The opinion of the court was delivered by: RYAN
In this consolidated reorganization proceeding under Chapter X of the Bankruptcy Act, the trustees on behalf of General Economics Syndicate, Inc. ('Syndicate') have asserted a claim of $ 897,209. against General Economics Corporation ('Corporation'), the parent of this corporate complex, arising out of a breach of the parent's fiduciary obligations and fraudulent acts as the controlling stockholder.
After a full hearing on the facts, we found the claim to be substantiated and it was allowed in the amount of $ 853,081.31.
The trustees now assert that the claim should be satisfied to the extent that funds are available in a special account, arising out of the sale of Corporation's stock in Syndicate pursuant to the amended plan of reorganization for Syndicate, to the exclusion of all other creditors of Corporation. The trustees' position was supported by the Securities and Exchange Commission, the reorganized Syndicate and the Class 'A' stockholders of Syndicate who appeared at the hearing; opposition was asserted by the special counsel and one creditor who would have all creditors of Corporation share ratably in Corporation's assets.
Since the basic issue must be resolved by weighing the equities between Corporation, its stockholders and creditors, and Syndicate, its stockholders and creditors, the facts of the transactions in question must be examined.
Syndicate was incorporated in Delaware on February 5, 1962. Two of Syndicate's four directors were Leonard Axelrad and his brother Nelson Axelrad. The Axelrads were also two of the four directors of Corporation, its principal officers and majority stockholders.
Leonard Axelrad testified that he was the moving spirit who initiated the whole transaction.
Syndicate issued 548,800 shares of Class 'B' common stock for 19 cents per share, and sold to the public 206,249 shares of Class 'A' common stock for $ 10. per share. Of the Class 'B' stock, 500,000 shares were sold to Corporation for a total consideration of $ 95,000., and the balance were sold to various insiders who assisted in the promotion of the corporate complex.
Syndicate sold its Class 'A' stock to the public under a Prospectus dated September 6, 1962 which stated that the proceeds of the public sale would be used to found two life insurance companies, one in New York and one in California, which would become wholly owned subsidiaries of Syndicate. The prospectus specifically asserted that Syndicate 'has no present intention of engaging in any activity not connected with the insurance industry.'
The public offering was completed on October 30, 1962 and on that date Syndicate received and deposited in its bank account the net proceeds amounting to $ 1,780,000. On the very next day, October 31, 1962, Leonard Axelrad signed a check on Syndicate payable to Corporation in the sum of $ 500,000. At that time Corporation had liquid assets of only $ 2,567.75. Thereafter, between November 26, 1962 and December 3, 1962, by four additional checks all signed by Leonard Axelrad, $ 200,000. more was transferred from the account of Syndicate to Corporation. Nothing in the prospectus, or in Syndicate's minute book, authorized these transfers, which totalled $ 700,000.
Corporation repaid a total of $ 150,000. so that $ 550,000. of the funds received from the public offering of Syndicate stock remained with Corporation. Corporation wiped out this debt by transferring to Syndicate all the capital stock of Life Capital Inc.,
then a wholly owned subsidiary of Corporation. Corporation caused Syndicate, on the transfer of Life Capital, to forgive the debt of $ 550,000., and further caused Syndicate to assume debts of Life Capital amounting to an additional $ 150,000. Leonard Axelrad testified that this transaction was his brainchild, and that he had 'arbitrarily' fixed the price -- which just happened to equal Corporation's debt to Syndicate.
At the time of the transfer, Life Capital's liabilities exceeded its assets, and it had operated at a loss in the nine months of its existence. At a Syndicate stockholder's meeting called to ratify this transaction, the true financial status of Life Capital was not revealed, nor was the fact that the payment for the Life Capital stock was to be the bookkeeping entry to wipe out the unauthorized advances already taken by Corporation.
Additional material facts were concealed or misstated. The vote of approval was controlled by the 500,000 shares of Class 'B' stock which was owned by Corporation. Thus Corporation, whose majority stockholder 'arbitrarily' fixed the price, controlled the vote of Syndicate to ratify the transaction.
We found that (1) the transfer of Lie Capital was inadequate consideration for Syndicate's forgiveness of Corporation's debt, (2) Corporation breached its fiduciary duty to Syndicate in the transfer of Life Capital, and (3) Syndicate's damage by reason of the breach of fiduciary duty equals the claim as allowed in the amount of $ 853,081.31.
The fiduciary duty Corporation, as majority and controlling stockholder, owed to Syndicate has long been recognized, and firmly enforced. Southern Pacific Co. v. Bogert, 250 U.S. 483, 39 S. Ct. 533, 63 L. Ed. 1099 (1919); Pepper v. Litton, 308 U.S. 295, 60 S. Ct. 238, 84 L. Ed. 281 (1939). In Pepper v. Litton, the Supreme Court not only spelled out the trust nature of the majority stockholder's obligation, but also established the rule that the bankruptcy trustee has the right to enforce the same. Thus the Court ruled:
'A director is a fiduciary. Twin-Lick Oil Co. v. Marbury, 91 U.S. 587, 588, 23 L. Ed. 328. So is a dominant or controlling stockholder or group of stockholders. Southern Pacific Company v. Bogert, 250 U.S. 433, 492, 39 S. Ct. 533, 537, 63 L. Ed. 1099. Their powers are powers in trust. See Jackson v. Ludeling, 21 Wall. 616, 624, 22 L. Ed. 492. Their dealings with the corporation are subjected to rigorous scrutiny and where any of their contracts or engagements with the corporation is challenged the burden is on the director or stockholder not only to prove the good faith of the transaction but also to show its inherent fairness from the viewpoint of the corporation and those interested therein. Geddes v. Anaconda Copper Mining Company, 254 U.S. 590, 599, 41 S. Ct. 209, 212, 65 L. Ed. 425. * * * While normally that fiduciary obligation is enforceable directly by the corporation, or through a stockholder's derivative action, it is, in the event of bankruptcy of the corporation, enforceable by the trustee.' 308 U.S. at pgs. 306-307, 60 S. Ct. at pg. 245.
The breach of the duty owed by Corporation to Syndicate is manifest from the grossly excessive price 'arbitrarily' fixed for the Life Capital transfer, the unauthorized transfers of hundreds of thousands of dollars out of the funds received from the public offering of Syndicate stock, the interlocking boards of directors of the two companies, both firmly under Axelrad's control, the improper, inadequate and misleading disclosures at the stockholder's meeting, and the personal benefits derived by the Axelrads by virtue of their majority interests in Corporation. All this was accomplished at the expense of Syndicate and its Class 'A' stockholders.
In the amended plan of reorganization for Syndicate, which has been approved by the parties affected and confirmed by the Court, the trustees on behalf of Corporation sold the 500,000 shares of Syndicate Class 'B' stock for a price of $ 200,000.