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335 U.S. 211
GROUP OF INSTITUTIONAL INVESTORS, etc., et al., and three other cases.
Nos. 451 to 454.
Argued March 9, 10, 1948.
Decided June 21, 1948.
Rehearing Denied Oct. 11, 1948.
See . [ Comstock v. Group of Institutional Investors 335 U.S. 211 (1948) ] [335 U.S. 211 , 212]
Mr. Maxwell Brandwen, of New York City, for petitioners.
Mr. Charles W. McConaughy, of New York City, for respondents, Group of Institutional Investors, etc., and others.
[335 U.S. 211 , 213] Mr. Harry Kirshbaum, of New York City, for respondents, Bondholders group.
Mr. Leonard P. Moore, of New York City, for respondents, Manufacturers Trust Co., trustee.
Mr. Justice JACKSON delivered the opinion of the Court.
Since 1933 the Missouri Pacific, the New Orleans, Texas and Mexico Railway Co. and a number of affiliated railroad corporations have been in reorganization under the Bankruptcy Act, 11 U.S.C. 205, 11 U.S.C.A. 205. A second plan of reorganization, approved by the Interstate Commerce Commission, was before the District Court for the Eastern District of Missouri. Comstock then, in 1944, made objection to allowance of a claim of approximately 10 million dollars by the Missouri Pacific, one debtor corporation, against another, the New Orleans, which, during the 10 years of proceedings, had been unchallenged. The issues raised by his objection were severed from other problems of reorganization which do not concern us here. After full hearing the District Court made findings and wrote an opinion, In re Missouri Pacific R. Co., D.C., 64 F.Supp. 64, overruling his objections. The Circuit Court of Appeals for the Eighth Circuit affirmed. Comstock v. Group of Institutional Investors, 8 Cir., 163 F.2d 350.
The issues of fact, contested in a long hearing, are not before us for review. Petitioner assured us, in support of the petition for certiorari here, that 'there is no factual controversy before this Court' and 'we assume the findings of the District Court. Our challenge is directed only to the legal import of these unchallenged facts.'
Much of petitioner's argument seems to depart from these assumptions and to invite us to reach conclusions from the voluminous record in the case, contrary to those reached by the two courts below. This we cannot do. [335 U.S. 211 , 214] A seasoned and wise rule of this Court makes concurrent findings of two courts below final here in the absence of very exceptional showing of error. Stuart v. Hayden, 169 U.S. 1 ; Brainard v. Buck, 184 U.S. 99 ; First National Bank v. Littlefield, 226 U.S. 110 ; Baker v. Schofield, 243 U.S. 114 ; Second Russian Insurance Co. v. Miller, 268 U.S. 552 ; Texas & N.O.R. Co. v. Brotherhood of R. & S. S. Clerks, 281 U.S. 548 ; Page v. Arkana Natural Gas Corp., 286 U.S. 269 ; Pick Mfg. Co. v. General Motors Corp., 299 U.S. 3 ; Virginian R. Co. v. System Federation No. 40, 300 U.S. 515 ; United States v. O'Donnell, 303 U.S. 501 ; Anderson v. Abbott, 321 U.S. 349 , 151 A.L.R. 1146; Allen v. Trust Co., 326 U.S. 630 ; United States v. Dickinson, 331 U.S. 745 . No. such error is claimed by petitioner.
Since we are concluded by such concurrent findings, we can do no better than to adopt the statement of facts made in the opinion of the Court of Appeals, 163 F.2d 350, 352, on the basis of which petitioner's propositions of law are predicated and must be decided. The essential facts so recited are:
We are confronted at the outset with petitioner's delay and conduct and its effect on the duty of this Court and that below to pass on the merits of his objections. Comstock, apparently with general knowledge of the conduct he alleges to be a wrong toward the securities which he now holds, bought them at about 10 cents on the dollar nearly seven years after the alleged misconduct had ended. Thus, it was not Comstock who was a victim of any wrongdoing but those in whose hands the securities depreciated to the low point at which Comstock bought. It is apparent that Comstock bought a grievance to exploit and to reap the advantage of its rectification. Those who realized the loss through sales to Comstock could, in no event, the indemnified in this proceeding. From every viewpoint, the delay in asserting these claims is unusual. The District Court found it also prejudicial due to the death of six named witnesses and participants, among others, whose testimony would be important. While it considered the objections barred by laches, it nonetheless adjudged their merits.
