McDonough v. Owl Drug Co.

WEBSTER, District Judge. Appellants, preferred stockholders of the Owl Drug Company, a corporation, organized under the laws of the state of Nevada, are prosecuting this appeal from an order or judgment of the District Court for the District of Nevada — the Honorable Jeremiah Neterer presiding — dismissing, on motion of the appellees, appellants’ petition praying that the order of the District Court adjudging the Owl Drug Company a bankrupt be set aside and annulled upon the ground that such adjudication had been procured by extrinsic fraud and that the District Court was being used as an agency or instrumentality through the mediumship of which the alleged fraudulent scheme or enterprise was being carried to consummation. It is conceded by appellants, through their counsel, that the United States District Court for the District of Nevada was a court of competent jurisdiction to entertain the voluntary petition in bankruptcy filed by the Owl Drug Company, and that under the conditions then disclosed to the court there was no alternative but to make the adjudication of bankruptcy now sought to be set aside. The sole claim of appellants is that because of after-discovered fraud on the part of the bankrupt and its controlling stockholder, the order of adjudication should be canceled. The petition filed by appellants contains many general and indefinite allegations, some of which are based on information and belief, as well as many conclusions, both of fact and law. In effect it-is alleged in the petition substantially that the voluntary bankruptcy of the Owl Drug Company was part of, or a step in, a preconceived plan or scheme by the controlling stockholder of that company to acquire the interests of appellants and some other preferred stockholders of the company; that this scheme whs being carried into effect by causing the bankrupt company to file a voluntary petition in bankruptcy in the District Court of Nevada at a time when the fair value of the company’s assets exceeded its liabilities, and by causing a purchase to be made of the entire assets of the bankrupt company by a subsidiary corporation of the bankrupt .at the bankruptcy sale of such assets ; that prior to such bankruptcy the controlling stockholder of the bankrupt company had, by certain transactions and manipulations, caused the subsidiary companies of such stockholder to be fraudulently and unjustly enriched at the expense of the bankrupt company and its - stockholders; that appellants contemplated the bringing of a suit against the subsidiaries of the bankrupt company and its controlling stockholder on behalf of the bankrupt company to recover damages for the alleged wrongful and fraudulent acts of such controlling stockholder, and also to have the property of the bankrupt company, purchased at the bankruptcy sale, declared to be held in trust for the benefit of the bankrupt company; and that in order for appellants, as preferred stockholders of the bankrupt company, to maintain such a suit or action, it is necessary that the offending adjudication of bankruptcy be annulled. Since the petition was dismissed on motion of the appellees-defend-ants, and in order to promote a full and clear understanding of the controversy, the petition, omitting formal parts, will be set forth at length. In ruling upon the motion to dismiss the petition, the trial court held that all matters of fact properly pleaded in the petition stood admitted for the purpose of the motion; that conclusions of law and generalizations and characterizations of fact were not so admitted; and that in passing upon the motion it was permissible for it to take judicial cognizance of the records and files of the bankruptcy proceeding in which the petition was filed. This ruling clearly was correct. Ben C. Jones & Co. v. West Publishing Co. (C. C. A.) 270 F. 563-565;. Hutton v. Joseph Bancroft & Sons Co. et al. (C. C.) 83 F. 17-19. We are not dealing with a case where, on consideration of a demurrer at law or motion to dismiss in equity, the court goes outside and takes judicial notice of matters wholly extrinsic to the record of the proceeding in which the ruling was made. Here the petition under review was filed by appellants in the bankruptcy proceeding, and it would i be going far to say that, in exercising discretionary powers to protect itself against fraud, a court may not take judicial cognizance of the very proceedings in connection with which its action is invoked. During the course of the argument in the court below, and after the court had indicated its purpose to sustain the motion to dismiss the petition upon the ground of [52] laches, counsel for appellants asked leave of the court to reduce to writing an amendment to the petition, which the appellants wished to be allowed to file. ■ The scope and purport of the proposed amendment was stated by counsel in this language: “We want to amend to show that we had no actual knowledge of the bankruptcy, no actual knowledge of the sale, and no actual knowledge of the fact that the sale took place in pursuance of the fraud which we allege, and no (actual) knowledge of the right or rights of these people until the senatorial hearing took place in. San Francisco and was completed some time in December or January, 1933; and that we had no opportunity thereafter to protect ourselves by litigation until we got our petition on file, because the time intervening was consumed in getting the stockholders together and forming the necessary committee and in raising the money to employ attorneys, and 'thereafter in employing attorneys, and that is what consumed the time, and. that is our excuse, as stated in our brief but not stated in our petition, for the intervening delay.”