Prudence Realization Corporation v. Geist

Decision Date27 April 1942
Docket NumberNo. 757,757
Citation62 S.Ct. 978,86 L.Ed. 1293,316 U.S. 89
CourtU.S. Supreme Court

Mr. Irving L. Schanzer, of New York City, for petitioner.

Mr. Morris A. Marks, of New York City, for respondent.

Mr. Chief Justice STONE delivered the opinion of the Court.

The question for our decision is whether an insolvent defaulting guarantor of certificates of participation in a mortgage, who is also the owner of a part of the mortgage indebtedness, is entitled to share pro rata in a distribution of the proceeds of the mortgage in a § 77B bankruptcy reorganization, 11 U.S.C.A. § 207.

Prudence Company, petitioner's predecessor, and a wholly owned subsidiary of New York Investors, Inc., loaned to Zo-Gale Realty Company $480,000 on its bond secured by a first mortgage on real estate. In 1925 Prudence Company put into execution a plan for selling participation certificates in the mortgage. It assigned the bond and mortgage without consideration to Prudence Bonds Corporation, also a wholly owned subsidiary of New York Investors, Inc. Prudence Bonds in turn lodged the bond and mortgage with a trust company depositary. Prudence Company then executed a guaranty of payment of the bond and mortgage, whereupon Prudence Bonds issued certificates of participation authenticated by the trust company, and totaling $382,800. It delivered them, without payment of any consideration, to the Prudence Company which then sold them to investors. The guaranty of Prudence Company, which was referred to in the participation certificates, was of payment of the bond interest when due and of the principal when due or within eighteen months thereafter.

Each certificate declares that the purchaser is entitled to an undivided share in the mortgage of a specified amount equal to the sum paid for it by the original pur- chaser. Each provides that the share in the bond and mortgage represented by it is not subordinate to any other shares or subject to any prior interest, and each reserves to Prudence Bonds the right 'to be the holder or pledgee of similar shares' in the bond and mortgage. The mortgage indebtedness was later reduced to.$390,000, leaving an undivided share of $7,200 of which Prudence Company was the equitable owner, for which no participation certificate had been issued.

In 1938 an order of the bankruptcy court, in which Prudence Company and Prudence Bonds were then being reorganized, directed a transfer to Prudence Company of the $7,200 interest, as part of a settlement and adjustment of mutual claims between the two companies, and Prudence Company has continued to be the owner of this share of the mortgage indebtedness. It has also acquired by purchase from certificate holders $816.67 in certificates of participation in the mortgage.

On foreclosure of a second mortgage on the Zo-Gale property, Amalgamated Properties, Inc., a wholly owned subsidiary of Prudence Company, acquired title to the property from the mortgagor, and later went into a bankruptcy reorganization. Upon approval by the court of a plan of reorganization of the Zo-Gale certificate issue, the title to the mortgaged property was transferred to respondent Geist as trustee for the benefit of the certificate holders. In confirming the plan for reorganization of Amalgamated, the court reserved for future decision the question whether the Prudence Company was entitled to payment of its two claims in the mortgage pro rata with the other certificate holders.

As provided by the reorganization plan of Prudence Company, petitioner Prudence Realization Corporation was organized to take over the assets from the trustees of Prudence Company and to liquidate them for the benefit of creditors under the direction of the bankruptcy court. Petitioner has thus acquired certificates issued in the Amalgamated reorganization proceeding, representing the interest of Prudence Company in the Zo-Gale bond and mortgage. The claims against Prudence Company recognized by its plan of reorganization amounted to $133,723,000, including its guaranties of mortgages amounting to $12,523,000; guaranties of bonds issued by Prudence Bonds for $58,833,000; and guaranties of mortgage participation certificates issued by Prudence Bonds (including the Zo-Gale mortgage certificates) for $50,858,000.

