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Hickey v. Ritz-Carlton Restaurant & Hotel Co.

May 2, 1938


Appeal from the District Court of the United States for the District of New Jersey; John Boyd Avis, Judge.

Author: Buffington

Before BUFFINGTON and DAVIS, Circuit Judges, and JOHNSON, District Judge.

BUFFINGTON, Circuit Judge.

This is an appeal from two orders of the District Court, one denying a motion to dismiss the petition filed under section 77B, Bankr. Act, 11 U.S.C.A. § 207, to reorganize the Ritz Carlton Restaurant & Hotel Company of Atlantic City, hereinafter called the debtor, and the other making permanent the appointment of the trustee of the debtor.

The main question involved in this case is whether or not the petition was filed in good faith.

The debtor, on July 1, 1920, issued $5,500,000 worth of 6 per cent. bonds which were secured by a first mortgage on the debtor's property in Atlantic City. Until July 1, 1931, the debtor operated the hotel and paid the interest on the bonds and in addition paid $1,977,000 on the principal of the bonds, thus reducing the amount to $3,523,000 which is still due.

The interest due July 1, 1931, was not paid and the trustee under the first mortgage took charge of the debtor's property consisting of the Hotel, the Annex, and the Ritz Gardens and operated them as mortgagee in possession. On October 19, 1934, the trustee owed trade obligations of about $85,000 and taxes with penalties of about $190,000.

In May, 1934, the trustee began proceedings in the Court of Chancery of New Jersey to foreclose the mortgage and those proceedings are still pending.

On October 19, of the same year, the trustee leased the property for a term of five years from November 1, 1934 to Mr. William Malamut, hereinafter called the tenant.

The appellants charge that the tenant found the lease so profitable that he is, endeavoring to perpetuate his possession of the debtor's property and acquire complete ownership of it at the expense and sacrifice of the bondholders; that in order to do this he obtained an option to purchase a majority of the voting stock of the debtor and later entered into a contract with the bondholders' committee, hereinafter called the committee, with which about 90 per cent. of the first mortgage bonds had been deposited by July 13, 1937. Under the terms of the contract he is to turn over to the committee his option to purchase the stock of the debtor and $8,500 in money, the amoubnt necessary to close the option, and the committee upon acquiring the stock is to cause the debtor to file a petition for reorganization under section 77B of the Bankruptcy Act, 11 U.S.C.A.§ 207. A plan of reorganization is to be filed substantially as provided in the contract.

Some of the important provisions of the contract are as follows: A new corporation is to be formed with the tenant or his nominees as stockholders. The new corporation is then to take over all the assets of the debtor, for which it is to issue twenty-year mortgage bonds to the amount of $1,761,500 to be distributed to the present first mortgage bondholders ar the rate of 50 cents on the dollar. For the first two years, the new company is to pay interest on the new bonds at the rate of 1 per cent., or $17,615 annually. For the next three years, in addition to the annual payment of $17,615, the new corporation is to pay 20 per cent. of the excess over $375,000 of its gross income for the four months of June, July, August, and September. The same arrangement is to continue for the next five years except that the interest is to be increased from 1 per cent. to 2 per cent. and for the following ten years the interest is to be raised from 2 per cent. to 3 per cent. per annum and the additional payment of 20 per cent. of the gross income for the same four months in excess of $450,000, instead of $375,000. The tenant is also to pay $40,000 annually, to be applied, first, to the payment of the trade obligations incurred by the trustee, which are now reduced to about $30,000, and, second, to the taxes in arrears, amounting now to about $180,000. These payments will cease when the trade creditors and taxes are paid in full. The tenant further agreed to pay $40,000 on the taxes when the real estate is conveyed to the new company, but he may under the agreement place a first mortgage on the property, ahead of the mortgage to secure the $1,751,500 of new bonds. He may thus avoid paying the $40,000 personally in cash when the real estate is conveyed. This mortgage to settle delinquent taxes is to be amortized by the new company at the rate of $25,000 annually, and credit for that amount is to be allowed on the $40,000 which the tenant is to pay annually to trade creditors and for taxes.

The agreement does not provide for new capital to be paid to the new company, and it is evident that the payments which the new company is to make are to be paid out of the operating receipts of the property. In other words, the plan of reorganization to which the debtor and committee are contractually bound contemplates that the tenant, through his new company, will take over the debtor's property, reduce the equity of the bondholders by 50 per cent., operate the hotel until the property pays for itself, and thus make it his own.

The Ritz-Carlton properties are among the best hotel properties in Atlantic City, and it appears that the tenant realized last year from his operation of them a profit of more than $70,000. He purchased the option on the majority of the common stock for $10,000 and has agreed to give the committee $50,000 for expenses to bring about the reorganization on the basis of the contractual "Plan."

The appellants allege that the property, real and personal, to be conveyed to the tenant or to his new company, is conservatively worth $2,500,000. This is to be conveyed to the new company for bonds whose face value is approximately $1,761,500, but, because of the low rate or interest provided in them, their actual value will not in any event exceed $1,000,000. In other words, property worth $2,500,000 is to be turned over to the new company for $1,500,000 less than its value, or 40 per cent. of its value. A petition to carry out such a plan and scheme, they ...

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