In an arrangement proceeding instituted by a corporate debtor
under Chapter XI of the Bankruptcy Act, an indenture trustee
objected to the allowance of claims equal to the principal amount
of debentures acquired at a discount, while the debtor was
insolvent, by respondents, who were close relatives and an office
associate of the debtor's directors. The referee found, in effect,
that there was no bad faith or unfair dealing, and that, during the
period of the purchases, respondents' conduct with reference to the
affairs of the debtor was to its material benefit. The referee
dismissed the objections, and both the District Court and the Court
of Appeals affirmed.
Held: on the record in this case, equitable
considerations do not require that respondents' claims be limited
to the cost of the debentures plus interest. Pp.
338 U. S.
305-315.
(a) The two respondents, who were close relatives of the
director purchased all their debentures while the debtor was a
going concern (though technically insolvent), and, even if their
claims be viewed as claims of directors, the probability that an
actual conflict of interests arose from their purchases is not
great enough to justify the exercise of equity jurisdiction to
limit their claims to the cost of the debentures plus interest. Pp.
338 U. S.
309-313.
(b) The third respondent did purchase a small portion of his
debentures after the debtor ceased to be a going concern, but he
was merely an office associate and friend of the directors, he had
begun to buy debentures some months before their election, there
was nothing to indicate that his purchases after they became
directors were influenced by advice from them, they had no interest
in his holdings, and consideration of his claim as that of a
director is precluded. Pp.
338 U. S. 314-315.
173 F.2d 944 affirmed.
In a proceeding under Chapter XI of the Bankruptcy Act, the
referee's dismissal of objections to the allowance of certain
claims was affirmed by the District Court (80
Page 338 U. S. 305
F.Supp. 822) and the Court of Appeals (173 F.2d 944). This Court
granted certiorari. 337 U.S. 923.
Affirmed, p.
338 U. S.
315.
MR. JUSTICE CLARK delivered the opinion of the Court.
This proceeding in bankruptcy is on objections to the allowance
of claims equal to the principal amount of bonds of the debtor
acquired at a discount during its insolvency by close relatives and
an office associate of directors of debtor. Petitioner's objection
that equitable considerations require limitation of the claims was
dismissed by the referee, and the District Court affirmed.
80 F. Supp.
822. Following affirmance by a divided Court of Appeals for the
Second Circuit, 173 F.2d 944, we granted certiorari because the
issue presented has importance in the administration of the
arrangement and corporate reorganization provisions of the
Bankruptcy Act. 337 U.S. 923.
On January 8, 1946, Calton Crescent, Inc., sold its only
property, an apartment house located in New Rochelle, New York, for
$300,000 pursuant to a contract entered into in October, 1945.
Being unable to discharge in full its obligations under debenture
bonds maturing in 1953, outstanding in principal amount of
$254,450, debtor filed, in May 1946, a petition under Ch. XI of the
Bankruptcy Act, 11 U.S.C. § 701
et seq. Under the plan of
arrangement, authorizing a dividend of 43.61% of the principal
Page 338 U. S. 306
amount of the bonds, respondents Regine Becker, Emily K. Becker,
and Walter A. Fribourg were to receive an aggregate dividend
of.$64,237.53 on allowance of claims based on respective individual
holdings of debentures which total $147,300 in principal sum but
were acquired at a total cost of $10,195.43. [
Footnote 1] Petitioner, Manufacturers Trust
Company, appearing individually as creditor for fees and
disbursements due it as indenture trustee and also as original
trustee under said indenture, objected to allowance of respondents'
claims as filed, on the ground that the circumstances of
respondents' acquisitions require limitation of their claims to the
cost of the debentures plus interest.
The circumstances pertinent to our consideration of petitioner's
objections are as follows: the debtor was organized in 1933 to take
title to the apartment property pursuant to a plan of
reorganization. By January, 1942, debtor had defaulted under the
terms of the first mortgage, and was operating with a deficit; at
no time in the previous several years had its debentures been
selling on the market at more than 8% of face value.
