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In re Stirling Homex Corp.

decided: November 22, 1978.


Appeal from two orders of the United States District Court for the Western District of New York, Harold P. Burke, Judge, sitting as a Chapter X bankruptcy court. The first order confirmed an earlier order continuing Chapter X proceedings and directing the trustee to submit a plan of orderly liquidation. The second order denied priority to the State's tax claim and modified certain findings of the bankruptcy judge with respect to the amount of that claim. The first order is affirmed. The second order is affirmed insofar as it grants the State's claim subject to interest from May 10, 1973, on a franchise tax refund due the debtor and reversed insofar as it denies priority to the State's claim, denies the State's setoff of the refund against the tax claim, and modifies the bankruptcy judge's findings with respect to the amount due for the first and second tax periods.

Before Oakes, Gurfein and Meskill, Circuit Judges.

Author: Oakes

It has been said that "reorganizations under Chapter X . . . involve some of the law's most difficult problems of analysis, adjustment of rights, and litigation."*fn1 The present consolidated appeal is no exception. Here the State of New York appeals from two orders of the United States District Court for the Western District of New York sitting as a bankruptcy court in Chapter X reorganization proceedings involving Stirling Homex Corp., the consolidated debtor (hereinafter Stirling Homex). The first of these orders denied the State's application to reopen and reargue a previous order which, although it found the debtor to be insolvent, continued Chapter X proceedings and directed the trustee to submit a plan of orderly liquidation.*fn2 The State also appeals from a second order, which, inter alia, denied priority to the State's claim for sales and use taxes. Although Section 64 of the Bankruptcy Act, granting priority to state tax claims, is inapplicable to Chapter X proceedings by virtue of Section 102 of the Act, the State argues that its claim should receive priority in the course of liquidation under Chapter X. We affirm the first order and therefore permit the debtor to liquidate in Chapter X rather than require it to proceed in ordinary bankruptcy. We affirm in part the second order insofar as it grants the State's claim and requires it to pay interest on a franchise tax refund due the debtor; but we reverse by directing that the State's claim for sales and use taxes be granted a priority as a matter of equity, and we reverse so much of the second order as overturns the bankruptcy judge's findings as to the amount of the State's claim.


On June 13, 1977, the court found that Stirling Homex was insolvent and that the stockholders had no equity and hence were not entitled to share in the assets or to vote on the plan of reorganization. The court further directed that Stirling Homex, in active reorganization under Chapter X since July 12, 1972, "continue in reorganization under Chapter X to enable the trustee to prepare and submit a plan in the nature of an orderly liquidation of the remaining assets of the consolidated debtor." No appeal was taken from the order of June 13, 1977. The State, which was not served with a copy of that order, upon discovery of it moved to reopen and reargue.*fn3 The State contends that as a matter of law the Chapter X petition should be dismissed, pointing to the trustee's statement (confirmed as a finding by the court) that the debtor was "hopelessly insolvent" and the further statement that it was "not feasible to formulate a Plan of Reorganization for the continued operation of the consolidated debtor, but that the Plan . . . should be the liquidation of the assets . . . and the distribution of the proceeds to the creditors." While the jurisdictional basis of this appeal is somewhat complex, See note 2 Supra, and could have been more fully briefed by the parties, we are satisfied that the question of law on the merits has been sufficiently raised that we may pass upon it.

The State relies on Fidelity Assurance Association v. Sims, 318 U.S. 608, 63 S. Ct. 807, 87 L. Ed. 1032 (1943), where the question was whether federal courts should retain jurisdiction of a newly filed Chapter X petition or dismiss it at the outset, and the Court held that the petition was not filed in good faith because liquidation, and not a readjustment of the rights of creditors, was from the very outset the only anticipated outcome. But the present case is clearly distinguishable. Here concededly the petition was initially filed in good faith with reasonable prospects for reorganization, and no appeal was taken from the order permitting Chapter X proceedings to commence.

