First Nat. Bank of Hollywood v. American Foam Rubber Corp.
| Decision Date | 05 February 1976 |
| Docket Number | D,No. 38,38 |
| Citation | 530 F.2d 450 |
| Parties | 18 UCC Rep.Serv. 1122 FIRST NATIONAL BANK OF HOLLYWOOD et al., Plaintiffs-Appellees, v. AMERICAN FOAM RUBBER CORP. and Milton R. Ackman, as Trustee of American Foam Rubber Corp., Bankrupt, Defendants, Marie Louise deMontmollin et al., Defendants-Appellants. ocket 75--7051. |
| Court | U.S. Court of Appeals — Second Circuit |
David Sive, New York City (Winer, Neuburger & Sive, New York City, on the brief), for defendants-appellants.
Jacob E. Heller, New York City (Joseph Heller and Jacob E. Heller, New York City, on the brief), for plaintiffs-appellees.
Before LUMBARD, MULLIGAN and VAN GRAAFEILAND, Circuit Judges.
This is an appeal from a judgment in favor of the executors of one corporate creditor against another corporate creditor whose right to receive payment was made subordinate to that of plaintiffs' testate. Two questions are presented:
1. Did the subordinated creditor have the right to discharge an unmatured subordinated indebtedness without the consent of the senior creditor?
2. Was there payment of a matured, subordinated debenture when the subordinated creditor took the note of the debtor's parent corporation instead of cash?
Litigation between the paties has now been in progress for fifteen years, and three opinions of the District Court have been reported. Buchman v. American Foam Rubber Corp., 250 F.Supp. 60 (S.D.N.Y.1965); First National Bank v. American Foam Rubber Corp., 306 F.Supp. 593 (S.D.N.Y.1969); First National Bank v. American Foam Rubber Corp., 309 F.Supp. 547 (S.D.N.Y.1969). 1 Repetition will not improve upon the recitals of fact contained in these opinions, and we will therefore review only so much background as is necessary to frame the issues on this appeal.
Prior to 1957, appellees' testate, Samuel Buchman, was president and a substantial stockholder of American Foam Rubber Corp. (AFR), a New York corporation. On May 17, 1957, Buchman resigned and sold his interest in AFR and its affiliate, Burlington Holding Corporation, to appellants. As part of the agreement of sale, certain debentures of the two corporations, maturing in 1960 and 1965, which were held by appellants were subordinated to debentures held by Buchman. The pertinent portion of the subordination agreement reads as follows:
To induce Samuel Buchman to sell his capital stock hereunder, Marie Louise deMontmollin and Alexander F. Pathy hereby agree with respect to the debentures of each of said corporations that the rights of any holder (including her or him) of the debentures thereof now held by her or him and referred to above, be subordinated to the rights of any holder or holders of the debentures thereof now held by Samuel Buchman (including him) as to the payment of interest and principal. No claim for interest under the debentures so subordinated shall be made unless all interest payable on the debentures now held by Samuel Buchman shall have been paid in full, and no claim for principal under any of the debentures so subordinated shall be made unless the entire principal of all the debentures now held by Samuel Buchman shall have been paid in full.
If for any reason, either corporation shall pay interest or principal on said debentures to any of the Buyers, or to any person deriving title to the debentures of said corporation from any of the Buyers, and said payment shall be made without first satisfying the priority to which the holder or holders of Samuel Buchman's debentures are entitled by reason of the foregoing provisions, the amount or amounts of the payment so made to the buyer (or to the person deriving title from her or him) shall be promptly paid by such Buyer to said holder or holders of Samuel Buchman's debentures.
A similar agreement of subordination was made with respect to some corporate promissory notes which were held by the parties.
In 1958, AFR decided to issue new stock for the purpose of improving its capital structure; and, over a period of time, appellant deMontmollin surrendered subordinated AFR debentures and notes with a face value of $322,000 for preferred stock with an equivalent face value.
On April 1, 1960, the Burlington debentures became due. Buchman was paid in cash for his, and Mrs. deMontmollin received a credit on Burlington's books for $15,000, the amount of her debentures. She immediately loaned this money to AFR, receiving a promissory note in return. 2 This was accomplished by a bookkeeping transfer of assets from Burlington to AFR; no money passed through appellants' hands.