While debtor was then considering a sale of the property for
$220,000, a suit to enjoin the sale was brought by Sanford Becker,
son of respondent Regine Becker and husband of respondent Emily
Becker. [
Footnote 2]
Thereafter, he proposed to arrange a loan on second mortgage to
debtor of $15,000 to pay off the arrearages on the first
mortgage,
Page 338 U. S. 307
all share and debenture holders being invited to participate. In
April, 1942, debtor accepted the offer, but none of its share or
debenture holders elected to participate other than respondent
Fribourg, who had desk room in the offices of Sanford Becker and
his brother Norman Becker and was a long-time friend of the former.
The loan was made by respondents Regine Becker, Emily Becker, and
Fribourg. The second mortgage thus created was in default by the
end of 1942, and, in 1943, respondents took an assignment of rents,
but did not foreclose; nor was there change in management of the
property. The second mortgage and interest were paid upon sale of
the property in 1946. In addition to the second mortgage, sums
aggregating $7,921.63 were advanced by respondents to pay taxes;
this amount was repaid without interest in 1944 and 1945. Pursuant
to provisions of the loan agreement in 1942, Sanford and Norman
Becker were made directors of debtor, and, when the remaining three
directors resigned in 1944, the vacancies were filled by nominees
of the Becker brothers.
The referee found that, from early 1942, the market value of the
property of debtor was insufficient to pay its debts. However, the
record shows a tax valuation during the period of only slightly
less than the outstanding indebtedness. [
Footnote 3] And although the debtor's operating account
frequently ran in arrears, it revealed a surplus in
Page 338 U. S. 308
1945. Prior to disposing of its property, debtor was at all
times a going concern. [
Footnote
4]
The debentures on which respondents claim were acquired at
prices varying from 3% to 14% of face value, after the Becker
brothers became directors in 1942. [
Footnote 5] Sanford Becker did not buy additional
debentures after becoming a director. Norman Becker never owned any
interest whatever in the debtor. Although neither of the Becker
directors was interested in any purchase of the respondents, the
debentures of Regine and Emily Becker were purchased through the
agency of the Becker brothers and in the latter's judgment. The
debentures of Regine Becker were purchased from an over the counter
securities broker. Those of Emily Becker were acquired in part from
the same dealer, in part from an estate whose attorneys were fully
informed as to debtor's financial affairs, and in part from a
Christian Association represented by a member of its investment
committee who was fully advised as to the condition of debtor.
Some of Fribourg's debentures were bought from dealers in the
over the counter market; others were acquired through an agent from
the president and vice-president of debtor when they withdrew from
its management in 1944, and from other holders after the retiring
president insisted that the offer made to him by Fribourg's agent
be extended to all holders and be accompanied by
Page 338 U. S. 309
a statement of the president's intention to accept. Fribourg was
in the market for speculative securities, and purchased the
debentures as a "gamble," being influenced by the tax valuation of
the apartment building.
All of respondents' debentures, with the exception of $2,000 in
face value purchased by Fribourg from a dealer, were acquired in
advance of the contract for sale of the apartment property and the
filing of debtor's petition for arrangement. [
Footnote 6]
It was the referee's finding, left undisturbed by both courts
below, that respondents' purchases were without overreaching or
failure to disclose any material fact to the selling bondholders.
Petitioner does not here contend that respondents' claims should be
limited because of conduct by the Becker directors or by
respondents amounting to bad faith or abuse of fiduciary advantage.
Nor does petitioner contend that respondents' bondholdings
influenced the conduct of corporate affairs to the injury of the
corporation or other creditors. Indeed, the referee found that the
purchases were not unfair to debtor, that, at the time of
respondents' purchases, debtor was not in the field to settle its
indebtedness on the debentures, and that the assistance rendered to
debtor by respondents materially aided in its grave financial
situation. Moreover, the findings indicate that the most generous
suggestion of an offer for the apartment building after the Beckers
became directors and prior to the sale was at a figure
substantially less than the sale price.