The State's position that reorganization proceedings should be terminated if they culminate in a liquidation is not without support. In dictum, Fidelity Assurance Association suggests that the statute "does not contemplate a liquidation in a Chapter X proceeding but a liquidation in ordinary bankruptcy or a dismissal outright." 318 U.S. at 621, 63 S. Ct. at 813. And decisions of the Tenth Circuit seem to stand for the proposition that absent a reorganization plan that will permit the corporation to continue in business, straight bankruptcy should prevail and the reorganization proceedings must be terminated. Claybrook Drilling Co. v. Divanco, Inc., 336 F.2d 697, 701 (10th Cir. 1964); In re Colorado Trust Deed Funds, Inc., 311 F.2d 288, 290 (10th Cir. 1962); See also In re Public Leasing Corp., 488 F.2d 1369, 1373-74 (10th Cir. 1973). But the rule in our circuit is plainly different. In the principal case, Patent Cereals v. Flynn, 149 F.2d 711 (2d Cir. 1945), the district court approved the sale of the debtor's physical assets under Chapter X, but when confronted with a reorganization plan to sell the remaining assets the court dismissed the Chapter X proceeding for lack of jurisdiction and directed that ordinary bankruptcy proceedings be pursued. The court of appeals, per Augustus N. Hand, J., reversed, rejecting the view that a sale of the debtor's property must be treated as a liquidation in bankruptcy. Even if such a sale precedes the reorganization plan, dismissal is not required. "Where the petition for reorganization has been filed in good faith" and "the plan finally proposed is fair and equitable it ought not to be necessary to dismiss the proceeding and proceed with straight bankruptcy." 149 F.2d at 712. See In re Sire Plan, Inc., 332 F.2d 497, 499 (2d Cir.), Cert. denied, 379 U.S. 909, 85 S. Ct. 206, 13 L. Ed. 2d 181 (1964); In re Pure Penn Petroleum Co., 188 F.2d 851, 854 (2d Cir. 1951) (dictum); Country Life Apartments, Inc. v. Buckley, 145 F.2d 935, 938 (2d Cir. 1944); In re Central Funding Corp., 75 F.2d 256, 259 (2d Cir. 1935); 6 Collier on Bankruptcy P 0.11, at 117 & n.2, P 3.27(2), at 630 & n.18, P 6.09, at 1072 & n.31 (14th ed. 1978); 6A Id. P 10.02, at 12-14 & n.28 (14th ed. 1977). See also In re Porto Rican American Tobacco Co., 112 F.2d 655, 657 (2d Cir. 1940) (per curiam).

Moreover, since in the present case the sale of the debtor's assets will occur as part of an approved reorganization plan, and not, as in Patent Cereals, prior to the plan's approval, an orderly liquidation under Chapter X is even easier to justify. Such a liquidation falls squarely within Section 216(10), which provides that a reorganization plan may include "the sale of all or any part of (the debtor's) property . . . at not less than a fair upset price and the distribution of all or any assets, or the proceeds derived from the sale thereof, among those having an interest therein." See Country Life Apartments, supra, 145 F.2d at 938. The above cited authorities also make it plain that in our circuit Fidelity Assurance Association does not go beyond requiring dismissal of a Chapter X petition if it is not filed in good faith. "Here when the petition was filed it did not appear that the debtor had no chance for reorganization or that reorganization would not be a reasonable method of serving the best interests of creditors and stockholders." Country Life Apartments, supra, 145 F.2d at 938.

Of course, the Second Circuit rule is of value to creditors because (among other reasons) the upset sales technique of Chapter X permits the avoidance of forced liquidation sales.*fn4 Our position appears to be supported by the wealth of judicial and textual authority.*fn5 We see no reason to change our rule, even if we could do so. There is no doubt that the rule applies to this case. In the district court's order of July 13, 1972, at Paragraph 4, it specifically found that the petition was filed in good faith, a finding which was not appealed. Moreover, it affirmatively appears that the trustee continued the business of the debtor in selling housing modules and endeavored to continue the debtor as a viable operation; only after a lapse of some time did the trustee conclude, based on his experience, that the debtor was hopelessly insolvent and orderly liquidation was required.

The State's purported distinction of some of the Second Circuit cases does not diminish their cumulative force: once a Chapter X reorganization has commenced in good faith, a later decision to liquidate by no means requires discontinuance of the petition and the added administrative and other expense that a newly commenced bankruptcy proceeding would entail. See Patent Cereals, supra, 149 F.2d at 713-14.*fn6

Because the district judge properly followed the law of this circuit in directing the continuance of Chapter X proceedings, his orders thereon are affirmed in all respects.


A. Facts. Stirling Homex, as this record and previous appeals in this court*fn7 disclose, was a manufacturer and seller of modular homes and residential units, operating with a number of subsidiary corporations including United States Shelter Corp., United States Home Management Service, Inc., Progressive Housing Corp., Clay Development Corp., Kabeth Properties, Inc., and, significantly here, Stirling Brothers, Inc. ("Brothers") and Stirling Cubet Corp. ("Cubet"). On January 21, 1970, the New York State Tax Commission issued a notice of determination that Stirling Homex owed sales and use taxes for the following periods and in the following amounts:

1. Period One: March 1, 1968, to July 31, 1968, $79,996.65 allegedly owing by virtue of a bulk transfer of the assets of Cubet to ...

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