The opinion of the court was delivered by: LEVET
On May 19, 1954, General Stores Corporation (hereinafter also called that debtor) in Chicago, Illinois, made and delivered its two promissory notes (attached to Secured Creditors' Exhibit F) to the secured creditors, Lewis J. Ruskin and Rexall Drug Company. The notes (originally totalling $ 2,065,000) provided for interest on principal at the rate of 4% per annum, and further provided that in case of an event of default as defined in the collateral agreement (Secured Creditors' Exhibit F) the total unpaid principal may be declared due and payable, in which event 6% interest was to accrue.
A collateral agreement by and between General Stores Corporation, said debtor, and Lewis J. Ruskin as trustee for the payees of the notes, which agreement was simultaneously entered into with the execution of the notes, provides, among other things, as follows:
'If any one of the following events of default (hereby defined and entitled 'event of default' or 'events of default') shall occur: * * * or if any proceedings before Control Date involving General or any subsidiary (other than Ford or Stineway) thereof or any successors thereto, and after Control Date involving General, Ford or Stineway or any subsidiary thereof or successors thereto, are commenced by or against such company under any bankruptcy, reorganization, arrangement, insolvency or readjustment of debt, dissolution or liquidation law or statute of the Federal Government or any state government * * *; then, in any such event, the holder or holders of any of the Notes then outstanding or the Trustee may, at their or his option, declare such Notes, to be, and thereupon such Notes shall become, forthwith, due and payable * * *.' Article VI, Section 1.
The notes covered the balance of the purchase price for all outstanding shares of stock of the Ford Hopkins Company. The debtor transferred to the collateral trustee, Lewis J. Ruskin, collateral, including all and the outstanding stock of the Ford Hopkins Company and of the Stineway Drug Company, with all voting rights thereof. This collateral was pledged to secure, among other sums, payment of the principal and interest on the aforesaid notes.
On October 18, 1954, the debtor General Stores Corporation, filed a petition for arrangement under Chapter XI of the Bankruptcy Act, 11 U.S.C.A. § 701 et seq.
After certain preliminary negotiations, none of which were formally reduced to writing, Lewis J. Ruskin as trustee under the said collateral agreement entered into a so-called 'standby agreement,' dated November 1, 1954, which is here set forth in full:
'General Stores Corporation
'For the purpose of allowing you an opportunity to effect an arrangement with your unsecured creditors in the proceedings instituted by you for an Arrangement under Chapter XI of the Bankruptcy Act, the undersigned Trustee under the Collateral Agreement dated May 19, 1954 agrees that provided and so long as no one or more of the following events (herein called 'events') occurs, to-wit: any action taken by you or anyone else to affect any of the rights of the Trustee or the Noteholders under the Collateral Agreement or the notes secured thereby, or you are adjudicated a bankrupt, or the pending Chapter XI proceedings is changed to Chapter X proceedings, or the principal payments on the notes secured by the Collateral Agreement payable November 1, 1954 and December 1, 1954, respectively, are not paid when due, the undersigned Trustee will not prior to July 18, 1955 foreclose the Trust Property held under the Collateral Agreement because of the institution by you of said proceedings for an Arrangement under Chapter XI of the Bankruptcy Act or your failure to pay in whole or in part interest payable on the notes secured by the Collateral Agreement on December 1, 1954 and January 1, 1955. Upon the occurrence prior to July 18, 1955 of any other event of default mentioned in Section 1 of Article VI of the Collateral Agreement or of any event herein mentioned this assurance not to foreclose shall thereupon terminate and be of no effect whatsoever.
'It is understood and agreed, and this assurance is accepted by you with the understanding that nothing herein contained shall affect or be deemed to affect any other rights or privileges of the Trustee or any rights whatsoever of the Noteholders or your obligations under the notes and Collateral Agreement.
'Very truly yours, '(Signed) Lewis J. Ruskin 'as Trustee under the Collateral Agreement by and between General Stores Corporation and Lewis J. Ruskin, dated May 19, 1954.'
