In re Phoenix Hotel Co. of Lexington, Ky.

• Decision Date: 13 May 1936
• Docket Number: No. 7319.,7319.
• Citation: 83 F.2d 724
• Parties: In re PHŒNIX HOTEL CO. OF LEXINGTON, KY. SECURITY TRUST CO. et al. v. BAKER et al.
• Court: U.S. Court of Appeals — Sixth Circuit

83 F.2d 724 (1936)

In re PHŒNIX HOTEL CO. OF LEXINGTON, KY.

SECURITY TRUST CO. et al. v. BAKER et al.

No. 7319.

Circuit Court of Appeals, Sixth Circuit.

May 13, 1936.

J. R. Bush, of Lexington, Ky. (Hunt & Bush, George R. Hunt, Rufus Lisle, A. S. Moore, and D. C. Hunter, all of Lexington, Ky., E. B. Rose, of Beattyville, Ky., and S. S. Carrick, William B. Gess, and Job D. Turner, Jr., all of Lexington, Ky., on the brief), for appellants.

Frank S. Ginocchio and Henry Duncan, both of Lexington, Ky. (Frank S. Ginocchio and Allen, Duncan & Duncan, all of Lexington, Ky., on the brief), for appellees.

Before MOORMAN, HICKS, and SIMONS, Circuit Judges.

SIMONS, Circuit Judge.

In a debtor proceeding for reorganization under sections 77A and 77B of the Bankruptcy Act (11 U.S.C.A. §§ 206, 207), this controversy arose as between preferred stockholders of the debtor corporation who had converted their stock into bonds, and unsecured creditors who had become such prior to the conversion. Decision requires construction of Kentucky corporation law, and more particularly of section 564, which as amended by an act of 1910 (chapter 79) has become section 564-1, Kentucky Statutes. The District Court denied priority to the bonds and their holders have appealed both under sections 24a and 24b, as amended by Act May 27, 1926, § 9 (11 U.S. C.A. § 47 (a, b). Since a question of law is presented cognizable within the narrower scope of section 24b, we find it unnecessary to determine which mode of appeal was proper.

Section 564 was part of the general corporation law of Kentucky enacted in 1893, and conferred upon corporations powers in respect to the issue of preferred stock, its priority, the manner of its increase or decrease, and the payment of dividends thereon. The act of 1910 (chapter 79) purported to enlarge the corporate powers to the extent that a corporation "may provide that the holders of its bonds shall be entitled, upon terms prescribed by it, to convert the same into the stock of the corporation, whether common or preferred, and 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." Section 1 (Ky.St. § 564-1). To the amendatory act was added an immediate effect clause which reads: "In view of the necessity for speedily providing a means to enable corporations to secure the necessary funds for developing their property by giving to those who may purchase their stock and bonds the right of conversion herein granted, an emergency is declared to exist." Section 2.

On December 19, 1921, the debtor's articles of incorporation were amended to create a capital structure consisting of $650,000 of common, $750,000 of first preferred, and $250,000 of second preferred stock. It was also provided that both classes of preferred stock might be converted into bonds or other obligations upon terms to be prescribed by the board of directors. On January 2, 1922, the debtor executed and delivered to the Security Trust Company as trustee two mortgages upon all of its real estate and other assets. The first mortgage was to secure bonds in the amount of $750,000, to be held, issued, and used by the trustee for the purpose of exchanging them for shares of first preferred stock; and the second mortgage, made subordinate to the first, was to secure $250,000 of bonds to be exchanged for second preferred stock. Both mortgages were recorded. All of the new stock was sold during 1922 at par, the preferred stock certificates incorporating provisions for their conversion into mortgage bonds. Contemporaneously with the execution of the mortgages the debtor executed the bonds of each class and placed them in the hands of the trustee for the indicated purpose.

No preferred shares were converted into bonds until the period between May 20, 1933, and October 22, 1934, during which substantially all first preferred stockholders, and a majority of second preferred stockholders, exercised their right of conversion. Prior to that, however, in 1931 and 1932, the contesting creditors had made advances to the debtor, evidenced by unsecured notes. A trustee appointed by the court in the debtor proceeding marshaled the claims against it, reporting the bonds as valid secured claims entitled to priority over the note holders to the extent of the respective mortgage liens. Exceptions being filed to the report of the trustee in respect to priority, they were sustained and a decree entered subordinating the bonds to the notes, though otherwise adjudging them valid and secured.

Briefly, the contention of the appellants is that whatever may have been the public policy of the state with respect to the rights of stockholders as against creditors prior to the enactment of the 1910 statute, that act marked a change in state policy, with its purpose indicated by the immediate effect clause; that the effect of the change was to permit corporations to issue preferred stock convertible into bonds secured by mortgage upon the corporation's property and having priority over all other debts; that this authority was exercised in conformity with the statute by the present debtor, and resulted in a contract between it and its preferred shareholders whereby the right to convert the shares into bonds attached to the certificates upon their issue; and that such right may not be subordinated to other claims whether such arose prior to or after the conversion of the stock into bonds. This, it is said, is the necessary meaning of the 1910 amendment; for if it means less it means nothing; since all other rights of preferred stockholders could have been granted to them under the original statute, and so under familiar rules of statutory construction the amendment must be construed as contemplating a change in the law; for we may not impute to the legislature a merely vain enactment.

The precise question here involved has never been decided in the Kentucky courts. Many local decisions are cited and discussed in the briefs, but none involves conflicting claims of preferred stockholders who have converted their shares into bonds and antecedent creditors. Most of the Kentucky cases are sufficiently reviewed in the opinion of the District Judge (13 F. Supp. 229), and no purpose will be served by analyzing them here. Under settled principles we view state precedents as authoritative only to the extent of the precise questions decided. Ne-Bo-Shone Association, Inc., v. Hogarth, 81 F.(2d) 70 (C.C.A.6); Philadelphia National Bank v. Raff, 76 F.(2d) 843 (C.C.A.6). The question here is one of first impression.

It is a fundamental rule of...