On February 21, 1961, AFR was adjudicated a bankrupt. In its opinion, 306 F.Supp. 593, 601, the District Court stated that, if Mrs. deMontmollin had not surrendered the $322,000 in debentures and notes, appellees, because of their right to priority in payment under the subordination agreement, would have been entitled to recover the bankruptcy dividends payable on these obligations. It therefore held appellant deMontmollin liable for the amount of the dividend which would have been paid. The District Court also held that the transaction involving the $15,000 Burlington debentures constituted payment of those debentures within the meaning of the subordination agreement and that appellant deMontmollin was liable for this amount. Id. at 607.
We reverse the holding of the District Court insofar as it predicates liability upon the exchange of the AFR debentures and notes for stock and affirm its holding insofar as it predicates liability upon the payment of the Burlington debentures.
Before examining the District Judge's theory of liability, we first note our approval of his rejection of an alternate theory which had been proposed by plaintiffs. Judge Cooper held that the exchange of debentures and notes for preferred stock did not constitute payment of these obligations, as that term was used in the subordination agreement, since no assets of the corporation passed into the creditors' hands. 306 F.Supp. at 599. Neither, he said, was the issuance of stock the first step in a plan to secure payment, since AFR was precluded by other contractual provisions from paying dividends or redeeming stock. Id. at 600. We find no error in these holdings.
Judge Cooper's theory of liability was that appellant had breached an implied provision in the subordination agreement that the subordinated debt would not be discharged. 3 He stated that the subordinated debt was 'a type of security for the senior debt, available to the senior creditor upon a distribution of the assets of the debtor' and might therefore be regarded as a 'cushion' or 'support' for the senior debt. 306 F.Supp. at 599. Although he then specifically refused to determine the true nature of the interest, 'if any', created in favor of the senior creditor, he held that, in the absence of provisions to the contrary, it was a breach of the subordination agreement for the junior creditor to discharge the subordinated debt. Id. at 606. We disagree.
The subordination agreement provided in substance that neither interest nor principal should be paid on the subordinated debt unless the interest and principal on the senior debt were paid in full and that, if such payments were made, they would be promptly paid over to the senior creditor. Clearly, the senior creditor had both equitable and contractual rights in the proceeds of such payments. Similar rights would attach to dividends declared in the estate of the bankrupt creditor. In re Credit Industrial Corporation, 366 F.2d 402 (2d Cir. 1966); Calligar, Subordination Agreements, 70 Yale L.J. 376, 383 (1961).
Various theories have been advanced to support the enforcement of subordination agreements in bankruptcy: equitable lien, equitable assignment, constructive trust and enforcement of contractual rights. In re Itemlab Inc., 197 F.Supp. 194, 197 (E.D.N.Y.1961); Calligar, supra, 70 Yale L.J. at 384; Leiby, Enforcement and the U.C.C., 23 Bus. Lawyer 57 (1967). This Circuit has favored the recognition of priorities based upon the 'lawful contractual arrangement between the parties.' In re Aktiebolaget Kreuger & Toll, 96 F.2d 768, 770 (2d Cir. 1938). As we stated in In re Credit Industrial Corporation, supra, 366 F.2d at 407, if the terms of the contract are unambiguous, there is no need to resort to 'strained theories of third-party beneficiary, estoppel or general principles of equity' to determine the rights of the parties.
Since most of the decisions in this area have dealt with the priority of payments in bankruptcy, there has been little need for the courts to explore the rights of the parties beyond those which attach to the bankruptcy dividends. The rules which have been laid down in these cases are not, therefore, determinative of the senior creditor's pre-bankruptcy rights, if any, in the payment which has not yet accrued or the dividend which has not been declared, i.e., in the debt itself. 4 To justify the judgment in favor of plaintiffs below, they must have had rights, rights of such nature that they precluded defendant's good faith discharge of the subordinated debt.
No recital of such rights can be found in the contractual arrangement between the parties. The terms of the subordination agreement are unambiguous and include no prohibition against discharge of the subordinated indebtedness. Moreover, based upon our decision in Cherno v. Dutch American Mercantile Corporation, 353 F.2d 147 (2d Cir. 1965), we see no equitable basis for holding that a prohibition should be implied.
The facts in Cherno are not dissimilar from those we are now considering. There, the subordinated creditor discharged a chattel mortgage which he held as security, in order that the debtor could mortgage the property to a third party. In denying the senior creditor's claim that it was a preferred lien creditor as an equitable assignee or equitable lienholder, we held that the...
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