We think that, in the reorganization proceeding, the courts may entertain on their merits objections to a plan even if made by one who might be barred from asserting a cause of action in his own behalf, if the subject matter of the objection is such that it goes beyond the objector's individual interests and affects the fairness and equity [335 U.S. 211 , 227] of the plan. In view of the amount and position of the claim involved, we do not disagree with the Court of Appeals that such was the case here.
It also is true, as the court below indicates, that this objector made no effort to exhaust or to avail himself of administrative remedies in support of his objection. Neither the objection nor the evidentiary support for it were laid before the Interstate Commerce Commission in its hearings on successive plans of reora nization. The requirement that the Commission 'hold public hearings, at which opportunity shall be given to any interested party to be heard and following which the Commission shall render a report' to the court is not provided without a purpose and is not to be ignored by persons with claims or objections to be heard. This issue involved matters with which the Commission and its staff are especially qualified to deal. It has had no opportunity to express a view on this issue, which was allowed to go by default before it, and the courts do not have the benefit of the Commission's informed judgment on the matter involved. To by-pass the Commission and make the court the original forum for such contentions is not to be encouraged.
But the court did not refuse to hear the objections on their merits. In view of the functions cast upon the court in such cases, we cannot say that it may not, in its discretion, consider objections on their merits even though they have not been presented to the Commission. Some circumstances might be disclosed to indicate a remand for their consideration by the Commission. They might indicate that the courts would withhold approval, not out of deference to the objecting parties' rights but because of the broad responsibility laid upon the court for the equity and fairness of the plan as a whole. The court will be diligent to protect itself and the public from approval of unfair plans, even by default, and may take for its own use evidence no party would have a right [335 U.S. 211 , 228] to force upon it. The court below evidently considered the circumstances of this case to warrant such inquiry into the merits, and we do not require whether the discretion was wisely exercised.
The case on the merits presents, as to several different and complicated transactions, a single question of law. It is said that our decision in Taylor v. Standard Gas & Electric Co., 306 U.S. 307, 618 , 59 S. Ct. 543, requires that the claim of Missouri Pacific against the New Orleans be disallowed and petitioner's objections sustained. In that case this Court reformulated for application to reorganization cases a wholesome equity doctrine to the effect that a claim against a debtor subsidiary be disallowed or at least subordinated when the claimant corporation has wholly dominated and controlled the subsidiary and in the transactions creating the debt has breached its fiduciary duty and acted both to its own benefit and to the detriment of the debtor. As we later said of the decision, 'This was based on the equities of the case-the history of spoliation, mismanagement, and faithless stewardship of the affairs of the subsidiary by Standard to the detriment of the public investors.' Pepper v. Litton, 308 U.S. 295, 308 , 246.
Petitioner asks us to declare the same result in this case despite explicit and unchallenged findings that, in its dealings with New Orleans during the period involved, 'the Missouri Pacific acted in good faith and with due regard to its obligations, legal and equitable, to the New Orleans and its security holders,' that the 'effect of the control by the Missouri Pacific of the Gulf Coast Lines was beneficial and advantageous to the New Orleans and the holders and pledges of its securities,' that all dividends in question 'were paid either out of the earned surplus of the New Orleans available for dividends or out of the net income of the New Orleans after payment of all prior charges against income,' and that the sub- [335 U.S. 211 , 229] ordination of the claim as asked 'would unjustly enrich the holders of the capital stock of the New Orleans and the holders of the Secured Serial Bonds,' as well as other more detailed findings to the same effect.