Secured Creditors' Exhibit I.
On March 7, 1955, certain motions of Max Shlensky, a stockholder of General Stores, and the Securities and Exchange Commission were granted by Judge Dimock. D.C., 129 F.Supp. 801. The order, after denial of motion for reargument, provided:
'1. The motion by the Securities and Exchange Commission for leave to intervene in this proceeding for the purpose of moving to dismiss the debtor's petition herein, to deny confirmation of the proposed Chapter XI proceeding and to dismiss the arrangement herein, be and the same hereby is granted;
'2. The petition of General Stores Corporation for relief under Chapter XI of the Bankruptcy Act and the proceedings under Chapter XI, be and they hereby are dismissed unless on or before March 15, 1955, General Stores Corporation file an amended petition to comply with the requirements of Chapter X for the filing of a debtor's petition or unless on or before such date a creditors' petition under Chapter X be filed.'
On or about April 14, 1955, the Court of Appeals of the Second Circuit affirmed the said order of the District Court in an opinion reported at General Stores Corp. v. Shlensky, 222 F.2d 234.
Thereafter, certiorari was granted by the Supreme Court of the United States, 350 U.S. 809, 76 S. Ct. 65, 100 L. Ed. 550, and on or about March 26, 1956, the said order of the District Court and the said affirmance of the Court of Appeals of the Second Circuit was duly affirmed in an opinion reported at 350 U.S. 462, 76 S. Ct. 516, 100 L. Ed. 726.
On June 28, 1955, the 'standby agreement' of November 1, 1954, was, at the request of the debtor, extended for thirty days to and including August 16, 1955. The provisions of the letter granting this extension are as follows:
'The expiration date specified in my assurance not to foreclose is July 17, 1955.
'Per your request, I hereby extend this expiration date 30 days to and including August 16, 1955.
'It is understood that this letter is accepted by you with the understanding that nothing herein contained shall affect or be deemed to affect any other rights or privileges of the Trustee under the Collateral Agreement or any rights whatsoever of the Noteholders or your obligations under the notes and Collateral Agreement.' Secured Creditors' Exhibit L.
On August 17, 1955, Lewis J. Ruskin as trustee under the aforesaid collateral agreement and Lewis J. Ruskin individually and Rexall Drug Company, the payees of the notes, notified the debtor that they elected to declare the aforesaid notes to be 'forthwith due and payable because of an event of default occurring and existing under said collateral agreement by reason of the proceedings involving General Stores Corporation under Chapter XI of the Bankruptcy Act, as amended, of the United States, commenced by General Stores Corporation and pending to this date in the United States District Court for the Southern District of New York.' (150 F.Supp. 868). Secured Creditors' Exhibit J.
On October 28, 1955, Lewis J. Ruskin as said trustee under said collateral agreement further notified the debtor in writing, in part, as follows:
'You are further advised that the principal amount of the notes secured by the Collateral Agreement dated May 19, 1954, namely, $ 1,594,248.63 on the note payable to the order of Lewis J. Ruskin and $ 455,751.37 on the note payable to the order of Rexall Drug Company, are past due and payable. They bear interest in accordance with their provisions at the rate of 6% per annum from and after August 17, 1955, when the notes were declared due and payable, and as of September 30, 1955, the interest payable on the note payable to the order of Lewis J. Ruskin aggregated $ 73,464.54, and the interest payable on the note payable to the order of Rexall Drug Company aggregated $ 21,002.29. Demand is hereby made and renewed for the immediate payment to the undersigned Trustee for the benefit of the holders of said notes of the whole amounts owing on such notes for principal and interest.' Secured Creditors' Exhibit N.
On or about April 30, 1956, the debtor filed an amended petition in this court asking for reorganization under Chapter X, 11 U.S.C.A. § 501 et seq., and on May 1, 1956, the United States District Court for the Southern District of New York approved the amended petition and appointed Charles H. Griffiths trustee in the reorganization proceeding.
