UNITED STATES BANKRUPTCY APPELLATE PANEL FOR THE FIRST CIRCUIT _______________________________
BAP No. MB 99-030 _______________________________
IN RE: TOWN & COUNTRY CORPORATION, Debtor. _______________________________
TOWN & COUNTRY CORPORATION, Plaintiff-Appellant,
v.
HARE & CO., CEDE & CO., JUSTINE CLARKE, PAUL GREGORY BURNINGHAM AND LORI BURNINGHAM STATE STREET BANK & TRUST CO., AND BOSTON EQUISERVE, Defendants-Appellees.
_______________________________
Appeal from the United States Bankruptcy Court for the District of Massachusetts (Hon. William C. Hillman, U.S. Bankruptcy Judge)
Before Votolato, Lamoutte, Vaughn, U.S. Bankruptcy Judges _______________________________
Daniel C. Cohn, David B. Madoff and Cohn & Kelakos LLP, for the Appellant.
Domenic P. Aiello, Alicia M. Duff and Lyne, Woodworth & Evarts LLP, for the Appellee Hare & Co.
July 10, 2000 _______________________________ Vaughn, J.
Town & Country Corporation (“Town & Country” or “Appellant”),
the debtor in this Chapter 11 Bankruptcy Proceeding, appeals from
an order by the bankruptcy court granting summary judgment in favor
of defendants Hare & Co. et al. on its complaint seeking
subordination of claims and for other relief pursuant to 11 U.S.C.
§ 510(c). For the reasons set for below, the bankruptcy court’s
order is affirmed.
APPELLATE JURISDICTION
This Court has jurisdiction of the subject matter and the
parties pursuant to 28 U.S.C. §§ 158(a) and (c), and Rule
8001-1(d)(1) of the Local Rules for the Bankruptcy Appellate Panel
for the First Circuit. 28 U.S.C. §§ 158(a) and (c) (1988 & Supp.
1998); 1S T CIR . B.A.P. R. 8001-1(d)(1) (1998). The parties, pursuant
to Rule 8001-1, have not elected to have their appeal heard by the
District Court for the District of Massachusetts. 1S T CIR . B.A.P. R.
8001-1(d)(1). Further, this proceeding constitutes a separate
proceeding within the context of the Debtor’s bankruptcy case, and
thus is appropriate for review. Smith v. Seaside Lanes (In re
Moody), 825 F.2d 81, 85 (5th Cir. 1987).
2 BACKGROUND
Town & Country is a holding company involved, through its
subsidiaries, in the manufacturing and marketing of jewelry. At
the time it voluntarily filed for bankruptcy protection, Town &
Country was publicly traded on the American Stock Exchange.
Defendants Hare & Co., Cede & Co., Justine Clarke, Paul Gregory
Burningham and Lori Burningham are holders of Exchangeable
Preferred Stock of Town & Country. Defendant State Street Bank is
the successor trustee under a trust agreement created to hold
certain shares of stock for the benefit of holders of the
Exchangeable Preferred Stock. Defendant Boston Equiserve is the
transfer agent for the stock held by the trustee State Street Bank.
In 1993, Hare & Co. was the holder of notes issued by Town &
Country that were in default after Town & Country failed to make
interest payments. As part of a financial restructuring Town &
Country established and issued shares of Exchangeable Preferred
Stock, which were exchanged for the notes. Hare & Co., as well as
Defendants Cede & Co, Clarke and the Burninghams, are the holders
of all shares of the Exchangeable Preferred Stock.
In order to insure the performance of Town & Country under the
arrangement, Town & Country created a trust (the “Little
Switzerland Trust”) in which it placed shares of Little
Switzerland, Inc. common stock equal in number to the outstanding
3 shares of Exchangeable Preferred Stock. Under the terms of the
arrangement, the trust was created “solely for the benefit of the
Holders of the Exchangeable Preferred Stock and the Corporation in
order to give the Holder a free and unfettered opportunity
(including, in the event the Corporation is in bankruptcy) to
exchange such shares of Exchangeable Preferred Stock for Little
Switzerland Common Stock . . . and to secure the performance of the
Corporation’s obligations under the terms of this Certificate of
Designation.” App. at 63-64. The Certificate of Designation
orders the trustee to hold the shares solely for the benefit of the
holders of the Exchangeable Preferred Stock and Town & Country.
