CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE TENTH CIRCUIT.
Warren, Black, Douglas, Clark, Harlan, Brennan, Stewart, White, Goldberg
MR. JUSTICE GOLDBERG delivered the opinion of the Court.
The issue in this case is whether respondent's attempted corporate rehabilitation under the Bankruptcy Act, materially affecting the rights of widespread public investor creditors, may be conducted under Chapter XI of the Bankruptcy Act, 52 Stat. 905, as amended, 11 U. S. C. § 701 et seq. (1958 ed.), or whether dismissal or, in effect, transfer to proceedings under Chapter X of that Act, 52 Stat. 883, as amended, 11 U. S. C. § 501 et seq. (1958 ed.), is required upon motion by the Securities and Exchange Commission or any other party in interest, pursuant to § 328 of the Bankruptcy Act, 66 Stat. 432, 11 U. S. C. § 728 (1958 ed.).*fn1
Respondent, American Trailer Rentals Company, was organized in 1958 to engage in the automobile-trailer rental business.*fn2 The business was financed largely through the sale of trailers to investors and their simultaneous lease-back. From 1959 to 1961 hundreds of small investors, scattered throughout the entire western part of the United States, purchased and leased back a total of 5,866 trailers, paying an aggregate price of $3,587,439 (approximately $600 per trailer). Under the usual form of lease-back agreement, the trailer owners were to receive a set 2% of their investment per month for 10 years.*fn3
The trailers sold to investors and then leased back are of the general utility type that are attached to the rear bumper of automobiles. They were placed by respondent at gasoline stations, the operators of which acted as respondent's rental agents, without the investors ever having seen them. Respondent had about 700 such service station operators in December 1961, although the number had declined to about 500 by the time the petition for an arrangement was filed a year later.
Respondent's further offering of these sale and lease-back arrangements to the public was halted in 1961, when the SEC advised respondent that these sale and lease-back arrangements were investment contracts and therefore securities, which could not be sold to the public unless and until a registration statement was filed and became
effective under the Securities Act of 1933, 48 Stat. 74, as amended, 15 U. S. C. § 77a et seq. (1958 ed.). Respondent then filed a registration statement with the SEC pertaining to these sale and lease-back arrangements. This registration statement, however, never became effective, and proceedings were instituted by the SEC to stop distribution of respondent's proposed prospectus on the grounds that it contained false and misleading statements. See Securities Act of 1933, § 8 (d), 48 Stat. 79, 15 U. S. C. § 77h (d) (1958 ed.). In June 1963, respondent consented to the entry of an order stopping distribution of this prospectus. See SEC, Securities Act Release No. 4615 (1963).
After this attempt to register the sale and lease-back agreements had failed, respondent's executive vice president and other persons organized a corporation named Capitol Leasing Corporation, which offered respondent's investor creditors an exchange of its stock for their trailers on the basis of one share of its stock for each $2 the investor creditors had paid for the trailers. After Capitol had acquired approximately 300 of the 5,866 trailers outstanding in exchange for its stock, the SEC suspended the exemption from registration for small offerings, upon which Capitol had relied in making this offer,*fn4 on the grounds that there was reasonable cause to believe that the material used in making this offer again contained false and misleading statements.
Following this event, respondent filed a petition and a proposed plan of arrangement under Chapter XI of the Bankruptcy Act. The petition, annexed schedules, and other documents show that respondent had never operated at a profit. For the three years ended September
, 1961, it had an aggregate income from "gross rentals" of $395,610. In the same period, it made rental payments to investor-trailer owners of $613,021; made payments to gasoline station operators of $118,400; and incurred additional "operating expenses" of $668,698.
