Consolidated Rock Products Co v. Du Bois Badgley v. Du Bois

Decision Date03 March 1941
Docket NumberNos. 400 and 444,s. 400 and 444
Citation85 L.Ed. 982,61 S.Ct. 675,312 U.S. 510
PartiesCONSOLIDATED ROCK PRODUCTS CO. et al. v. DU BOIS. BADGLEY et al. v. DU BOIS
CourtU.S. Supreme Court

[Syllabus from pages 510-513 intentionally omitted] Messrs. Paul R. Watkins and Dana Latham, both of Los Angeles, Cal., for petitioners in 400.

Messrs. Graham L. Sterling, Jr., Homer I. Mitchell, and John C. Macfarland, all of Los Angeles, Cal., for petitioners in 444.

Mr. Kenneth E. Grant, of Los Angeles, Cal., for respondent.

Francis Biddle, Sol. Gen., for Securities and Exchange Commission as amicus curiae, by special leave of Court.

Mr. Justice DOUGLAS delivered the opinion of the Court.

This case involves questions as to the fairness under § 77B of the Bankruptcy Act, 48 Stat. 912, 11 U.S.C.A. § 207, of a plan of reorganization for a parent corporation (Consolidated Rock Products Co.) and its two wholly owned subsidiaries1—Union Rock Co. and Consumers Rock and Gravel Co., Inc. The District Court confirmed the plan; the Circuit Court of Appeals reversed. In re Consolidated Rock Products Co., 9 Cir., 114 F.2d 102. We granted the petitions2 for certiorari because of the importance in the administration of the reorganization provisions of the Act of certain principles enunciated by the Circuit Court of Appeals.

The stock of Union and Consumers is held by Consolidated. Union has outstanding in the hands of the public3 $1,877,000 of 6% bonds secured by an indenture on its property, with accrued and unpaid interest4 thereon of $403,555—a total mortgage indebtedness of $2,280,555. Consumers has outstanding in the hands of the public5 $1,137,000 of 6% bonds secured by an indenture on its property, with accrued and unpaid interest6 thereon of $221,715—a total mortgage indebtedness of $1,358,715. Consolidated has outstanding 285,947 shares of no par value preferred stock7 and 397,455 shares of no par common stock.

The plan of reorganization calls for the formation of a new corporation to which will be transferred all of the assets of Consolidated, Union,8 and Consumers free of all claims.9 The securities of the new corporation are to be distributed as follows:

Union and Consumers bonds held by the public will be exchanged for income bonds10 and preferred stock11 of the new company. For 50 per cent of the principal amounts of their claims, those bondholders will receive income bonds secured by a mortgage on all of the property of the new company; for the balance they will receive an equal amount of par value preferred stock. Their claims to accrued interest are to be extinguished, no new securities being issued therefor. Thus Union bondholders for their claims of $2,280,555 will receive income bonds and preferred stock in the face amount of $1,877,000; Consumers bondholders for their claims of $1,358,715 will receive income bonds and preferred stock12 in the face amount of $1,137,000. Each share of new preferred stock will have a warrant for the purchase of two shares of new $2 par value common stock at prices ranging from $2 per share within six months of issuance, to $6 per share during the fifth year after issuance.

Preferred stockholders of Consolidated will receive one share of new common stock ($2 par value) for each share of old preferred or an aggregate of 285,947 shares of new common.

A warrant to purchase one share of new common for $1 within three months of issuance will be given to the common stockholders of Consolidated for each five shares of old common.13

The new preferred stock, to be received by the old bondholders, will elect four out of nine directors of the new company; the new common stock will elect the re- mainder.14 But on designated delinquencies in payment of interest on the new bonds, the old bondholders would be entitled to elect six of the nine directors.

The bonds of Union and Consumers held by Consolidated,15 the stock of those companies held by Conslidated, and the intercompany claims (discussed hereafter) will be cancelled.