The trust is irrevokable.
Pursuant to the Certificate of Designation, holders of the
Exchangeable Preferred Stock were entitled to receive a dividend
beginning on the second anniversary of the stock’s issuance. In
addition, a mandatory redemption was established requiring Town &
Country to redeem all outstanding shares of the Exchangeable
Preferred Stock on December 31, 2000 for $14.59 per share (the
“Liquidation Value”). The redemption price could be paid in cash
or in shares of Little Switzerland stock. In addition, Town &
Country could elect for an optional redemption which allows the
corporation, after the second anniversary of their issuance, to
redeem the shares for a cash price set as a percentage of the
Liquidation Value; if during the period before the second
4 anniversary the sale price of the Little Switzerland stock rose to
$18.75 per share, Town & Country could redeem the Exchangeable
Preferred Stock, in whole, for the Liquidation Value.
After March 1, 1994, holders of the Exchangeable Preferred
Stock were given the right to exchange each share for one share of
the Little Switzerland Stock, subject to certain adjustments.1
1 The applicable characteristics of the Exchangeable Preferred Stock, as stated by the Bankruptcy Court, were as follows:
Each share of Exchangeable Preferred Stock will have a liquidation preference of $14.59, plus accrued and unpaid dividends (the “Liquidation Value”). . . . The Exchangeable Preferred Stock will be senior to all Junior Stock (as defined) . . . and will be subordinate in right of payment to all indebtedness of the Company....
No dividends will be paid on the Exchangeable Preferred Stock until after the second anniversary (the “Second Anniversary Date”) of the date on which shares of Exchangeable Preferred Stock are issued (the “Issuance Date”). Thereafter, holders of the shares of Exchangeable Preferred Stock will be entitled to receive, when and as declared by the Board of Directors of the Company, cumulative cash dividends at the rate of 6% per annum of the Liquidation Value thereof. . . . The amount of accrued and unpaid dividends shall be added to the Liquidation Value thereof. . . . The amount of accrued and unpaid dividends shall be added to the Liquidation Value. If and whenever two semi- annual dividend payments on the Exchangeable Preferred Stock are in arrears, then during the period commencing with such time and ending when all arrearages in dividends on the Exchangeable Preferred Stock shall have been paid (hereinafter called the “Class Voting Period”), the holders of the Exchangeable Preferred Stock . . . will be entitled to elect one or more additional directors equal to 30% of the entire Board of Directors of the Company. . . .
5 On November 17, 1997, Town & Country filed for relief under
Chapter 11 of the Bankruptcy Code. As part of its confirmed plan
of reorganization, all proceeds realized from preferential and
Except as set forth below, the Company may not redeem the Exchangeable Preferred Stock until the Second Anniversary Date. Thereafter, the Company may redeem the Exchangeable Preferred Stock, in whole at any time or in part from time to time, at a price equal to 100% of Liquidation Value, if redeemed during the twelve month period beginning on the Second Anniversary Date, and thereafter at prices declining annually to 100% of principal amount on or after the fifth anniversary of the Issuance Date. The Company is required to redeem the Exchangeable Preferred Stock on December 31,2000 at a price per share equal to the Liquidation Value thereof (“the Mandatory Redemption”). Notwithstanding the foregoing, in the event that during the period from the date of issuance until the Second Anniversary Date, the Closing Sale Price (as defined)for a share of common stock of Little Switzerland, Inc. (“Little Switzerland”) equals or exceeds $18.75 per share for 30 consecutive trading days, the Company may redeem the Exchangeable Preferred Stock in whole at a price per share equal to 100% of the Liquidation Value (a “Company Optional Redemption”). In the case of a Mandatory Redemption, the Company may pay any redemption price by delivering cash, shares of common stock of Little Switzerland (the “Little Switzerland Common Stock”), other Exchange Property (as defined), or other combination thereof. In all other cases, the Company shall pay the redemption price by delivering cash. . . .
