Continental Inv. Corp., In re

• Decision Date: 31 October 1978
• Docket Number: 78-1205 and 78-1238,Nos. 78-1204,s. 78-1204
• Citation: 586 F.2d 241
• Parties: Bankr. L. Rep. P 67,032 In re CONTINENTAL INVESTMENT CORPORATION, Debtor. Monte J. WALLACE and Neil W. Wallace, Continental Investment Corporation, and Creditors' Committee, Appellants, v. SECURITIES AND EXCHANGE COMMISSION, Appellee.
• Court: U.S. Court of Appeals — First Circuit

Page 241

586 F.2d 241

Bankr. L. Rep. P 67,032

In re CONTINENTAL INVESTMENT CORPORATION, Debtor Monte J. WALLACE and Neil W. Wallace, Continental Investment Corporation, and Creditors' Committee, Appellants, v. SECURITIES AND EXCHANGE COMMISSION, Appellee.

Nos. 78-1204, 78-1205 and 78-1238.

United States Court of Appeals First Circuit.

Argued Sept. 13, 1978.

Decided Oct. 27, 1978.

As Amended Oct. 31, 1978.

Charles P. Normandin, Boston, Mass., with whom Richard W. Southgate, H. Reed Witherby, and Ropes & Gray, Boston, Mass., were on brief, for Continental Inv. Corp.

Frederick G. Fisher, Jr., Boston, Mass., with whom Hale & Dorr, Boston, Mass., was on brief, for Creditors Committee.

Arthur F. Mathews, Washington, D.C., with whom Irving Widett, Stephen F. Gordon, Widett, Widett, Slater & Goldman, Boston, Mass., P. C., Michael R. Klein, Alexander F. Wiles, and Wilmer, Cutler & Pickering, Washington, D.C., were on brief, for Monte J. Wallace and Neil W. Wallace, intervenors.

David Ferber, Sol. to the Commission, Washington, D.C., with whom Marvin E. Jacob, Associate Administrator, Jerome Feller, Sp. Counsel, Philip M. Mandel, Sp. Counsel, New York City, and Irving H. Picard, Asst. Gen. Counsel, Washington, D.C., were on brief, for Securities and Exchange Commission.

Before COFFIN, Chief Judge, CAMPBELL and BOWNES, Circuit Judges.

COFFIN, Chief Judge.

The debtor, Continental Investment Corporation (CIC), a committee of its creditors, See 11 U.S.C. § 738, and the debtor's principal stockholders have appealed from the decision of the district court granting a motion by the Securities and Exchange Commission (SEC) to transfer proceedings from Chapter XI to Chapter X of the Bankruptcy Act pursuant to 11 U.S.C. § 728. ¹ We are required to explore the boundaries of the rule promulgated by SEC v. American Trailer Rentals Co., 379 U.S. 594, 85 S.Ct. 513, 13 L.Ed.2d 510 (1965), and the extent of its exceptions.

CIC is a holding company operating through subsidiaries providing financial services. In 1974 CIC defaulted first on obligations to 16 banks holding senior debt and then on interest payments to subordinated public debentureholders. As a consequence, negotiations began among CIC, the banks, a Debentureholders Protective Committee formed by institutions holding about ten per cent of the outstanding debentures, and another institutional holder of 16 per cent of the debentures. These negotiations produced a plan of arrangement agreed to in principle by all parties on July 29, 1975, and filed under Chapter XI on April 30, 1976. See 11 U.S.C. § 723. Before filing the plan CIC submitted it to its public stockholders and debentureholders via a combined registration and proxy statement processed by the SEC. About 90 per cent of the stockholders and 82 per cent of the debentureholders approved the plan. The percentage of debentureholders had risen to about 90 by the date of the district court opinion.

As of June 30, 1975, CIC owed the banks about $61,000,000. As part of the agreement, but not contingent upon the Chapter XI proceedings, the banks purchased one of CIC's subsidiaries for $34,000,000, reducing the senior debt to $27,000,000. Under the plan of arrangement, if approved, the banks would receive $20,000,000 in Senior Term Notes and $7,000,000 in Senior Preferred Stock with attached warrants to purchase 600,000 shares of CIC common stock.

CIC owed the approximately 1,600 public investors about $42,000,000 as of May 1, 1975. Under the plan they would receive $3,500,000 of Subordinated Interest-Inclusive Debentures, $22,500,000 of Junior Preferred Stock, and $16,000,000 of Convertible Preferred Stock. The Junior Preferred Stock carries warrants to buy 1,780,000 shares of common stock, and the convertible stock can be converted to 4,000,000 shares. Dividends on the new securities will be paid only if all more senior obligations are satisfied. Unpaid dividends will not accumulate. The holders of the Convertible Preferred Stock will elect a majority of the board of directors of CIC. If all warrants were exercised and all convertible shares converted, the outstanding common stock would be diluted by about one-third.

The plan's purpose is to greatly reduce CIC's annual debt service obligations. Combined with steps already taken by management to divest CIC of marginal and unprofitable subsidiaries and to reduce costs, the parties hope to return CIC to profitable operation. Indeed CIC has been able to produce positive operating revenue in 1976 and 1977.