Petitioner urges broadly that directors are precluded from
profiting by the purchase of claims against an insolvent
Page 338 U. S. 310
corporation. And, it contends, if directors may claim only the
cost of debt securities acquired at a discount during a debtor's
insolvency, those related as respondents are to the Becker
directors should not be permitted to do more. Thus, we view
respondents' claims initially as if they were claims of
directors.
This Court has repeatedly insisted on good faith and fair
dealing on the part of corporate fiduciaries. It is especially
clear, when claims in bankruptcy accrue to the benefit of a
corporate officer or director, that the court must reject any claim
that would not be fair and equitable to other creditors.
Pepper
v. Litton, 308 U. S. 295,
308 U. S.
308-309 (1939). [
Footnote 7]
Claims of a corporate officer or director arising out of
transactions with the corporation have been enforced when good
faith and fairness were found.
Sanford Fork & Tool Co. v.
Howe, Brown & Co., 157 U. S. 312
(1895);
cf. Manufacturing Co. v. Bradley, 105 U.
S. 175 (1892);
see Richardson's Ex'r v. Green,
133 U. S. 30,
133 U. S. 43
(1890);
Twin-Lick Oil Co. v. Marbury, 91 U. S.
587,
91 U. S.
589-591 (1876). Likewise, a standard of good faith and
fair dealing has been found applicable, where not superseded by a
differing legislative or administrative rule, to purchases by
directors of corporate shares, in the over the counter market at
less than book value on conversion under a plan of public utility
reorganization.
Securities and Exchange Commission v. Chenery
Corporation, 318 U. S. 80
(1943);
cf. id. 332 U. S. 332 U.S.
194 (1947). In the first
Chenery
Page 338 U. S. 311
decision, it was declared that equity has not imposed
"upon officers and directors of a corporation any fiduciary duty
to its stockholders which precludes them, merely because they are
officers and directors, from buying and selling the corporation's
stock."
318 U.S. at
318 U. S.
88.
When the transactions underlying respondents' claims here are
drawn alongside a good faith standard of fiduciary obligation, they
appear unobjectionable. There is no component of unfair dealing or
bad faith. [
Footnote 8] The
findings negative any misrepresentation or deception, any
utilization of inside knowledge or strategic position, or any
rivalry with the corporation. [
Footnote 9] During the period of the purchases, the
conduct of the Becker directors and of respondents with reference
to the affairs of the debtor was to its substantial benefit, and to
the advantage of the other debenture holders. And there is nothing
to suggest that, had the debentures been acquired by the Becker
directors, they would have been unjustly enriched.
Cf.
Securities and Exchange Commission v. Chenery Corporation,
supra, at
318 U. S.
86.
However, it is the contention of petitioner, and of the
Securities and Exchange Commission as
amicus curiae, that
a standard of good faith and fair dealing is inadequate here.
Relying particularly upon
Magruder v. Drury, 235 U.
S. 106 (1914), they invoke the principle that a trustee
can make no profit from his trust. But
Magruder v. Drury
involved an express trust, and, even during insolvency, corporate
assets "are not, in any true
Page 338 U. S. 312
and complete sense, trusts."
Hollins v. Brierfield Coal
& Iron Co., 150 U. S. 371,
150 U. S.
381-382 (1893). [
Footnote 10]
The Commission asserts, also, that, if a director is free to
acquire corporate obligations at a discount during insolvency and
later enforce them in full, he will be subject to a possible
conflict of interests inconsistent with his role as fiduciary to
creditors of the corporation. Specifically it is argued that he may
seek to postpone adjustment of claims or the institution of
proceedings for relief, when such action would serve the interests
of the corporation and its creditors, in order to continue his own
purchase of corporate obligations at a market price lower than the
valuation which he has made with the benefit of inside
information.
This Court has recognized that equity must apply not only the
doctrines of unjust enrichment when fiduciaries have yielded to the
temptation of self-interest, but also a standard of loyalty which
will prevent a conflict of interests from arising.
