Consolidated Rock Products Co. v. Du Bois, 312 U.S. 510 (1941)
U.S. Supreme CourtConsolidated Rock Products Co. v. Du Bois, 312 U.S. 510 (1941)
Consolidated Rock Products Co. v. Du Bois
Argued February 13, 14, 1941
Decided March 3, 1941*
312 U.S. 510
In a proceeding to reorganize a parent corporation and its two wholly owned subsidiaries, a plan was approved which provided, inter alia: that all assets of the companies be transferred free and clear to a new corporation; that, in exchange for the outstanding bonds of the subsidiaries, which were secured on their respective properties by separate mortgages, the bondholders receive, for 50% of the principal amounts of their claims, income bonds of inferior grade secured on the property of the new company, and for the balance receive an equal amount of its par value preferred stock, with warrants to purchase its common stock on certain terms, but that their claims to accrued interest be extinguished; that the preferred stockholders of the parent corporation receive common stock of the new corporation, and that its common stockholders receive warrants to purchase the new common on terms stated. Although the mortgage debts of the subsidiaries differed in amount, the net income of the new company was to be applied one-half to the one and one-half to the other group of bondholders for servicing their new securities. Each of the two subsidiaries had a money claim against the parent company under an agreement whereby the latter had taken over the entire management and financing of the business and properties of the subsidiaries, and which stipulated, inter alia, that that company would make certain payments and allow certain credits to the subsidiaries and, upon termination of the agreement, would return their properties and render final accountings. The agreement declared that it was made for the benefit of the parties, and not "for the benefit of any third person," and contained a provision for extension of its date of expiration at the option of the parent company. The District Court did not find specific values for the separate properties or the properties of the enterprise as a unit; yet,
in face of a poor earnings record, it found that the present fair value of all the assets, exclusive of goodwill and going concern value, was in excess of the total bonded indebtedness, plus accrued and unpaid interest. It further found that, including goodwill and going concern value, the value was insufficient to pay the bonded indebtedness plus accrued and unpaid interest and certain liquidation preferences and accrued dividends on the parent company's preferred stock; that the present value of the assets subject to the trust indentures of the subsidiaries was insufficient to pay the face amount, plus accrued and unpaid interest, of the respective bond issues; that, as a result of commingling under the operating agreement, it would be physically impossible to segregate with any degree of accuracy or fairness properties which originally belonged to the companies separately, and that an appraisal would produce further confusion. No finding was made of the amount or validity of the inter-company claims, the court concluding that any liability under the operating agreement was not for the benefit of third parties, including the bondholders.
1. To warrant approval of any plan of reorganization, there should have been a determination of what assets were subject to payment of the respective claims. P. 312 U. S. 520.
2. The mortgaged assets being, as found by the District Court, insufficient to pay the mortgage indebtedness, the bondholders, under the full and absolute priority rule, would have, as against the parent corporation and its stockholders, prior recourse against any unmortgaged assets of the subsidiaries, including the money claims of the subsidiaries against the parent company. P. 312 U. S. 520.
3. Assuming that, because of the extension provision, the operating contract is still executory, the trustees of the subsidiaries are entitled, under § 77B(b) of the Bankruptcy Act, to prove their claims at present worth. P. 312 U. S. 521.
4. Equity will not permit a holding company which has dominated and controlled its subsidiaries to escape or reduce its liability to them by reliance upon self-serving contracts which it has imposed on them. P. 312 U. S. 522.
5. A holding company in dominating and controlling position has fiduciary duties to security holders of its system which will be strictly enforced. P. 312 U. S. 522.
6. A holding company owing money to its subsidiaries under an agreement between them cannot defeat or postpone an accounting in the interest of their bondholders by resort to a declaration in
the agreement that it was made for the benefit of the parties to it, not "for the benefit of any third person." P. 312 U. S. 522.
7. The bankruptcy court, having exclusive jurisdiction over the holding company and the subsidiaries, has plenary power to adjudicate all the issues pertaining to such inter-company claim. P. 312 U. S. 523.
8. In view of the unified operation of all the properties by the parent company, the commingling of assets, and the treatment of the subsidiaries as mere departments of its business, that company is in no position to assert that its assets are insulated from the claims of the subsidiaries' bondholders. P. 312 U. S. 523.
9. The value of the assets of the holding company must be determined, to furnish criteria for appropriate allocation of the new securities between bondholders and stockholders in case any equity remains after bondholders have been made whole. P. 312 U. S. 524.
10. To determine the fairness of the plan as between the bondholders of the subsidiaries, there must be at least an approximate ascertainment of the value of their respective assets, notwithstanding the difficulties occasioned by the lack of earnings records and by the commingling of properties. P. 312 U. S. 524.
11. Future earning capacity of the enterprise is the appropriate criterion for the determination of solvency in connection with reorganization plans involving productive properties; valuations for other purposes are not relevant to that issue except as they may indirectly bear on earning capacity. P. 312 U. S. 525.
Unless meticulous regard for earning capacity be had, indefensible participation of junior securities in plans of reorganization may result. Findings as to earning capacity are essential for determination of the feasibility and fairness of a plan of reorganization.
12. Estimate of earning capacity must be based on an informed judgment which embraces all facts relevant to future earning capacity, and hence to present worth, including the nature and condition of the properties, the past earning record, and all circumstances which indicate whether or not that record is a reliable criterion of future performance. P. 312 U. S. 526.
A sum of values based on physical factors and assigned to separate units of the property without regard to the earning capacity of the whole enterprise is plainly inadequate.
13. Whether there should be a formal appraisal of properties in this case is left to the discretion of the District Court. P. 312 U. S. 527.
14. The absolute priority principle applies to reorganizations of solvent, as well as insolvent, corporations. P. 312 U. S. 527.
15. Under this principle, interest accrued on the bonds is entitled to the same priority as the principal. P. 312 U. S. 527.
16. The absolute priority principle does not mean that creditors cannot be given inferior grades of securities or even securities of the same kind as are received by junior interests; but, even where the enterprise as a whole is solvent in the bankruptcy sense, the principle is violated, in cases where stockholders are participating in the plan, if creditors are given securities inferior in grade to those they give up and of the same face amounts, with no additional compensation for the senior rights surrendered. P. 312 U. S. 528.
17. 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 the facts and requirements of each case. 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. P. 312 U. S. 529.
18. The fact that a plan of reorganization substitutes for several old bond issues, separately secured, new securities constituting an interest in all of the properties does not make it unfair and inequitable per se. If the creditor are adequately compensated for the loss of their prior claims, it is not material out of what assets they are paid. P. 312 U. S. 530.
114 F.2d 102 affirmed.
Certiorari, 311 U.S. 636, to review the reversal of a judgment confirming a plan of reorganization under § 77B of the Bankruptcy Act.