579 F.2d 206 (2nd Cir. 1978), 598, Matter of Stirling Homex Corp.

Docket Nº:598, 896, Dockets 77-5019, 77-5022.
Citation:579 F.2d 206
Party Name:In the Matter of STIRLING HOMEX CORPORATION, Debtor. Gregory JEZARIAN, Geraldine Jezarian, Lonetown Company, Harry E. Jones, Aleck Goldberg, as Custodian for Mark Goldberg, and Mrs. D. Windsor Dixon, Appellants, v. Frank G. RAICHLE, Reorganization Trustee, Lincoln First Bank of Rochester, Chemical Bank, the Chase Manhattan Bank, N. A., the First Na
Case Date:June 19, 1978
Court:United States Courts of Appeals, Court of Appeals for the Second Circuit

Page 206

579 F.2d 206 (2nd Cir. 1978)


Gregory JEZARIAN, Geraldine Jezarian, Lonetown Company,

Harry E. Jones, Aleck Goldberg, as Custodian for

Mark Goldberg, and Mrs. D. Windsor

Dixon, Appellants,


Frank G. RAICHLE, Reorganization Trustee, Lincoln First Bank

of Rochester, Chemical Bank, the Chase Manhattan Bank, N.

A., the First National Bank of Chicago, Marine Midland Bank,

the Travelers Indemnity Company, and the Securities and

Exchange Commission, Appellees.

Nos. 598, 896, Dockets 77-5019, 77-5022.

United States Court of Appeals, Second Circuit

June 19, 1978

Argued March 20, 1978.

Page 207

Robert B. Block, New York City (Pomerantz, Levy, Haudek & Block, New York City, of counsel), for appellants Gregory Jezarian, Geraldine Jezarian and Lonetown Company.

I. Walton Bader, New York City (Bader & Bader, New York City, of counsel), for appellant Mrs. D. Windsor Dixon.

Milberg, Weiss, Bershad & Spechtrie, New York City, of counsel, for appellants Harry E. Jones and Aleck Goldberg, as Custodian for Mark Goldberg.

Irving H. Picard, Asst. Gen. Counsel, S. E. C., Washington, D. C. (David Ferber, Sol. to the Commission, S. E. C., Washington, D. C., Marvin E. Jacob, Associate Administrator, S. E. C., New York Regional Office, New York City, of counsel), for appellee Securities and Exchange Commission.

Page 208

Frank G. Raichle, Buffalo, N. Y. (Byron Johnson, Johnson, Reif & Mulligan, P. C., Rochester, N. Y., of counsel), for trustee-appellee Frank G. Raichle.

Henry L. Goodman, New York City (Zalkin, Rodin & Goodman, Richard S. Toder, Andrew D. Gottfried, New York City, Sherman I. Goldberg, Chicago, Ill., of counsel), for appellees, Chemical Bank and The First National Bank of Chicago.

Alexander C. Cordes, Buffalo, N. Y. (Phillips, Lytle, Hitchcock, Blaine & Huber, Buffalo, N. Y., of counsel), for appellee Marine Midland Bank.

Nixon, Hargrave, Devans & Doyle, Rochester, N. Y., of counsel, for appellee Lincoln First Bank of Rochester.

Milbank, Tweed, Hadley & McCloy, John J. Jerome, Barry G. Radick, Michael J. Levin, Patrick E. Mears, New York City, of counsel, for appellee The Chase Manhattan Bank, N. A.

Brown, Kelly, Turner, Hassett & Leach, Buffalo, N. Y. (Frederick D. Turner, Buffalo, N. Y., of counsel), for appellee The Travelers Indemnity Company.

Before KAUFMAN, Chief Judge, and MULLIGAN and MESKILL, Circuit Judges.

MESKILL, Circuit Judge:

This appeal raises questions concerning the proper status of allegedly defrauded investors in reorganization proceedings under Chapter X of the Bankruptcy Act. The principal issue is whether claims filed by allegedly defrauded stockholders of a debtor corporation should be subordinated to claims filed by that corporation's ordinary unsecured creditors for purposes of formulating a reorganization plan. Judge Harold P. Burke of the United States District Court for the Western District of New York held that they should be, and we affirm.

The debtor in this case is Stirling Homex Corporation ("Homex"). 1 As recently explained by this Court, "Homex manufactured and assembled prefabricated multi-family modular housing. Its operations consisted of mass-producing individual apartment units, or 'modules,' using assembly-line production techniques, shipping them to a construction site and installing them in a previously-constructed concrete and steel frame so as to form multi-unit apartment buildings." United States v. Stirling, 571 F.2d 708, 712 (2d Cir. 1978), Petition for cert. filed, 46 U.S.L.W. 3723 (U.S. May 1, 1978). The nature of Homex's actual operations, however, did not reflect the basically sound and straightforward character of the corporation's underlying concept. Instead, its operations included "land transactions that were not what they were claimed to be, labor relations that were not only inappropriately 'cozy' but undisclosed, contracts for module sales based on guile and trickery rather than agreement, and deceptive bookkeeping practices . . . ." 571 F.2d at 713. Key officials of the corporation "engaged collectively in a calculated and multi-faceted plan to give the investing public the false impression that Homex was in a sound and steadily improving financial position and at the same time withhold adverse information that was material to an accurate appraisal of the company's prospects." 571 F.2d at 713-14. 2