On June 18, 1976, six weeks after the Chapter XI petition was filed, the SEC moved the bankruptcy judge to transfer the proceedings from Chapter XI to Chapter X. The bankruptcy judge denied the motion without making explicit reference to SEC v. American Trailer Rentals Co., 379 U.S. 594, 85 S.Ct. 513, 13 L.Ed.2d 510 (1965), and confirmed the plan. The district court reversed, holding that American Trailer Rentals required the case to proceed in Chapter X. This appeal is taken from the district court's order.

Our starting point for analysis must be American Trailer Rentals, wherein Justice Goldberg, speaking for a unanimous Court, explained in great detail the relationship between Chapters X and XI and the factors determining the choice between those chapters in a particular case. Though the decision to transfer is committed to the district court's discretion, Schreibman v. Mason,377 F.2d 99, 102 (1st Cir. 1967); See 11 U.S.C. § 728 (note 1, Supra ), that discretion must be exercised in reliance on the principles stated in American Trailer Rentals, 379 U.S. at 619, 85 S.Ct. 513, which reaffirms and explains the decisions in General Stores Corp. v. Shlensky, 350 U.S. 462, 76 S.Ct. 516, 100 L.Ed. 550 (1956), and SEC v. United States Realty & Improvement Co., 310 U.S. 434, 60 S.Ct. 1044, 84 L.Ed. 1293 (1940).

The Supreme Court's examination of the legislative history ² of the Bankruptcy Act revealed that Chapter XI was created "to provide a quick and economical means of facilitating simple compositions among general creditors who have been deemed by Congress to need only the minimal disinterested protection provided by that Chapter." 379 U.S. at 606-07, 85 S.Ct. at 520. The purpose of Chapter X, on the other hand, is "to afford greater protection to creditors and stockholders by providing greater judicial control over the entire proceedings and impartial and expert administrative assistance . . . through appointment of a disinterested trustee and the active participation of the SEC." 379 U.S. at 604, 85 S.Ct. at 519. "The basic assumption of Chapter X . . . is that the investing public dissociated from control or active participation in the management, needs impartial and expert assistance in the ascertainment of facts, in the detection of fraud, and in the understanding of complex financial problems." 310 U.S. at 448-49 n.6, 60 S.Ct. at 1050.

On the basis of the above distinctions, Congress drafted the two chapters to meet different ends. "In enacting these two distinct methods of corporate rehabilitations, Congress has made it quite clear that Chapters X and XI are not alternate routes, the choice of which is in the hands of the debtor. Rather, they are legally, mutually exclusive paths to attempted financial rehabilitation." 379 U.S. at 607, 85 S.Ct. at 520. Compare 11 U.S.C. § 546(2) With 11 U.S.C. § 728. Congress has allocated corporate rehabilitation schemes between Chapters X and XI on the basis of assumptions properly within the legislative domain. The task of the courts is to determine in which chapter a particular scheme belongs.

The Supreme Court has rejected the SEC's suggestion that the structure of a corporation or the structure of its public debt automatically determines the appropriate chapter. All corporations with public investors need not submit to Chapter X, 379 U.S. at 607, 85 S.Ct. 513, nor must all cases directly affecting the rights of public investor creditors of a publicly held debtor proceed in Chapter X, 379 U.S. at 611, 85 S.Ct. 513. The Court has, however, endorsed a general rule that normally Chapter X is "adapted to the reorganization of corporations with complicated debt structures and many stockholders" and Chapter XI is adapted "to composition of debts of small individual businesses and corporations with few stockholders", 379 U.S. at 608, 85 S.Ct. at 521, Quoting United States Realty, 310 U.S. at 447, 60 S.Ct. 1044, 1049. CIC does have a complicated debt structure and many stockholders. Therefore, it falls within the general rule.

The fact that the Court has chosen a general rule rather than an absolute rule means, of course, that there are exceptions. But the exceptions are very narrow, 379 U.S. at 614, 85 S.Ct. 513, and must be related to the unique purposes of Chapter XI. United States Realty, which first expressed the general rule, pointed out that "(a) large company with publicly held securities may have as much need for a simple composition of unsecured debts as a smaller company. And there is no reason we can see why c. XI may not serve that end." 350 U.S. at 466, 76 S.Ct. at 519. American Trailer Rentals elaborated on the purpose of the exception. " 'Simple' compositions are still to be effected under Chapter XI. Such a situation, even where public debt is directly affected may exist, for example, where the public investors are few in number and familiar with the operations of the debtor, or where, although the public investors are greater in number, the adjustment of their debt is relatively minor, consisting, for example, of a short extension of time for payment." 379 U.S. at 614, 85 S.Ct. at 524. These two situations are given only as examples. The Court has not excluded the possibility that there may be other situations in which the rights of public investor creditors can be adjusted in Chapter XI. We conclude, however, that any such situations would have to fall within the definition of "simple composition"...