The present proceeding was begun by respondent's petition in the consolidated reorganization of Prudence Company and Amalgamated Properties in the Eastern District of New York for an order directing that petitioner was not entitled to any distribution on account of the Prudence Company's interest in the Zo-Gale mortgage until the other certificate holders were paid in full. The district court granted the order, which the Circuit Court of Appeals for the Second Circuit affirmed. 122 F.2d 503. Both courts applied the rule of the New York Court of Appeals, see Matter of Title & Mortgage Guaranty Co., 275 N.Y. 347, 9 N.E.2d 957, 115 A.L.R. 35; Pink v. Thomas, 282 N.Y. 10, 24 N.E.2d 724; Matter of People (Union Guarantee & Mortgage Co.), 285 N.Y. 337, 34 N.E.2d 345, that a guarantor of mortgage certificates, who also has an interest in the mortgage, cannot share in the proceeds of its collection until the certificate holders are paid, unless there is a clear reservation in the certificate of the right of the guarantor to share on a parity with other certificate holders. The Circuit Court of Appeals by a divided court held that it was bound to apply the rule announced in the New York cases cited, which it deemed to be a rule of construction of the guaranty of the certificates. We granted certiorari, 315 U.S. 606, 62 S.Ct. 479, 86 L.Ed. —-, because of the importance in bankruptcy administration of the questions raised.

The court below recognized the implication of the requirement that a plan of reorganization under former § 77B, sub. f(1) of the Bankruptcy Act, see 11 U.S.C. § 621(2), 11 U.S.C.A. § 621(2), be one which (122 F.2d 505) 'is fair and equitable and does not discriminate unfairly in favor of any class of creditors', see Southern Pacific Co. v. Bogert, 250 U.S. 483, 492, 39 S.Ct. 533, 537, 63 L.Ed. 1099; Case v. Los Angeles Lumber Co., 308 U.S. 106, 60 S.Ct. 1, 84 L.Ed. 110, and that § 65, sub. a, 11 U.S.C.A. § 105, sub. a, requires that in liquidations a distribution of 'dividends of an equal per centum' shall be made 'on all allowed claims, except such as have priority or are secured', see Globe Bank & Trust Co. v. Martin, 236 U.S. 288, 305, 35 S.Ct. 377, 383, 59 L.Ed. 583; Moore v. Bay, 284 U.S. 4, 52 S.Ct. 3, 76 L.Ed. 133, 76 A.L.R. 1198. It recognized also that the equity powers of the bankruptcy court may be exerted to subordinate the claims of one claimant to those of others of the same class where his conduct in acquiring or asserting his claim is contrary to established equitable principles. See Taylor v. Standard Gas & Electric Co., 306 U.S. 307, 618, 59 S.Ct. 543, 83 L.Ed. 669; Pepper v. Litton, 308 U.S. 295, 60 S.Ct. 238, 84 L.Ed. 281; In re Bowman Hardware & Electric Co., 7 Cir., 67 F.2d 792.

But the court found it unnecessary to choose between such competing considerations, and rested its decision on the ground that Prudence Company's guaranty of the certificates was under state law to be interpreted as impliedly agreeing that any claim of its own to the mortgage indebtedness was to be subordinated to those of other certificate holders. After referring to cases in which the New York Court of Appeals had directed such a subordination, the court said (122 F.2d 505): 'An important issue herein is whether this is primarily a rule of construction of the guaranty in the certificates or is a rule of administration of insolvent estates which violates bankruptcy principles of equal distribution of a bankrupt estate among creditors. If it is a rule of construction, we would follow it * * *', citing Erie Railroad Co. v. Tompkins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed. 1188, 114 A.L.R. 1487. 'And if we thus found the guarantee to amount to an actual agreement between two creditors that the claim of one against the debtor should be subordinated to that of the other, we should give effect to it * * *.'

The only evidence of the actual intent of the parties to which the court referred was the fact that Prudence Company, unlike Prudence Bonds, had not reserved the right in the certificates to be the holder of 'similar shares' in the bond and mortgage. But there is no contention that in the absence of such a provision in the certificates, Prudence Company was not free to acquire certificates or hold an interest in the guaranteed mortgage in its own right. Consequently, its ownership of the $816.67 in certificates and $7,200 of the uncertificated indebtedness evidences no actual intention to subordinate those interests in a liquidation. And neither the terms of the guaranty nor of the certificates give any indication of such an intent of the parties.

The court arrived at its conclusion that the Prudence Company had agreed to subordinate its claims, not from an examination of the relevant documents read in the light of the surrounding circumstances, except as we have noted, but from its reading and application of the opinions of the New York...

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