- Leave thus to amend was denied and exception taken. This ruling is one of the grounds relied upon by appellants for reversal. In view of our conclusions upon the whole matter,-we shall treat the petition as though the proffered amendment had been allowed. From the petition and the record in .the bankruptcy proceeding the following pertinent .facts - appear: The Owl Drujg Company was adjudicated a bankrupt on October 10, T932; a temporary, receiver was appointed and in due bourse George K; Edler, Esquire, was duly appointed' trustee of the bankrupt estate; the' administering of the estate has continued ever since the adjudication, and in the- course thereof on- September 22, 1933, all of. the business and asset.s of'the bankrupt were sold.pursuant to the order of the court, and the sum of $1,550,000 was-realized therefrom;-which fundís now in the custody of the .court- for the benefit of creditors; approximately .seventeen months .after the adjudication, and five months after the sale, viz., on March 7), 1934, the appellants filed their petition ,in the bankruptcy proceeding to set aside the order of adjudication; the temporary receivership, involved the expenditure of approximately $42,500, the propriety of'which expenditures is not challenged; that the trustee in bankruptcy, pursuant to the authorization of the court, operated the business of the bankrupt company, consisting of a chain of one hundred and twenty drug stores located in the states of California, Oregon, Washington, and Utah, and continued these activities until November 30, 1933; that the trustee has adjusted future rentals and leases of the bankrupt’s chain of stores and the status of the bankrupt toward its various landlords has been changed, either by a rejection of existing leases or by a change in the terms thereof; that approximately twelve hundred creditors have filed claims against the bankrupt estate, aggregating approximately $10,000,-000; that at the time of the filing of appellants’ petition, claims aggregating approximately $2,000,000 had been approved and allowed; that after due notice the assets of the estate were sold to the highest bidder for $1,550,000; the sale was duly confirmed without objection of a single creditor, and it was stated without denial at the argument that the creditors expressly consented to such confirmation; the purchase price for the property was paid and the property delivered to the purchaser; that a full report of the operation of the business was filed by the trustee and large sums have been allowed to the trustee’s attorneys, which are not challenged in this proceeding, and the trustee had been, ordered by the court to pay a dividend of 5 per cent, to creditors; that the aggregate expenditures by the trustee in carrying on the business and administering the estate approximated $140,000;' that if the rejected and modified leases on business location's should be -reinstated, the bankrupt would be hopelessly insolvent, the appraised value of the property of the-bankrupt being $3,100)000, or less than one-third' of the amount of the claims filed. Many additional facts of importance might be recited, but the foregoing will perhaps serve to give an adequate idea of -the setting at the time appellants’ petition was filed. No. creditor .of the bankrupt has. joined with appellants in seeking to have the adjudication of bankruptcy annulled, but on the contrary the trustee, conceiving that it is primarily his duty to protect the rights of creditors, is vigorously -opposing the setting aside of the. adjudication. It may be granted that preferred stockholders of a corporation are competent to file a petition in a bankruptcy proceeding attacking an order adjudging such corporation a bankrupt on the ground that such order was procured by fraud and imposition, and may in that manner invoke the incidental equity powers of a court of bankruptcy in the [53] premises. Such a challenge, however, must be based upon such grounds as will appeal to the conscience of a chancellor and must be seasonably interposed. Zeitinger et al. v. Hargadine-McKittrick Dry Goods Co. (C. C. A.) 244 F. 719; Hanna v. Brictson Manufacturing Co. (C. C. A.) 62 F.