Appeal from the District Court of the United States for the Southern District of New York.
Before MANTON, L. HAND, and AUGUSTUS N. HAND, Circuit Judges.
Appellants are two committees representing preferred stockholders and appeal from orders entered below, questioning whether the debtor was insolvent and whether the plan of reorganization is fair and equitable. The special master heard the proofs and held that the debtor was insolvent and that the plan proposed was fair and equitable. The District Court confirmed his report.
The balance sheet of December 31, 1934, submitted with the petition, showed that the debtor had liabilities amounting to $40,982,342.03 and assets of $31,762,050.99. The balance sheet, showing the condition of the company as of the date of the petition, July, 1935, shows a reduction in assets to $23,720,439.36, with a capital deficiency of over seventeen millions. The physical equipment of the debtor, such as tracks, etc., is included at book value based on reproduction cost determined in the 1925 and subsequent additions at cost, amounting to $19,912,458.51.
The appellants' first objection as to the master's report is his failure to find that the Fifth Avenue Coach Company held about $11,114,831.88 in income bonds with $7,057,918.24 accumulated interest thereon as constructive trustees for the New York Railways Company and for them, as preferred stockholders.
When the debtor reorganized in 1924, it cut down a ninety-one million dollar capitalization to bonds of thirty-eight millions and certain no par value stock, 90,000 shares of voting common, and 170,000 issued shares of nonvoting stock preferred as to dividends but not as to assets. The new company owned the stock of seven subsidiary companies; the bonds of the system consisting of fourteen millions in bonds of some of these subsidiaries, four millions senior bonds, and twenty millions income bonds. It is plain that the debtor was overcapitalized. It fell behind about a million dollars yearly, the operating revenues failing by that amount to keep pace with the interest on the income bonds. Its passenger revenues fell off from $7,252,079.03 in 1925 to $4,428,056.49 in 1934. Motorization presented a possible solution, and a bus treaty was entered into with the Fifth Avenue Coach Company in 1926.
Shortly after that, the Fifth Avenue Coach Company bought all the voting (common) stock of the New York Railways Company at $10 per share, securing the approval of the Transit Commission on the basis of the reproduction costs formerly used. At the first subsequent election, the majority of the directors of the New York Railways Company elected were interested as directors or officers of the Fifth Avenue Coach Company or its affiliates.
In 1930 a resolution was passed by the debtor's board still dominated by the Fifth Avenue Coach Company, approving the selection, for the purpose of making a reorganization survey of two banking firms which became managers of the plan of reorganization. Each firm had a member on the boards of the debtor and the Fifth Avenue Coach Company. The Fifth Avenue Coach Company adopted a similar resolution and guaranteed the payment of the bankers' fees payable by the debtor. On the advice of the reorganization managers, the debtor bought in some eight millions of its subsidiaries' bonds, at about one and a quarter million dollars to preserve its operating system and prevent foreclosure. Both companies were contemplating motorization, and the reorganization was conducted with this in mind. It became apparent that there was no equity in the stock, as one reorganization manager said, because the city of New York was not going to give liberal bus franchises. On his recommendation, the Fifth Avenue Coach Company began to buy income bonds in September, 1933. These purchases were made through public advertisement, and the Fifth Avenue Coach Company succeeded in acquiring about eleven millions at an average price of 10 per cent. of their face value. The bonds were on the exchange, and their prices have always been far below face value. Before the Fifth Avenue Coach Company acquired any of the bonds, its position on the board of the debtor had changed. After April, 1933, there were sixteen directors, eight of these are not shown to have had any connection with the Fifth Avenue Coach Company and two others had previously terminated their coach company directorships. Thus, although the Fifth Avenue Coach Company had complete voting control, it did not have a majority on the board. Although appellants assert a majority of the debtors' executive committee at that time were interested in the Fifth Avenue Coach Company, it is apparent that the directors could have authorized the debtors' purchase of the income bonds without the executive committees' cooperation.
