Grayson-Robinson Stores, Inc. v. SECURITIES AND EXCHANGE COM'N

• Decision Date: 06 June 1963
• Docket Number: No. 381,Docket 28191.,381
• Citation: 320 F.2d 940
• Parties: GRAYSON-ROBINSON STORES, INC., Debtor-Appellee, v. SECURITIES AND EXCHANGE COMMISSION, Appellant.
• Court: U.S. Court of Appeals — Second Circuit

320 F.2d 940 (1963)

GRAYSON-ROBINSON STORES, INC., Debtor-Appellee, v. SECURITIES AND EXCHANGE COMMISSION, Appellant.

No. 381, Docket 28191.

United States Court of Appeals Second Circuit.

Argued May 9, 1963.

Decided June 6, 1963.

Rehearing Denied August 20, 1963.

Richard V. Bandler, Asst. Regional Administrator, Securities and Exchange Commission, New York City (Peter A. Dammann, General Counsel, David Ferber, Associate General Counsel, Securities and Exchange Commission, Washington, D. C., Martin Mushkin, Attorney, Securities and Exchange Commission, New York City), for Securities and Exchange Commission.

Isidor E. Schlesinger (Schlesinger & Teller, New York City), for Ladd & Connecticut General Life Ins. Co.

Lloyd K. Garrison (Paul, Weiss, Rifkind, Wharton & Garrison, New York City, Neale M. Albert, Sanford I. Hansell, New York City, of counsel; Eugene Frederick Roth, New York City, Special Counsel to Debtor-in-Possession), for Grayson-Robinson Stores, Inc.

Ballon, Stoll, Shyman & Levine, New York City, and Phillips, Nizer, Benjamin, Krim & Ballon, New York City, for Creditors Committee.

Before FRIENDLY, KAUFMAN and MARSHALL, Circuit Judges.

Rehearing in Banc Denied August 20, 1963.

FRIENDLY, Circuit Judge.

The issue is the propriety of an order of Judge Edelstein, in the District Court for the Southern District of New York, denying a motion by the Securities and Exchange Commission (hereafter the SEC), to dismiss the petition of Grayson-Robinson Stores, Inc. (hereafter "Grayson" or "the debtor"), a large retail chain, for an arrangement under Chapter XI of the Bankruptcy Act unless the petition was amended or a new petition filed so that the proceedings would continue under Chapter X. The SEC's motion was supported and its appeal has been joined by Katherine B. Ladd and Connecticut General Life Insurance Company (hereafter referred to collectively as a single landlord), who have filed a claim based on Grayson's guarantee of a lease entered into by a subsidiary that has defaulted.¹ Weighing the conflicting considerations in the light of the controlling authorities, we have concluded to affirm.

The facts have been so painstakingly stated in Judge Edelstein's opinion, 215 F.Supp. 921, that we shall limit ourselves to the essentials:

Grayson, a California corporation, is a nation-wide chain selling women's and children's apparel. All the stores are separately incorporated, and many of them are operated under leases entered into by the subsidiary and guaranteed by the parent. Until October, 1962, Grayson also owned and operated a "Peerless-Willoughby" division engaged in the retail sale of photographic and audio equipment. Prior to November, 1960, the controlling stock interest in Grayson, some 32%, was owned by Hyman P. Kuchai and Philip S. Harris, who also controlled the S. Klein department stores. Until 1956 Grayson owned all the stock of Klein; in that year 92% was distributed to the debtor's stockholders.

On November 6, 1960, Kuchai and Harris entered into a contract to sell their stock in the debtor to Maxwell H. Gluck, who was and is sole owner of Darling Stores Corporation, another retail chain selling women's apparel. The consideration was $2,467,500, of which $715,575 was payable in cash at the closing and the balance on January 5, 1961. Kuchai and Harris made it a condition that Grayson be released from a guarantee of a 4¼% note of Klein to Prudential Insurance Company, then outstanding in the sum of $7,375,000, which imposed restrictions on both Klein and Grayson, with a breach by either working a default on both. This release was accomplished by a three-cornered transaction in which Grayson transferred to Klein the 8% of Klein stock (68,250 shares) owned by it, Prudential released Grayson from its guarantee, and Klein agreed to purchase the 4¼% $7,375,000 note. It financed the purchase by paying $1,350,000 and issuing a new 5.7% note in the amount of $6,775,000 to Prudential, which credited Klein with $6,025,000 against the 4¼% note and delivered to Klein for cancellation another 5¾% $750,000 note previously issued by Klein in place of a required prepayment on the 4¼% note.² At the annual meeting of Grayson's stockholders on November 23, 1960, Gluck, Stanley Roth (previously president of Darling), and Eugene F. Roth, an attorney, were elected as directors. Gluck became chairman of the board, and Stanley Roth, who resigned as president of Darling, became president. He told a special stockholders' meeting on December 19 that the new management was "sensitive to the need for developing added volume and profits" and that "Among others we have been giving some consideration to ways of accomplishing the objective by some arrangement with Darling Stores Corporation."