From the facts above set forth, it appears that the right of the secured creditors to foreclose is predicated upon (1) an alleged default by reason of the commencement by the said debtor of arrangement proceedings under Chapter XI of the Bankruptcy Act, filed as above stated on October 18, 1954 (no other default was claimed); and (2) a notice of acceleration given by the said secured creditors on August 17, 1955, based upon the commencement of the said proceedings under Chapter XI of the Bankruptcy Act.
The reorganization trustee and Richard Goodman, a stockholder and creditor, contend that the secured creditors are estopped to rely upon the commencement of the Chapter XI proceeding as an event of default by reason of certain acts of Lewis J. Ruskin and of Harry M. Ruskin, his attorney. While there is proof that the secured creditors acquiesced in, and may to some extent have been instrumental in, bringing about General Stores' original resort to this court, I have concluded that the proof in this regard is insufficient to establish estoppel against default or acceleration.
The evident intent of the collateral trustee, Lewis J. Ruskin, in signing the so-called 'standby agreement' of November 1, 1954 (Exhibit I) was to agree not to foreclose the trust property held under the collateral agreement prior to July 18, 1955. There is no indication that by this agreement the collateral trustee waived the default involved in filing the petition under Chapter XI of the Bankruptcy Act. The extension of this 'standby agreement' on June 28, 1955 (Exhibit L) to August 16, 1955, was of like character.
The 'standby agreement' and the extension thereof constituted, in my opinion, only an agreement by the collateral trustee to defer foreclosure. The fact that the collateral trustee gave no notice of foreclosure until April 13, 1956, does not constitute ground for concluding that default was waived. It may be that one of the reasons why the creditor delayed foreclosure related to the tax situation of General Stores Corporation. There was no requirement that the creditor seek to foreclose before April 1956, or at any other particular time.
The fact that an order had been entered on March 7, 1955, dismissing the petitioner under Chapter XI 'unless on or before March 15, 1955 General Stores Corporation file an amended petition to comply with the requirements of Chapter X * * *' is not, in my opinion, sufficient to erase the default created by the filing of the petition under Chapter XI. As above stated, the Court of Appeals upheld Judge Dimock's order and the United States Supreme Court affirmed. Later, the debtor filed an amended petition, this time under Chapter X rather than Chapter XI. The filing of such an amended petition is expressly authorized by Section 328 of the Bankruptcy Act, 11 U.S.C.A. § 728. No interpretation of the collateral agreement can be used to obliterate the effect of the filing of the petition under Chapter XI as an event of default. Consequently, I have concluded that the principal of the notes was validly accelerated and became overdue on August 17, 1955. (The amount of the principal indebtedness then was $ 2,050,000.) The fact that other defaults may have occurred subsequent to October 18, 1954, is immaterial.
The Secured Creditors' Claim for Interest
The two promissory notes held by the secured creditors provide for interest on principal at the rate of 4% per annum prior to any default by General Stores and prior to acceleration of the debt by the collateral trustee, but provide for interest at the rate of 6% per annum after default and acceleration.
The secured creditors claim interest at 4% to August 17, 1955, and at the rate of 6% per annum thereafter. On that date, the secured creditors notified General Stores of their election to accelerate the debt by virtue of the commencement of Chapter XI proceedings, an event of default under the collateral agreement. As already stated, I have concluded that the principal of the notes was validly accelerated and became overdue on August 17, 1955.
