IN RE BRUNNER AIR COMPRESSOR CORP.
287 F.Supp. 256 (1968)
In the Matter of BRUNNER AIR COMPRESSOR CORP., Bankrupt.
No. 66-BK-530.
United States District Court N. D. New York.
July 15, 1968.
Laurence F. Sovik, of Smith, Sovik, Terry, Kendrick, McAuliffe & Schwarzer, Syracuse, N. Y., for Trustee.
Bruce B. Roswig, of Costello, Cooney & Fearon, Syracuse, N. Y., for debenture holders H. S. Sheble, and others, Estate of J. H. Sheble and R. N. Sheble.
Richard Kehoe, of Ferris, Kehoe, Tenney & Murname, Utica, N. Y., for debenture holders Anthony J. Barrett, Ellen M. Cooney, Frank M. Dulan, William J. Hogenkamp, Gertrude F. Karl, John F. Karl, Robert Costello and Annamary Costello.
TIMBERS, District Judge.* QUESTION PRESENTEDIn this proceeding, pursuant to Section 39c of the Bankruptcy Act, 11 U.S.C.
§ 67(c) (1964), on petitions to review an order of Honorable David J. Goldstein, Referee in Bankruptcy, entered November 13, 1967, the question presented is whether the Referee erred in subordinating claims of certain debenture holders of the debtor, Brunner Air Compressor Corp., to claims of general unsecured creditors upon the ground that advances of the debenture holders were in reality capital contributions rather than loans. The Court holds (1) that there was substantial evidence to support the Referee's finding that the debtor corporation was undercapitalized from June 13, 1963, the date of its organization, to the date of bankruptcy, and as to that finding the order of the Referee is affirmed; but (2) with respect to the Referee's conclusion that the claims of the debenture holders1 should be subordinated to the claims of general unsecured creditors, the order of the Referee is reversed and the case is remanded to the Referee with instructions (a) to dismiss the trustee's subordination petition of July 6, 1967 as to the claims of all debenture holders who at no time were officers or directors of the debtor, and (b) to hold a further hearing and make appropriate findings, conclusions and an order, not inconsistent with this opinion, with respect to those debenture holders who at any time were officers or directors of the debtor, for the purpose of determining the ability and intent of any such officers or directors, or combination thereof, to dominate the corporation to their advantage and to the detriment of creditors. FACTSThe debtor, Brunner Air Compressor Corp., was organized as a New York corporation on June 13, 1963, to manufacture and sell a line of air compressors. It opened a place of business in Chadwicks, New York, and began doing business in early 1964.
The board of directors at its first meeting on June 14, 1963 authorized the issuance and sale, through a private offering, of 20,000 shares of common stock, par value $1.00; it also authorized the issuance and sale in like manner of 6% subordinated debentures in units of $500, due December 31, 1968, in an aggregate principal amount of $300,000.
* Chief Judge of the District of Connecticut, sitting by designation.
1. With the exception of the debenture held by Utica General Jobbing Foundry, Inc., which the Referee concluded, having been given by the debtor in payment of a debt due for work, labor and services, should not be subordinated. The Court affirms the Referee's conclusion as to this debenture holder.
2. This bank loan constituted the debtor's only senior indebtedness; both the Marine Midland and the SBA had been fully paid off by the trustee prior to the hearings in the instant proceedings before the Referee. Hence, there are no claims of senior indebtedness outstanding against the debtor.
3. See APPENDIX A, a sample of the debentures issued by the debtor (the sample being the $5,000 debenture issued to J. Howard Sheble, Jr. on September 3, 1964).
4. In view of the Court's decision herein ordering a remand to the Referee for further proceedings not inconsistent with this opinion, there is no need for the Court to attempt to unravel the procedural morass referred to. The rights of all debenture holders who have filed proofs of claim as required by law will be fully protected in accordance with this decision.
5. In Costello, while the court of appeals reversed the district court's affirmance of the Referee's finding that the corporation was adequately capitalized at the time of its incorporation and noted that the confirmatory opinion of experts was not required to supplement the accounting data to this effect, 256 F.2d at 908, the court of appeals nevertheless summarized at some length the testimony of four expert witnesses who expressed opinions on the question of undercapitalization. Id. at 906-08.
6. The burden of proof is clearly on the trustee to sustain his petition to subordinate the claims of debenture holders who were not officers or directors. As stated in Sampsell v. Imperial Paper Corp., 313 U.S. 215, 219 (1941), "The power of the bankruptcy court to subordinate claims or to adjudicate equities arising out of the relationship between the several creditors is complete. Taylor v. Standard Gas & Electric Co., 306 U.S. 307; Pepper v. Litton, 308 U.S. 295; Bird & Sons Sales Corp. v. Tobin, 78 F.2d 371. But the theme of the Bankruptcy Act is equality of distribution. § 65-a; Moore v. Bay, 284 U.S. 4. To bring himself outside of that rule * * * [one] carries a burden of showing by clear and convincing evidence that its application * * * would work an injustice." 7. The trustee has expressly disclaimed fraud on the part of the debenture holders; and fraud is not an essential element of the trustee's claim against even the debenture holders who were officers or directors. Heiser v. Woodruff, 327 U.S. 726, 732-33 (1946); Costello v. Fazio, 256 F.2d 903, 910 (9 Cir. 1958).