Upon (i) a Change of Control of the Company (as defined), (ii) a Change of Control of Little Switzerland (as defined), (iii) the voluntary or involuntary bankruptcy of the Company, (iv) upon receipt of a notice of a Company Optional Redemption, or (v) in any event after March 1, 1994, each holder of a share of Exchangeable Preferred Stock may exchange such share for one share of common stock of Little Switzerland (the “Exchange Rate”).
App. at 210-11.
6 fraudulent transfer actions are to be distributed to the general
unsecured creditors. After Hare & Co. sought to exercise its
rights of exchange under the Certificate of Designation following
Town & Country’s bankruptcy petition, Town & Country brought the
underlying action to subordinate the claims of the holders of the
Exchangeable Preferred Stock and to turn over the security interest
securing the claims. Hare & Co. agreed to a temporary injunction
enjoining the exchange pending a determination by the bankruptcy
court.
Count I of the complaint characterizes Town & Country’s
arrangement with the holders of the Exchangeable Preferred Stock as
a stock redemption agreement. Therefore, contends Town & Country,
the rights of the holders may be subordinated to the claims of
general unsecured creditors pursuant to 11 U.S.C. 510(c). Count II
seeks an injunction and declaratory judgment that the exchange of
Exchangeable Preferred Stock for the Little Switzerland Stock is a
distribution by Town & Country to a stockholder while the
corporation is insolvent, and thus unlawful under Massachusetts
law. Count III asks the court to declare the trust an unlawful
self-settled trust.
The court below granted summary judgment in favor of the
Defendants.2 The court’s decision turned on whether the holders of
2 Motions for summary judgment were brought by Town & Country and Hare & Co. only. However, following a status conference, is was agreed that the judgment should be granted in
7 the Exchangeable Preferred Stock are holders of a claim against the
bankruptcy estate or an equity interest. The court found that the
Exchangeable Preferred Stock is in the nature of an equity
interest. The court then found that the plain language of 11 U.S.C.
§ 510(c) makes the provision inapplicable to this case as it allows
the court to subordinate claims to other claims and interests to
other interests, but does not allow the court to subordinate an
interest to a claim. As to Counts II and III, the court found that
Massachusetts law does not forbid the transactions.
STANDARD OF REVIEW
The Bankruptcy Appellate Panel reviews a bankruptcy court’s
grant of summary judgment de novo. Cumberland Farms, Inc., v.
Florida Department of Environmental Protection, 116 F.3d 16, 18 (1st
Cir. 1997); Adams Co-Operative Bank v. Greenberg (In re Greenberg),
229 B.R. 544, 545 (B.A.P. 1st. Cir. 1999). Rule 56 of the Federal
Rules of Civil Procedure, as made applicable by Rule 7056 of the
Federal Rules of Bankruptcy Procedure, provides that summary
judgment “shall be rendered forthwith if the pleadings,
depositions, answers to interrogatories, and admissions on file,
together with the affidavits, if any, show that there is no genuine
issue as to any material fact and that the moving party is entitled
to a judgment as a matter of law.” Fed. R. Civ. P. 56(c). Both
favor of all defendants.
8 parties moved for summary judgment, and agree that no material
facts are in dispute.
DISCUSSION
I. Application of Section 510(c).
Town & Country’s principal argument is that the Certificate of
Designation and the agreement between Town & Country and the
holders of the Exchangeable Preferred Stock is a stock redemption
agreement, by which the holders are given the right to require Town
& Country to redeem their shares of Exchangeable Preferred Stock
for shares of the Little Switzerland Stock held in the Little
Switzerland Trust. Town & Country argues that because the right of
redemption is a claim against the bankruptcy estate, it should be
subordinated pursuant to § 510(c) of the Bankruptcy Code. On the
other hand, the holders argue that they do not hold redemption
rights, but simply a right to exchange their Exchangeable Preferred
Stock for shares of Little Switzerland Stock. They claim that
because the Little Switzerland Stock is held in an irrevokable
trust and is not part of the Town & Country estate, they do not
hold a claim against the estate, and therefore, § 510(c) is
inapplicable.
The Panel agrees with the court below that the Little
Switzerland Stock is not property of the estate. It further agrees
that the holders of the Exchangeable Preferred Stock hold an equity
9 interest rather than a claim against the Town & Country bankruptcy
estate.