The estate of the debtor is here sufficient in estimated value (although neither sold nor liquidated) to pay all of its debts, including at least 4% interest, the security has been productive of income during reorganization (although no dividends have been declared or paid to the debtor during reorganization), and the value of the security exceeds the amount of the debt. Therefore, even under the interest rules applicable to straight bankruptcy cases, the secured creditors are reasonably entitled to interest at the non-accelerated rate of 4% per annum. See Sexton v. Dreyfus, 1911, 219 U.S. 339, 31 S. Ct. 256, 55 L. Ed. 244; Brown v. Leo, 2 Cir., 1929, 34 F.2d 127; In re Macomb Trailer Coach, Inc., 6 Cir., 1953, 200 F.2d 611; Castaner v. Mora, 1 Cir., 1956, 234 F.2d 710; In re Magnus Harmonica Corp., D.C.D.N.J.1958, 159 F.Supp. 778. The absolute priority rule is applicable to this portion of the secured creditors' interest claim. See Consolidated Rock Products Co. v. DuBois, 1941, 312 U.S. 510, 61 S. Ct. 675, 85 L. Ed. 982; Eddy v. Prudence Bonds Corporation, 2 Cir., 1947, 165 F.2d 157, certiorari denied Prudence Realization Corp. v. Eddy, 1948, 333 U.S. 845, 68 S. Ct. 664, 92 L. Ed. 1128.
However, there remains for determination the issue as to whether or not the secured creditors are entitled to interest at the accelerated rate of 6% per annum. Determination of this issue depends first upon whether this court has the equitable power to prevent the accrual of additional interest at the accelerated rate, and, second, upon whether the equities in this proceeding militate for or against the accrual of such additional interest.
The rule is now too clear for argument that a bankruptcy court is vested with broad equity powers and in a Chapter X proceeding is just as much a court of equity as its statutory and chancery antecedents. Vanston Bondholders Protective Committee v. Green, 1946, 329 U.S. 156, 165, 67 S. Ct. 237, 91 L. Ed. 162; In re Schafer's Bakeries, D.C.E.D.Mich. 1957, 155 F.Supp. 902, 913; see also Pepper v. Litton, 1939, 308 U.S. 295, 60 S. Ct. 238, 84 L. Ed. 281. In Vanston Bondholders Protective Committee v. Green, supra, the court in the exercise of its equitable powers denied the first mortgage bondholders' claim for interest on interest accruing after receivership.
The secured creditors have sought to distinguish the Vanston case from the instant proceeding on a number of grounds. For example, they contend in substance that the decision in the Vanston case is applicable only to interest on interest in the nature of a penalty and not to extra interest which constitutes liquidated damages for increased risk. They further argue that whether a contract provision is one for a penalty or for added compensation is determined by applicable state law.
In the Vanston case, Mr. Justice Black, speaking for the majority of the court, expressly noted that the extra interest covenant there involved might be deemed added compensation for the creditor or 'something like a penalty to induce prompt payment of simple interest.' 329 U.S. at page 166, 67 S. Ct. at page 242. However, he concluded that in either event equitable principles required a denial of the claim.
While the Vanston case involved a claim for interest on interest, the principles there enunciated are, in my opinion, applicable to a claim based upon a contractual provision for additional simple interest. The latter form of contractual provision may, and in the instant proceeding does, provide for a substantially larger return to the creditor than would a provision for interest on interest, and the need for equitable regulation is equally vital.
Equally without merit is the secured creditors' contention that the validity of their claim for additional interest is determined by state law. In this regard Mr. Justice Black stated:
'When and under what circumstances federal courts will allow interest on claims against debtors' estates being administered by them has long been decided by federal law. Cf. Board of Comm'rs of Jackson County v. United States, 308 U.S. 343, 60 S. Ct. 285, 84 L. Ed. 313; Royal Indemnity Co. v. United States, 313 U.S. 289, 61 S. Ct. 995, 85 L. Ed. 1361 * * *'. Vanston Bondholders Protective Committee v. Green, supra, 329 U.S. at page 163, 67 S.Ct at page 240.
The secured creditors seek to distinguish the Vanston case on the further ground that the default which there gave rise to the claim for extra interest resulted from the court's suspension of the debtor's obligation to pay an installment of interest when due, whereas in the instant proceeding the default resulted from the debtor's 'voluntary' act of filing a Chapter XI petition.
