1. Pursuant to a plan of its creditors, an insolvent corporation
was adjudged bankrupt; its assets were sold by the bankruptcy
trustee, bid in by the creditors' committee, and acquired by a new
corporation in exchange for its stock, all of which was issued to
creditors of the old corporation in satisfaction of their claims,
the old stockholders being eliminated. Non-assenting minority
creditors were paid in cash. Operations were not interrupted by the
reorganization, and were carried on subsequently by substantially
the same persons as before.
Held:
(1) A "reorganization" within the meaning of § 112(i)(1) of the
Revenue Act of 1928, so that, in computing depreciation and
depletion for the year 1934, the assets of the new corporation, so
acquired, had the same basis that they had when owned by the old
corporation. Pp.
315 U. S. 181,
315 U. S.
183.
(2) The continuity of interest test was satisfied, since the
creditors had effective command over the disposition of the
property from the time when they took steps to enforce their
demands against their insolvent debtor by the institution of
bankruptcy proceedings. At that time, they stepped into the shoes
of the old stockholders. P.
315 U. S.
183.
(3) The transaction here met the statutory standard of a
"reorganization" even though, at the time of acquisition by the new
corporation, the property belonged to the committee, and not to the
old corporation, since the acquisition by the committee was an
integrated part of a single reorganization plan. P.
315 U. S.
184.
Page 315 U. S. 180
2. The full priority rule of
Northern Pacific R. Co. v.
Boyd, 228 U. S. 482,
applies to proceedings in bankruptcy, as well as to equity
receiverships. P.
315 U. S.
183.
3. The full priority rule gives creditors, whether secured or
unsecured, the right to exclude stockholders entirely from a
reorganization plan when the debtor is insolvent. P.
315 U. S.
183.
119 F.2d 819, affirmed.
Certiorari, 314 U.S. 598, to review a judgment affirming a
decision of the Board of Tax Appeals, 41 B.T.A. 324, which
overruled a deficiency assessment.
MR. JUSTICE DOUGLAS delivered the opinion of the Court.
Respondent, in 1931, acquired all the assets of Alabama Rock
Asphalt, Inc., pursuant to a reorganization plan consummated with
the aid of the bankruptcy court. In computing its depreciation and
depletion allowances for the year 1934, respondent treated its
assets as having the same basis which they had in the hands of the
old corporation. The Commissioner determined a deficiency, computed
on the price paid at the bankruptcy sale. [
Footnote 1] The Board of Tax Appeals rejected the
position of the Commissioner. 41 B.T.A. 324. The Circuit Court of
Appeals affirmed. 119 F.2d 819. We granted the petition for
certiorari, 314 U.S. 598, because
Page 315 U. S. 181
of the conflict between that decision [
Footnote 2] and
Commissioner v. Palm Springs
Holding Corp., 119 F.2d 846, decided by the Circuit Court of
Appeals for the Ninth Circuit, and
Helvering v. New President
Corp., 122 F.2d 92, decided by the Circuit Court of Appeals
for the Eighth Circuit.
The answer to the question [
Footnote 3] turns on the meaning of that part of §
112(i)(1) of the Revenue Act of 1928, 45 Stat. 791, 818, which
provides:
"The term 'reorganization' means (A) a merger or consolidation
(including the acquisition by one corporation of . . .
substantially all the properties of another corporation). . .
."
The essential facts can be stated briefly. The old corporation
was a subsidiary of a corporation which was in receivership in
1929. Stockholders of the parent had financed the old corporation,
taking unsecured notes for their advances. Maturity of the notes
was approaching, and not all of the noteholders would agree to take
stock for their claims. Accordingly, a creditors' committee was
formed late in 1929, and a plan of reorganization was proposed to
which all the noteholders except two assented. The plan provided
that a new corporation would be formed which would acquire all the
assets of the old corporation. The stock of the new corporation,
preferred and common, would be issued to the creditors in
satisfaction of their claims. Pursuant to the plan, involuntary
bankruptcy proceedings were instituted in 1930. The appraised value
of the bankrupt corporation's assets was about $155,000. Its
obligations were about $838,000, the unsecured notes with accrued
interest aggregating somewhat over $793,000.
Page 315 U. S. 182
The bankruptcy trustee offered the assets for sale at public
auction. They were bid in by the creditors' committee for $150,000.
The price was paid by $15,000 in cash, by agreements of creditors
to accept stock of a new corporation in full discharge of their
claims, and by an offer of the committee to meet the various costs
of administration, etc. Thereafter, respondent was formed, and
acquired all the assets of the bankrupt corporation. It does not
appear whether the acquisition was directly from the old
corporation on assignment of the bid or from the committee.
Pursuant to the plan, respondent issued its stock to the creditors
of the old corporation -- over 95% to the noteholders, and the
balance to small creditors. Nonassenting creditors were paid in
cash. Operations were not interrupted by the reorganization, and
were carried on subsequently by substantially the same persons as
before.
From the
Pinellas case,
Pinellas Ice & Cold
Storage Co. v. Commissioner, 287 U. S. 462, to
the
Le Tulle case,
Le Tulle v. Scofield,
308 U. S. 415, it
has been recognized that a transaction may not qualify as a
"reorganization" under the various revenue acts though the literal
language of the statute is satisfied.
