the approved disclosure statement and also gives very detailed information regarding the Debtor’s past business, future business plan, the 8% and 13% notes, risk factors, ability to resell, and other important facts. The court has reviewed the contents of the Private Placеment Memorandum and finds that it contains adequate information within the meaning of
b. Anti-fraud.
Although the notes are exempt from registration and prospectus delivery requirements, § 364(f) does not exempt is-suances from the anti-fraud and sanctions provisions of §§ 17(a) and 12(2) of the 1933 Act or Rule 10b-5 of the Securities Exchange Act. See 3 NORTON BANKRUPTCY LAW & PRACTICE § 57.13 (1991); Mitchell, supra, at 111; Morgan, supra, at 863. Therefore, the Debtor is, and shall remain, subject to §§ 17(a) and 12(2) of the 1933 Act and Rule 10b-5 regarding the issuance of the 8% and 13% notes. 17
c. Resale of Notes.
Will the administrative claimant noteholders be legally authorized to resell their notes? Under securities laws, there are two types of exemptions. A
securities exemption
exempts a security from registration and prospectus delivеry requirements at the time of issuance
and
when resold by holders and subsequent holders.
Certificates of indebtedness under the Bankruptcy Act were considered transaction exemptions. See Morgan, supra, at 879; Sequential Info. Sys., Inc., SEC No-Action Letter, [1972-73 Transfer Binder] Fed.Sec.L.Rep. (CCH) 1179,139 (Dec. 4, 1972); Seaferro, Inc., SEC No-Action Letter, [1970-71 Transfer Binder] Fed.Sec. L.Rep. (CCH) 1178,097 (April 22, 1971). The legislative history of § 364(f) states that it does not change then existing law. 124 CONG.REC. Hll,098 (daily ed. Sept. 28, 1978) (remarks of Rep. Edwards). The practice under the Bankruptcy Act and the legislative history of § 364(f) indicate that issuances under § 364(f) are intended to be a transaction exemption or a “one-shot” exemption. See Morgan, supra, at 879; Mitchell, supra, at 137.
This court concludes that § 364(f) was intended by Congress as a transaction exemption only. Noteholders are not legally entitled to freely resell their notes. 18 Any noteholder who desires to resell the 8% or 13% notes must either comply with the registration and prospectus delivery requirements or locate another exemption. 19
C. Subsequent Issuance of Securities Under § 1145.
The Debtor requests a declaratory order that it may, under a confirmed plan of reorganization, issue shares оf its reorganized corporate stock in exchange for the administrative claims of the notehold-ers as an exempt transaction. The Debt- or’s request is based in § 1145(a)(1) which states, in pertinent part:
(a) Except with respect to an entity that is an underwriter as defined in subsection (b) of this section, section 5 of the Securities Act of 1933 (15 USC lie) and any State or local law requiring registration for offer or sale of a security or registration or licensing of an issuer of, underwriter of, or broker or dealer in, a security does not apply to—
(1) the offer or sale under a plan of a security of the debtor ...
(A) in exchange for a claim against, an interest in, or a claim for an administrative expense in the case concerning, the debtor ...; or
(B) principally in such exchange and partly for cash or property[.]
Section 1145(a)(1) provides an exemption from the registration and prospectus delivery requirements for securities issued to creditors in exchange for claims in connection with a plan.
See Frontier Airlines,
Plan confirmation is not now before this court. The Debtor is requesting an advisory opinion that any proposed swap of securities for administrative noteholder claims will satisfy § 1145(a)(1). Consideration of this issue is premature. Although the Debtor has filed a plan of reorganization and its disclosure statement has been approved, all issues regarding possible plan confirmation will be considered later. This court will determine, if necessary, the Debtor’s proposed exchange of stock for the administrative note claims at the time of confirmation of the proposed plan.
Cf. Murray Indus., Inc. v. Federal Ins. Co. (In re Murray Indus., Inc.),
V. CONCLUSION
Based on the discussion above, this court holds:
1. The Debtor is authorized to incur debt by the sale of 8% notes in an amount not to exceed $650,000 pursuant to
2. The Debtor is authorized to incur debt by the sale of 13% notes in an amount not to exceed $6,500,000 (which amount shall include the proceeds from the sale of the 8% notes). The purchasers of the 13% notes are entitled to an administrative priority pursuant to
3. Pursuant to
4.A determination of whether the Debtor may, under a confirmed plan, issue securities exempt from the registration and prospectus delivery requirements of § 5 of the 1933 Act and any state or local law requiring registration of securities in exchange for administrative claims is premature. The court will decide the issue if it is properly brought before it at a plan сonfirmation hearing.
