Appeals by holders of 4 3/4% subordinated debentures of W.T. Grant Co. from an order of the District Court for the Southern District of New York, Kevin Thomas Duffy, Judge, 20 B.R. 186 (1982), approving the proposal by Grant's bankruptcy trustee of a settlement between the debentureholders and the bankrupt estate.
Waterman, Friendly and Meskill, Circuit Judges.
These appeals arise from the mammoth bankruptcy proceedings of W.T. Grant Co. before Bankruptcy Judge Galgay in the Southern District of New York. Grant initially filed a petition for an arrangement under Chapter XI*fn1 on October 2, 1975, and was adjudged bankrupt on April 13, 1976. Secured suppliers, holders of senior debentures, bank creditors, general unsecured creditors, and holders of two issues of subordinated debentures filed claims against the bankrupt estate. The present appeals concern the last of a series of compromises and settlements*fn2 designed to avoid what would necessarily have been extremely protracted litigation with the various claimants. We shall assume familiarity with Judge Galgay's opinions and will endeavor to state only what is necessary to an understanding of these appeals.
The History of Grant's Financings
Prior to July, 1973, Grant, which operated a large chain of retail stores, generally satisfied its short-term cash needs by selling commercial paper through a wholly owned subsidiary, W.T. Grant Financial Corporation (Grant Financial); it had relatively small revocable lines of credit at several hundred banks.*fn3 In the spring of 1973 Grant determined that a portion of the commercial paper outstanding should be converted into long-term debt and approached Morgan Guaranty Trust Co. of New York (Morgan Guaranty) to structure a $100,000,000 five year term loan. On July 5, 1973, Morgan Guaranty arranged such a loan to Grant Financial from eight banks replacing an equivalent amount in their lines of credit to Grant. Among these banks were, in addition to Morgan Guaranty, Chase Manhattan Bank, N.A. (Chase), which was the trustee under an indenture under which $92,507,000 of Grant's 4 3/4% unsecured subordinated debentures issued April 15, 1971, were outstanding as of the date of filing under Chapter XI, and First National City Bank, now Citibank, N.A. (Citibank), which was trustee under an indenture under which $834,000 of Grant's 4% unsecured subordinated debentures issued June 1, 1965, were outstanding as of the date of filing under Chapter XI.
Grant's financial performance declined during 1973 and in December Moody's and Standard and Poor's lowered Grant Financial's commercial paper ratings from prime 1 to prime 2 and also downgraded Grant's long-term securities. Grant resorted to borrowing under its lines of credit. On March 5, 1974, Moody's withdrew Grant Financial's commercial paper rating and further downgraded Grant's long-term securities. Faced with the need to raise more than $132,000,000 in order to meet commercial paper maturities in the next week, Grant asked the eight banks to reestablish their lines of credit. They did this in proportion to their prior exposure, with the result that their loans and advances to Grant Financial shortly reached $415,000,000. Even this borrowing was not enough; in August, 1974, Morgan Guaranty, Chase and Citibank each advanced an additional $5,000,000 to Grant (Secured Demand Loans) secured by an assignment of certain accounts receivable. Later in August, 1974, Grant Financial, Grant as guarantor, and eleven bank lenders entered into an Interim Loan and Guaranty Agreement wherein Grant Financial became indebted to the eleven banks in the aggregate amount of $44,000,000 by assuming Grant's obligation to repay the $15,000,000 of Secured Demand Loans just described and incurring New Loans of $29,000,000, all such loans being guaranteed by Grant and secured under an Interim Security Agreement dated as of August 21, 1974, by accounts receivable arising out of the sale of goods at designated stores. This brought the total short-term and long-term loans from Grant's 12 major bank lenders to approximately $517,000,000.
The Interim Loan and Guaranty Agreement was shortly succeeded by a Loan and Guaranty Agreement dated as of September 16, 1974, which became effective October 8, 1974, less than a year before Grant filed under Chapter XI. The parties were Grant Financial, Grant as guarantor, and 143 banks. The maturity of all outstanding short-term unsecured loans and the $44,000,000 of secured loans under the Interim Agreement was extended through June 2, 1975, and the banks agreed to increase their loans to $600,000,000. The obligations of Grant Financial were to be guaranteed by Grant. An Initial Security agreement dated September 16, 1974, secured the $600,000,000 total of outstanding short-term loans and future commitments under the Loan and Guaranty Agreement and the $100,000,000 long-term notes issued under the Term Loan Agreement of July, 1973.*fn4 On the date when the Loan and Guaranty Agreement became effective, the banks advanced an additional $66,587,500, thereby reaching the $600,000,000 in loans due June 2, 1975, contemplated by the agreement, plus the $100,000,000 represented by the July, 1973, Term Loan Agreement. As of April 1, 1975, Grant, Grant Financial and Morgan Guaranty entered into a Loan Extension Agreement actually executed June 2, 1975, within four months of the filing of Grant's Chapter XI petition. This provided for paying off a debt of $56,931,665.59 to 116 banks whose individual loans to Grant ranged from $50,000 to $5,000,000 and the extension to March 31, 1976, of outstanding short-term loans in the principal amount of $540,916,978 made by the other banks.
