In re Beck Industries, Inc.

• Decision Date: 30 April 1973
• Docket Number: Docket 72-2277.,No. 582,582
• Citation: 479 F.2d 410
• Parties: In the Matter of BECK INDUSTRIES, INC., in Proceedings for the Reorganization of a corporation, Debtor. Jack FELDMAN et al., Appellants, v. TRUSTEES OF BECK INDUSTRIES, INC., Appellees.
• Court: U.S. Court of Appeals — Second Circuit

479 F.2d 410 (1973)

In the Matter of BECK INDUSTRIES, INC., in Proceedings for the Reorganization of a corporation, Debtor.

Jack FELDMAN et al., Appellants, v. TRUSTEES OF BECK INDUSTRIES, INC., Appellees.

No. 582, Docket 72-2277.

United States Court of Appeals, Second Circuit.

Argued March 20, 1973.

Decided April 30, 1973.

Donald N. Rothman, Baltimore, Md. (Robert E. Sharkey, Gordon, Feinblatt, Rothman, Hoffberger & Hollander, Ober, Grimes & Schriver, Baltimore, Md., Winer, Neuburger & Sive, New York City, of counsel), for appellants.

Milton S. Gould, New York City (Martin I. Shelton, Herman A. Bursky, Shea Gould Climenko & Kramer, New York City, of counsel), for appellees.

Before SMITH, FEINBERG and MANSFIELD, Circuit Judges.

MANSFIELD, Circuit Judge:

The issue on this appeal is whether the Bankruptcy Court had jurisdiction under 11 U.S.C. §§ 511¹ and 516(4)² to restrain Maryland state court proceedings against a wholly-owned subsidiary of the debtor in Chapter X proceedings, Beck Industries, Inc. (hereinafter "Beck"). The subsidiary, Webster Clothes, Inc. (hereinafter "Subsidiary"), had been newly created by Beck for the purpose of entering into a corporate acquisition but subsequent to the acquisition the Subsidiary also was a self-sustaining, viable, autonomous entity engaged in the conduct of its own business, which was separate and distinct from that of Beck. Judge John M. Cannella affirmed the order of Referee Asa Herzog who, by restraining the Maryland court proceedings, in effect found that the assets of Subsidiary constituted "property" of Beck within the meaning of the Bankruptcy Act and thus that the Bankruptcy Court had jurisdiction. The decision was based on the premise that Subsidiary was a mere adjunct or instrumentality of the debtor, permitting the court to disregard its separate corporate existence and pierce the corporate veil. For reasons stated below, we find that the Bankruptcy Court was without jurisdiction to restrain the Maryland court proceedings and we therefore reverse the restraining order.

THE FACTS

The record, which consists of various affidavits and documentary exhibits, reveals the following:³ In early 1969, negotiations were conducted between Beck, which was a conglomerate, Webster Clothes, Inc. (hereinafter "Webster-Md."), which was a Maryland corporation, and the latter's stockholders regarding the acquisition by Beck of Webster-Md., a long-established, closely-held, going corporate concern engaged in the manufacture and the sale of men's clothing. The form of the transaction was to be a triangular three-party merger, which would conform to the requirements for a hybrid "Type A" form of tax-free reorganization as prescribed by the Internal Revenue Code, 26 U.S.C. §§ 368(a)(1)(A) and 368(a)(2)(D).⁴ The hybrid "Type A" merger permits a subsidiary to exchange its parent's stock for shares of a third corporation being acquired in a statutory merger in which the third corporation is merged into the subsidiary. Such a transaction qualifies as a tax-free "A" reorganization if: (1) none of the subsidiary's stock is used, and (2) the exchange would have been an "A" type reorganization if the acquired corporation had merged directly into the parent. Here Webster-Md. was to be merged into Subsidiary, which would be newly formed for the purpose. Subsidiary would acquire the property of Webster-Md., giving to the Webster-Md. stockholders shares of Beck stock in exchange for their Webster-Md. stock.

The transaction was set forth in two documents, both dated May 6, 1969: (1) the Plan and Agreement of Reorganization (hereinafter "Plan & Agreement") which was entered into by Webster-Md., its stockholders, Beck, and Subsidiary;⁵ and (2) the "Articles and Agreement of Merger" (hereinafter "Merger Agreement") which was entered into between Subsidiary and Webster-Md.

Under the terms of these documents, Webster-Md. was to be merged into Subsidiary, which would become the surviving corporation. The Webster-Md. stockholders would receive approximately $2.5 million worth of Beck stock, or 84,388 shares, in immediate payment for their Webster-Md. stock. In the event that on December 31, 1971, the market value of 84,388 shares of Beck stock should be less than 150% of its market value on May 6, 1969, then according to an "Adjustment of Consideration" (set forth in the Plan & Agreement), Subsidiary would make a deferred payment to Webster-Md.'s former stockholders by delivering to them sufficient additional shares of Beck stock to increase the total value of Beck shares held by them to 150% of the value of such shares on May 6, 1969.

