Elias v. Clarke

• Decision Date: 20 June 1944
• Docket Number: No. 312.,312.
• Citation: 143 F.2d 640
• Parties: ELIAS et al. v. CLARKE et al.
• Court: U.S. Court of Appeals — Second Circuit

143 F.2d 640 (1944)

ELIAS et al. v. CLARKE et al.

No. 312.

Circuit Court of Appeals, Second Circuit.

June 20, 1944.

Abraham Mitnovetz, of New York City, for claimants-appellants Elias, Menachen, and Moise.

Louis Boehm, of New York City (Boehm & Fischman, Geist & Netter, Netter & Netter, and Bernard D. Fischman, all of New York City, on the brief), for claimants-appellants Jones, Sutton, Van Kirk, and Perlman.

Samuel J. Silverman, of New York City (Stanley Clarke, Allen E. Throop, O. John Rogge, and William W. Golub, all of New York City, on the brief), for respondents-appellees Clarke and others.

Jack Lewis Kraus, II, of New York City (Harry B. Kurzrok, Kelsey, Waldrop & Spalding, H. Boardman Spalding, Breed, Abbott & Morgan, Lloyd V. Almirall, and William Roberts, all of New York City, on the brief), for respondents-appellees Associated Gas and Electric Company's Senior Creditors.

Before SWAN, AUGUSTUS N. HAND, and CLARK, Circuit Judges.

CLARK, Circuit Judge.

This appeal brings up for review an order of the district court in reorganization proceedings, classifying certain obligations of the debtor, Associated Gas and Electric Company, as junior in character to other obligations which are more than sufficient to exhaust the debtor's estate. The issue involves peculiarly interesting questions of priority and subordination of corporate bonds in that the district court has made a distinction between original holders and transferees of certain bonds and has subordinated the claims of transferees to an extent which it has not been prepared to go with respect to the claims made by original holders of the same bonds. For an understanding of this comparatively narrow issue a full exposition of the Company's towering and complicated financial structure is not necessary and, indeed, may be confusing. Hence we shall limit our discussion to the facts immediately pertinent. A more extensive statement of facts may be found in the opinion of the district court, In re Associated Gas & Electric Co., D.C.S.D.N.Y., 53 F.Supp. 107; and yet other facts appear in a later opinion of the district court, In re Associated Gas & Electric Co., D.C.S.D.N.Y., 53 F.Supp. 118, which deals with a plan for the compromise of other claims in issue below. As we shall see, only the fact of compromise, and not the details of its terms, is before us at this time.

The main problem herein arises because of a difference of view as to the legality of an option for conversion into preferred stock of the debtor's bonds known as Convertible Debenture Certificates (called by the parties herein, CDC's), of which $36,333,539 was publicly held on May 11, 1932. Appellants challenge the legality of this option because it was reserved to the Company, and not to the holders of the bonds; and they further challenge its attempted exercise here on the ground of nonfulfillment of certain conditions precedent, namely, that the Company should not be in default in the payment of dividends on its preferred stock and should not have transferred its assets to another corporation not assuming payment of the obligations.¹

On May 11, 1932, the debtor sent a letter to the registered holders of these bonds informing them that its directors had determined to exercise the privilege of conversion, and that the bonds were ipso facto converted into preferred stock on June 15, 1932. It then, however, went on to offer holders the privilege of taking in lieu of the stock "a newly authorized issue of convertible obligations * * * which contain provisions more favorable to the holders and are believed to be more desirable, until converted, than the stock into which your present holdings are now convertible." These new obligations were "Convertible Obligations, due 2002" (of two series, "A" and "B," together called COAB's by the parties), which, however, contained express provisions that they were subordinate to "all bonds, debentures and other indebtedness of the Company" and any successor to it, "except (1) the Obligations of this issue and (2) indebtedness or Obligations convertible at the option of the Company into stock of the Company of any class or subordinated by their terms to other indebtedness or obligations of the Company." No such subordination provisions appeared in the original CDC's. The COAB's were an already existing issue, and a considerable number of present holders of them — to a face value in excess of twenty millions — are not involved in this present dispute, which concerns only those who took these bonds in exchange for CDS's pursuant to the Company's offer.