See Paul, Studies in
Federal Taxation (3d Series) p. 91
et seq. The
Pinellas case introduced the continuity of interest theory
to eliminate those transactions which had "no real semblance to a
merger or consolidation" (287 U.S. p.
287 U. S. 470),
and to avoid a construction which "would make evasion of taxation
very easy."
Id., p.
287 U. S. 469.
In that case, the transferor received in exchange for its property
cash and short term notes. This Court said (
id., p.
287 U. S.
470),
"Certainly we think that, to be within the exemption, the seller
must acquire an interest in the affairs of the purchasing company
more definite than that incident to ownership of its short-term
purchase money notes."
In the
Le Tulle case, we held that the term of the
obligation received by the seller was immaterial.
"Where the consideration is wholly in the transferee's bonds,
or
Page 315 U. S. 183
part cash and part such bonds, we think it cannot be said that
the transferor retains any proprietary interest in the
enterprise."
308 U.S. pp.
308 U. S.
420-421. On the basis of the continuity of interest
theory as explained in the
Le Tulle case, it is now
earnestly contended that a substantial ownership interest in the
transferee company must be retained by the holders of the ownership
interest in the transferor. That view has been followed by some
courts.
Commissioner v. Palm Springs Holding Corp., supra;
Helvering v. New President Corp., supra. Under that test,
there was "no reorganization" in this case, since the old
stockholders were eliminated by the plan, no portion whatever of
their proprietary interest being preserved for them in the new
corporation. And it is clear that the fact that the creditors were,
for the most part, stockholders of the parent company does not
bridge the gap. The equity interest in the parent is one step
removed from the equity interest in the subsidiary. In any event,
the stockholders of the parent were not granted participation in
the plan
qua stockholders.
We conclude, however, that it is immaterial that the transfer
shifted the ownership of the equity in the property from the
stockholders to the creditors of the old corporation. Plainly, the
old continuity of interest was broken. Technically, that did not
occur in this proceeding until the judicial sale took place. For
practical purposes, however, it took place not later than the time
when the creditors took steps to enforce their demands against
their insolvent debtor. In this case, that was the date of the
institution of bankruptcy proceedings. From that time on, they had
effective command over the disposition of the property. The full
priority rule of
Northern Pacific R. Co. v. Boyd,
228 U. S. 482,
applies to proceedings in bankruptcy, as well as to equity
receiverships.
Case v. Los Angeles Lumber Products Co.,
308 U. S. 106. It
gives creditors, whether secured or unsecured, the right to
exclude
Page 315 U. S. 184
stockholders entirely from the reorganization plan when the
debtor is insolvent.
See In re 620 Church St. Bldg. Corp.,
299 U. S. 24. When
the equity owners are excluded and the old creditors become the
stockholders of the new corporation, it conforms to realities to
date their equity ownership from the time when they invoked the
processes of the law to enforce their rights of full priority. At
that time, they stepped into the shoes of the old stockholders. The
sale "did nothing but recognize officially what had before been
true in fact."
Helvering v. New Haven & S.L. R. Co.,
121 F.2d 985, 987.
That conclusion involves no conflict with the principle of the
Le Tulle case. A bondholder interest in a solvent company
plainly is not the equivalent of a proprietary interest, even
though, upon default, the bondholders could retake the property
transferred. The mere possibility of a proprietary interest is, of
course, not its equivalent. But the determinative and controlling
factors of the debtor's insolvency and an effective command by the
creditors over the property were absent in the
Le Tulle
case.
Nor are there any other considerations which prevent this
transaction from qualifying as a "reorganization" within the
meaning of the Act. The
Pinellas case makes plain that
"merger" and "consolidation," as used in the Act, includes
transactions which "are beyond the ordinary and commonly accepted
meaning of those words." 287 U.S. p.
287 U. S. 470.
Insolvency reorganizations are within the family of financial
readjustments embraced in those terms as used in this particular
statute. Some contention, however, is made that this transaction
did not meet the statutory standard because the properties acquired
by the new corporation belonged at that time to the committee, and
not to the old corporation. That is true. Yet the separate steps
were integrated parts of a single scheme. Transitory phases of an
arrangement frequently are disregarded
Page 315 U. S. 185
under these sections of the revenue acts where they add nothing
of substance to the completed affair.
Gregory v.
Helvering, 293 U. S. 465;
Helvering v. Bashford, 302 U. S. 454.
Here, they were no more than intermediate procedural devices
utilized to enable the new corporation to acquire all the assets of
the old one pursuant to a single reorganization plan.
Affirmed.
MR. JUSTICE ROBERTS did not participate in the consideration or
decision of this case.
[
Footnote 1]
Petitioner now takes the position that the new basis should be
measured by the market value of the assets, rather than the bid
price.
See Bondholders Committee v. Commissioner, post, p.
315 U. S. 189.
[
Footnote 2]
And see Commissioner v. Kitselman, 89 F.2d 458, and
Commissioner v. Newberry Lumber & Chem. Co., 94 F.2d
447, which are in accord with the decision below.
[
Footnote 3]
If there was a "reorganization," the respondent was entitled to
use the asset basis of the old corporation as provided in §
113(a)(7).