Gannett Co., Inc., Appellant, v. E. Charles Larry, Trustee in Bankruptcy of Berwin Paper Manufacturing Corp., Appellee, 221 F.2d 269 (2d Cir. 1955)

The trustee in bankruptcy filed a petition asking that the claim of Gannett Co., Inc., be either disallowed or subordinated to the claims of the other creditors. The parties stipulated as follows:

"1. Gannett Co., Inc., a New York corporation having its principal offices at 55 Exchange Street, Rochester, New York, is and has been for many years engaged in the business of publishing daily newspapers in various localities in New York State and elsewhere.

"2. Berwin Paper Manufacturing Corp., the bankrupt herein, is a New York corporation with offices and plant in the Village of Dansville, New York, and has engaged in the manufacture and sale of various paper products.

"3. On September 17, 1951, Gannett Co., Inc., based on bankrupt's balance sheet at August 31, 1951, purchased 1,000 shares of the capital stock of said bankrupt, being all of the shares of the capital stock of said bankrupt, at a purchase price of $400,000, which it paid to the holders of said shares in cash. Gannett Co., Inc., bought bankrupt as an emergency source of a limited supply of newsprint for the newspapers published by Gannett Co., Inc. In 1951, newsprint was in short supply and such newsprint as was available sold at a price in excess of the market price.

"4. Up to the time of the purchase of the bankrupt by Gannett Co., Inc., the bankrupt had never manufactured newsprint. After the purchase of the bankrupt by Gannett Co., Inc., one of the machines used in the production of paper products of bankrupt was converted to the production of newsprint and during the balance of 1951, 232 tons of newsprint were produced in addition to the production of other paper products. No newsprint was manufactured by bankrupt after February of 1952.

"5. Had all machines of the bankrupt used in the production of paper products been converted to the production of newsprint, the capacity of bankrupt for the production of newsprint during the period September 17, 1951 to December 31, 1951, would have been approximately 800 tons, and the total annual capacity of bankrupt to produce newsprint would have been approximately 5,000 tons. During 1951, the total newsprint consumed by newspapers owned or controlled by Gannett Co., Inc., was 54,993 tons. In 1952 and 1953 these newspapers consumed 56,950 tons and 57,585 tons, respectively.

"6. From September 17, 1951, to and including the date of the filing of said bankrupt's petition in bankruptcy, the bankrupt sold 91.3 tons of newsprint to Gannett Co., Inc. During this period, 277 tons of newsprint was manufactured by bankrupt and sold to others than Gannett Co., Inc.

"7. From September 17, 1951 to May 11, 1953, the gross income from the manufacture and sale by bankrupt of paper products other than newsprint was $169,600 of which it is estimated that approximately $15,000 was from the sale of paper products in finished form on hand on September 17, 1951.

"8. During the period February through November of 1952, manufacturing operations at bankrupt were discontinued in order to permit extensive repairs and improvements in the plant and equipment of the bankrupt. Such repairs and improvements had been recommended by engineers as the only way to eliminate complaints received from customers of bankrupt as to the quality of paper produced. When bankrupt commenced operations again in December of 1952, the source of these difficulties had been eliminated through the aforesaid program of repair and improvement, but at that time it was discovered that bankrupt's customers had arranged to supply their needs from other sources and bankrupt ceased operations again in January of 1953.

"9. From September 17, 1951, to and including the date of the filing of said bankrupt's petition in bankruptcy, the three directors of said bankrupt were individuals who were also among the directors of Gannett Co., Inc., and with one exception, the officers of said bankrupt were individuals who were also among the officers of Gannett Co. Inc.

"10. The meetings of the directors of both corporations were held at 55 Exchange Street, Rochester, New York, the principal office of Gannett Co., Inc.

"11. The amount of claim of Gannett Co., Inc., against said bankrupt in this proceeding is $590,624.23, which amount is not disputed.

"12. From September 17, 1951, up to and including the date of the filing of the bankruptcy petition of said bankrupt, Gannett Co., Inc., advanced to said bankrupt the sum of $590,624.23, which sum was carried on the books of said bankrupt and said Gannett Co., Inc., as a loan from the latter to the former. This money was employed by bankrupt for the following purposes and in approximately the following amounts:

 a. To pay accounts payable as of September 17, 1951 $111,165.92 b. To pay notes payable as of September 17, 1951 $147,828.87 c. To rehabilitate and modernize the paper mill of said bankrupt $104,446.45 d. To provide sufficient cash for operations of said bankrupt to enable it to continue in business $227,183.89

"13. From September 17, 1951, to and including the date of the filing of the petition in bankruptcy of said bankrupt, no dividends were paid by said bankrupt and none of the monies advanced to bankrupt by Gannett Co., Inc., as aforesaid, was repaid.

