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Brooklyn Trust Co. v. Kelby

February 16, 1943

BROOKLYN TRUST CO.
v.
KELBY ET AL.; IN RE PRUDENCE BONDS CORPORATION.



Appeal from the District Court of the United States for the Eastern District of New York; Robert A. Inch, Judge.

Author: Frank

Before SWAN, AUGUSTUS N. HAND, and FRANK, Circuit Judges.

FRANK, Circuit Judge.

Brooklyn Trust Company (which we shall call Brooklyn) brought suit in the New York Superme Court against the President and Directors of the Manhattan Company (which we shall call Manhattan), also joining as defendants a New York company (resulting from the reorganization under Bankr. Act § 77B, 11 U.S.C.A. § 207 of Prudence-Bonds Corporation, which we shall call the debtor) and two holders of bonds of the debtor. The United States District Court for the Eastern District of New York, sitting in the bankruptcy reorganization proceeding of the debtor, entered an order restraining, temporarily, the prosecution or defense of that suit. Brooklyn appeals from that order.

1. This appeal is a chapter of a reorganization proceeding, begun some nine years ago, which has given rise to many earlier appeals. For an understanding of the present appeal, it is necessary to recite a portion of the complicated story.*fn1

The debtor, over a period of some fourteen years, sold throughout the country and abroad, great numbers of its bonds, divided into eighteen separate "series," the bonds in each series being secured by separate "pools" of mortgages title to which was held by divers corporate trustees under separate trust agreements, one for each series. Each trust agreement reserved to the debtor the power to withdraw mortgages from the "pool" upon substituting other securities of equal value. The debtor, becoming financially embarrassed, filed a petition for reorganization under § 77B of the Bankruptcy Act in June, 1934. There ensued many decisions relating to the rights of the bondholders and the corporate trustees.*fn2

In 1938, the bankruptcy court entered an order approving separate plans for each of the "series" of bonds and a "general" plan for the debtor, the court having found that there was no "equity" for the debtor's general creditors or stockholders. Under the "general" plan, a new company was to be created; its stock was to be placed in a voting trust, all the voting trust certificates to be distributed pro rata among the bondholders; the debtor and trustees in bankruptcy of the debtor were to transfer all their interests to this new company, which was to become liable on all the bonds. Under each of the separate plans for the several "series," a separate supplemental trust agreement was to be made; each of the corporate trustees (which we shall call the old trustees) was to transfer the securities held by it to a new or successor corporate trustee. The order approving these reorganization plans reserved in the court jurisdiction to "give such further authorizations and directions as may be necessary in order to make effective, consummate and carry out, this order, the * * * plans of reorganization, and generally to determine any and all matters pertaining to these proceedings or to said * * * plans of reorganization and not determined heretofore or by this order." This order, in its entirety, was, on appeal, affirmed by this court; In re Prudence Bonds Corp., 2 Cir., 79 F.2d 205.

2. The bankruptcy court, as part of the proceedings to make effective and carry out the plans, then made an order which approved the form of the supplemental trust agreements; authorized and directed the debtor and its trustees in bankruptcy to assign all their right, title and interest in the collateral in the trust funds to the new company; authorized and directed the old corporate trustees to deliver their respective trust funds to the new corporate trustee under the supplemental trust agreements; designated a particular trust company as the new corporate trustee; and "authorized and directed" each of the old corporate trustees to file "in this proceeding" an account of its acts as trustee and to make application to the bankruptcy court for the judicial settlement of those accounts so that, after a hearing, such accounts should be "settled herein," the order expressly providing that the "authorization and direction to account * * * " should "not be prejudiced" by the fact that the old trustees were directed to turn the trust funds over to the new trustee "in advance of such accounting."

None of the old corporate trustees ever objected to the order to account.*fn3 On the contrary, each of them, during the months of august and September, 1938, filed in the bankruptcy proceeding a purported accounting of its conduct as trustee from the inception of its trusteeship up to and subsequent to the date of the bankruptcy proceedings; and each old trustee also then filed a petition praying that the court judicially settle its account, releasing and discharging it from all responsibility as trustee, after a hearing given to all persons interested in the estate of the debtor, and for an order perpetually enjoining "all persons, firms and corporations from instituting or prosecuting or continuing the prosecution" of any suits including all suits then pending with respect to the trust agreements "or with respect to any matters contained in said accounts." Pursuant to these petitions, the court entered orders that objections to such accounts be filed on or before a fixed date, and that hearings be held on subsequent named dates at which all parties to and intervenors in the bankruptcy proceedings, all creditors and stockholders of the debtor, and all other persons interested in the debtor's estate, should show cause why the orders sought by the old trustees should not be made.Such notices were then given.*fn4