In the case before us there was domination of the subsidiary, a relationship between corporations which the law has not seen fit to proscribe. By the application of long-standing principles of equity this Court fashioned the rule in the Taylor case to prevent a fiduciary i such a position from enriching itself by breach of its trust. It is not mere existence of an opportunity to do wrong that brings the rule into play; it is the unconscionable use of the opportunity afforded by the domination to advantage itself at the injury of the subsidiary that deprives the wrongdoer of the fruits of his wrong. On the findings in this case, the claim of Missouri Pacific was the outgrowth of complicated but legitimate good faith business transactions, neither in design or effect producing injury to the petitioner or the interests for which he speaks.
Special emphasis has been placed on the fact that under control of the Missouri Pacific dividends were paid by the subsidiary at a time when it was borrowing money represented by this claim. It is clear from the findings that the dividends were paid out of current earnings or surplus, and not in violation of law or contract. Only in 1929 did New Orleans earn currently sufficient to pay its dividends. Nevertheless in all three years there was sufficient earned surplus legally to permit dividends. Heavy investments in improvements may require borrowings for dividends; but no law or public policy requires a corporation to finance capital additions out of earnings or to pass dividends because of low current earnings when past earnings are available for dividend purposes. These past earnings may be used to compensate the capital that produced them, and capital additions may be made from funds borrowed or raised by issues of capital securities, [335 U.S. 211 , 230] so long as the authorizations required in the case of railroads are obtained. No question is raised as to the authority to borrow.
While the contemporaneous borrowing to pay for capital additions, and payment of dividends, is not in itself illegal, it would, of course, come under the ban of the Taylor decision if it were carried out in breach of good faith for the advantage of the holding company to the detriment of the subsidiary. But the findings of good faith, fair dealing and freedom from fraud or overreaching over the dividend policy as well as other questioned transactions. Such being the facts, the allowance of the claim is not error of law.
The findings here do not stop with holding that the questioned transactions were intended to and did benefit the system as a whole. An over-all benefit to the system might be attained at the injury of one of its units and the security holders of that unit. But here the finding of good faith and of benefit applies to the New Orleans and its security holders as well as to the system generally. The finding is unequivocal that the control of Missouri Pacific not only 'was in good faith and with due regard to its obligations, legal and equitable, to the New Orleans and its security holders,' but also that its control of the Gulf Coast Lines 'was beneficial and advantageous to the New Orleans and the holders and pledgees of its securities.' The criticised transactions are thus not only exonerated of evil or illegal intent but are also established as beneficial rather than injurious to the interests which now challenge them. The findings to that effect are entitled to special weight where, as here, they are based on the District Judge's complete familiarity with the case. Reconstruction Finance Corporation v. Denver & Rio Grande Western R. Co., 328 U.S. 495, 533 , 1301, 1302, 1384. Affirmed by the Circuit Court of Appeals, they are, under the rule concerning concurrent findings, and on the basis of our grant of certiorari, conclusive in this Court. [335 U.S. 211 , 231] Disallowance of petitioner's objections on such findings was not error of law. In this view of the case we need not consider questions tendered as to validity or effect of the issuance of notes or of their pledge.
The judgment below in No. 451 is affirmed.
Petitions in Nos. 452, 453 and 454, were addressed to dismissals by the Court of Appeals from the same order as No. 451 but taken in different names. Thep etitions were filed as safeguards against procedural objections to review of the order. The writs in these cases are dismissed.
Mr. Justice MURPHY, with whom Mr. Justice BLACK, Mr. Justice DOUGLAS and Mr. Justice RUTLEDGE agree, dissenting.
The rule that makes concurrent findings of fact by two courts below binding on us in the absence of some very exceptional error is a wise one. But it is not a rule to be applied in a blind manner simply because a case involves a complex factual situation. In my view, there is an exceptional error involved in the conclusions reached by the District Court and affirmed by the Circuit Court of Appeals, an error that is apparent on the face of the District Court's findings. And since this error is not sufficiently illuminated by the opinion of the Circuit Court of Appeals, 163 F.2d 350 as quoted by the majority in this Court, I deem it essential to make an independent statement of the relevant facts as found by the District Court.