"14. A Balance Sheet representing the financial condition of the bankrupt at August 31, 1951, is attached hereto, made a part hereof and marked Schedule I.

"15. Seven of the claims set forth in said bankrupt's schedules, out of a total of 18 claims in the said Schedule were in existence or arose out of claims for paper sold and delivered by said bankrupt prior to September 17, 1951.

"16. In connection with the foregoing facts, there was no fraud whatsoever on the part of Gannett Co., Inc."

 "Schedule I, Attached to Foregoing Stipulation "Berwin Paper Manufacturing Corp. "Balance Sheet — August 31, 1951 Assets Current Assets Cash on hand and in banks $ 23,765.61 Accounts receivable $ 13,167.97 Accounts receivable — assigned 65,671.90 ___________ 78,839.87 Less: Provision for doubtful accounts 981.44 77,858.43 ___________ Notes receivable 1,951.46 Inventories 124,026.82 Prepaid supplies and expenses 6,657.20 ____________ Total Current Assets $234,259.52 Property, Plant and Equipment 155,853.90 Less: Accumulated depreciation 8,906.13 146,947.77 __________ Other Assets 533.50 ____________ $381,740.79 ____________ Liabilities and Capital Stock Liabilities Notes payable Sterling National Bank 52,450.22 Helen Friedman 29,000.00 Reconstruction Finance Corp. 74,500.00 155,950.22 _________ Accounts payable 131,194.97 Sundry accounts payable 12,019.18 Accrued payrolls, taxes and expenses 2,644.07 ____________ $301,808.44 Capital Stock Common stock — no par value Authorized, issued and outstanding, 1,000 shares 125,000.00 Deficit ( 45,067.65) ____________ $381,740.79" ____________

At the first meeting of the bankrupt's creditors, Cyril Williams, Assistant Secretary of the bankrupt and also Secretary and Assistant Treasurer of the Gannett Co., testified as follows:

"Q. Gannett Co., Inc., is the sole stockholder of the bankrupt. Is it not? A. Yes. It is the parent of a group of corporations which have been engaged for many years in the publishing of newspapers in New York, Connecticut, New Jersey and Illinois.

"Q. Now, will you briefly describe the circumstances under which the Gannett Co., Inc., acquired the stock of the bankrupt. A. At the date of acquisition to the bankrupt, on the basis of estimates by their management, the Gannett newspapers faced a shortage of some five thousand tons of newsprint for the year 1952. To meet this emergency, this mill was bought to produce newsprint to help to offset this shortage.

"Q. Where is this paper mill located? A. Dansville, New York.

"Q. Did the mill produce the newsprint as you planned? A. No. By early 1952 the newsprint market had changed completely. Supply had improved and the estimated shortage never developed, never did materialize.

"Q. Now, how much did the Gannett Co., Inc., pay for the Berwin Paper Manufacturing Company control? A. Gannett Co., Inc., acquired the entire outstanding capital stock of the bankrupt for four hundred thousand dollars.

"Q. That was paid in cash? A. yes.

"Q. What was the date of the transfer? A. September 17, 1951.

"Q. How soon thereafter did Gannett Co., Inc., begin to lend money to Berwin? A. On that same day they loaned the sum of one hundred and forty-eight thousand dollars, and a few days later an additional seventy-seven thousand dollars was loaned.

"Q. How was this money used by Berwin who was not then bankrupt? A. The money was used to pay off notes to the Reconstruction Finance Corporation and to two others and to liquidate outstanding accounts payable.

"Q. Were those notes and accounts payable standing on the books of Berwin payable to creditors at that time? A. Yes.

"Q. Why were further additional amounts loaned to the bankrupt by Gannett Co., Inc.? A. To effect major and minor repairs and refinements necessary to put the mill in shape so it could produce newsprints, show a shortage deficit and to pay its operating losses.

"Q. Now, you said that the indicated newsprint shortage which appeared in September, 1951, never became a reality. Did you not? A. Yes.

"Q. Could not this mill be used for the production of other types of paper than newsprint? A. Yes. We discovered that we later could produce other low grade papers, papers for converting to napkins, toilet tissue, etc. I might add first that the production of newsprint was only at a cost which was much in excess of the market price at the time. The cost of production of these other low grade papers was in excess of the amount for which it could be marketed in normal markets.