Somewhat earlier Grant had been obliged, in order to induce its largest vendors and suppliers to continue providing it with credit, to enter into an Inventory Security Agreement dated as of May 15, 1975, wherein Grant gave a lien on designated store inventories to specified vendors and suppliers. Under the Loan and Guaranty Agreement, the bank claimants were to receive a lien on inventory junior to that of the suppliers and the senior debenture-holders.
The final transaction was an Amended Loan Extension Agreement entered into as of August 6, 1975, which became effective on September 15, 1975. This further extended the maturity of the $540,916,978 of short-term bank loans to July 30, 1976; subordinated $300,000,000 of that debt to certain trade obligations (the "Trade Subordination Agreement"); and subordinated Grant Financial's loans of $819,887,663 to the banks' total claim of $640,916,978 (the "Intercorporate Subordination Agreement").
The Proceedings in the Bankruptcy Court and the District Court
After Grant had been ordered into liquidation, the banks and Charles G. Rodman, as Trustee, asserted a multitude of claims against each other in an adversary proceeding, the details of which are described in Judge Galgay's opinion, 4 Bankr. Ct. Dec. at 601-02. The Trustee conducted an elaborate investigation into the affairs of Grant under Bankruptcy Rule 205(a). This encompassed production of the books, records and other documents of Grant, and examination of its remaining and former officers, directors and employees. Before any extensive discovery by the banks, settlement negotiations were instituted. These resulted in an agreement which, in addition to settling the claims of the banks, encompassed what Judge Galgay termed a "global settlement", i.e., a "framework for the further administration of the bankrupt estate and the satisfaction of claims filed against such estate." 4 Bankr. Ct. Dec. at 602. So far as here relevant, the settlement provided that the bank claimants were to receive an initial cash distribution of $165,700,000, or approximately 25% of their allowed claims. More was to be paid when and if funds became available. The Trustee agreed not to sue the 116 banks whose loans of $56,931,665.59 were paid in June, 1975. Finally, the agreement created a fund of $95,378,373, the full amount of the claims of subordinated debentureholders, pending resolution of their dispute with the bank claimants as to whether the subordination clauses of their indentures should be given effect so as to subordinate the debenture-holder's claims to the bank claims. The Bankruptcy Judge approved the banks' settlement on July 20, 1978, finding that "the Trustee will have achieved a result for the estate which approximates, and may exceed, the results which are likely to be achieved by the continued prosecution of his defenses in the Adversary Proceeding" which the bank claimants had initiated, 4 Bankr. Ct. Dec. at 609. There was no appeal of this "global settlement" to the district court.*fn5
Having thus provided the necessary framework, the Trustee, the bank claimants, United States Trust Company (U.S. Trust) as indenture trustee replacing Chase under the Indenture for the 4 3/4% Subordinated Debentures, and representatives of these debentureholders entered into negotiations for the settlement of the latter's claims. The rights of the debentureholders depended on the interpretation and application of a clause in their indentures subordinating their claims to "Senior Indebtedness" of Grant. The Indenture under which the 4 3/4% Debentures were issued defined this as stated in the margin;*fn6 the Indenture securing the small amount of outstanding 4% Debentures was to the same effect. If the bank claims were and remained enforceable as Senior Indebtedness to which the debentureholders were subordinated, the latter would receive nothing. However, U.S. Trust alleged that for a number of reasons the conduct of the banks might require the contractual subordination provisions be disregarded and even that the subordinated debentureholders be accorded a status prior to that of the banks.*fn7 These reasons, stated in detail in Judge Galgay's opinion approving the settlement, 4 B.R. at 60-61, were as follows:
(a) At the time of the Initial Security Agreement of September 16, 1974, the bank claimants knew or had reasonable cause to believe that Grant was insolvent and the granting of security interests would discourage further extensions of trade credit to Grant and substantially reduce the flow of merchandise into Grant stores, thereby impairing the prospects for a successful reorganization of Grant.
(b) By forcing Grant into the Inventory Security Agreement and Trade Subordination Agreement the bank claimants increased the amount of Senior Indebtedness to which ...