Securities and Exchange Com'n v. Crumpton Builders, Inc.

Decision Date21 October 1964
Docket NumberNo. 20712.,20712.
PartiesSECURITIES AND EXCHANGE COMMISSION, Appellant, v. CRUMPTON BUILDERS, INC., et al., Appellees.
CourtU.S. Court of Appeals — Fifth Circuit

David Ferber, Atty., SEC, Philip A. Loomis, Jr., Dolph B. H. Simon, Nathan Markowitz, Washington, D. C., for appellant.

Anthony S. Battaglia, Madeira Beach, Fla., for appellees.

Before RIVES, JONES and WISDOM, Circuit Judges.

WISDOM, Circuit Judge.

This case presents the question whether a proceeding under Chapter XI of the Bankruptcy Act should be dismissed on the ground that Chapter X of that Act affords the appropriate relief. In light of the nature and history of the bankrupt, the make-up of its equity and debt holders, and the creditor arrangement that it proposed before the district court, we hold that the district court exceeded the proper limits of its judicial discretion in denying the motion of dismissal. We reverse.

Crumpton Builders, Inc., the parent corporation, owns all of the stock of the other nine corporate appellees. Since 1954 the Crumpton complex has engaged in the business of building, selling, and financing "shell homes" over a nine state area in southeastern United States. Its operations were profitable until 1962 when the national shell home market suffered a sharp decline lasting for at least eighteen months. Its net income for the years 1956 to 1962 were as follows:

                  Fiscal year ending         Net income
                       June 30              after taxes
                  1956                     $    16,872
                  1957                          57,042
                  1958                          28,910
                  1959                          76,580
                  1960                         173,561
                  1961                         100,991
                  1962                      (1,358,444)
                  6 months ended 12/30/62   (  416,180)
                                            ===========
                  Total Net losses         $(1,320,668)
                

March 5, 1963, Crumpton filed a petition for an arrangement under Chapter XI of the Bankruptcy Act (Bankruptcy Act §§ 301-99, 52 Stat. 905 (1938), as amended 11 U.S.C. §§ 701-99 (1952)). March 14, 1963, it filed a proposed arrangement whereby secured claims were to be paid in full, after which unsecured claims were to be discharged on the basis of 15 cents on the dollar.1 As of December 31, 1962, the consolidated assets had a book value of $3,408,928 of which $2,347 was in cash and $1,765,048 was in accounts receivable. There were secured claims in the amount of $1,389,595 and unsecured obligations of $2,032,769 leaving a book value insolvency of $13,436. Of the unsecured claims trade creditors held $607,109 while the remaining $1,425,660 was in the form of 9% convertible debentures.

The losses began only a short period after Crumpton had "gone public" and acquired approximately $2,700,000 in working capital from the investing public. This sum was raised by marketing $3,000,000 in securities under a registration statement filed with the SEC. The securities consisted of 150,000 "units" each of which consisted of one 9% convertible debenture with a principal amount of $10, five shares of common stock with a par value of $.50, and one warrant to purchase another unit (one debenture and five shares) exercisable in 1964 upon payment of an additional $14. The registration became effective February 10, 1962, and the securities were marketed immediately afterwards. The units were divisible only after the original sale. 630 investors in 24 states hold the outstanding debentures in the face amount of $1,425,660. About 2,000 investors hold the 1,250,000 shares of Crumpton common stock. Russel B. Crumpton, president of the company, and his wife own 39% or 495,000 shares of the common stock.

After the proposed arrangement was filed March 14, 1963, the district court granted the Commission's motion to intervene in the proceeding. The court also ordered that certain acceptances signed by creditors be rendered null and void as a result of their being solicited in a manner considered confusing and misleading.

April 17, 1963, the Commission filed its motion to dismiss the arrangement proceedings under Chapter XI of the Bankruptcy Act unless the debtors' petition were to be amended, or a creditors' petition were to be filed, in conformity with Chapter X (Bankruptcy Act §§ 101-276, 52 Stat. 883 (1938), as amended 11 U.S.C. §§ 501-676 (1952)). The First National Bank of Tampa, Florida, the indenture trustee for the convertible debentures, joined in the motion. The movants appeal from the denial of the motion.