The $613,021 paid to trailer owners included payments to investors whose trailers had not yet been obtained and put into the system. In order to make the necessary payments to trailer owners and station operators, respondent had not only borrowed money from its officers, directors, and stockholders but also had used funds obtained for purchase of new trailers. Virtually all the trailers were purchased from an affiliate in which respondent's officers and directors had interests. Many of these trailers proved defective in design or otherwise unsuitable for rental. About a year prior to the filing of respondent's Chapter XI proceeding, this manufacturing affiliate became bankrupt, owing respondent approximately $200,000 for trailers that were never manufactured and an additional amount of approximately $150,000 for trailers that were manufactured but never delivered. These latter trailers had been mortgaged by the affiliate to a third party who took possession upon the affiliate's bankruptcy. In addition, in June 1961, some 100 trailers, as to which respondent, although obligated by the lease-back arrangements to do so, did not have insurance coverage, were unlocatable and considered lost. Finally, certain funds received from investors for the purchase of trailers had been, at an earlier period, misappropriated by a member or members of respondent's management. Respondent's executive vice president, who estimated this misappropriation loss to be at least $141,000, attributed it "almost completely" to a deceased member of the original management group, but did not feel "qualified to make [the] judgment" that the two remaining members
of that group, including one who owned over 15% of respondent's common stock, could be held liable.
At the time of filing its Chapter XI petition, respondent stated its total assets as $685,608, of which $500,000 represented the stated estimated "value" of its trailer-rental system, an intangible asset. It stated in its petition that its trailer-rental system (which then consisted of arrangements with some 500 service station operator agents) "was built by [respondent] at an estimated cost of $500,000," despite the fact that respondent's balance sheet in 1961 showed the cost of establishing a system of 700 stations as only $33,750, and that in 1961 respondent had estimated that the cost of establishing an additional 800 rental stations would be only $56,000. The total liabilities were stated at $1,367,890, of which $710,597 was owed to trailer owners under their leasing agreements; $200,677 was owed to the investors who had paid for trailers that had never been manufactured; $71,805 was owed to trade and other general creditors; and $285,277 was owed to respondent's officers and directors.
Under the proposed plan of arrangement submitted by respondent the investor-trailer owners were to exchange their entire interests (their rights in the trailers as well as the amounts owed them under the rental agreements) for stock of Capitol on the basis of one share of stock for each $2 of "remaining capital investment in the trailers," which sum was to be determined by deducting from the original purchase price of the trailers the amount, if any, which the owners had received as rental payments.*fn5 Respondent's officers and directors, as well as trade and other general creditors, were to receive one share of stock
for each $3.50 of their claims. Respondent, itself, in exchange for transferring to Capitol its trailer-rental system, was to receive 107,000 shares which it would then distribute to its stockholders. Finally, obligations to two banks, totaling $55,558, although clearly unsecured, were to be paid in full, presumably because the officers and directors of respondent would otherwise have been liable as guarantors of these obligations.
If this plan were approved and all of the investor-trailer owners participated, a total of approximately 866,000 shares of Capitol's stock would be issued to them, but approximately 81,500 shares would be issued directly to the officers and directors of respondent, 22,400 to trade and other general creditors, and 107,000 to respondent itself to be distributed to its stockholders. More than 60% of respondent's stock was held by eight men, seven of whom are officers and directors and the eighth one of the original promoters of the venture.
The SEC then filed a motion, under § 328 of the Bankruptcy Act, to dismiss the Chapter XI proceeding or, in effect, transfer it to Chapter X on the ground that it should have been brought under Chapter X of the Bankruptcy Act and thus Chapter XI is not available. A referee in bankruptcy to whom, as a special master, the motion was referred, recommended that it be denied on the grounds that the Commission had not made "a sufficient showing to warrant the granting of the Section 328 motion." At his hearing on this matter, the District Judge recognized that, in light of the fact that the investor-trailer owners were widely scattered and the nature of their individual holdings was small, the proposed plan's issuance of approximately 15% of Capitol's stock to respondent's officers and directors would mean that they, rather than the investor-trailer owners, would have effective control over Capitol, and expressed his "disapproval" of such a result. He also expressed disapproval
of preferential treatment of the banks in order to avoid the obligations of the officer and director guarantors.*fn6 The District Court, however, "accepted and adopted" the referee's findings and denied the motion without a written opinion. The Court of Appeals affirmed, holding that, "since the granting of the motion rests in the discretion of the [district] court, while we think this is a border-line case, it does not appear that the S. E. C. has shown that adequate relief is not obtainable in Chapter XI ...