This offer the Company repeated in several subsequent letters. Eventually, while a small amount of CDC's remained unconverted and a still smaller amount was converted into preferred stock, the offer was accepted by holders of bonds in excess of $30,000,000, of which now, as the parties estimate, about one-third in face value is still held by the original takers, while the balance is held by the transferees, who are represented herein by the appellants, the Elias Protective Committee. The Company paid interest upon these bonds at first, and then, in 1933, issued therefor certain unsubordinated scrip which is not involved here. Thereafter it paid no interest, but in 1936 and 1937, it resumed the issue of scrip for interest, which took two forms — Interest Bearing in multiples of $100 face amount and Non-Interest Bearing for fractions of $100 face value, called by the parties IB Scrip and NIB Scrip. This scrip, however, contained subordination provisions substantially identical to those of the COAB's themselves. Scrip so issued to an amount in excess of $10,000,000 was outstanding when the debtor filed its petition for reorganization January 10, 1940, and the holders thereof are represented by the second protective committee, who are appellants herein, the Jones Committee, and by one individual appellant, Murray Perlman.

Upon the initiation of the reorganization proceedings and when the time set by the court for presenting claims had expired, it appeared that not only were there various classes of security holders, but that objections were being offered as to their classification on a parity. Hence the court referred all these issues to Honorable Frederick E. Crane, former chief judge of the New York Court of Appeals, as special master to hear the evidence and to report his findings of fact and conclusions of law "as to the validity, priorities and proper division into classes of said claims." The learned special master held extensive hearings wherein the holders of the exchanged bonds and the scrip participated and presented their claims that the original conversion option was illegal and illegally exercised, that they thus had the right to rescind the transaction by which the new bonds were exchanged for the original bonds, notwithstanding the passage of time and the receipt of interest and scrip, and hence that they were entitled to be placed on an equality with holders of the unsubordinated CDC's. In addition, they asserted that the subordination provisions of their present holdings were ambiguous and illusory in character and were unenforceable.

In due course the master filed his report, together with his findings of fact and conclusions of law; and those are before us, so far as they concern the bonds here in dispute, and are most detailed and complete both with reference to the facts found and the conclusions of law reached. The master held that the conversion option of the CDC's was valid and legal, that it was validly and properly exercised, that the offer of bonds in substitution for preferred stock was made in good faith and without fraud, that the subordination provisions of the COAB's and the scrip were valid and enforceable, and hence that all the obligations here involved were subordinate to the debtor's senior obligations. In view of the amount of the latter, this conclusion meant that the holders of these securities, including these claimants, could not share in the estate and hence had no interest in any plan for reorganization of the debtor. The master indicated, however, a possibility of legal question as to his conclusions with reference to the claims made by original holders of COAB's taken in exchange for CDC's, but not as to the claims made by the transferees or the holders of the scrip.

This differentiation in legal vulnerability of the respective claims apparently suggested to the managers of the reorganization that when an extensive agreement for compromise of these and related proceedings was being negotiated, some offer should be made to the holders of the less doubtful claims. In any event, negotiations have resulted in a compromise which settles, among other things, the legal issues between this company and a corporation to which its assets were transferred, the Associated Gas and Electric Corporation, and provides for a plan of reorganization of the whole Associated Gas & Electric system. In that compromise the claims of the original holders of COAB's in exchange for CDC's — as well as of those who did not convert or who took preferred stock — were settled by their recognition to the extent of 40 per cent of their face value. As appears from the second of the two opinions of the district court cited above, the special master has now recommended acceptance of this compromise. Because of its existence, the trustee moved below herein to confirm only that part of the master's report which rejected the claims of the transferees and of the scrip holders; and the district court took that course in granting the motion. The court thus held in reserve the claims granted some recognition in the compromise with the obvious purpose of considering later and as a single matter the validity of the compromise and of the accompanying plan of reorganization.

The appellants herein, acting on behalf of the transferees and the scrip holders, attack the result below both in form and...