In Securities and Exchange Commission v. United States Realty & Improvement Co., 1940, 310 U.S. 434, 448-451, 60 S.Ct. 1044, 1050-1051, 84 L.Ed. 1293, 1300-1301, the Supreme Court discussed at length the history and complexities of proceedings under Chapter X, permitting a "reorganization" of any class of securities, and Chapter XI, permitting only an "arrangement" of unsecured claims.2 In brief, proceedings under Chapter XI are instituted by the bankrupt, are subject to minimum controls by the courts or their agents, and are marked by their speed and lack of expense. Reorganization proceedings under Chapter X are slower,3 more expensive, and have more elaborate safeguards to protect the public and the parties. One of the important purposes of Chapter X is to protect widely dispersed and largely uninformed investors and creditors against underhanded manipulations by corporate insiders.4

The jurisdictional scope of Chapters X and XI, both enacted as part of the 1938 Chandler Amendment to the Bankruptcy Act, has perplexed lawyers and judges. Chapter X seems appropriate for a giant corporation with a complex debt and equity structure or for a corporation in dire need of new capital or management; Chapter XI seems appropriate for a small closely held corporation to settle with its trade creditors. But there was no formula in the statute and no guideline in the legislative history.5 In the United States Realty case the Supreme Court, recognized the power of a district court, on intervention by the SEC, to require the transfer of a proceeding from Chapter XI to Chapter X, after due consideration of the nature of the debtor, the arrangement proposed, and the number, nature and position of its creditors. The Court favored a Chapter X proceeding on the grounds that: (1) Chapter XI does not contain necessary safeguards for public investors; (2) where the debtor has public investors, a plan under Chapter XI would not be "fair and equitable" according to the traditional interpretation given that clause by the federal courts.

In 1952 Congress added Section 3286 to the Bankruptcy Act (11 U.S.C. § 728)7 in order to codify the principles established in the United States Realty case. The applicability of this section is at issue in this case.

Since the decision in United States Realty, one Supreme Court case,8 more than half a dozen circuit court cases,9 and almost as many district court proceedings10 have wrestled with the problem of transfer from Chapter XI to Chapter X. In United States Realty the court's primary concern was that a procedure be chosen which would be best calculated to bring a "fair and equitable" result, as required by the language of Chapter XI. The Court explained that the words "fair and equitable", are terms of art incorporating the absolute priority rule established in Northern Pacific R. Co. v. Boyd, 1913, 228 U.S. 482, 33 S.Ct. 554, 57 L.Ed. 931, and Case v. Los Angeles Lumber Products Co., 1939, 308 U.S. 106, 60 S.Ct. 1, 84 L.Ed. 110. This rule would require that a plan of reorganization reduce the claims of investors on a strict priority basis; junior interests would have to be scaled down before senior interests could be reduced. Here, all debt holders would have to agree to the arrangement or be satisfied in whole before shareholders could participate in a revitalized corporation. The Supreme Court recognized that insofar as equity holdings could not be juggled under Chapter XI absolute priority might never be possible in a Chapter XI proceeding, especially when a large number of debt holders were involved, but by the means of a good working fiction the court retained the possibility of using Chapter XI for closely held corporations. "In cases where subordinate creditors or the stockholders are the managers of the business, the preservation of going-concern value through their continued management of the business may compensate for reduction of the claims of the prior creditors without alteration of the management's interests, which would otherwise be required by the Boyd case." 310 U.S. at 454, 60 S.Ct. 1052 at 84 L.Ed. at 1303.

When Section 328 was added in 1952, Congress adopted the transfer procedure established in United States Realty but specifically removed the "fair and equitable" requirement. A great deal of controversy has centered over the meaning of this so-called "uncontroversial" omission.11 There is little doubt of the general awareness of the infeasibility of applying the absolute priority rule in the Chapter XI context.12 However, that the omission does not mean that fairness and equity, in their usual sense, are no longer relevant in determining between the priority of a Chapter X or Chapter XI, is clear from a moment's reflection. This view was quickly established. General Stores Corp. v. Shlensky, 1956, 350 U.S. 462, 76 S.Ct. 516, 100 L.Ed. 550. Moreover, the amendment does not mean that the fact that shareholders were participating in a revitalized corporation before all dissenting creditors were paid off in full was not a relevant consideration in determining fairness and equity, in their usual sense. Securities and Exchange Commission v. Liberty Baking Corp., supra, 240 F.2d p. 515 no. b. What it does mean is that there is no longer any absolute necessity for absolute priority, nothing more.

While the General Stores case reinstated or at least reinforced the traditional notions of fairness and equity, it did so in a new...

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