In re Brunner Air Compressor Corp.

• Decision Date: 15 July 1968
• Docket Number: No. 66-BK-530.,66-BK-530.
• Citation: 287 F. Supp. 256
• Parties: In the Matter of BRUNNER AIR COMPRESSOR CORP., Bankrupt.
• Court: U.S. District Court — Northern District of New York

287 F. Supp. 256

In the Matter of BRUNNER AIR COMPRESSOR CORP., Bankrupt.

No. 66-BK-530.

United States District Court N. D. New York.

July 15, 1968.

COPYRIGHT MATERIAL OMITTED

Laurence F. Sovik, of Smith, Sovik, Terry, Kendrick, McAuliffe & Schwarzer, Syracuse, N. Y., for Trustee.

Bruce B. Roswig, of Costello, Cooney & Fearon, Syracuse, N. Y., for debenture holders H. S. Sheble, and others, Estate of J. H. Sheble and R. N. Sheble.

Richard Kehoe, of Ferris, Kehoe, Tenney & Murname, Utica, N. Y., for debenture holders Anthony J. Barrett, Ellen M. Cooney, Frank M. Dulan, William J. Hogenkamp, Gertrude F. Karl, John F. Karl, Robert Costello and Annamary Costello.

TIMBERS, District Judge.^*

QUESTION PRESENTED

In this proceeding, pursuant to Section 39c of the Bankruptcy Act, 11 U.S.C. § 67(c) (1964), on petitions to review an order of Honorable David J. Goldstein, Referee in Bankruptcy, entered November 13, 1967, the question presented is whether the Referee erred in subordinating claims of certain debenture holders of the debtor, Brunner Air Compressor Corp., to claims of general unsecured creditors upon the ground that advances of the debenture holders were in reality capital contributions rather than loans.

The Court holds (1) that there was substantial evidence to support the Referee's finding that the debtor corporation was undercapitalized from June 13, 1963, the date of its organization, to the date of bankruptcy, and as to that finding the order of the Referee is affirmed; but (2) with respect to the Referee's conclusion that the claims of the debenture holders¹ should be subordinated to the claims of general unsecured creditors, the order of the Referee is reversed and the case is remanded to the Referee with instructions (a) to dismiss the trustee's subordination petition of July 6, 1967 as to the claims of all debenture holders who at no time were officers or directors of the debtor, and (b) to hold a further hearing and make appropriate findings, conclusions and an order, not inconsistent with this opinion, with respect to those debenture holders who at any time were officers or directors of the debtor, for the purpose of determining the ability and intent of any such officers or directors, or combination thereof, to dominate the corporation to their advantage and to the detriment of creditors.

FACTS

The debtor, Brunner Air Compressor Corp., was organized as a New York corporation on June 13, 1963, to manufacture and sell a line of air compressors. It opened a place of business in Chadwicks, New York, and began doing business in early 1964.

The board of directors at its first meeting on June 14, 1963 authorized the issuance and sale, through a private offering, of 20,000 shares of common stock, par value $1.00; it also authorized the issuance and sale in like manner of 6% subordinated debentures in units of $500, due December 31, 1968, in an aggregate principal amount of $300,000.

The stock and debentures were purchased for the most part by the same individuals at cost ratios ranging from approximately 1:10 to 1:25, that is, cost of stock to debentures. Some 37 separate individuals purchased securities during the period 1963-1966 (mostly during 1963 and 1964); of these, 30 purchased stock and debentures, 4 purchased only stock and 3 purchased only debentures. No stockholder owned more than 14% of the stock; that was the Estate of J. H. Sheble which purchased $2700 of stock and $36,250 of debentures. The company's financing raised $19,630 from the sale of stock, $188,750 from debentures and $75,000 from a bank loan in May 1964 from the Marine Midland Trust Company of the Mohawk Valley, participated in by the Small Business Administration.²

The debentures³ were sold upon the express understanding that they were subordinated to "all Senior Indebtedness, as hereinafter defined." This was the only condition of subordination in the debentures. "Senior Indebtedness" was defined in the debentures as "the principal of, and interest on, indebtedness heretofore or hereafter incurred by the Company for money borrowed from banks, trust companies, insurance companies and other financial institutions and investing organizations, evidenced by notes, bonds, debentures or similar obligations and any and all renewals, extensions, refundings, amendments and modifications of any of the foregoing." In short, so far as the issues here are concerned, there is no present indebtedness of the debtor to which the debentures by their terms are subordinated.