In the Vanston case, the court did not direct the receiver to pay the interest installment when due and thereby precipitated a default because 'the debtor could not pay.' 329 U.S. at page 159, 67 S. Ct. at page 238. In the instant proceeding, General Stores filed a petition in reorganization for essentially the same reason. To term the default in the Vanston case 'involuntary' and the default in the present proceeding 'voluntary' is to ignore substance for form. In both cases, the defaults arose out of the financial helplessness of the debtors and in each a need for equitable relief arose. Yet, under the distinction here urged by the secured creditors, this court would be powerless to provide equitable relief with respect to the accrual of extra interest during reorganization, where, by contractual provision, the very act of resorting to reorganization is made an event of default.
Considerations of fairness and justice clearly require that a bankruptcy court have the equitable power to disallow a claim for extra interest accruing during reorganization regardless of whether an event of default occurred before or after the commencement of reorganization proceedings and irrespective of whether or not the default resulted under court order.
In In re Schafer's Bakeries, D.C.E.D.Mich.1957, 155 F.Supp. 902, the corporate debtor obtained $ 87,500 from a creditor in return for two notes totalling $ 103,150, payable in 24 monthly installments commencing June 1, 1954. Each note provided for interest at the rate of 1 1/2% per month upon each installment payment from the due date thereof until paid. The debtor paid the first monthly installment due June 1, 1954, but defaulted on the second installment due July 1, 1954. The debtor commenced Chapter X proceedings on July 13, 1954. Though the creditor was ultimately paid the full face value of the notes, it, nevertheless, sought to recover interest at the rate of 1 1/2% per month on all defaulted installments from the due date of each installment until the same was paid. The court permitted a recovery of interest on the July 1, 1954, installment from that date until the filing of the reorganization petition. However, it disallowed the creditor's claim for interest during reorganization since the face amount of the notes already included substantial compensation to the creditor for the use of its money. In so holding the court stated:
'Since the amount of the notes in the sum of $ 103,150 has been paid in full, it is clear that Woodward has already received simple interest on these loans and has been well recompensed for the use of its money. Any further payment by the trustee under the prevailing circumstances, except interest on the second installment to July 13, 1954, heretofore allowed, would only constitute a penalty for the late payment of those portions of the overdue installments representing the principal sum loaned. * * *' (at page 914.)
In the Schafer's Bakeries case the court exercised its equitable power to disallow a claim for extra interest during reorganization even though the original event of default occurred prior to the filing of the Chapter X petition. The court not only refused to allow what it termed 'interest on overdue interest,' but also refused to allow 'interest on that part of each overdue installment that constitutes repayment of principal.' 155 F.Supp. at page 913.
In the Schafer's Bakeries case the debt apparently was not accelerated and the extra interest was sought only on those installments which actually became overdue. Here, the secured creditors seek additional interest on the entire unpaid balance of their loan. Their claim for extra interest is many times larger, and the need for the exercise of equitable control is, therefore, at least as great, if not proportionately greater, than was true in the Schafer's Bakeries case, supra.
The secured creditors argue that the equitable doctrine with respect to extra interest enunciated in the Vanston case, supra, is not appropriate where the contest is between the stockholders and a secured creditor, and the debtor is solvent. The following portion of the Vanston opinion is pertinent in this regard:
'It is manifest that the touchstone of each decision on allowance of interest in bankruptcy, receivership and reorganization has been a balance of equities between creditor and creditor or between creditors and the debtor. See Sexton v. Dreyfus, supra, 219 U.S. (339) at page 346, 31 S. Ct. (256) at page 258 * * *'. (Emphasis supplied.)329 U.S. 156, 165, 67 S. Ct. 241.
Under the amended plan of reorganization in the instant proceeding, the secured creditors' claim for extra interest, if allowed, would be paid by Richard Goodman, who, in turn, and in consideration therefor, would receive additional shares of stock in the reorganized corporation. The granting of the secured creditors' additional interest claim would thus result in an inflation of capital structure without any commensurate increase in the assets of the reorganized corporation. The condition thereby created and its detrimental effects upon the financial future of the reorganized corporation is of concern not only to the stockholders whose equity in General Stores would be proportionately decreased, but also to those creditors who elect to accept long-term notes of the ...