"Q. Well, after you acquired that knowledge that the mill would not be required for producing newsprint for the Gannett papers, what happened with respect to the continuing losses sustained by the bankrupt corporation? A. We tried to sell the mill, but kept it in operation at a loss, so it could be shown as a going concern. We felt the chances of selling were much better if the mill was actually in operation.

"Q. Did you succeed in your efforts to sell the property? A. No. Our efforts in the direction of a sale were not successful at all. It was finally decided to shut the mill down. The Gannett Company, in fairness to its stockholders, could not afford to lend the bankrupt any more money.

"Q. Now, when was business suspended at this mill? A. January 31, 1953.

"Q. Now, since the shut-down last January, has the Gannett Company been advancing any money since that date to the bankrupt? A. Yes. Since that date, the Gannett Company advanced money to Berwin to maintain its property in its idleness. Four watchmen have been retained, the power bills have been paid, insurance has been kept in force. All bills have been paid.

"Q. So, you kept the property preserved since January but it has not been producing paper. Is that it? A. That's right.

"Q. Now, I gather the principal assets of the bankrupt are in this paper mill and the various inventories at Dansville, New York. Is that right? A. Right.

"Q. Can you describe this mill briefly for the record? A. A very good description appears in Schedules B-I and B-2j in the bankrupt's schedules. Mr. Leo Wesley is here. He has been office manager of the plant and he can elaborate far better than I can. That's the description that appears in the schedules.

"Q. You are not a paper man yourself? A. No, I am not.

"Q. Your connection with this bankrupt has been one of policy or supervision rather than operation? A. That's right.

"Q. Have you had the books and accounts of Berwin audited? A. Yes. The books and accounts have been audited by Peat, Marwick, Mitchell & Co., independent Certified Public Accountants, New York City, through December 31, 1952.

"Q. They have also been examined by auditors for other large creditors? A. Yes. By Central National last Friday.

"Q. They have been examined, yes. Have you anything further to add, Mr. Williams? A. I might add that other companies had a somewhat similar experience with paper mills acquired during this critical period, that is, around the same time we acquired this mill and since. A comment in the Annual Report for 1952 of St. Regis Paper Company shows that even the experts had these troubles, since 1950. This is a comment from that report: To cover the shortage in market pulp, accompanied by abnormally high prices, particularly from overseas producers, St. Regis purchased and rehabilitated the Howland Mill at West Enfield, Maine, having a capacity of thirty thousand tons of Kraft pulp a year. This emergency was taken in order to tide over an emergency condition. On December 20, 1952, the Howland mill which had been acquired was shut down permanently and the plant was abandoned. A mill similar to Berwin in Phoenix, New York, I have been told, in fact that was told us by representatives of the Central National who filed a petition in bankruptcy, voluntary, and there are some others who have permanently abandoned their plants. That is all I have."

The Referee in Bankruptcy ordered the claim of the Gannett Company subordinated. His entire opinion reads thus: "The claim of the Gannett Co., Inc., in the sum of $590,624.23 is allowed, but subordinated to all other claims filed and duly approved in this proceedings. See In re V. Loewer's Gambrinus Brewery Co., 2 Cir., 1948, 167 F.2d 318." On review, the district judge affirmed. His opinion is as follows:

"Gannett Co., Inc., filed a claim against the bankrupt for monies loaned. The Referee allowed the claim, but subordinated it to the claims of all other creditors. The order of the Referee is here for review.

"The Gannett Co., is in the newspaper publishing business. It was faced with a threatened shortage of newsprint for the year 1952. As a solution in part for the threatened shortage it purchased the capital stock of Berwin on September 17, 1951, paying to Berwin's stockholders $400,000 in cash. Berwin's assets on September 17, 1951, exceeded its liabilities, consisting of notes payable, accounts payable, accrued pay rolls, taxes and expenses, by a margin of $79,932.35. Berwin operated a paper mill and was engaged in the manufacture and sale of various paper products but not newsprint. Berwin was not equipped to manufacture newsprint. One of the machines theretofore used in the manufacture of paper products was converted to make possible the production of newsprint. Gannett immediately began to loan money to Berwin. Within a few days it loaned $258,993.89 to pay off notes to the Reconstruction Finance Corporation and others and to liquidate outstanding accounts payable. It loaned Berwin additional amounts to make the changes necessary in the mill so that it could produce newsprint, to modernize the mill, and to provide cash for operating expenses. The total amount of the loans, with interest, was $590,624.23, the amount claimed against the bankrupt. Actually the apprehended newsprint shortage never developed. By early 1952 the newsprint market had changed completely. The production of newsprint by Berwin was at a cost much in excess of the market price at the time. Other low-grade papers suitable for use other than newsprint were produced, but the cost of production was in excess of the amount for which they could be sold on the market. When it was found that the mill would not be required for producing newsprint for Gannett newspapers, an attempt was made to sell the mill, but the effort was unsuccessful. Meanwhile it was being operated at a loss, so it could be sold as a going business. Finally it was decided to shut down operations. Business was suspended January 31, 1953.