Section 510(c) of the bankruptcy code provides:
Notwithstanding subsections (a) and (b) of the section, after notice and hearing, the court may –
(1) under principles of equitable subordination, subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim or all or part of an allowed interest to all or part of another allowed interest; or
(2)order that any lien securing such subordinated claim be transferred to the estate.
11 U.S.C. § 510(c).
The starting point for a bankruptcy court in determining the
application of § 510(c) is determining whether a party holds a
claim against the estate or an equity interest in the nature of a
capital contribution. See Diasonics Inc., v. Ingalls, 121 B.R.
626, 630 (Bankr.N.D.Fla.1990). Where a party holds an equity
interest, then the interest, by its nature, is subordinated and the
court need not reach the issue of whether to equitably subordinate,
since “the essential nature of a capital interest is a fund
contributed to meet the obligations of a business and which is to
be repaid only after all other obligations have been satisfied.”
Id. (quoting Herzog and Zweibel, The Equitable Subordination of
Claims in Bankruptcy, 15 Vand.L.R. 83 (1961)). See also Central
Cooperatives, Inc. v. Irwin (In re Colonial Poultry Farms), 177
B.R. 291, 299 (Bankr.W.D.Mo. 1995)(quoting same).
10 The Panel agrees with the bankruptcy court that the holders of
the Exchangeable Preferred Stock hold an interest rather than a
claim against the estate. Town & Country’s argument is based on
the contention that the holders were exercising their rights of
redemption when they attempted to exchange their Exchangeable
Preferred Stock for the Little Switzerland Stock, and that the
right of redemption created a claim against the estate. However,
in order to find that the transaction was a redemption, the Panel
must first find that the shares of Little Switzerland Stock held in
the Little Switzerland Trust are part of the bankruptcy estate.
Like the court below, we find that the shares of Little Switzerland
Stock held by the Little Switzerland Trust are not property of the
Property of the estate includes “all legal or equitable
interests of the debtor in property as of the commencement of the
case.” 11 U.S.C. § 541(a)(1). The scope of property that comes
within this definition is necessarily broad as it serves the basic
framework of the bankruptcy system: to create a bankruptcy estate
that is subject to the jurisdiction of the bankruptcy court which
can in turn effectuate a fresh start for the debtor and create a
systematic distribution for creditors according to their relative
priority as defined by the Bankruptcy Code. However, despite the
broad definition of “property of the estate” the Bankruptcy Code
does not vest the bankruptcy estate with any more rights in
11 property than the debtor held prior to the filing of the petition.
See, L. King, 5 Collier on Bankruptcy, ¶ 541.11 (15th Ed. Rev.
2000).
What is and what is not property of the estate is a question
of federal law, however courts look to the applicable state law to
determine the debtor’s equitable and legal interests in property.
Marrs-Winn Company v. Giberson Electric, Inc. (In re Marrs-Winn
Company), 103 F.3d 584, 591 (7th Cir. 1996). An express trust
“creates a fiduciary relationship with respect to property,
subjecting the person by whom the title to the property is held to
equitable duties to deal with the property for the benefit of
another person, which arises as a result of a manifestation of an
intention to create it.” Restatement (Second) of Trusts § 2
(1959). There is no question that an express trust was created in
this case, placing title in the hands of a third party trustee for
the benefit of the stockholders and Town & Country. However,
because the bankruptcy estate can establish no greater rights to
the corpus of the trust than was held by Town & Country at the
commencement of the case, the question becomes what interest does
Town & Country have in the trust?
In determining whether Town & Country is the true owner of the
trust property, and thus the Little Switzerland Stock is property
of the estate, we find guidance in the approach taken by the
district court in In re Medalion Realty Trust, 120 B.R. 245
12 (D.Mass.1990). In that case the court endeavored to determine
whether an entity ostensibly a business trust was in reality a
partnership. The court looked to the discretion and control of the
beneficiary of the trust, holding that the more power the
beneficiary of the trust holds and exercises over the affairs of
the entity the more likely it is that the business trust is a
partnership. Id. at 248. The approach taken by the court in
Medallion has been applied by bankruptcy courts in determining
whether trust property is property of the estate under section 541
of the Bankruptcy Code. See In re Simon, 179 B.R. 1, 5
(Bankr.D.Mass.1995); In re Eastmere Development Corp., 150 B.R.