See Weil v.
Neary, 278 U. S. 160,
278 U. S. 173
(1929);
cf. Woods v. City Nat. Bank & Trust Co.,
312 U. S. 262,
312 U. S. 268
(1941). In this case, the consideration is whether or to what
extent a conflict of interests would arise from a director's
opportunity to purchase unmatured obligations of a corporation
which, though technically insolvent, remains nevertheless a going
concern. That "there is no such conflict in the ordinary case of
the purchase by a director in a going corporation of its
outstanding obligations,"
Seymour v. Spring Forest Cemetery
Assn., 144 N.Y. 333, 344, 39 N.E. 365, 367 (1895),
Page 338 U. S. 313
would seem true not only of solvent corporations. [
Footnote 11] Certainly the present
record does not tend to establish that the opportunity for such
purchases during insolvency would deprive a going corporation of
the sound judgment of its officer. And, in any event, the
potentiality of conflict must be weighed against the desirability
of permitting reinforcement of the insolvent's position insofar as
a director's acquisition of claims may help. [
Footnote 12] On this record, the probability
that an actual conflict of loyalties arose from the opportunity to
purchase respondents' claims, while the debtor was a going concern,
is not great enough to justify the exercise of equity jurisdiction
which petitioner urges. [
Footnote 13]
Undoubtedly the possibilities of a conflict of interests for the
purchasing director are intensified as the corporation becomes less
a going concern and more a prospective subject of judicial relief.
And if it is clear that a fiduciary may ordinarily purchase debt
claims in fair transactions
Page 338 U. S. 314
during solvency of the corporation, [
Footnote 14] the lower federal courts seem equally
agreed that he cannot purchase after judicial proceedings for the
relief of a debtor are expected or have begun. [
Footnote 15] In this case, which lies
between, it is unnecessary to determine precisely at what point the
probability of conflict requires that equity declare ended the
opportunity for profitable trading. It could hardly have been prior
to the latest purchases of Regine and Emily Becker. [
Footnote 16]
The nature of the relation between Fribourg and the Becker
directors makes immaterial that some of Fribourg's debentures may
have been purchased after the corporation ceased to have the
potency of a going concern, in expectation of or even after
bankruptcy. Neither director had any indirect interest in
Fribourg's holdings, or served as his agent for purchase. Fribourg,
moreover, had begun to acquire debentures some months before the
negotiations leading to the election of the Beckers as directors of
the debtor, and, according to Fribourg's uncontradicted testimony,
he began to purchase after looking over the apartment following
Sanford Becker's mention of his own purchase. There is nothing in
the record to indicate that Fribourg's purchases after the Beckers
became directors were influenced by advice from them.
Page 338 U. S. 315
Accordingly, any consideration of Fribourg's claim as that of a
director is precluded.
A word of caution as to the scope of our decision is desirable
in view of Judge Learned Hand's opinion below. He suggested that
if, in fact, liquidation had been imminent at the time of
respondents' purchases or if it were fairly demonstrable, as a
matter of experience, that a director free from all potential
self-interest would be more likely to initiate liquidation
proceedings or to effect a debt settlement than one not wholly
disinterested, a court of equity should explore such issues, and
not dismiss them out of hand. This decision is not meant to
negative the relevance of these issues when raised by a proper
record. We mention these matters because the Securities and
Exchange Commission urges the importance of a decision in this case
for questions that may well arise in proceedings under Ch. X. In
such proceedings the Securities and Exchange Commission, acting as
the statutory advisor to the court, would be within its rightful
function in submitting to the court the light of its experience on
dealings of the general kind disclosed in this case. Here, we have
proven facts in a particular case, and not a body of evidence
submitted by the Securities and Exchange Commission, presumably
informed by expert understanding.
The decision of the Court of Appeals is
Affirmed.
MR. JUSTICE DOUGLAS took no part in the consideration or
decision of this case.