This case grows out of the joint reorganization of the Missouri Pacific Railroad Company and affiliated railroad corporations under 77 of the Bankruptcy Act, 11 U.S.C. 205, 11 U.S.C.A. 205. It involves a claim of $10,565,226.78 filed by the Missouri Pacific against one of its subsidiaries which was also undergoing reorganization and the application to that claim of the so-called Deep Rock doctrine enunciated in Taylor v. Standard Gas & Electric Co., 306 U.S. 307, 618 . [335 U.S. 211 , 232] It is unnecessary for present purposes to detail the long, complicated and still unfinished proceedings which have marked the reorganization of the Missouri Pacific railway system. The instant proceeding is directly related to a revised plan of reorganization approved in 1944 by the Interstate Commerce Commission. The District Court below then heard objections to the plan by various parties in interest. Included among them was the petitioner Comstock. He stated that he owned $ 80,000 principal amount of the 5 1/4% Secured Serial Gold Bonds of the Missouri Pacific. His objections were filed on behalf of himself, of fourteen other public investors holding in excess of $900,000 additional principal amount of these bonds, and of all other owners and holders of the bonds. A committee of these bondholders, representing an additional $ 315,000 principal amount of the bonds, also joined in Comstock's objections. Of the total principal amount of these bonds publicly outstanding, about 11 1/2% were specifically represented by Comstock.
Comstock's objection No. 19, which is our sole concern, related to the validity and priority of a $10,565,226.78 claim filed by the Missouri Pacific (hereinafter called MOP) against its subsidiary New Orleans, Texas and Mexico Railway Co. (hereinafter called NOTM) in the joint reorganization proceedings. It appears that MOP had acquired the controlling interest in NOTM's common stock in 1924 and had completely dominated and controlled NOTM until the reorganization proceedings began in 1933. MOP's claim against NOTM was based upon 'cash advances for operation, interest payments, etc., at various times from March, 1929, to February, 1933, both inclusive.' Most of the NOTM stock which MOP held was pledged as security for the class of MOP 5 1/4% secured bonds which Comstock owned, the pledge constituting 82% of the outstanding shares of NOTM's sole class of stock. MOP sought to put its claim against [335 U.S. 211 , 233] NOTM ahead of the claims of the holders of these MOP bonds who looked to the NOTM common stock for security. The revised plan of reorganization gave effect to MOP's desire in this respect.
A separate hearing was held by the District Court on Comstock's objection No. 19. After carefully considering the voluminous and complicated evidence adduced at this hearing, the court entered a separate order overruling the objection and holding that the $10,565,226.78 claim should be allowed in full; with interest, this claim now aggregates more than $18,000,0 0. The court further held that this claim, so allowed, was entitled to priority over the claims of the public investors holding MOP 5 1/4% secured bonds. In addition, the court felt that objection No. 19 was not timely and should be barred from consideration under the doctrine of laches.
At the same time, the District Court entered another order overruling the other objections raised by Comstock and the other parties in interest and approving the revised plan of reorganization. An opinion was then filed detailing the reasons for the two orders. In re Missouri Pacific R. Co., D.C., 64 F.Supp. 64. Comstock appealed from the order dismissing his objection No. 19.1 The Eighth Circuit Court of Appeals affirmed the District Court's [335 U.S. 211 , 234] action on this objection, holding that the findings of that court were not clearly erroneous. Comstock v. Group of Institutional Investors, 163 F.2d 350. At the suggestion of the Interstate Commerce Commission, the Circuit Court of Appeals then remanded the revised plan of reorganization back to the Commission for reconsideration and revision. Wright v. Group of Institutional Investors, 8 cir., 163 F.2d 1022. The Commission has not yet disposed of the matter.
