In re Phoenix Hotel Co., Lexington, Ky.

• Decision Date: 26 October 1935
• Docket Number: No. 907.,907.
• Citation: 13 F. Supp. 229
• Parties: In re PHŒNIX HOTEL CO., LEXINGTON, KY.
• Court: U.S. District Court — Eastern District of Kentucky

13 F. Supp. 229

In re PHŒNIX HOTEL CO., LEXINGTON, KY.^*

No. 907.

District Court, E. D. Kentucky.

October 26, 1935.

Stoll, Muir, Townsend & Park and S. S. Yantis, all of Lexington, Ky., for Roy Carruthers, trustee.

Hunt & Bush and Rufus Lisle, all of Lexington, Ky., for Security Trust Co., trustee for bondholders.

Allen, Duncan & Duncan, of Lexington, Ky., for Union Bank & Trust Co., executor.

Frank Ginocchio, of Lexington, Ky., for R. L. and Auval Baker.

FORD, District Judge.

This is a proceeding for the reorganization of the Phœnix Hotel Company of Lexington, Kentucky, under the provisions of sections 77A and 77B of the Bankruptcy Act (11 U.S.C.A. §§ 206, 207).

The petition was approved by the court and a trustee was duly appointed and qualified with power to operate the business and affairs of the debtor under the orders of the court.

The trustee was directed to report to the court all claims filed against the estate of the debtor and to classify the claims and report the respective priorities as between the various classes of claims.

It appears that the debtor, the Phœnix Hotel Company, is a corporation organized and existing under the laws of Kentucky and engaged principally in the business of conducting and operating a hotel in the city of Lexington, Ky.

The company was originally incorporated in 1891. On the 19th day of December, 1921, the original articles of incorporation were amended authorizing an increase in the capital stock of the company by the amount of $1,000,000 par value by the issue of first preferred stock to the amount of $750,000 and second preferred stock to the amount of $250,000, and further providing for the conversion of both classes of said stock into bonds or other obligations of the corporation, upon such terms as might be prescribed by the board of directors.

Pursuant to these amended articles and in accordance with appropriate resolutions of the stockholders and board of directors, the company issued and sold $750,000 par value of the first preferred stock and $250,000 par value of the second preferred stock and at the same time executed first and second mortgages to the Security Trust Company of Lexington, Ky., as trustee, covering all of the company's real estate, furniture, fixtures, and machinery. The first mortgage was to secure the payment of 750 first refunding and improvement gold bonds of the par value of $1,000 each due and payable January 1, 1947, and bearing interest at the rate of 6 per cent. per annum from January 1, 1922, payable semiannually. The second mortgage was to secure an issue of 250 second improvement gold bonds of the par value of $1,000 each, due and payable on the first day of January, 1947, bearing interest at the rate of 7 per cent. per annum from the first day of January, 1922, payable semiannually.

The bonds described in each of the said mortgages were executed and delivered to the trustee simultaneously with the execution of the mortgages.

The first mortgage provided that the bonds executed and delivered to the trustee and described in said mortgage should be held, issued, and used by said trustee only for the purpose of being exchanged, par for par, for shares of the first preferred stock of the company, in multiples of ten, upon proper presentation and surrender of said stock.

The second mortgage provided that the bonds executed and delivered to the trustee and described in said mortgage should be held, issued, and used by said trustee only for the purpose of being exchanged, par for par, for shares of the second preferred stock of the company, in multiples of ten, upon proper presentation and surrender of said stock.

The certificates evidencing the first preferred stock contained the stipulation that the shares of stock represented thereby, in multiples of ten, might be converted, at the election of the holder, into first refunding and improvement mortgage bonds described in and secured by the said first mortgage, and the certificates evidencing the second preferred stock contained the same option of conversion into second mortgage bonds.

Prior to 1933, the company became indebted to R. L. Baker in the sum of $50,000, to Auval Baker in the sum of $50,000 and to Miss Elizabeth Stanhope in the sum of $49,500, for money loaned the company for use in the operation of its business. All of said debts are evidenced by promissory notes of the company.

The company is also indebted upon open accounts to numerous creditors to the extent of approximately $19,000 in the aggregate.

In 1933 most of the holders of the first preferred stock exchanged their stock for first mortgage bonds and in 1934 a large number of the holders of the second preferred stock likewise exchanged their stock for second mortgage bonds.