In all respects, the debentures have the indicia of the conventional debenture bond. They are payable in a fixed sum, at a fixed time and at stated interest due in specified installments. Payment of interest is in no way dependent on earnings. They have standard default, redemption and acceleration clauses. They are subordinated by their terms to only one class of indebtedness. The debenture holders are given no rights to control. The debentures have none of the characteristics of stock.

Some debenture holders were officers and directors; but the composition of the officers and directors changed in part during the company's existence.

The debtor lost money continuously from the time it started operations until it went into bankruptcy in May 1966. By December 1964, at least some members of the board of directors felt that lack of working capital was holding back the company.

The debtor was adjudicated a bankrupt as a result of an involuntary petition filed in May 1966. Among the petitioning creditors were two debenture holders. The debentures were then in default for non-payment of interest.

The trustee in bankruptcy, William A. Schmitt, during the summer of 1966 completed a sale of the debtor's business as a unit, from the proceeds of which the Marine Midland and SBA loans were paid off.

The instant proceedings to expunge the claims of the debenture holders or to subordinate them to the claims of general unsecured creditors were instituted before the Referee in July 1967.

PROCEEDINGS BEFORE REFEREE

Upon petition of the trustee, the Referee on July 6, 1967 issued an order to show cause, returnable July 19, requiring certain named debenture holders to show cause "why their claims filed herein should not be either expunged or subordinated to all other claims of general unsecured creditors as being in fact and effect capital contributions to the Bankrupt and not loans as asserted in their claims filed herein."

At the July 19 hearing before the Referee, the trustee called one witness, George W. Ledermann, secretary and later treasurer of the company. Through him, the trustee introduced a copy of the debenture, certain books of account, corporate records and financial statements of the company. Ledermann also testified in explanation of certain portions of the books and records. The trustee then rested. Counsel for the debenture holders moved to dismiss the trustee's petition on the ground that he had failed to prove his case. The Referee did not act on that motion, but adjourned the matter to August 9.

At the resumed hearing on August 9, the trustee again stated that he had rested his case and moved "for an order subordinating the claims of those persons who haven't appeared today." The Referee replied, "Well, they're not appearing, you may take your order as far as they're concerned. They've been on notice." Actually, the record indicates that the trustee's petition in support of the order to show cause issued on July 6 had never been served on any of the debenture holders; and the record is bewildering, to put it mildly, as to who actually entered appearances for which debenture holders.⁴ The matter was further adjourned to August 30.

At the final hearing on August 30, William F. Ryan, a debenture holder who also owned stock, testified that he had bought his debentures and stock through an acquaintance who represented to him that the company would be a good investment. The trustee reasserted that he had rested. Counsel for the debenture holders renewed his motion to dismiss the trustee's petition on the ground that he had failed to prove facts to sustain the order to show cause. The Referee again did not act on the motion, but granted leave to all parties to submit briefs which in due course were filed.

The Referee on October 30 filed his decision setting forth findings of fact and conclusions of law. On November 13, the Referee entered his order that the claims of all debenture holders, except that of Utica General Jobbing Foundry, Inc. (see note 1, supra), "are in equity subordinated in dividend distribution to the claims of general unsecured creditors."

Timely petitions to review the Referee's order of November 13 have been filed by the debenture holders on whose behalf appearances in this Court are noted above.

CLAIMS OF THE PARTIES

The position of the trustee essentially is that, since the debtor's books indicate that the company was undercapitalized from its inception, the advances by the debenture holders (who for the most part are also stockholders) were contributions to capital rather than loans; and therefore it would be inequitable to accord to the debenture holders a parity with the general unsecured creditors. The trustee argues that broad equitable principles, under the circumstances here presented, "prevent the depletion of the dividend to general creditors who have never been insiders and who have no first hand knowledge of the bankrupt's capital structure by requiring them to share the estate with those very persons who launched the corporation on its unsuccessful venture and who, had it been successful, would have been the profiteers".

The position of the debenture holders, on the other hand, may be briefly summarized: mere identity of debenture holders and stockholders does not invalidate a bona fide debt; undercapitalization is not established solely by corporate records that show a low debt-equity ratio; even assuming thin...