(2d) 139-149. A proceeding of this character is addressed to the sound judicial discretion of the court and must be predicated upon considerations which will appeal to the conscience of a chancellor, and the relief sought will be granted or denied, depending upon what a careful balancing of all pertinent equitable factors dictates to be just. Let it not be forgotten that in liquidating a bankrupt corporation the rights of creditors come first. The interests of corporate stockholders in such proceedings are always secondary and subordinate to the interests of the corporate creditors. Indeed, it is only after the lawful claims of creditors are satisfied that the rights of stockholders attach for practical purposes. Unless there is a surplus over and above the amount necessary to satisfy creditors, there is nothing to which the stockholders may assert any claim. Creditors are the peculiar favorites of courts of bankruptcy. When a court of bankruptcy is asked to assert its incidental equity powers, its action must be governed by precisely the same principles and considerations which would move a chancellor to action. With these elementary principles in mind it does not seem difficult to chart a true course in this case. The learned trial court, in dismissing appellants’ petition, stressed the question of laches and palpably, in face of the facts to which we have already adverted, there is much to be said in support of that view. However, we prefer to rest the determination of the controversy upon what we consider to be a broader and a more fundamental ground, viz., the want of equity in the petition in the light of the circumstances of the case in hand. It requires no unusually vivid imagination to picture measurably the consequences which would follow if the adjudication in question should be set aside. No creditor is complaining. No creditor has manifested any dissatisfaction with the adjudication, nor with the steps which have been taken in liquidating the estate. The creditors holding approved claims are relieved from the injurious effects of the onerous long-time leases made under conditions vastly different from those prevailing at the present time. Large sums have been expended in liquidating the estate which would be irretrievably lost if' the adjudication should be annulled. The fund of $1,550,000, now in the custody of the court, would be withdrawn from the creditors, and they would be launched upon a sea of chaos and confusion. They would be postponed in the enjoyment of their rights and be subjected to untold hazard, expense, delay, and inconvenience. And all this to the end that preferred stockholders may speculate through protracted litigation, without regard to the hurt of creditors, in the hope that something may be salvaged for themselves. If it be suggested that claims of landlords have been rejected or reduced, the obvious answer is that such landlords are not complaining and appellants cannot be heard to complain in their behalf. If the adjudication should be set aside, the leases of these landlords would automatically be reinstated, and with these claims revived it is too plain for serious discussion that there would not be any surplus over and above the debts to which appellants could assert any claim. In these circumstances it would be inequitable, unconscionable, and unjust to subject the creditors to the evils and hazards which the cancellation of the adjudication would inevitably entail. The creditors of the bankrupt corporation are not involved in the fraud upon which appellants rely. The creditors are as innocent of the wrong complained of as are the appellants themselves. If the allegations of appellants’ petition be taken for true, the creditors, like themselves, are the victims of a fraud, not the authors of it. The creditors have done nothing to harm or injure the appellants, and while courts of bankruptcy may, in the exercise of their incidental equity powers, preserve the integrity of their processes and protect themselves against fraud, trickery, and imposition, these powers may not be invoked by one class of litigants to the injury, detriment, or hazard of another class who are themselves blameless, and especially is this true when the class sought to be adversely affected occupy a favored position and who possess rights of superior, and paramount dignity to the class seeking the intervention of the court. In relieving against fraud the consequences must b,e laid at the door of those who perpetrate it. With respect to the allegations in the petition that the appellees “stifled” the bidding when the assets of the bankrupt corporation were offered for sale, it may be said that no facts are pleaded tending to show any such conduct on the part of the [54] appellees.. The allegation is a mere naked characterization of facts not pleaded or disclosed. Moreover, appellants are not attacking the sale and seeking to have the property-resold at a sale where bidding will be fair and unrestricted. Appellants seek to annul the adjudication of bankruptcy to the end that the entire bankruptcy proceeding shall be a nullity. Obviously such is not the proper remedy for stifling bidding at a judicial sale. In paragraph 13 of the petition it is alleged that the petitioners contemplate the commencement of certain legal proceedings in the courts of California and that it is necessary, in order to obtain relief, that the decree of the District Court adjudicating the Owl Drug Company to be a bankrupt be vacated and set aside. Such allegation patently is a mete conclusion of law not admitted by the motion to dismiss, and upon the correctness of that conclusion we neither express nor intimate any opinion. Affirmed.