495, 500 (Bankr.D.Mass.1993).
Applying this approach to the Little Switzerland Trust, we
find that the legal title to the subject shares of Little
Switzerland Stock is held by the trustee, and the trustee is
forbidden from transferring any of the shares except as expressly
set out in the agreement. Id. at 95, 96. The trust agreement
further provides that the only manner in which Town & Country can
regain title to the shares is if it redeems or otherwise acquires
all of the outstanding shares of the Exchangeable Preferred Stock.
Id. at 99. Finally, the trust is irrevokable. Id. at 95.
The terms of the trust agreement and the Certificate of
Designation make clear that Town & Country exercises little if any
control over the Little Switzerland Stock. As described earlier,
13 Town & Country’s only discretionary power over the Little
Switzerland Stock is an option to order the trustee to use the
stock to pay the holders the Exchangeable Preferred Stock under
either the optional or mandatory redemption provisions set out
under the Certificate of Designation.
Moreover, the trust fails to meet the definition of a nominee
trust, under which courts have held that the beneficiaries are the
true owners of the trust property. See In re Rosencranz, 193 B.R.
629,635 (Bankr.D.Mass.1996); In re Eastmare Development, 150 B.R.
at 503. Under a nominee trust, the trustee exercises little or no
control over the trust assets, but acts at the direction of the
beneficiaries.3 Instead, as we have noted, the Trustee of the
Little Switzerland Trust holds the stock for the primary benefit of
the holders of the Exchangeable Preferred Stock, and is permitted
by the terms of the trust agreement and the Certificate of
3 The features of a nominee trust are as follows: (1) the names of the beneficiaries are filed with the trustees rather than being publicly disclosed; (2) a trustee may serve simultaneously as a beneficiary; (3) the trustees lack power to deal with their trust property except as directed by the beneficiaries; (4) a third party may rely on the disposition of trust property pursuant to any instrument signed by the trustee, without having to inquire as to whether the terms of the trust have been complied with; and (5) the beneficiaries may terminate the trust at any time, thereby receiving legal title to the trust property as tenants in common in proportion to their beneficial interest.
In re Grand Jury Subpoena, 973 F.2d 45,48 (1st Cir. 1992).
14 Designation to dispose of the stock only upon the holders’ election
to exchange their shares of Exchangeable Preferred Stock or upon
one of the redemption events specified. Thus, we find that Town &
Country’s lack of discretion or control over the Little Switzerland
Stock supports the bankruptcy court’s finding that it is not
property of the bankruptcy estate.
Because we find that the Little Switzerland Stock is not
property of the bankruptcy estate, we hold that the holders of the
Exchangeable Preferred Stock do not hold a claim in the form of
redemption rights against Town & Country, but rather an equity
interest. We agree with Town & Country that an equity interest is
subordinate to claims. However, it is important to note that the
interest represented by the Exchangeable Preferred Stock is not
extinguished. Rather, upon exchange it will be in the hands of the
trustee, where it will remain subordinate to claims. Because the
property for which the Exchangeable Preferred Stock will be
exchanged is not property of the estate, there will be no effect on
the bankruptcy distribution scheme.
Furthermore, we find nothing in the language of § 510(c), or
any other provision of the Bankruptcy Code, which would prevent the
holders of the Exchangeable Preferred Stock from exercising their
rights of exchange for property that is not property of the estate.
Rather, § 510(c) is designed simply to deal with equitable
subordination of claims to other claims or interests to other
15 interests. It’s language does not extend to treatment of interests
vis a vis claims because, as discussed supra, equity interests are
already subordinate to claims. However, the fact that equity
interests are subordinate to claims does not alter the result here
as the equity interest will still remain, just in the hands of the
trustee.
The Panel will not import some other interpretation to §510(c)
when its language is clear and unambiguous on its face. It is “a
fundamental canon that statutory interpretation begins with the
language of the statute itself.” Pennsylvania Department of Public
Welfare v. Davenport, 495 U.S. 552, 557-58 (1990). The Appellant
has presented no authority to suggest that the statute should or
can be interpreted in any manner other than how it plainly reads.