For somewhat different reasons than those advanced by the Court, I agree that a judicial consideration of Comstock's objection No. 19 is not now precluded by the doctrine of laches.
The joint reorganization proceedings commenced in 1933. Comstock did not purchase any of the MOP 5 1/4% secured bonds until 1940, soon after a Senate subcommittee investigating railroads issued a report criticizing the MOP management of NOTM. S.Rep. No. 25, Part 9, 76th Cong., 3d Sess. He then bought some of the bonds at about 10 cents on the dollar and employed an accountant to study the relationships between MOP and NOTM prior to 1933. Not until 1943 did Comstock suggest that there might have been some irregularities on the part of MOP. And not until November, 1944, when he filed his objection No. 19 to the revised plan of reorganization, did he really press his allegations.
Prior to Comstock's objection, more than a decade of the reorganization process had produced no charge or revelation of impropriety as to MOP's $10,565,226.78 claim against NOTM. Numerous investigations and hearings had been held during that long period concerning the pre- reorganization administration of the affairs of MOP and its subsidiaries. The public holders of the MOP 5 1/4% secured bonds and other creditors had ample [335 U.S. 211 , 235] opportunity to question the allowance of the claim. But no charges were made until after Comstock purchased his bonds and conducted his own investigation. Many of the events to which objection No. 19 relates took place more than twenty years ago; and some of the persons who had personal knowledge of those events and who might have been able to testify in regard thereto are now dead.
I do not believe, however, that the doctrine of laches is properly applicable to the facts of this case. The District Court had before it a revised plan of reorganization of MOP and its subsidiaries, a plan which recognized that NOTM was indebted to MOP and which permittedM OP to collect that debt without subordination to other creditors. That court was duty bound to test this portion of the plan by the fair and equitable rule and to approve it only if the rule was found to be satisfied. American United Mut. Life Ins. Co. v. Avon Park, 311 U.S. 138 , 145, 146, 161, 162, 136 A.L.R. 860. The court's duty was nonetheless existent because an attack on the MOP claim came late in the day. Comstock's objection served only to emphasize the circumstances surrounding this indebtedness and to give the court an opportunity to inquire into the matter more fully than it might otherwise have done. Moreover, the fact that this objection had not previously been raised and adjudicated in the 77 proceedings added to the appropriateness of a judicial determination of the validity of the debt at this juncture. Only by examining the matter now could the court be certain whether the treatment accorded the debt the reorganization plan was fair and equitable.
The motives which led Comstock to acquire his bond holdings and to raise his objection No. 19 are not pertinent to the performance of the District Court's duty of testing the fairness of the reorganization plan. Nor is it decisive under these circumstances that the objection might have been raised earlier by Comstock or some other [335 U.S. 211 , 236] bondholder. It is enough that the matter was presented in an appropriate fashion at a time when the court was compelled to pass judgment upon the reorganization plan and at a time when no prejudicial change in the position of other parties had yet occurred.
In this connection, it is noteworthy that that the Interstate Commerce Commission at an early stage in the 77 proceedings held that the validity of the MOP claim is a matter 'for litigation in the Courts.' Thus Comstock would likely have been unsuccessful had he attempted to secure a determination of his objection by the Commission before going to court. The Court today, however, expressly holds that the Deep Rock issues raised by Comstock involve matters over which the Commission has jurisdiction and with which it is especially qualified to deal. See Schwabacher v. United States, 334 U.S. 182 . On this phase of the case, I am in agreement with the Court. The Commission should determine the applicability of the Deep Rock doctrine to railroad reorganization plans which it formulates. But since the Commission had previously refused to adjudicate the merits of the MOP claim and since Comstock's objection has been thoroughly aired in the District Court, it is inappropriate to remand the case now to the Commission for an expression of its views.