From these facts, it is clear enough that there is no basis for the contention that the Fifth Avenue Coach Company was in any fiduciary relationship such as would make directors liable for taking advantage of their position within the rule of Irving Trust Co. v. Deutsch, 73 F.2d 121 (C.C.A. 2), or In re McCrory Stores Corporation, 12 F. Supp. 267 (D.C.S.D.N.Y.). The Fifth Avenue Coach Company had not so usurped the management of the debtor that the board of directors were influenced to inaction and silence on any plan for the debtor itself to buy in its income bonds at a low figure. The failure of the debtor to so act was undoubtedly due to its financial inability rather than to any other fiduciary faithlessness.
The situation was that there were bonds of the corporation outstanding prior to the income bonds and any money directed for their purchase would weaken the security for this prior issue. Moreover, if any accumulated income were used in the purchase, we would have the situation of interest payments on the income bonds being held up and their value dropping as an inevitable result and then the purchase out of income of these bonds depressed by the default. Article 13, § 1, of the income indenture, is directed against such a possibility. The provisions of article 5, § 5, allowing, before determination of available net income, the deduction of "reserves for unascertainable items or existing or future contingencies (including without limitation the retirement or amortization of Underlying Bonds, Prior Lien Bonds or other capital obligations)" cannot be read so as to make the ambiguous "other capital obligations" include the very income bonds themselves.
There had been $400,000 paid to one of the debtor's subsidiaries, 42nd Street Ferry, for the condemnation of some real estate. Appellants contend that this should have been voted as a dividend, since the debtor had the ferry company's stock and had the power to vote it, although the stock was pledged under the prior lien indenture. Since the debtor had spent over a million dollars in retiring subsidiary bonds by December, 1933, by article 3, § 3, of the prior lien indenture, it was entitled to an equivalent amount of additional prior lien bonds. Article 7, § 4, provides that the debtor, instead of accepting such prior lien bonds, could take any cash distributions for the pledged stock "paid otherwise than out of current earnings or earned surplus of the company issuing such stock." This would be done by drawing the sum off through the income bond trustee who was authorized to use such funds for the retirement of income bonds by purchase of the bonds on the market at prices not above par. However, no matter how able the debtor was to buy the income bonds for itself, there is nothing to show, and no ground to infer, that its inaction in this respect was due to the Fifth Avenue Coach Company's control. During this period, its board had a majority of independent directors free to act without being influenced by any allegiance to the Fifth Avenue Coach Company. The mere fact that the debtor could have made the purchase does not render the stockholders' purchase voidable. A stockholder is under the duty not to use the power that is his by virtue of his stockholdings unfairly to the other stockholders. Southern Pacific Co. v. Bogert, 250 U.S. 483, 39 S. Ct. 533, 63 L. Ed. 1099; Rothchild v. Memphis & C.R. Co. (C.C.A.) 113 F. 476, certiorari denied Rothschild v. Memphis & C.R. Co., 188 U.S. 740, 23 S. Ct. 848, 47 L. Ed. 677; Gamble v. Queens County Water Co., 123 N.Y. 91, 25 N.E. 201, 9 L.R.A. 527. If the Fifth Avenue Coach Company had actively prevented the purchase of these bonds by the debtor, the nonvoting stockholders might have a proper protest against the Fifth Avenue Coach Company's later purchase. But the debtor had been left free to make the purchase itself if it could. The voting stockholder was not thereby barred by this inaction, not caused by it.
The allegations that the Fifth Avenue Coach Company used inside information to secure an unfair advantage in buying these bonds has no substance. The underlying subsidiary bonds had been bought through advertisements without secrecy. The stockholders must have known what they could expect from a reorganization where they were preceded in interest by income bonds. At the outset their shares had been given an equity of one and a half million and the debtor had piled up a debt larger than this on the unpaid income bonds, leaving these bonds as an outside margin that could expect substantial rights after reorganization. The terms of the announced plan could result in no surprise to one familiar with the company.
The appellants contend that the liability of the income bonds might be cut down, since they were only payable in 1965; that they should be considered, at their discounted present value for the purpose of determining the question of insolvency at the time of filing the petition. The principal amount of twenty millions is increased yearly by the interest, and, although not currently payable except out of available net income, it will have increased by unpaid amounts at maturity. To argue that this should be discounted is to ignore the statute (section 63 of the Bankruptcy Act, as amended [11 U.S.C.A. § 103]) which provides for a "rebate of interest upon such [debts] as were not then payable and did not bear interest." However, the statute seems to force a discount of the accrued interest item of $13,000,000. By the terms of the ...