Appeal from District Court of the United States for the Southern District of New York.
Before L. HAND, AUGUSTUS N. HAND, and FRANK, Circuit Judges.
1. This case is here on appeal from a summary judgment, for the defendant, entered on the pleadings and affidavits. As a consequence some of the highly complicated facts are not entirely clear and the following statement of facts must be read with that in mind. Wherever in this opinion we refer to our conclusions "on the facts now before us" or use similar locutions, it is to be understood that we are not now making any findings, but are merely deciding that the issues of fact should be decided after the trial court hears the evidence on a trial.
Two brothers named Van Sweringen owned 80% of the stock of The Vaness Company (which we shall call Vaness). That company owned all the stock of a Delaware corporation, Van Sweringen Corporation (which we shall call the debtor), and it, in turn, owned all the stock of the Cleveland Terminals Building Company (which we shall call the subsidiary). The record is silent concerning the previous history of these parties, but tells us that on May 1, 1930 (some months after the stock market debacle of 1929) the debtor issued $30,000,000 of notes payable in five years, bearing interest at 6% per annum payable semi-annually. At the time of their issuance, these notes were sold to the public by a syndicate, including the Guaranty Company of New York, a wholly-owned subsidiary of the defendant, Guaranty Trust Company of New York.
The notes were issued under an instrument executed by the debtor and the defendant which described the instrument as a "Trust Indenture" and the defendant as "the trustee." The notes were not made a lien on any assets. The Indenture contained so-called "negative pldge" clauses of a more or less conventional kind. It provided that the debtor would acquire, simultaneously with the issuance of the notes, 500,000 shoares of the common stock of Alleghany Corporation which at that time had a market value of $15,000,000. Such shares, and any proceeds thereof, were called "segregated assets." The debtor agreed that, until at least $15,000,000 principal amount of the notes had been retired and cancelled, the debtor would not mortgage, pledge, sell, transfer or otherwise dispose of any of the segregated assets, "except for cash, to be applied by the debtor only for the following purposes: (a) To be held as cash; (b) to retire the notes by purchase or redemption, all notes so retired to be cancelled; (c) to purchase common stock of said Alleghany Corporation; (d) to purchase United States Government obligations; or (e) to purchase and hold uncancelled in its treasury any of the notes." The Indenture provided that, whenever the aggregate value of the "segregated assets" exceeded 50% of the principal amount of all notes outstanding, the amount of such excess should no longer be subject to such restrictions and might be used by the debtor for its general corporate purposes.
There then followed provisions about which it might be said that the present suit revolves: The Indenture stated that in accordance with an agreement simultaneously executed by the trustee and the Van Sweringen brothers,*fn1 they agreed that, whenever the value of the "segregated assets" became less than 50% of the principal amount of all notes then outstanding, the Van Sweringens would repair such deficiency by assigning and delivering to the debtor readily marketable securities in an amount sufficient at their then market value to equal the amount of such deficiency. Such securities were referred to as "assigned securities." For the "assigned securities" the debtor was to give the Van Sweringens a non-negotiable obligation which the Van Sweringens were to hold in trust for the benefit of the holders of outstanding notes to the extent that, in the event of a liquidation of the debtor and after full distribution to the holders of the notes, a deficiency in the full payment of the notes and accrued interest thereon might remain, the Van Sweringens would, to meet such deficiency, pay to the trustee for distribution to the noteholders all monies the Van Sweringens received in such liquidation on account of such non-negotiable obligation. Such "assigned securities" (subject to withdrawal provisions described below) were to be available to the creditors of the debtor for appliable to the creditors of the debtor's liabilities; as the defendant construes the instrument, those securities (until such withdrawal) were to be the property of the debtor. The instrument contained these unusual withdrawal provisions: When $15,000,000 of the notes were retired and cancelled, then all obligations of the Van Sweringens should terminate and they were to have the right to withdraw and to have reassigned and delivered to them by the debtor all "assigned securities," on the surrender to the debtor of any obligation theretofore issued to the Van Sweringens therefor. Also, at any time before the debor's liquidation, any excess in the "assigned securities" was to be withdrawable by the Van Sweringens.*fn1a
