In re Commonwealth Light & Power Co.

• Decision Date: 06 April 1944
• Docket Number: No. 8126.,8126.
• Citation: In re Commonwealth Light & Power Co., 141 F.2d 734 (7th Cir. 1944)
• Parties: In re COMMONWEALTH LIGHT & POWER CO. et al. BACHRACH v. CENTRAL HANOVER BANK & TRUST CO.
• Court: U.S. Court of Appeals — Seventh Circuit

141 F.2d 734 (1944)

In re COMMONWEALTH LIGHT & POWER CO. et al.BACHRACH v.CENTRAL HANOVER BANK & TRUST CO.

No. 8126.

Circuit Court of Appeals, Seventh Circuit.

February 25, 1944.

Rehearing Denied April 6, 1944.

Robert Bachrach and Moses, Kennedy, Stein & Bachrach, all of Chicago, Ill., for trustee.

Robert N. Golding, of Chicago, Ill., for Middle West Corporation.

Perry M. Chadwick, of Chicago, Ill., for Guaranty Trust Co. of New York.

James G. Culbertson and Joseph H. Hinshaw, both of Chicago, Ill. (Oswell G. Treadway, of Chicago, Ill., of counsel), for Arthur E. Swanson, Kellogg Logsdon, and Gary Barthell.

Thomas B. Hart, John I. Mayer, and Edward P. McGuire, all of Chicago, Ill., John F. Davis, Sol., and Homer Kripke, Asst. Sol., both of Philadelphia, Pa., and Morton E. Yohalem, Special Counsel, Public Utilities Division, of New York City, Theodore L. Thau, of Philadelphia, Pa., for appelleeSecurities and Exchange Commission.

Irwin T. Gilruth and Gilruth & Beck, all of Chicago, Ill., and Frank H. Heiss and Rathbone, Perry, Kelley & Drye, all of New York City(A. M. Lewis and Frederick W. Doolittle, Jr., both of New York City, of counsel), for appelleeCentral Hanover Bank & Trust Co.

Before SPARKS, KERNER, and MINTON, Circuit Judges.

KERNER, Circuit Judge.

We have here an appeal from an order of the District Court in the reorganization of Inland Power & Light¹ Corporation, regarding the allocation of $1,045,134.24 — the proceeds of the sale of the common stock of Michigan Public Service Company — to the bonds issued by Inland of which Central Hanover Bank and Trust Company is indenture trustee and pledgee.

Appellant, Guaranty, as trustee under a certain trust agreement made by Inland and covering Inland's unsecured debentures, and the unsecured creditors, Middle West and Bachrach, as trustee of Commonwealth, and appellees, the bondholders, secured creditors of Inland, and the S.E.C. are in a bankruptcy court, asserting claims against Inland to a fund representing the proceeds of assets of Inland's estate.

At the time of these proceedings all of the common stock of Michigan was owned by Inland, all of the common stock of Inland was owned by Commonwealth, and all of the common stock of Commonwealth was owned by Middle West and one of its subsidiaries.Middle West holds claims against Inland consisting of $288,100 of Inland's unsecured debentures and $1,160,600 of Inland's bonds.Commonwealth holds an unsecured claim against Inland for $3,449,647 and Middle West holds 85% of all of Commonwealth's indebtedness.

In 1934, proceedings for the reorganization of Commonwealth, the parent, and Inland, the subsidiary, were instituted under § 77B of the Bankruptcy Act, 11 U.S.C.A. § 207, to supersede prior equity receiverships of the two companies.These proceedings were, by order of the court, consolidated.

Inland, on April 1, 1927, owned all of the common stock of Michigan.This stock, Inland pledged with Central to secure Inland Bonds in the par amount of $4,782,500.In addition, Inland, on September 27, 1940, owned, as part of its unpledged assets, demand notes of Michigan in the principal amount of $620,132.24.September 12, 1940, the trustee of Inland filed a petition or application for leave to sell the common stock of Michigan and to sell or cancel the Michigan demand notes.September 27, 1940, the District Court directed Inland's trustee to surrender to Michigan, for cancellation, the demand notes, and ordered that the Michigan stock be sold for $1,045,134.24, and reserved for future disposition all questions relating to the allocation of the proceeds of the sale between the stock and the demand notes.

On November 20, 1940, upon the petition of the trustee of Commonwealth, the court entered a rule to show cause why the demand notes should not be first paid out of the fund of $1,045,134.24.Answers were filed thereto by Central, as trustee of the Inland bond indenture under which the stock had been pledged, and by a committee for Inland Bonds, and by the S.E.C., asserting that the entire proceeds of sale should be allocated to the Michigan common stock.