[
Footnote 1]
The amount and cost of the respective holdings of the
respondents, insofar as objected to, are as follows:
Principal
Amount Cost
Regine Becker . . . . . . $44,500 $3060.63
Emily K. Becker . . . . . 52,800 5010.00
Walter A. Fribourg. . . . 50,000 2124.80
[
Footnote 2]
Sanford Becker and respondent Fribourg first became interested
in the affairs of debtor in September, 1941. Soon thereafter, each
purchased, independently, debentures of debtor of the face value of
$5,000. No contest is made of these purchases.
It appears that transactions in the debentures included the
transfer of capital shares of the debtor which had no market apart
from the debentures.
[
Footnote 3]
The major items of indebtedness consisted of (1) the first
mortgage on the apartment building in original principal amount of
$175,000, which had been reduced by 1946 to $154,000, of which
reduction $7,875 had been paid since 1943; (2) the second mortgage
and tax advances of the respondents totalling some $22,000, and (3)
the debentures of $254,450, on which, however, interest was payable
only if earned. The tax valuation was $421,630.
[
Footnote 4]
The District Court's characterization of debtor as a going
concern was not upset by the Court of Appeals, and is accepted
here.
[
Footnote 5]
[
Footnote 6]
The latest purchase by a respondent clearly prior to the
contract for sale was by Regine Becker on August 30 preceding the
contract in October 1945. Fribourg apparently acquired $1,500 of
debentures after the contract of sale and an additional $500 after
the filing of debtor's petition.
[
Footnote 7]
Since the power of disallowance of claims, conferred on the
bankruptcy court by § 2 of the Act, 30 Stat. 545, 11 U.S.C. § 11,
embraces the rejection of claims "in whole or in part, according to
the equities of the case,"
Pepper v. Litton, 308 U.
S. 295,
308 U. S.
304-305 (1939), the court may undoubtedly require
limitation of the amount of claims in view of equitable
considerations.
Cf. Bankruptcy Act, § 212, 52 Stat. 895,
11 U.S.C. § 612.
[
Footnote 8]
Cf. In re The Van Sweringen Co., 119 F.2d 231 (1941);
In re Norcor Mfg. Co., 109 F.2d 407 (1940).
[
Footnote 9]
Cf. In re Jersey Materials Co., 50 F. Supp.
428 (1943);
In re McCrory Stores Corp., 12 F. Supp.
267 (1935).
[
Footnote 10]
Other holdings upon which the Commission relies,
Pepper v.
Litton, supra, note 7 and
Woods v. City Nat. Bank & Trust Co., 312 U.
S. 262 (1941), were considered in
Securities and
Exchange Commission v. Chenery Corporation, 318 U. S.
80,
318 U. S. 89
(1943), and there distinguished on grounds which are also
dispositive here.
[
Footnote 11]
Courts of equity, in defining the responsibility of officers of
a corporation which is insolvent and yet a going concern, have
frequently assigned greater importance to the corporation's
vitality than to its insolvency.
E.g., Sanford Fork & Tool
Co. v. Howe, Brown & Co., 157 U.
S. 312 (1895);
White, Potter & Paige Mfg. Co. v.
Henry B. Petters Importing Co., 30 F. 864 (1887).
[
Footnote 12]
"is the very time when such purchases may be of most benefit to
the corporation, since the credit of the corporation may be
improved if it is known that directors are purchasing the
corporation's securities; also, it may be possible to forestall a
bankruptcy petition while the corporation improves its financial
position."
[
Footnote 13]
Cf. In the Matter of Wade Park Manor Corporation, Report of
Special Master: Claims of Macklin et al. (N.D.Ohio, 1949);
see 3 Collier, Bankruptcy (14th ed.), p. 1784, 1948 Supp.
p. 124.
[
Footnote 14]
See In re Philadelphia & Western R.
Co., 64 F. Supp.
738, 739 (1946);
Ripperger v. Allyn, 25 F. Supp.
554, 555 (1938);
In re McCrory Stores Corp., note 9 supra, 12 F. Supp. at
269.