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On July 12, 1972, after Homex had been in business for approximately four years, reorganization proceedings were voluntarily initiated in the Western District of New York under Chapter X of the Bankruptcy Act, 11 U.S.C. § 501 Et seq. 3 Nearly five years later, in July of 1977, Judge Burke determined that the fair market value of Homex's assets was $16,986,376 and that Homex's debts amounted to $45,961,000. 4 Accordingly, he found Homex insolvent and declared that Homex stockholders had no equity in the corporation and could neither vote on a plan of reorganization nor share in the distribution of proceeds resulting from the liquidation of Homex's assets. Judge Burke then ordered the Trustee to prepare and submit a plan for such a distribution.

That same month, at the request of the Trustee and with the consent of the stockholders, Judge Burke filed a written decision in which he held that the claims of allegedly defrauded stockholders, some of whom had begun proceedings against Homex and its officers for violations of federal securities laws, 5 were subordinate to those

Page 210

of Homex's general unsecured creditors. Relying on § 197 of the Bankruptcy Act, 11 U.S.C. § 597, and Bankruptcy Rule 10-302(a), Judge Burke ordered that claims by "those creditors whose claims are grounded on fraud or securities law violations committed upon them as stockholders" be subordinated. In so doing, he made the following observations:

If the claims of alleged defrauded stockholders are not subordinated to the claims of conventional general unsecured creditors, a wholly new element will have been created in the financial structure of business. No longer will creditors, whether banks, suppliers, or subcontractors, be free as they now are to extend credit to the ordinary course of business on their presumed right to be accorded priority over the claims of investors and speculators in securities, without first obtaining a secured basis which will guarantee them a priority status in the event their customer defaults. Such a fundamental change in the financial structure of the business community is unwarranted in the absence of legislation designed to overturn the long established rule of absolute priority.

. . . I find that (it) is fair and equitable that the class of conventional general creditors take precedence over the class of alleged defrauded stockholder claims.

Defrauded stockholder claimants in the purchase of stock are presumed to have been bargaining for equity type profits and assumed equity type risks. Conventional creditors are presumed to have dealt with the corporation with the reasonable expectation that they would have a senior position against its assets, to that of alleged stockholder claims based on fraud. They may be presumed to have bargained for debt type profits and certainty of payments.

For the reasons that follow, we affirm Judge Burke's order. 6


One of the more significant responsibilities assigned to the bankruptcy court

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in a Chapter X proceeding is to supervise the formulation of a plan of reorganization that is not only "feasible" but also "fair and equitable." See 11 U.S.C. §§ 574, 621(2). Central to the accomplishment of this task is the proper classification and ordering of the debtor corporation's creditors and stockholders: "For the purposes of the plan and its acceptance, the judge shall fix the division of creditors and stockholders into classes according to the nature of their respective claims and stock." 11 U.S.C. § 597; See Bankruptcy Rule 10-302(a). 7

As explained by the Tenth Circuit in 1945, this classification of claims "is simply a method of recognizing difference in rights of creditors which calls for difference in treatment." Scherk v. Newton, 152 F.2d 747, 750. Once classified, the various classes must not only be ranked "according to the nature of their respective claims," but also according to the "absolute priority" rule. Under this rule, no class may receive anything of value until senior classes have received full compensation for the value of their claims. For example, creditors holding security interests in the assets of the debtor must be ranked ahead of all other creditors with respect to those assets. After the satisfaction of the secured creditors, general unsecured creditors are entitled to satisfaction before assets may be allocated to creditors whose interests have been subordinated, whether by express agreement or otherwise. Finally, after all creditors have been paid, provision may be made for stockholders. When the debtor is insolvent, the stockholders, as such, receive nothing. See Northern Pacific Ry. v. Boyd, 228 U.S. 482, 33 S.Ct. 554, 57 L.Ed. 931 (1913); Case v. Los Angeles Lumber Co., 308 U.S. 106, 60 S.Ct. 1, 84 L.Ed. 110 (1939); Consolidated Rock Co. v. DuBois, 312 U.S. 510, 61 S.Ct. 675, 85 L.Ed. 982 (1941); Protective Committee v. Anderson, 390 U.S. 414, 88 S.Ct. 1157, 20 L.Ed.2d 1 (1968). See also Caplin v. Marine Midland Grace Trust Co., 406 U.S. 416, 435-38, 92 S.Ct. 1678, 32 L.Ed.2d 195 (1972) (Douglas, J., dissenting); See generally 6A Collier on Bankruptcy P 11.06. The question on this appeal, of course, is not whether Homex stockholders are entitled, as stockholders, to a portion of the proceeds that will result from the liquidation of Homex's assets. Because of the absolute priority rule, they are not. Rather, the question is whether persons who were allegedly induced by fraud to purchase Homex...

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