Despite the claimed difficulties due to the age of the pertinent events and the death of some of the witnesses, the District Court was able to give a comprehensive treatment to Comstock's objection and to render an informed judgment on the fairness of MOP's claim against NOTM. Many of the issues revolved about written evidence and statistics. And the court was able to draw upon its intimate knowledge of the MOP-NOTM relationships, knowledge gained from long association with the reorganization proceedings. Hence the court could and did perform fully its function as to that portion of [335 U.S. 211 , 237] the revised reorganization plan with which objection No. 19 was concerned.
In this situation, the desirability and necessity of determining the fairness and equitableness of MOP's claim far outweigh any possible inconvenience caused by the late presentation of the matter.
In Taylor v. Standard Gas & Electric Co., supra, this Court established the principle that where a parent corporation has not only dominated but has mismanaged a subsidiary corporation, which is presently in bankruptcy or reorganization, and where the parent has a claim which is intimately related to the mismanagement, a court may refuse to permit the parent to assert the claim as a creditor except in subordination to the claims of the subsidiary's other creditor and preferred stockholders. This principle, which has become known as the Deep Rock doctrine, is equitable in nature. As explained in Pepper v. Litton, 308 U.S. 295, 308 , 246, the doctrine was applied in the Taylor case on the basis of 'the equities of the case-the history of spoliation, mismanagement, and faithless stewardship of the affairs of the subsidiary by Standard to the detriment of the public investors.'
The fulcrum of Comstock's objection No. 19 is the Deep Rock doctrine. The argument is that the items constituting the $10,565,276.78 claim filed by MOP against NOTM are impregnated with MOP's alleged mismanagement of NOTM and that the claim should therefore be subordinated to the claim of the public investors in the MOP 5 1/4% secured bonds, who are secured by MOP's pledge of the NOTM common stock.
It is no answer to Comstock's claim that the District Court found that the transactions giving rise to the MOP claim were carried out in good faith. The equities which form the Deep Rock doctrine relate not alone to matters [335 U.S. 211 , 238] of bad faith. They are also concerned with the essential fairness and propriety of transactions from an objective standpoint. Pepper v. Litton, supra, 308 U.S. at page 306, 60 S.Ct. at page 245. Like negligence, inequity may be present where there is the utmost subjective good faith. If there is mismanagement and if there is undue harm to the creditors and preferred stockholders of the subsidiary, the Deep Rock doctrine dictates subordination of the parent's claim. And if there be good faith on the part of the parent's officers, if hardly justifies ignoring the injury to the subsidiary's creditors and stockholders. Equity looks in all directions. Only in that way can the various interests in the corporate community be adequately protected.
Moreover, the issues raised by Comstock are not resolved by the District Court's finding that operational benefits accrued to NOTM and its subsidiaries by virtue of the transactions underlying MOP's cliam. These transactions were undoubtedly tied in with the expansion program which MOP was undertaking during this period. But a breach of fiduciary obligations is not to be condoned by the presence of accompanying benefits where the subsidiary's assets are depleted to the injury of the stockholders and creditors of the subsidiary.
Nor does the fact that MOP, the parent, is insolvent bar an application of the Deep Rock doctrine to the facts of this case. The insolvency of the parent and the consequent effect of subordination upon the parent's innocent creditors are certainly factors to be considered. See Consolidated Rock Products Co. v. DuBois, 312 U.S. 510, 524 , 684; Prudence Realization Corp. v. Geist, 316 U.S. 89, 97 , 983. But they are not necessarily decisive in all cases. The equities of a particular situation may turn upon something more than the solvency or insolvency of the parent. It may well be that a balancing of competing equities reveals that it is unjust to permit the advantages arising from [335 U.S. 211 , 239] the parent's breach of fiduciary duties to adhere to the benefit of the innocent creditors of the insolvent parent. Some other innocent parties may have an overriding interest which justifies subordination of the claim. Or the claim itself may be so tainted with inequity and unenforceability as to require subordination regardless of the parent's insolvency. And so the Deep Rock doctrine is as broad and as narrow as the equities in each case.
