Geist v. Prudence Realization Corporation

• Decision Date: 11 August 1941
• Docket Number: No. 343.,343.
• Parties: GEIST v. PRUDENCE REALIZATION CORPORATION.
• Court: U.S. Court of Appeals — Second Circuit

122 F.2d 503 (1941)

GEIST v. PRUDENCE REALIZATION CORPORATION.

No. 343.

Circuit Court of Appeals, Second Circuit.

August 11, 1941.

Irving L. Schanzer, of New York City, for appellant.

Morris A. Marks, of New York City (Geist & Netter, of New York City, on the brief), for appellee.

Before SWAN, CLARK, and FRANK, Circuit Judges.

CLARK, Circuit Judge.

The Prudence Company, Inc., and Prudence-Bonds Corporation, wholly owned subsidiaries of the same parent corporation — New York Investors, Inc. — were together engaged in the mortgage-guaranty business. By a common practice, Prudence would lend money on a bond and real property mortgage, which it would assign to Prudence-Bonds. The latter would place them with a public depository and would issue certificates authenticated by the depository of undivided shares of specified amounts in the bond and the mortgage. These certificates would then be sold to the public with Prudence's guarantee attached. The practice is described in Re Westover, Inc., 2 Cir., 82 F.2d 177, and see, also, In re Prudence Co., Inc., 2 Cir., 89 F.2d 689; In re Prudence Co., Inc., 2 Cir., 98 F.2d 559, certiorari denied Stein v. McGrath, 306 U.S. 636, 59 S.Ct. 485, 83 L.Ed. 1037; In re Prudence Bonds Corp., 2 Cir., 79 F.2d 212.

This procedure was followed in connection with the issue here involved. Prudence having lent the Zo-Gale Realty Co., Inc., $480,000, the loans were consolidated in 1925 in one bond secured by mortgage of the premises at 202 Riverside Drive, New York City. Prudence immediately assigned the bond and mortgage to Prudence-Bonds, which deposited them with Central Union Trust Company of New York and sold to the public certificates guaranteed by Prudence to the amount of $382,800. The mortgage was thereafter reduced by payment to $390,000. In 1932, Prudence repurchased two certificates in the amount of $800, and otherwise became entitled to one in the amount of $16.67. Whether claims in reorganization proceedings on these certificates totalling $816.67 and on the uncertificated balance of the loan, to wit, $7,200, stand on a parity with, or are subordinated to, the claims of general certificate holders is the question here at issue.

In proceedings for the foreclosure of a mortgage junior to the one received by Prudence, following the mortgagor's default, the property was transferred February 1, 1933, subject to Prudence's mortgage, to Amalgamated Properties, Inc., a subsidiary of Prudence. Reorganization proceedings against Prudence were begun February 1, 1935, and against Amalgamated, March 16, 1936. By an order therein of January 28, 1938, the court approved a transfer by Prudence-Bonds, also in reorganization, to the Prudence trustees of the $7,200 uncertificated portion of the Zo-Gale mortgage, in compromise of other claims. A plan for the reorganization of the Zo-Gale issue was subsequently confirmed, February 19, 1938, and pursuant thereto, title to the mortgaged property was transferred to Geist, petitioner herein, to carry out the plan.

The order of confirmation did not settle, however, the question which had been raised regarding the right of the Prudence trustees to satisfaction of their claims on a parity with other certificate holders. By Paragraph 7 thereof, Geist was forbidden to make distribution of cash or securities on account of these claims unless their right thereto had "been finally adjudicated by a court of competent jurisdiction," and by Paragraph 30, the court retained in itself jurisdiction to decide the question.

Respondent, Prudence Realization Corporation, which succeeded to the interest of the Prudence trustees following the reorganization of Prudence by an order of May 26, 1939, now opposes Geist's petition for subordination of the claims. The court below held, however, that under New York law a guarantor of mortgage certificates who also has an interest in the mortgage cannot share in the collateral until the certificate holders are paid, unless there is a clear reservation in the certificate of a right to share on a parity. Respondent has appealed from the resulting order of subordination against it.