The trustee has reported to the court these claims together with his recommendation and opinion that the preferred stockholders who have converted their stock into first mortgage bonds are entitled, by virtue of said mortgage, to a first and prior lien upon the assets of the company, superior to the claims of all other creditors of the company and that the second preferred stockholders who have converted their stock into the second mortgage bonds are entitled to be adjudged a lien inferior to the first mortgage bondholders but prior and superior to all other creditors.

To this report of the trustee, R. L. Baker, who holds an unsecured note of the company for $50,000, Auval Baker, who holds an unsecured note of the company for $50,000, and the Union Bank & Trust Company, as executor of Miss Elizabeth Stanhope, which holds an unsecured note for $49,500, have filed exceptions.

Obviously the approval of any plan of reorganization must await the determination of the relative rights of priority as between these preferred stockholders who have converted their stock into bonds and the general creditors of the corporation.

The contentions of the general creditors, constituting the basis for their exceptions to the report of the trustee, and their claim to priority are (1) that all provisions of the contract or arrangement, hereinabove referred to, between the company and its preferred stockholders, by the terms of which the preferred stockholders purported to acquire a lien upon or any right to the assets of the company superior to the rights of general creditors or even upon an equality with them, were entirely unauthorized by the laws of Kentucky, are in direct violation of section 560 of the Statutes of Kentucky, and are contrary to the public policy of the state; and (2) that the issuance of bonds of the company in exchange for preferred stock at the time and in the manner disclosed in this record was in contravention of section 193 of the Constitution of Kentucky.

The preferred stockholders who have exchanged their stock for bonds, claiming priority by virtue of the mortgages securing their bonds, rest their claims entirely upon the powers, expressly and by necessary inference, conferred upon corporations by the terms of section 564-1 of the Statutes of Kentucky, the pertinent provisions of which are as follows: "Any corporation organized under this law may divide its shares into classes, such as preferred, common and deferred shares, * * * and it may give to each of the several classes such priority of right * * * in the redemption of the shares, as may be prescribed in the rules and regulations adopted by the shareholders; and may provide * * * that holders of its preferred stock shall be entitled, upon terms prescribed by it, to convert the same into the bonds or other obligations of the corporation."

This case involves no question arising under the Constitution or Statutes of the United States or of general or commercial law. The questions to be decided concern only the laws and the public policy of the state of Kentucky relative to the powers of corporations created under state statutes and deriving their powers therefrom. It appears to be a settled rule of federal jurisprudence that it is exclusively the province of the highest court of the state to decide questions so distinctly local, and when so decided the federal courts, sitting in that state, will adopt and follow such decisions without question. This rule seems to be especially applicable to cases involving interpretation of state statutes defining and limiting the powers of corporations created and existing under state laws, and the nature and extent of the rights and interests of stockholders and creditors in and to the property of such corporations. The ordinary administration of the law in such matters is carried on by the state courts. By the course of their decisions certain rules of interpretation are established and public policies declared which have all the effect of law. When so established and declared by the highest court of the state, they are regarded by the federal courts as authoritative and controlling declarations of what the law is in that state. Elmendorf v. Taylor, 10 Wheat. 152, 6 L.Ed. 289; Burgess v. Seligman, 107 U.S. 20, 2 S.Ct. 10, 27 L.Ed. 359; Hawks v. Hamill, 288 U.S. 52, 53 S.Ct. 240, 77 L.Ed. 610; Petition of Stuart et al. (C.C.A.) 272 F. 938; Keystone Wood Co. v. Susquehanna Boom Co. (C. C.A.) 240 F. 296, and Hughes Federal Practice, §§ 3692-3700.

Only in the absence of a decision of the state court applicable to the questions under consideration will the federal courts exercise their independent judgment upon such questions of local law.

Acting in accordance with this rule, founded as it is, not only upon comity, but upon the necessity of avoiding, if possible, the anomalous and confusing results which would arise from lack of harmony between two co-ordinate jurisdictions dealing with purely local matters in the same territory, we turn to the consideration of the decisions of the Kentucky Court of Appeals.

In the case of Rider v. John G. Delker & Sons Co., 145 Ky. 634, 140 S.W. 1011, 1012, 39 L.R.A.(N.S.) 1007, the...