The Indenture described various "events of default," including, among others, a default in the payment of any installment of interest continuing for thirty days; a default in the provisions as to the "segregated assets" or in the negative pledge clauses; the appointment of a receiver of the debtor or of the major part of its property, or a judicial declaration that the debtor was bankrupt or insolvent. If any one or more of such events occurred, it was agreed that the trustee "may, and upon the written request of the holders of at least 25% in principal amount of the notes then outstanding, shall, declare the principal of all the notes then outstanding to be due and payable immediately, and upon any such declaration the same shall become and be due and payable immediately, anything in this Indenture or in the notes contained to the contrary notwithstanding." Upon such an acceleration of the maturity of the notes, the debtor was to pay to the trustee the amount due thereon. If it did not do so, then "the trustee, in its own name and as trustee of an express trust" was empowered to institute an action at law or in equity for the amounts thus due and unpaid, to obtain a judgment in such proceedings, and to enforce any such judgment against the debtor. All rights of action under the Indenture or under any of the notes could be enforced by the trustee without possession of the notes. In the event of any insolvency or bankruptcy of the debtor, the trustee was given power to execute and file proofs of debt on behalf of, and as agent of, the noteholders. The trustee was also given power to institute such proceedings as it might deem necessary or expedient "to prevent any impairment of its rights or the rights of the noteholders by any acts of the" debtor "or of others in violation of the Indenture * * * or deemed by the trustee necessary or expedient to preserve and protect its rights and the rights of the noteholders." No noteholder was to have any right to institute any action under the Indenture or for any remedy thereunder unless the holders of at least 25% of the face amount of the notes then outstanding should first have requested the trustee to act and the trustee, after a reasonable time, failed to do so. It was provided that the trustee should not be liable for anything in connection with the trust "except for its own wilful misconduct"; the Indenture contained other exculpatory clauses which we shall later discuss.
Not long after the issuance of the notes, because of a decline in the market price of Alleghany shares, the Van Sweringens delivered to the debtor, as "assigned securities," 400,000 shares of the Alleghany Corporation.
In October 1930, as the time approached for the payment of the first semi-annual installment on the debtor's notes, it faced serious difficulties. Neither the debtor nor its parent Vaness had funds available to pay that interest. Moreover, because of a further decline in the market value of the Alleghany stock, the value of the 900,000 Alleghany shares, constituting the "segregated assets" and "assigned securities," threatened to sink below $15,000,000, i.e., the requisite 50% of the notes. In order to meet those difficulties and also because of grave financial problems confronting Vaness and the debtor's subsidiary, a group of banks (which we shall call the lending banks) headed by J. P. Morgan & Company (which we shall call Morgan) made two loans, one of $16,000,000 to Vaness*fn1b and one of $23,500,000 to the debtor's subsidiary. The defendant, because of the interest of its subsidiary, Guaranty Company, as one of the important sellers of the debtor's notes, participated in these loans to the extent of $11,000,000. the loan to Vaness was secured by the pledge of various securities, including all the stock of the debtor i.e., 1,744,800 share. The loan to the debtor's subsidiary was secured by listed stocks owned by it, having a market value of $38,000,000. Part of the proceeds of the loan to Vaness was used by it to purchase $10,000,000 face amount of government bonds which were substituted for the 500,000 Alleghany shares, the "assigned securities," in this way: Vaness delivered those bonds to the Van Sweringens who delivered them as "assigned securities" to the debtor in exchange for the Alleghany stock.The Van Sweringens, in turn, delivered to Vaness the non-negotiable obligation of the debtor for $10,000,000. That obligation was pledged by Vaness to the banks which made the loan to it. $5,000,000 of the loan to the debtor's subsidiary was used to purchase government bonds which, by arrangements between the debtor and the subsidiary (not necessary to describe here) were substituted for the 400,000 Alleghany shares theretofore constituting the "segregated assets." As a result of this and other transactions, the debtor, in addition to $15,000,000 of "segregated assets" and "assigned securities" and all the stock of the subsidiary, also became the owner of an open account claim against the subsidiary in the amount of approximately $27,000,000. The November 1, 1930 interest on the notes was paid out of the proceeds of the loan to Vaness. The only debts of the debtor consisted of the $30,000,000 note issue, the subordinated obligation to the Van sweringens, and a contingent liability for a maximum of $4,000,000, as guarantor of an $8,000,000 secured first mortgage bond issue of the subsidiary.*fn2 As the record stands, on appeal from a summary judgment, there is no reason to believe that the debtor would ever have been called upon to pay anything on this guaranty.