3. As the new corporate trustee, City Bank Farmers Trust Company, designated by the court was a trust company which had itself been an "old trustee" for some of the series, each of the supplemental trust agreements provided, at the instance of that trust company, that the new corporate trustee should "not be required to institute any actions, legal or equitable, against any of its predecessors as trustees under the original trust agreement." That clause was, of course, not intended to release the old corporate trustees from any such claims; provisions of each of the supplemental trust agreements and of the court's order show that any such claims against the old trustees which, except for that clause, the successor trustee would have been obliged to pursue, were vested - derivativelY and for the benefit of the respective trust funds - either in the new company or the bondholders.*fn5

When, in May 1938, the debtor and its trustees in bankruptcy, pursuant to the court's order, transferred all their interests in the trust funds to the new company, neither the new company nor the trustees in bankruptcy nor the court were aware of any wrongful acts on the part of the old corporate trustees. Subsequently, the new company and the debtor's trustees in bankruptcy asked the court for an extension of time in which to file objections to the accounts of the old corporate trustees, advising the court that they had just learned of facts which indicated that each of the old corporate trustees had, from time to time, negligently permitted the debtor, in the years before the bankruptcy, to withdraw collateral from the trust funds in violation of the trust agreements, without substitution of new securities of equal value, thereby depleting, as to each trust, the trust fund or res.

Some of the old trustees (all of whom had theretofore been eager for a complete adjudication, in the bankruptcy proceedings, of their respective liabilities) now shifted their position and questioned the court's jurisdiction with respect to such alleged misconduct; others of those old trustees, however, took a different view. The court held that it had no jurisdiction in so far as the claims against the old corporate trustees arose out of improper conduct prior to the bankruptcy in which the debtor had participated, and entered an order to that effect. One of the old corporate trustees was dissatisfied with that limitation and appealed to this court from that order; all the other old trustees (including Brooklyn, as old trustee for the Eighth Series, and Manhattan, as old trustee for the Fifth Series) joined in the appeal either as appellants or appellees.*fn6 On that appeal, it was urged in support of the order that the claims against the old corporate trustee of which the lower court had refused to take jurisdiction were the personal claims of individual bondholders and were no part of any assets with which the bankruptcy court could concern itself, especially as the debtor itself had participated in the wrongs which gave rise to those claims and was so hopelessly insolvent that it had no "equity" in any property. In Central Hanover Bank & Trust Company v. President, etc., of Manhattan Company, 2 Cir., 105 F.2d 130, this court reversed the order. Our opinion (per L. Hand, J.) held that the bankruptcy court had jurisdiction on the following grounds: A reorganization plan under § 77B may deal with property securing the debtor's obligations even if, for any reason, the debtor no longer has an interest in such property; accordingly the court had jurisdiction of any assets which were part of the trust funds securing the debtor's bonds; the claims against the old corporate trustees did not run to the bondholders individually but were for restoration of the trust funds and were thus parts of those funds; consequently the bankruptcy court had jurisdiction of those claims.

4. On the coming down of the mandate, the bankruptcy court, on July 12, 1939, entered an order decreeing that "to make effective, consummate and carry out the plans," it took "full and exclusive jurisdiction" of all the claims against the old corporate trustee, of which it had previously denied jurisdiction. The order provided that any such claims against those old trustees respectively (described as "objections" to the accounts filed by those trustees) made by the new company or the trustees in bankruptcy would be deemed to be made on behalf of the bondholders for restoration of the respective trust funds; it authorized bondholders to join in such claims; it continued its earlier order staying all suits in other courts by bondholders against the former trustees; and it referred the claims for hearing to a special master.

To the several accounts of the old trustees, objections were then filed by the new company, the debtor's trustees in bankruptcy and certain of the bondholders. When these objections came on to be heard by the special master, each of the old trustees asserted that it was not a trustee but merely a depositary;*fn7 that the asserted claims, if any, belonged exclusively to the bondholders individually and were not for restoration of the respective trust funds; that those individual claims belonged only to those persons who had been bondholders at the times when the alleged wrongs were committed;*fn7a and that, in any event, they were barred by the ...


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