[
Footnote 15]
Monroe v. Scofield, 135 F.2d 725 (1943);
In re
Norcor Mfg. Co., note 8
supra; In re Philadelphia & Western R. Co., note 14 supra; In re Jersey
Materials Co., note 9
supra; In re Los Angeles Lumber Products
Co., 46 F. Supp.
77 (1941).
[
Footnote 16]
Thus, it becomes unnecessary to determine whether the relation
of the Becker respondents to the directors was such as to require
limitation of these respondents' claims if they would be disallowed
in part as claims of directors.
MR. JUSTICE BURTON, with whom MR. JUSTICE BLACK joins,
dissenting.
While corporate directors are not classed as express trustees,
their obligations to their respective corporations are fiduciary in
character. The more precarious the condition
Page 338 U. S. 316
of the corporation, the more it needs the undivided loyalty of
its directors. Conflicts of interest must be resolved in its favor.
An example of the need for doing so arises whenever, in the face of
a prospect of the corporation's liquidation, some of its directors
invest in its notes at a substantial discount. An inherent conflict
of interests is thereby created. It may be necessary for them to
choose between a corporate policy of reorganization which might be
best for the corporation and one of liquidation which might yield
more certain profits to them as noteholding directors. The
fiduciary obligation of such directors to their corporation might
thus conflict with their personal interests as noteholders. Their
access to confidential corporate information emphasizes the good
faith expected of them. The solution lies in making them
accountable to their corporation for their profits from such an
investment, much as a trustee must account to his beneficiaries for
his profits from dealings in the subject matter of his trust. This
result would spring wholly from the fiduciary nature of the
obligations of directors to their corporation. It would need no
proof of a breach of trust or of the actual overreaching of anyone.
[
Footnote 2/1]
As long as a corporation enjoys the healthy status of a going
concern, its directors generally may invest freely in its
securities without accountability for their resulting
Page 338 U. S. 317
profits. Their directorships should make them accountable for
such profits when their personal interests as purchasers of
securities may conflict with their obligations as directors.
[
Footnote 2/2] A mere excess of a
corporation's liabilities over its assets may not subject its
directors to this accountability. Nevertheless, any evidence of the
financial instability of their corporation obligates the directors
to overcome whatever presumption of conflict of interests between
their own and those of the corporation or of its creditors that
such evidence presents.
In the instant case, there should be a finding whether or not,
at the time of the purchases of the debentures in question, there
was a sufficient prospect of liquidation to bring the interests of
directors as debenture purchasers into conflict with the interests
of their corporation. If such a conflict is established, it then
will be necessary to determine the extent, if any, to which the
relatives and associates of such directors are to be identified
with them.
I agree with the reasoning of the dissent below. 173 F.2d 944,
951. Accordingly, I would reverse the judgment and remand the cause
for further findings in accordance with this opinion.
[
Footnote 2/1]
Expression has been given to such a principle in many cases
where there have also occurred breaches of trust of a nature so
serious as not to require a final reliance upon the principle.
See, e.g., In re The Van Sweringen Co., 119 F.2d 231;
In re Norcor Mfg. Co., 109 F.2d 407;
In re
Philadelphia & Western R. Co., 64 F. Supp.
738;
In re Jersey Materials Co., 50 F. Supp.
428;
In re Los Angeles Lumber Products
Co., 46 F. Supp.
77;
In re McCrory Stores Corp., 12 F. Supp.
267, 269.
See also 3 Fletcher, Cyclopedia of
Corporations § 869.1 (1947); 2 Remington on Bankruptcy § 975.01
(Supp. 1947).
[
Footnote 2/2]
Directors ordinarily may buy and sell the stock of their
corporation, without accountability, except under special
circumstances of unfairness in the particular transaction. 3
Fletcher, Cyclopedia of Corporations §§ 1171, 1174 (1947);
Ballantine on Corporations § 80 (Rev. ed.1946). Their purchase of
stock increases their stake in the ultimate interests of the
corporation they serve.