The Plan & Agreement sets forth a series of obligations and warranties that extend from both Beck and Subsidiary to Webster-Md. and to the latter's stockholders. In Paragraph 3(f) Beck undertook, should the provisions of the "Adjustment of Consideration" be invoked, to apply to the American Stock Exchange ("AMEX") for the listing of additional shares and covenanted to "take such steps as may be necessary to maintain the existence and solvency of Beck Subsidiary." In Paragraph 6 of the Plan & Agreement Beck and Subsidiary make a series of parallel representations and warranties. For instance, Paragraph 11(e) provided: "BECK and BECK Subsidiary hereby agree to indemnify and hold harmless the stockholders against and in respect of any and all damage, deficiency, loss, claims, demands, actions, suits, proceedings, judgments and assessments . . . resulting from any misrepresentations, breach of warranty or nonfulfillment of any agreement, obligation or covenant to be performed by Beck or Beck Subsidiary. . . ." (emphasis added). Correspondingly, Beck and Subsidiary received in Paragraphs 1(a-d) certain assurances and remedies from Webster-Md. and its stockholders.

On July 10, 1970, the American Stock Exchange suspended trading in Beck Common Stock and thereafter its shares were traded only in the Over-the-Counter market. On May 27, 1971, Beck filed a petition for reorganization under Chapter X of the Bankruptcy Act, which was approved by order of the district court on that date. In addition to the appointment of the Trustees and the delineation of their powers and duties the order restrained all persons from interfering with the Bankruptcy Court's exclusive jurisdiction over the debtor and its property.⁶

Needless to say, on December 31, 1971, the 84,388 Beck shares received by Webster-Md.'s former stockholders were not worth 150% of their value on May 6, 1969, and because of the Chapter X proceeding Beck was unable to comply with the "Adjustment of Consideration" as set forth in the Plan & Agreement.

On January 13, 1972, Jack Feldman, et al.,⁷ the appellants (hereinafter "the Feldmans"), who, as the former owners of about 65% of the Webster-Md. shares, were participants in the merger, instituted an action in the Circuit Court of Baltimore City, Baltimore, Maryland, against Subsidiary by filing a Bill of Complaint which sought, among other things, to cancel and rescind the Merger Agreement. Neither Beck nor its Trustees were named as defendants. In Count I of the Bill, the Feldmans claimed that the inability of Subsidiary to deliver additional shares of Beck stock having the value required by the "Adjustment of Consideration" provisions of the Plan & Agreement

"constituted a total failure of the consideration promised to Plaintiffs the Feldmans by the Defendant in exchange for the delivery by the Plaintiffs of all their stock in Webster-Md. to the Defendant and in consideration for Plaintiffs\' actions which caused Webster-Md. to agree to the merger of Webster-Md. into the Defendant."

The prayer for relief sought the cancellation and rescission of the Merger Agreement, the return to the Feldmans of the shares necessary to restore them to their prior percentage of equity in Webster Clothes (65%) and an accounting.

Under Paragraph 11(e) of the Plan & Agreement, Count II sought indemnification by Subsidiary for damages and losses "resulting from the breach or non-fulfillment of any agreements, obligations or covenant to be performed by Beck under the Plan & Agreement or Merger Agreement" including the prorata share of $2.7 million. In Count III, essentially the same relief was sought, this time based on Subsidiary's breach of its own covenants under Paragraph 11(e). Count IV sought damages in the sum of $2,425,746.63.

The Baltimore Circuit Court, upon the Feldmans' ex parte motion, issued an order enjoining Subsidiary, "its officers, agents, servants, employees, and attorneys, and all other persons in active concert and participation with it from doing any of . . ." an enumerated list of acts which might facilitate the depletion of Subsidiary's assets by Beck. Neither the Bill of Complaint nor the ex parte petition for injunctive relief named Beck as a defendant.

The instant action arose from the Trustees' attempt to enjoin the Maryland proceedings. Although the Maryland proceedings failed to name Beck as a defendant and were directed against Subsidiary, the Trustees of Beck, on January 21, 1972, claiming a violation of the Chapter X protective order⁸ prayed for an order to show cause why the Feldmans "should not be enjoined from taking any further steps or actions in the Maryland proceedings and why they should not be restrained from in any other manner interfering with the possession or management by the Trustees of the estate. . . ." On the same date Judge Cannella signed the order to show cause containing a provision staying until his hearing of the issue any further steps in the Maryland proceedings and ordering the respondents (the Feldmans) to vacate the ex parte Maryland order. By stipulation filed on January 25, 1972, the Feldmans agreed to vacate the Maryland ex parte order and the Trustees agreed to refrain from entering into any unusual transactions with Subsidiary.

In a decision dated April 19, 1972, Referee Herzog granted the motion to...