"From September 17, 1951, to the date of the filing of the petition in bankruptcy on May 14, 1953, Berwin had three directors. All three were also directors of Gannett. During the same period Berwin had five officers. All except one were also officers of Gannett. The meetings of the directors of both corporations were held at the principal office of Gannett.

"The Referee subordinated the claim of Gannett to the claims of other creditors on the authority of In re V. Loewer's Gambrinus Brewery Co. [2 Cir.], 167 F.2d 318. If the Gambrinus Brewery Co. decision be taken at face value, there is no need in these circumstances to show either fraud or unfairness to justify subordination. The judge who wrote the first opinion in the Gambrinus case so interpreted the decision in Schwartz v. Mills [2 Cir.], 192 F.2d 727, at page 731, 732 [29 A.L.R.2d 1161]. But even assuming that there must be unfairness to justify subordination, the creditors of Berwin had a right to expect that its affairs would be `conducted with an eye single to its own interests.' Taylor v. Standard Gas [& Electric] Co., 306 U.S. 307, 323 [59 S. Ct. 543, 83 L. Ed. 669]. Instead, through its control over Berwin by interlocking directors and officers, Gannett loaned monies to Berwin to launch Berwin on a new venture, which soon turned out to be a perilous one, not primarily to improve the financial status of Berwin but to secure for itself an emergency source of newsprint. It would be unfair to allow the claim of Gannett on a parity with other creditors who lacked the interest which Gannett had in Berwin's disastrous experiment in the newsprint field." The Gannett Co., Inc., has appealed.

Nixon, Hargrave, Devans & Dey, Rochester, N. Y. (Justin Doyle, E. Willoughby Middleton, Jr., and Leonard S. Zartman, Rochester, N. Y., of counsel), for appellant.

Nathan Relin and Paul J. Suter, Rochester, N. Y., for appellee.

Lehman, Goldmark & Rohrlich, New York City (Mortimer Brenner and Bernard K. Rothenberg, New York City, of counsel), for intervenor-appellee, Central National Corp.

Before FRANK and MEDINA, Circuit Judges, and BRENNAN, District Judge.

FRANK, Circuit Judge.

1. In the light of Comstock v. Group of Institutional Investors, etc., 335 U.S. 211, 229, 68 S. Ct. 1454, 92 L. Ed. 1911, we think the strict rule of In re V. Loewer's Gambrinus Brewery Co., 2 Cir., 167 F.2d 318, cannot stand.¹ 

2. Judge Burke, however, rested his decision on the alternative ground that Gannett Co., Inc. — controlling the Berwin Paper Manufacturing Company — had pursued solely its own interests in its management of Berwin. The Referee, who heard and saw Williams while he testified, made no finding in that respect. Judge Burke did not see and hear Williams; but taking Williams' testimony as true, and coupling it with the stipulated facts, we think Judge Burke's finding is correct, and that it supports his decision.

In Comstock v. Group of Institutional Investors, etc., supra, the parent company dominated the subsidiary of which it owned from 58 to 83% during the period in question; in that period, the parent advanced funds to the subsidiary. The Court held that the parent must be allowed to share as a creditor of the subsidiary on a plane equal to the other creditors. In Comstock, however, there is a specific finding that the parent's management was beneficial to the subsidiary's creditors. Here we have the opposite facts. At the date of the acquisition of Berwin by Gannett, Berwin was in a position to pay all of its creditors, and is now no longer able to do so. Gannett argues that although, in retrospect, mistakes of management were made, they were business errors made in good faith. Assuming this to be true, the fact remains that the losses suffered by Berwin were suffered, not in an attempt by Gannett primarily to make the subsidiary a financially profitable proposition, but to turn it into a source of newsprint, of no interest to the other creditors — unless financially profitable — but of distinct interest to Gannett, whether or not financially profitable, because of Gannett's newsprint shortage. It is because of this factor, totally absent in the Comstock case, that, in the words of Judge Burke, "It would be unfair to allow the claim of Gannett on a parity with other creditors who lacked the interest which Gannett had in Berwin's disastrous experiment in the newsprint field." In such circumstances, proof of fraud or illegality is not necessary.²