The issues thus raised were referred to a master.He heard the evidence and filed his report in which he found facts from which he concluded that Inland, having pledged the Michigan stock as security for its bonds and having sold such bonds on the strength of such security, owed a fiduciary duty to its bondholders as pledgees not to exercise its control of Michigan to serve its own interest at the expense of the bondholders as such pledgees; that Inland had failed to observe the standard of conduct imposed by that relationship, and had, instead, organized, managed, and controlled Michigan as best served its own interest; that such control and management resulted in a dilution of the value of the Michigan stock and a consequent injury to Inland bondholders as pledgees thereof; and that because of the breach of its fiduciary duty, its claim must be subordinated to the claims of the bondholders.The District Court adopted the master's findings of fact, overruled exceptions and objections to the report, and entered a decree that the $1,045,134.24 be subjected to the lien of the indenture securing the Inland Bonds and that the claim of Inland be subordinated to the claims of the holders of Inland Bonds.From that decree, this appeal is prosecuted.

Appellant Guaranty makes the point that the District Court was without jurisdiction to pass upon the claim of Inland based on the demand notes.It admits that the court had jurisdiction to pass upon the claims of Inland's creditors against the assets of Inland, to allow or disallow them or to subordinate one to another, but it argues that since the court was not administering the assets of Michigan, it had no jurisdiction to adjudicate a claim by Inland on the notes.

A bankruptcy court is essentially a court of equity, applying principles and rules of equity jurisprudence.It is empowered to allow or disallow claims and to determine controversies in relation thereto, and has full power to inquire into the validity of any claim asserted against the estate and to sift the circumstances surrounding any claim, to see that injustice or unfairness is not done in the administration of the bankrupt estate.Pepper v. Litton, 308 U.S. 295, 304-308, 60 S.Ct. 238, 84 L.Ed. 281.The demand notes were a part of the Inland estate, which estate was being reorganized in a court of equity possessing ample powers for the exigencies of varying situations.American United, etc., v. City of Avon Park, 311 U.S. 138, 146, 61 S.Ct. 157, 85 L.Ed. 91, 136 A.L.R. 860.But Michigan was not a necessary party to the reorganization, Equitable Trust Co. v. Denney, 7 Cir., 24 F.2d 169, and the fact that Michigan was not in bankruptcy did not preclude the parties who were before the court from claiming property which was within the jurisdiction and custody of the court.The Inland bondholders were parties to the reorganization proceedings and were entitled to participate in the reorganization in order to obtain the full value of their security.The debenture-holders were also parties to the proceedings, asserting their claim to Inland's assets.With these parties before it, the court considered the respective equities of the claimants in the proceeds of the sale of the Inland estate and determined that the equities were with the bondholders.Under this state of the record we see no lack of jurisdiction.

On the facts found by the master, most of which came into the record by stipulation and are not in dispute, all of the appellants contend that under the facts the doctrine of equitable subordination, upon which the District Court based its decision, is not applicable.

On the other hand, appellees, in support of the order, contend that Inland mismanaged Michigan through its dividend and depreciation policies and by its failure to make provision for sound financing of Michigan's expansion program and by creating an enormous debt and issuing preferred stock ahead of the pledged stock, committed a breach of its fiduciary duty to its pledgees, and, since the entire proceeds of the sale are necessary to make Inland bondholders whole, the notes, because of the superior equities of the bondholders, must be subordinated to the common stock of Michigan.

It is true that Inland, by reason of its entire ownership and control of Michigan, occupied a fiduciary position requiring scrupulous observance of its obligations to safeguard and preserve the interest of Inland Bonds, and owed to its bondholders, a duty not to impair the value of the Michigan stock.²And where there is a violation of those principles, equity will undo the wrong.Pepper v. Litton, 308 U.S. 295, 311, 60 S.Ct. 238, 84 L.Ed. 281.

This brings us to the questions of law and fact which the District Court decided in entering the order challenged.

As already indicated, the master found that Inland, having pledged Michigan stock as security for its bonds which were sold on the strength of such security, owed a fiduciary duty to its bondholders as pledgees, not to exercise its control of Michigan to serve its own interest at the expense of the bondholders as such pledgees; and that Inland so managed and controlled Michigan as best served its own interest, resulting in a dilution of the value of the Michigan stock to the injury of the bondholders as pledgees.

In view of the contentions made, it is clear that the decisive questions are (1) did Inland so exercise its control of Michigan as to impair the security of the Inland Bonds in violation of its fiduciary duty to its bondholders; and (2) whether the court erred in subordinating Inland's claim on the notes to the bondholders' claim on the Michigan stock with respect to the fund derived from the cancellation of the notes and the sale of the stock.There are, however, other issues which will be discussed in the opinion.

The...