The New York law to which the district court refers has been established in a series of recent cases dealing with the liquidation of companies engaged in the guaranteed mortgage business. In re Union Guarantee & Mortgage Co., 285 N.Y. 337, 34 N.E.2d 345; Pink v. Thomas, 282 N.Y. 10, 24 N.E.2d 724; In re Title & Mortgage Guaranty Co. of Sullivan County, 275 N.Y. 347, 9 N.E.2d 957, 115 A.L.R. 35, and other cases cited in these decisions. An important issue herein is whether this is primarily a rule of construction of the guaranty in the certificates or is a rule of administration of insolvent estates which violates bankruptcy principles of equal distribution of a bankrupt estate among creditors. If it is a rule of construction, we would follow it as we held in Re Prudence Co., Inc., 2 Cir., 82 F.2d 755, certiorari denied 298 U.S. 685, 56 S.Ct. 958, 80 L.Ed. 1405; and see, of course, Erie R. Co. v. Tompkins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed. 1188, 114 A.L.R. 1487. And if we thus found the guarantee to amount to an actual agreement between two creditors that the claim of one against the debtor should be subordinated to that of the other, we should give that effect to it, as was done in St. Louis Union Trust Co. v. Champion Shoe Machinery Co., 8 Cir., 109 F.2d 313; Bird & Sons Sales Corp. v. Tobin, 8 Cir., 78 F.2d 371, 100 A.L.R. 654; and Searle v. Mechanics' Loan & Trust Co., 9 Cir., 249 F. 942, certiorari denied 248 U.S. 592, 39 S.Ct. 67, 63 L.Ed. 437, even though there appears to be authority contra to the effect that the enforcement of such agreements, not amounting to assignment of a claim, is entirely collateral to the interests of the estate and outside the bankruptcy power. In re Railroad Supply Co., 7 Cir., 78 F.2d 530; In re Goodman-Kinstler Cigar Co., 32 A.B.R. 624; see Nixon v. Michaels, 8 Cir., 38 F.2d 420. Where the state law determines what the actual agreement made by the parties is, and therefore the real basis of their claims in bankruptcy, it must be given effect.

If, however, the matter is one of insolvent liquidation only, we have a different situation. It is a necessary implication of the requirement of a plan of reorganization that "it is fair and equitable and does not discriminate unfairly in favor of any class of creditors," Bankruptcy Act, former § 77B, sub.f(1), 11 U.S.C.A. § 207, sub.f(1), as it is a corollary of the strict priorities rule of Case v. Los Angeles Lumber Products Co., 308 U.S. 106, 60 S.Ct. 1, 84 L.Ed. 110, that a plan may not discriminate between different members of the same class of creditors or classify creditors arbitrarily, without due regard to their economic status as defined in their respective claims. See Southern Pacific Co. v. Bogert, 250 U.S. 483, 492, 39 S.Ct. 533, 63 L.Ed. 1099; 49 Yale L.J. 881, 882; 2 Gerdes, Corporate Reorganizations, 1682; Finletter, Bankruptcy Reorganization, 465. Similarly, Bankruptcy Act, § 65, sub. a, 11 U.S.C.A. § 105, sub. a, requires, in liquidation, the distribution of "dividends of an equal per centum" "on all allowed claims, except such as have priority or are secured." Moore v. Bay, 284 U.S. 4, 52 S.Ct. 3, 76 L.Ed. 133, 76 A.L.R. 1198; Globe Bank & Trust Co. v. Martin, 236 U.S. 288, 305, 35 S.Ct. 377, 59 L.Ed. 583; Sampsell v. Imperial Paper & Color Corp., 61 S.Ct. 904, 907, 85 L. Ed. 1293. The only departures made from the ordinary rule of equality are based on some very definite equity, such as fraud, Pepper v. Litton, 308 U.S. 295, 60 S.Ct. 238, 84 L.Ed. 281, mismanagement of the debtor by a parent corporation, Taylor v. Standard Gas & Electric Co., 306 U.S. 307, 59 S.Ct. 543, 83 L.Ed. 669, or concealment of a claim to the prejudice of another creditor, In re Bowman Hardware & Electric Co., 7 Cir., 67 F.2d 792. In the absence of such an equity, subordination is not a function of the bankruptcy court. Crowder v. Allen-West Commission Co., 8 Cir., 213 F. 177, 184; Sampsell v. Imperial Paper & Color Corp., supra; cf. Moise v. Scheibel, 8 Cir., 245 F. 546.

Notwithstanding the antithesis thus stated, the question might still remain somewhat more extensive than whether the New York rule is a mere rule of interpretation. For if it is a rule of law, but one attributing a certain legal result to a contract, that result must still be the basis of the bankruptcy claim — just as, for example, a New York contract of insurance must legally incorporate in itself provisions which may be directly opposed to the parties' actual intent. American Lumbermens Mut. Cas. Co. v. Timms & Howard, Inc., 2 Cir., 108 F.2d 497, 502. It is still the difference between finding out what the contract claim is as opposed to adjusting priorities among ascertained claims. But, however far the answer to such a question might take us, we need not determine it here, for the New York decisions emphasize that it is the intent of the parties which they are seeking to ascertain with the aid of a "presumption of intent derived from the guaranty of the assignor." The language just quoted is from In re Title & Mortgage Guaranty Co. of Sullivan County, supra 275 N.Y. 347, 9 N.E.2d 960, 115 A.L.R. 35, where the present Chief Judge has made the most extensive analysis of the subject of any of the cases and where he discusses not merely New York, but general, precedents. He finds that the rule "is supported by the weight of authority in this and other jurisdictions and produces an equitable result in accordance with the intent of the parties," that "the decisive test in every case is the intention of the parties, either as actually expressed, or as derived from the natural equity of the situation," and that "a presumption of such intent is derived from special equities," of which the guaranty seems to be the one most noted. 275 N.Y. pages 353-355, 9 N.E.2d page 960, 115 A.L.R. 35. In thus stating...