As a result of a study conducted by the well-known accounting firm, S. D. Leidesdorf & Co., a plan to that end was shortly evolved. Under this plan Grayson purchased all of Darling's inventory, supplies, and New York office equipment at the lower of cost or market, and agreed to operate Darling's stores and leased departments for a minimum of five years; the compensation for this service was set at 90% of the stores' "operating profits", which were to be determined without provision for general and administrative expense. The plan was embodied in an Operating Agreement entered into by Grayson and Darling on January 5, 1961 — the same day on which Gluck was obligated to pay Kuchai and Harris approximately $1,751,925 as the balance of the purchase price of the Grayson shares. This sum was in fact paid to Kuchai and Harris by or for the account of Darling, which thereby acquired a proportionate interest in the Grayson stock being purchased; Darling received $500,000 from Grayson on January 19, 1961, in part payment for the inventory, supplies, and equipment and another $750,000 on February 2. By a separate agreement dated January 6, 1961, Darling guaranteed that for 1961 Grayson's 90% of the operating profits would be no less than 6% of sales; however, liability under the guarantee was limited to $500,000, and it was further provided that any amounts charged to Darling under the guarantee would be recouped by it out of Grayson's 90% compensation in years subsequent to 1961. Darling was also to receive $210,000 on August 14, 1962, for certain fixtures purchased by it subsequent to the Operating Agreement and 0.92% of sales as a rental for fixtures earlier acquired.

The new management of Grayson embarked upon a substantial expansion program which took the form of opening leased departments to sell apparel in established discount stores — a method of operation in which Darling had already engaged and which was thought to have advantages in the way of lower capital and overhead costs more than compensating for the lower profit margin. This expansion imposed a severe strain on the debtor's working capital. It sought to alleviate this by increased loans from Bankers Trust Co., as security for which it pledged the stock and notes of its profitable photographic subsidiaries. In a further expansion move it agreed, on July 5, 1961, to buy from Shoe Corporation of America 51% of the stock of A. S. Beck Shoe Corporation for $4,900,000 of 5% convertible debentures (subordinated to bank and other borrowings but not to trade creditors), and to purchase Beck shares from other stock-holders on the same terms. The Shoe Company shares were acquired on December 4, 1961, the Gluck management took control of Beck on December 15, and 33 shoe departments selling Beck shoes were later opened in Grayson or Darling locations.

This rapid expansion without increase of the equity base or other long-term financing proved to be unwise. As stated in Grayson's Annual Report for the year ended July 28, 1962, early in 1962 "Pressure to liquidate the major bank loan developed. When knowledge of this pressure became public, serious limitations in trade credit resulted. The flow of merchandise, which is the life blood of the business, was gravely affected." In an effort to meet its problems, Grayson placed a $10,000,000 convertible debenture issue in registration with the SEC on January 26, 1962, and also a $4,702,500 issue of subordinated convertible debentures to be offered to the minority stockholders of Beck pursuant to the agreement with Shoe Corporation of America. However, the registrations had not been completed when the stock market experienced its radical decline in May, 1962, whereupon the underwriter of the $10,000,000 issue withdrew; both registration statements were subsequently withdrawn. Meanwhile, on March 14, 1962, Grayson secured a $2,500,000 six-month loan at 6% from Schroder Trust Company secured by pledge of the Beck stock and a personal guarantee of Gluck collateralized by deposit of $1,000,000 in other securities; on March 26 it borrowed another $2,500,000 for one year from James Talcott, Inc., at 1/30% per day, secured by customer accounts receivable of 130 stores. Despite all this, debts to trade creditors mounted to $10,000,000, and the flow of merchandise was drastically curtailed.³ On August 14 a petition under Chapter XI was filed.

On August 20 a Creditors' Committee of 40 persons was elected at a creditors' meeting. One of its co-chairmen represented American Credit Indemnity Co., with a claim of $350,000; the other members were merchandise suppliers with claims of varying amounts, and a representative of display fixture creditors, the total claims represented by committee members being some $2,381,000. At the suggestion of Referee Herzog, a sub-committee of 13 was chosen to act as the Official Creditors' Committee under § 338 of the Bankruptcy Act. The Committee retained counsel and accountants to investigate the debtor's affairs, and a merchandising subcommittee supervised purchases to insure that the debtor did not over-commit itself. With the approval of the court the photographic subsidiaries were sold for approximately...