In 1929 when Conslidated acquired control of these various properties, they were appraised in excess of $16,000,000 and it was estimated that their annual net earnings would be $500,000. In 1931 they were appraised by officers at about $4,400,000, 'exclusive of going concern, good will and current assets.' The District Court did not find specific values for the separate properties of Consolidated, Union, or Consumers, or for the properties of the enterprise as a unit. The average of the valuations (apparently based on physical factors) given by three witnesses16 at the hearing before the master were $2,202,733 for Union as against a mortgage indebtedness of $2,280,555; $1,151,033 for Consumers as against a mortgage indebtedness of $1,358,715. Relying on similar testimony, Consolidated argues that the value of its property, to be contributed to the new company, is over $1,359,000, or exclusive of an alleged good will of $500,000, $859,784. These estimated values somewhat conflict with the conslidated balance sheet (as at June 30, 1938) which shows assets of $3,723,738.15 and liabilities (exclusive of capital and surplus) of $4,253,224.41. More important, the earnings record of the enterprise casts grave doubts on the soundness of the estimated values. No dividends were ever paid on Consolidated's common stock; and except for five quarterly dividends in 1929 and 1931, none on its preferred stock. For the eight and a half years from april 1, 1929, to September 30, 1937, Consolidated had a loss of about $1,200,000 before bond interest but after depreciation and depletion. And except for the year 1929, Consolidated had no net operating profit, after bond interest and amortization, depreciation and depletion, in any year down to September 30, 1937.17 Yet on this record the District Court found that the present fair value of all the assets of the several companies, exclusive of good will and going concern value, was in excess of the total bonded indebtedness, plus accrued and unpaid interest. And it also found that such value, including good will and going concern value, was insufficient to pay the bonded indebtedness plus accrued and unpaid interest and the liquidation preferences and accrued dividends on Consolidated preferred stock. It further found that the present fair value of the assets admittedly subject to the trust indentures of Union and Consumers was insufficient to pay the face amount, plus accrued and unpaid interest of the respective bond issues. In spite of that finding, the District Court also found that 'it would be physically impossible to determine and segregate with any degree of accuracy or fairness properties which originally belonged to the companies separately'; that as a result of unified operation properties of every character 'have been commingled and are now in the main held by Consolidated without any way of ascertaining what part, if any thereof, belongs to each or any of the companies separately'; and that, as a consequence, an appraisal 'would be of such an indefinite and unsatisfactory nature as to produce further confusion.'

The unified operation which resulted in that commingling of assets was pursuant to an operating agreement which Consolidated caused its wholly owned subsidiaries18 to execute in 1929. Under that agreement the subsidiaries ceased all operating functions and the entire management, operation and financing of the business and properties of the subsidiaries were undertaken by Consolidated. The corporate existence of the subsidiaries, however, was maintained and certain separate accounts were kept. Under this agreement Consolidated undertook, inter alia, to pay the subsidiaries the amounts necessary for the interest and sinking fund provisions of the indentures and to credit their current accounts with items of depreciation, depletion, amortization and obsolescence.19 Upon termination of the agreement the properties were to be returned and a final settlement of accounts made, Consolidated meanwhile to retain all net revenues after its obligations thereunder to the subsidiaries had been met. It was specifically provided that the agreement was made for the benefit of the parties, not 'for the benefit of any third person.' Consolidated's books as at June 30, 1938, showed a net indebtedness under that agreement to Union and Consumers of somewhat over $5,000,000. That claim was cancelled by the plan of reorganization, no securities being issued to the creditors of the subsidiaries therefor. The District Court made no findings as respects the amount or validity of that intercompany claim; it summarily disposed of it by concluding that any liability under the operating agreement was 'not made for the benefit of any third parties and the bondholders are included in that category.'

We agree with the Circuit Court of Appeals that it was error to confirm this plan of reorganization.

I. On this record no determination of the fairness of any plan of reorganization could be made. Absent the requisite valuation data, the court was in no position to exercise the 'informed, independent judgment' (National Surety Co. v. Coriell, 289 U.S. 426, 436, 53 S.Ct. 678, 681, 682, 77 L.Ed. 1300, 88 A.L.R. 1231) which appraisal of the fairness of a plan of reorganization entails. Case v. Los Angeles Lumber Products Co., 308 U.S. 106, 60 S.Ct. 1, 84 L.Ed. 110. And see First National Bank v. Flershem, 290 U.S. 504, 525, 54 S.Ct. 298, 306, 78 L.Ed. 465, 90 A.L.R. 391. There are two aspects of that valuation problem.

In the first place, there must be a determination of what assets are subject to the payment of the respective claims. This obvious requirement was not met. The status of the Union and Consumers bondholders emphasizes its necessity and importance. According to the District Court the mortgaged assets are insufficient to pay the mortgage debt. There is no finding, however, as to the extent of the deficiency or the amount of unmortgaged...

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