During the summer of 1931, the debtor's outsanding notes fell in market value. The debtor, using part of the "segregated assets," purchased on the market some of those notes at fifty cents on the dollar and some at thirty cents on the dollar. By October 29, 1931, the debtor had thus purchased, for $1,815,057.89, notes in the face amount of $3,773,000. Had that process of buying in notes at fifty or less continued, the debtor, on acquiring $15,000,000 of such notes, would have caused them to be cancelled; thereupon the remaining "assigned securities," having a cash value of at least $7,500,000, could, under the unusual provision of the Indenture, be withdrawn by Vaness upon surrender to the debtor of its non-negotiable obligations.In that event the debtor and its creditors would lose any claim to that $7,500,000, i.e., there would be $7,500,000 less of assets available to the noteholders. The noteholders could then look only to the other assets of the debtor, which consisted of the shares of the debtor's subsidiary (which appear by that time to have become valueless) and the $27,000,000 open account claim against the subsidiary on which, so the trustee then apparently believed, the debtor would probably never recover a sufficient amount to pay more than a relatively small portion of the face of its notes. At the same time, the $7,500,000 withdrawn by Vaness, under the terms of its arrangements with the lending banks, would be paid to those banks on account of their loans to Vaness.
The defendant, the trustee, was fully aware of this situation. It also knew that another crisis was at hand. For it knew that the debtor had no funds with which to pay the third installment, due November 1, 1931, of interest on its notes; that the debtor's subsidiary could not supply those funds; that Vaness had no money or assets available for that purpose except $300,000 of excess value of "assigned securities"; and that $300,000 was insufficient to pay all the interest, which amounted to approximately $728,000.*fn3
The trustee canvassed the possibility of liquidation proceedings against the debtor, since such proceedings would stop the process of buying in notes and would prevent the withdrawal by Vaness of "assigned securities" after the reduction of the note issue to $15,000,000 which would result from such purchases if they continued. The affidavits, presented by defendant on its motion for summary judgment, of the officers of the defendant and of Guaranty Company, strongly indicate that the trustee then believed that it could, and that in fact it then could, compel the debtor's liquidation in November 1931, because of the inability of the debtor to pay the November 1 interest installment due on the notes.*fn3a For, if default should then occur, the trustee would have the power, under the Indenture, to accelerate the maturity of the notes, thereupon to obtain a judgment for approximately $27,000,000, and then, armed with that judgment, to cause the debtor's liquidation.
Moreover, because of the sharp drop in market value of the listed stocks owned by the subsidiary, and because of the serious reduction in the value of the subsidiary's other assets (consisting principally of mortgaged real estate), the investments of the debtor in the subsidiary (which constituted the debtor's only assets other than cash in the amount of about $13,444,000) had become so reduced in value that the debtor was probably insolvent, i.e., the amount of its liabilities probably exceeded the value of its assets. Under the Delaware statutes, a receiver of a Delaware corporation which is thus insolvent may be appointed in that state at the suit of an unsecured creditor having no judgment. It may, then, be true that the trustee could have procured the appointment of a receiver for the debtor.*fn3b After such appointment, the trustee, under the Indenture, could have accelerated the maturity of the notes, quite apart from any default in payment of interest.*fn3c
The trustee believed that liquidation proceedings, if then begun against the debtor, would almost surely precipitate insolvency proceedings against Vaness and the debtor's subsidiary. On the facts now before us, we cannot say that the trustee did not believe that such insolvency proceedings against the subsidiary would substantially reduce the recovery by the lending banks on their $23,500,000 loan to the subsidiary. That loan was secured only by the subsidiary's listed stocks which then had a market value of only approximately $8,200,000, leaving a definiency of more than $15,000,000. The trustee may have hoped that the market value of those listed stocks would rise to some extent so as to reduce that deficiency, and believed that, if receivership or bankruptcy of the subsidiary were then averted, its real estate would increase in value sufficiently to enable it to pay some of that deficiency and also to pay something substantial on its open account claim of $27,000,000 held by the debtor.