An order has been entered accordingly.
Notes
. Unless otherwise noted, all future statutory references are to Title 11 of the United States Code, sometimes referred to as the "Bankruptcy Code".
. The Debtor originally filed a motion on October 16, 1991. On November 5, 1991, after reviewing the original motion, the court requested the Debtor to seek a no action letter or some other response from the Securities and Exchange Commission ("SEC"). The SEC responded with a letter on November 19, 1991. The SEC was concerned that options sought to be issued by the Debtor in exchange for the note-holders’ administrative claims might be converted to stock before plan confirmation. On December 3, 1991, the court dismissed the original motion without prejudice to file a more specific motion. The Amended Motion has eliminated any options from the proposed note issuance in accordance with the SEC’s letter.
. The Debtor was originally incorporated in Colorado under the name Automated Learning, Inc. In 1973, the Debtor merged with and into a Delaware corporation named Automated Information Industries, Inc. In 1987, the company changed its name to Standard Oil and Exploration of Delaware, Inc. (See Debtor’s Exhibit 5, at 5.)
. The Debtor also owns working interests of 10% or less in two other projects known as the Try-Ex Wells and Bagley 17. The Debtor does not operate either of these projects. (See Debt- or’s Exhibit 5, at 43-44.)
. The confirmation hearing is scheduled to take place on May 5, 1992. (See Order Approving Disclosure Statement and Fixing Time for Filing Acceptances or Rejections of Plan and Notice of Date, Time and Place for Hearing on Confirmation of the Plan Proponents’ Joint Chapter 11 Plan dated January 17, 1992.)
. Although
. Section 3(a)(7) exempts from the 1933 Act ‘‘[c]ertificates issued by ... a trustee or debtor in possession in a case under Title 11, with the approval of the [bankruptcy] court.”
. Under the Bankruptcy Act, a trustee, receiver, or debtor in possession, after notice and a hearing, could incur debt for various purposes, including the operation of the debtor’s business, by issuing certificates of indebtedness. See § 116(2) of Bankruptcy Act; 6 COLLIER ON BANKRUPTCY ¶ 3.26, at 615-23 (14th ed. 1978). The certificates were debt securities and enabled the debtor to obtain cash during the reorganization proceeding. See Mitchell, Securities Regulation in Bankruptcy Reorganizations, 54 AM.BANKR.LJ. 101, 107-08 (1980). The certificates documented loans and were often accorded a higher priority of distribution. See 6 COLLIER ON BANKRUPTCY ¶ 3.26, at 622-23 (14th ed. 1978).
. Section 5 of the 1933 Act pertains to the sale of unregistered securities, and the necessity of complying with prospectus and registration requirements.
See
.
. The prior subsection of
. The 1933 Act defines issuer as "every person who issues or proposes to issue any security...."
. Under the Bankruptcy Code, a “ ‘security’ includes — (i)
note;
(ii) stock; (iii) treasury stock; (iv) bond; (v) dеbenture; ...”
. The court is cognizant that there exists apparently conflicting legislative history in § 1145 of the Bankruptcy Code. “[Section 1145(a)(1) ] exempts the offer or sale under
. Additionally, because the issuance has been approved by the court and involves a debtor in possession under Title 11, the notes are also exempt pursuant to § 3(a)(7) of the 1933 Act.
See
. In enacting chapter 11 of the Code, Congress reаlized the extreme burden a debtor incurs by complying with the registration and prospectus requirements. "The cost of developing a prospectus or proxy statement for a large company often runs well over $1 million. That cost would be nearly prohibitive in a bankruptcy reorganization.” H.R.REP. No. 595, 95th Cong., 2d Sess. 228 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6187.
. The Debtor has not requested the court to shield it from any liability for fraud.
. The Private Placement Memorandum states on the cover: “PURCHASERS WILL BE UNABLE TO RESELL THE 8% AND 13% NOTES ABSENT REGISTRATION OF THE NOTES UNDER THE [1933] ACT AND APPLICABLE STATE LAW OR ABSENT AN EXEMPTION THEREFROM." This same language appears in several portions of the Private Placement Memorandum. (See Debtor’s Exhibit 5). The court finds that the Private Placement Memorandum adequately informs potential investors of the restrictions on resale of the notes.
. For a discussion on possible exemptions for resale of the notes, see Mitchell, supra, at 135-46; Morgan, supra, at 881-902.