In fact, the legislative history suggests the Congress was
cognizant of the separate treatment of claims and interests: “After
notice and a hearing, the court may, under principles of equitable
subordination, subordinate for the purposes of distribution all or
part of an allowed claim to all or part of another allowed claim or
all or part of an allowed interest to all or part of another
allowed interest. As a matter of equity, it is reasonable that a
court subordinate claims to claims and interests to interests.”
124 Cong. Rec. H 11,095 (Sept. 28, 1978; S 17,412 (Oct. 6,
1978)(emphasis added).
The creation of the trust and the exchange rights may well
16 have been the fruits of careful bankruptcy planning. However, this
does not alter our conclusion that the property held by the Little
Switzerland Trust is not property of the estate, and thus the
holders of the Exchangeable Preferred Stock do not hold claims, in
the form of redemption rights, which may be subordinated to the
claims of unsecured creditors.
II. Voidness of the Little Switzerland Trust.
Town & Country also argues that the Little Switzerland Trust
is void under Massachusetts law as a self-settled trust. Town &
Country relies on Merchants National Bank of New Bedford v.
Morrissey, 109 N.E.2d 821 (Mass. 1953), which stated that a self-
settled trust is void against creditors of the settlor. Id. at 823.
Town & Country asks this panel to extend Merchants National Bank,
which involved an individual who transferred assets to a
spendthrift trust for his own benefit, to a corporation which
places assets in trust for the benefit of its shareholders. Like
the court below, we reject this argument.
We agree with Town & Country that the rule in Massachusetts is
that a settlor who establishes a trust for the settlor’s own
benefit and reserves the ability to amend, revoke or invade the
corpus of the trust cannot protect the trust from the reach of
creditors. See Aylward v. Landry (In re Landry), 226 B.R. 507,
510(Bankr.D.Mass.1998); In re Rosencranz, 193 B.R. 629, 633
17 (Bankr.D.Mass.1996); In re Kellogg, 179 B.R. 379,
389(Bankr.D.Mass.1995). However, the Little Switzerland Trust,
which was created by Town & Country, was not created for the sole
benefit of the corporation, but rather was created for the benefit
of the holders of the Exchangeable Preferred Stock. The bankruptcy
court held that to find that the Little Switzerland Trust was a
self-settled trust would require the court to pierce the corporate
veil, that is, find that there was no distinction between the
stockholders and the corporation. We agree with the bankruptcy
Town & Country offers no authority for the proposition that we
should refuse to recognize a distinction between the corporation
and the stockholders. To treat the corporation and the
shareholders as one, as Town & Country proposes, would be to ignore
one of the central tenets of corporate law: the corporate entity is
separate and distinct from its shareholders. See Spaneas v.
Travelers Indemnity Company, 668 N.E.2d 325, 326 (Mass.1996); Zora
v. State Ethics Commission, 615 N.E.2d 180, 186 (Mass.1993); In re
Plantation Realty Trust, 232 B.R. 279, 282 (Bankr.D.Mass.1999).
Without piercing the corporate veil and finding that the
distinction between the stockholders and the corporation should be
disregarded, we can find no justification for finding the Little
Switzerland Trust is a self-settled trust.
18 III. Violation of Massachusetts Corporate Law.
The final argument of Town & Country is that the exchange
constitutes an unlawful stock redemption in violation of the
Massachusetts statute forbidding corporations from making
distributions while the corporation is insolvent. Mass. Gen. Laws
ch. 156B, §45. However, to find that the exchange was an improper
distribution would require us to find that the exchange was a stock
redemption. We have already determined that the exchange does not
constitute a stock redemption. Therefore, this argument fails as
well.
CONCLUSION
The Panel finds that because the Little Switzerland Stock is
not property of the bankruptcy estate the holders of the
Exchangeable Preferred Stock do not hold a claim against the
estate, but an equity interest. Section 510(c) of the Bankruptcy
Code cannot be utilized to prevent the holders of this Exchangeable
Preferred Stock from exchanging this interest for property that is
not property of the estate. Furthermore, the Little Switzerland
Trust is not void as a self-settled trust, and the exchange rights
of the holder of the Exchangeable Preferred Stock do not violate
Massachusetts law. Accordingly, the judgment of the bankruptcy
court is affirmed.