On the facts as they now appear, if liquidation proceedings against the debtor had been instituted in 1931, all the noteholders would have received from the cash on hand at least from 42.2% to 49% of the face of their notes. For the debtor then would have had available for distribution among its creditors approximately $13,444,000 of cash (or its equivalent) consisting of "segregated assets" and "assigned securities."*fn4 The debtor's liabilities (ignoring the subordinated obligation to the VanSweringens) consisted of outstanding notes, in the face amount of approximately $26,227,000, and the contingent obligation previously described. Assuming that no actual obligation would have accrued on the contingent liability, there would have been available on liquidation proceedings, before deducting expenses, sufficient to pay in cash more than 51% of the face of the notes. As the debt structure of the debtor was very simple, and as its assets other than cash and government bonds consisted solely of the stock of, and the open account claim against, its subsidiary, the expense of such a proceeding, we estimate, for present purposes, as not to exceed $590,000.*fn4a On that basis, the debtor's liquidation would have yielded all the noteholders at least 49% in cash. Even if we assume that the debtor would have been obliged to meet the $4,000,000 contingent liability in full, we estimate that the liquidation would have yielded, after expenses, about 42.2% in cash for all noteholders.*fn5
The trustee decided not to bring about the liquidation of the debtor. Instead, on or about October 29, 1931, the trustee, the debtor, Vaness, Morgan and the lending banks agreed upon a plan which we shall call the offer plan. Under this plan, all noteholders were paid the 3% interest on November 1, and were offered, in exchange for their notes, 50% of the face of the notes in cash and 20 shares of the debtor's stock for each $1,000 note.*fn5a The offer was to remain open until December 1, 1931.*fn5b On October 29, $26,227,000 face amount of notes were outstanding. By the terms of the offer plan, the first $11,227,000 of notes thus acquired were to be cancelled, thereby reducing the note issue to $15,000,000. Thereupon Vaness was to withdraw the remaining "assigned securities" consisting of about $7,500,000 of cash (or its equivalent) and those monies were to be used, so far as necessary, to acquire further notes from those who accepted the offer. Such notes, being purchased by Vaness, were not to be cancelled but were to remain outstanding, and to be delivered to the lending banks as additional collateral security for their loans. The $300,00 of excess "assigned securities" was to be applied towards payment of the November 1 interest on the notes; the balance of the money necessary for that interest payment (estimated as "approximately $500,000") was to be procured by a loan to the debtor by certain Cleveland banks. If, after the $11,227,000 notes were cancelled, any noteholder did not accept the offer, so that, as a result, some part of the $7,500,000 was not used to purchase notes, it was to be applied by Vaness first in payment of that loan by the Cleveland banks and then on account of the $1,280,000 interest then due on the loan of the lending banks, no other funds for the payment of that interest being available. If there were not a sufficient balance of the $7,500,000 to pay the Cleveland banks in full, then they were to be paid out of the first amounts realized by the landing banks on the debtor's uncancelled notes which the lending banks were to receive as collateral security under the plan. The lending banks agreed to release from their collateral so much of the stock of the debtor as might be necessary to carry out the terms of offers accepted by noteholders.
Those noteholders who accepted the offer would thus receive in cash 53%, i.e., 50% principal and 3% interest. Those who did not accept would receive merely the 3% interest in cash. Thus the offer plan gave accepting noteholders from 4% to 10.8%*fn6 more in cash than they would have received in liquidation, i.e., 42.2% to 49%. But nonacceptors, receiving in cash only 3% interest, were, under the offer-plan, denied from 39.2% to 46% of the amount of cash they would have received on liquidation. As to the principal of their notes, they were left merely with a right to participate - as part of a class of holders of $15,000,000 of notes - in whatever the debtor might subsequently realize on the open account claim against the subsidiary. In the next year, the nonaccepting noteholders received an additional 6% by way of interest. this payment reduced their loss so that, regarding solely their loss of participation in the cash assets, they lost from 33.2% to 40%.*fn6a
If all the noteholders had accepted the offer, the only advantages to them over and above the results of liquidation, if then caused by the trustee, would have been the saving of the expense of such liquidation (and perhaps the sharing in the $300,000 excess). But the disadvantage or avoiding liquidation to those who did not accept the offer would, so the trustee appears to have believed, be far greater. For the facts now before us strongly suggest that the trustee, while anticipating that, after the consummation of the offer-plan, there would be some recovery for the non-accepting noteholders, did not believe that such recovery, together with the interest they received, would amount to anything remotely approaching what they would have received on liquidation in 1931.
