In re Prudence Bonds Corporation

• Decision Date: 08 August 1935
• Docket Number: No. 388.,388.
• Parties: In re PRUDENCE BONDS CORPORATION (PRESIDENT AND DIRECTORS OF MANHATTAN CO. et al., Appellants).
• Court: U.S. Court of Appeals — Second Circuit

79 F.2d 212 (1935)

In re PRUDENCE BONDS CORPORATION (PRESIDENT AND DIRECTORS OF MANHATTAN CO. et al., Appellants).

No. 388.

Circuit Court of Appeals, Second Circuit.

August 8, 1935.

Mudge, Stern, Williams & Tucker, of New York City (Joseph V. Kline, of New York City, of counsel), for appellant President and Directors of the Manhattan Co.

Cullen & Dykman, of Brooklyn, N. Y. (Ralph W. Crolly, of Brooklyn, N. Y., of counsel), for appellant Brooklyn Trust Co.

Powell & Ruch, of New York City (Frederick J. Powell, of New York City, of counsel), for appellee debtor.

George C. Wildermuth, of Brooklyn, N. Y., for appellees Charles H. Kelby and Clifford S. Kelsey, trustees of debtor.

Archibald Palmer, of New York City (Harry D. Glicksman and Sydney Basil Levy, both of New York City, on the brief), for appellees intervening creditors.

Before MANTON, SWAN, and CHASE, Circuit Judges.

SWAN, Circuit Judge.

On June 29, 1934, Prudence-Bonds Corporation, existing under the Stock Corporation Law of New York (Consol. Laws N. Y. c. 59), filed a petition for reorganization under section 77B of the Bankruptcy Act (11 USCA § 207). The petition was approved on the same day, with the usual clauses providing for a stay of suits pending against the debtor and for an injunction against the enforcement of liens upon its property. The debtor had outstanding eighteen issues of bonds and fifty-four issues of mortgage participation certificates. Each of the bond issues is secured by a trust indenture under which the debtor assigned to the indenture trustee real estate mortgages. The appellant Brooklyn Trust Company is trustee under an indenture securing the bond issue known as the "eighth series" of the debtor's first mortgage collateral 5½ per cent. bonds. Each issue of certificates represents undivided participating interests in a bond and mortgage which have been deposited by the debtor with a bank or trust company as depositary. The appellant Manhattan Company, as depositary under an agreement and by assignment from the debtor, holds title to the underlying bond and mortgage on Hotel Taft against which were issued participation certificates known as the Taft issue. The debtor is under no obligation to pay principal or interest of the certificates. They are guaranteed by Prudence Company, Inc., an affiliate of the debtor. At the date the petition was filed, there was pending in the Supreme Court of New York a suit by the Manhattan Company to foreclose the Taft mortgage and to recover from the Prudence Company, Inc., on its guaranty of the Taft certificates. On November 22, 1934, after a hearing on the petition of counsel for certain bondholder creditors of the debtor to determine the court's jurisdiction under section 77B over the fifty-four certificate issues, the District Court entered an order upholding its jurisdiction over the "outstanding mortgage participation certificate issues of the Debtor, as well as its outstanding issues of bonds." The Manhattan Company appeared specially to oppose the taking of jurisdiction over the Taft certificates and the Taft mortgage. Thereafter, on December 21, 1934, the court denied a petition of the Manhattan Company for leave to intervene generally, for modification of the order staying pending suits so as to allow the continuance of its foreclosure action, and for modification of the order of November 22, 1934, so as to exclude the Taft certificates and the Taft mortgage from the court's jurisdiction. The petition to intervene was granted for the limited purpose of empowering the Manhattan Company to appeal from the order of November 22. The Manhattan Company thereupon appealed from both orders. Brooklyn Trust Company has appealed from the order of November 22.

The jurisdiction of the District Court to entertain any plan of reorganization which includes the Taft certificates is challenged on the ground that the holders thereof are not creditors of the debtor and that the debtor has no property interest in the underlying bond and mortgage on the Hotel Taft property. For an understanding of the facts concerning the Taft mortgage and the Taft certificates, it is necessary to explain briefly the relations of the debtor and Prudence Company, Inc. The latter is an "investment company" organized under the New York Banking Law. Both it and the debtor are stock-controlled subsidiaries of another New York corporation, New York Investors, Inc. The business of Prudence Company was to acquire real estate mortgages and sell them to the investing public. Prudence Company made a loan to the owner of the Hotel Taft property, taking the borrower's bond secured by mortgage. For convenience both the bond and mortgage are referred to as the Taft mortgage. Prudence Company assigned the Taft mortgage to the debtor, who assigned it to the Manhattan Company as depositary under an agreement with the debtor, and issued against it participation certificates which were delivered to Prudence Company and by it sold to the public with its guaranty of payment of principal and interest. The debtor assumed no obligation with respect to the payment of the Taft certificates. It reserved to itself the option, on thirty days' notice, to redeem them before maturity upon payment of the principal amount and interest accrued to the date of redemption. The Taft mortgage bore interest at the rate of 6 per cent. per annum, while the rate on the certificates was one-half of 1 per cent. less. This difference was reserved by the debtor and was payable to Prudence Company as a premium for its guaranty and so-called "servicing" of the mortgage. Under the deposit agreement with the Manhattan Company, the debtor was appointed agent of the depositary (the power of revocation being reserved) to collect the interest payable on the Taft mortgage and to disburse the interest payable on the Taft certificates. By agreement between the debtor and Prudence Company, the collecting and disbursing was done by the latter. Any profits on the sale of the certificates and any excess of interest collected over interest disbursed were likewise retained by Prudence Company. The debtor pays no salaries or wages, maintains no separate offices, and has no overhead expense of any kind. It was used as the medium for the issuance of the Taft certificates so that they could be guaranteed by Prudence Company and sold on the strength thereof. All profits resulting from the operations of the two affiliates accrued to Prudence Company. In October, 1932, the Manhattan Company duly revoked the agency of the debtor to collect and disburse interest. The appellant's brief states that at no time since such revocation has there been available any sum in excess of the 5½ per cent. due to holders of Taft certificates. On July 5, 1933, the Manhattan Company instituted the aforesaid foreclosure action which it desires to be allowed to prosecute.

The District Court apparently considered that holders of Taft certificates were creditors of the debtor within the definition of "creditors" contained in section 77B (b) of the Bankruptcy Act (11 USCA § 207 (b), and consequently any property held by the Manhattan Company for their benefit could be reorganized in this proceeding. With that conclusion we are unable to agree. The statutory definition is as follows:

"The term `securities' shall include * * * certificates of beneficial interest in property. * * * The term `creditors' shall include * * * all holders of claims of whatever character against the debtor or its property. * * * The term `claims' includes debts, securities, other than stock, liens, or other interests of whatever character. * * *"

Clearly the Taft certificate holders have no claim based on any obligation of the debtor to pay the principal of the certificates or interest thereon. This is conceded by the debtor. But it is urged that the debtor has contracted with the certificate holders as follows: (1) That the depositary will continue to hold the underlying mortgage for the benefit of the certificate holders; (2) that the debtor will disburse pro rata any collections received from the mortgage; (3) that outstanding certificates shall...