The trustee sent to the noteholders no information or advice concerning the offer plan. The written offer sent by the debtor to the noteholders was completely silent as to the existence of the loans by the lending banks, the participation of the defendant in such loans, the provision of the plan that those banks might receive part of the $7,500,000 and part of the uncancelled notes, the loan by the Cleveland banks and the arrangements for the payment of that loan, the fact that as an alternative to the offer plan the trustee could have caused liquidation of the debtor, or an estimate by the trustee of what such liquidation would have yielded.*fn7
As matters worked out, the holders of all but $1,213,000 face amount of notes accepted the offer. As a consequence, there were left outstanding $15,000,000 of notes, of which $13,784,000 were, under the offer plan, delivered to the lending banks as additional collateral security. Because holders of $1,213,000 of notes did not accept, there remained, out of the $7,500,000 withdrawn cash, the sum of $606,000,*fn8 i.e., the 50% which would have been paid to the non-accepting noteholders if they had accepted the offer.Of this amount, approximately $500,000 was, under the plan, payable and paid to the Cleveland banks. The lending banks, under the plan, were entitled to receive the balance of the $606,000 - i.e., $106,000 - to be applied on the interest on their loans. Morgan, on behalf of the lending banks, received that $106,000, but (for reasons not appearing in the record) allowed Vaness to expend it for other purposes.*fn9 Accordingly, the lending banks actually received $106,000 which apparently they could not possible have received had the trustee instituted liquidation proceedings against the debtor in 1931.
But the offer plan might have yielded the banks far more than $106,000. For, of course, no one knew when the offer was made, how many noteholders would not accept. Had the holders of, say, $3,500,000, failed to accept, them, out of the $7,500,000, of cash, there would have been left $1,750,000 of which (after paying the Cleveland banks) the lending banks would have received not $106,000 but $1,250,000.
Nor can we say that the trustee did not then believe that, in addition to participation in some part of the $7,500,000, the banks would receive other substantial advantages from the offer plan.*fn9a for, at the time when the offer was made, the lending banks, including the trustee, were apparently confident that, if liquidation proceedings against the debtor did not occur and thereby insolvency proceedings against the subsidiary were prevented, the debtor would subsequently realize (on its open account claim against the subsidiary) a substantial sum. That they anticipated that this realization would be at least $500,000 appears from the fact that the loan of the Cleveland bank could not be assured of payment unless that sum were thus realized since, if all the noteholders accepted the offer, the only source of payment of that loan would be such a realization of $500,000. The trustee knew that if a sufficient number of noteholders failed to accept, so that out of the $7,500,000 enough cash remained to pay off the Cleveland banks, then the lending banks would, as pledgees, become the holders of at least (approximately) $1,000,000 face amount of the $15,000,000 notes left outstanding and that any such anticipated realization of at least $500,000 would be paid, pro-rata, to the banks, as such holders of notes, and the non-accepting note-holders.*fn10 since the banks, as matters turned out, became the pledgee-holders of about 92% of those $15,000,000 of notes, it follows that, if the anticipated minimum of $500,000 had been realized, those banks would have received 92% of any such realization, or $460,000, while the non-accepting noteholders would have received merely $40,000, i.e., less than 4% of the face of their notes.
In fact, because of the subsequent difficulties of the subsidiary, nothing was thereafter paid on any of the outstanding notes except a payment of 6% interest in 1932. The non-accepting noteholders thus never received for their investment anything other than interest up to, and including, November 1, 1932, (i.e., interest ...