In this instance, I believe that the public holders of the MOP 5 1/4% secured bonds have a sufficiently direct and overriding interest in the financial well-being of NOTM to justify subordinating the MOP claim should it appear that this claim is intimately associated with a breach of MOP's fiduciary duties. MOP secured these bonds with a pledge of the NOTM common stock and expressly undertook not to impeach the pledge. Any wrongful conduct by MOP which dimii shed the size of NOTM assets would impair the value of the NOTM stock. Subordination of the claim would thus tend to make the NOTM stock more valuable and to make possible a realization of MOP's express pledge to its bondholders. True, creditors of MOP other than the bondholders would be unable to benefit from whatever could be collected on the claim. But they were not the recipients of a pledge of NOTM stock and they lacked the immediate interest that the bondholders had in a proper performance of MOP's fiduciary duties. The indirect loss they would suffer by subordination is outweighed by the direct injury to the bondholders as a result of allowing the claim.
It is therefore essential to study the various transactions in detail to determine whether they represent the type of mismanagement by a parent which leads to subordination of the resulting claim against the subsidiary. [335 U.S. 211 , 240] III.
The District Court found that during the period from March, 1929, to February, 1933, MOP advanced to NOTM the net sum, after deducting principal payments, of $10,565,226.78-which constitutes the claim in issue. Included in these advances was the greater portion of the $2,795,000 loaned to NOTM between November 30, 1928, and November 27, 1931, to make additions and improvements to the railroad properties of NOTM and other related subsidiaries. But each time one of these advances was made, there was an almost simultaneous payment of a dividend by NOTM on its stock, which was largely owned by MOP. This phenomenon is demonstrated in the following table:
Dates of Dividends by NOTM Advances by MOP Total Amount to Advances Dividends to NOTM amount MOP 
Nov. 30, 1928 Dec. 1, 1928 $300,000 $259,576 $233,231 Feb. 28, 1929 Mar. 1, 1929 250,000 259,576 234,237 Aug. 31, 1929 Sept. 3, 1929 275,000 259,576 239,429 Nov. 29, 1929 Dec. 1, 1929 310,000 259,576 241,529 Feb. 28, 1930 Mar. 1, 1930 260,000 259,576 242,072 May 31, 1930 June 1, 1930 275,000 259,576 242,212 Nov. 29, 1930 Dec. 1, 1930 300,000 259,576 243,360 Feb. 25, 1931 Feb. 28, 1931 75,000 259,576 243,510 May 27, 1931 June 1, 1931 200,000 259,576 244,387 Aug. 29, 1931 Aug. 31, 1931 250,000 259,576 244,527 Nov. 27, 1931 Nov. 30, 1931- 300,000 259,576 244,527 Dec. 1, 1931. ------------- -------------- -------------- * $2,795,000 $2,855,336 $2,653,021 
* It is contended by the respondents that this figure should be reduced to $2,082,456, since the first two advances in November 1928, and February 1929, were repaid and since the excess of the advances over the dividends should not be counted.
It is said, however, that MOP's action in making these loans and receiving back the dividends followed a natural pattern of a company devoted to improving the properties of its subsidiaries, there being merely a 'near coincidence as to the dates of certain dividends and advances.' [335 U.S. 211 , 241] Reference is made in this respect to the relationship which MOP bears to the various companies in the Gulf Coast Lines system (hereinafter called GCL). In 1924, MOP acquired a controlling interest in NOTM and thereby inherited complete control of the GCL system, the rail lines of which are interlaced with others in the MOP system. NOTM at all times has been primarily a holding company owning all the stocks and bonds of the fourteen subsidiary companies constituting the GCL group, NOTM itself operating only about 11% of the total GCL mileage. Of the GCL operating companies, the St. Louis, Brownsville and Mexico Railway Co. (hereinafter called Brownsville) is the most important, operating about one-third of the GCL mileage and group's income during the period in question. NOTM is the only one of the GCL contributing from 61% to 84% of the group which has securities outstanding in the hands of the public.
According to the District Court fini ngs, MOP's policy in advancing the $2,795,000 to NOTM was to reimburse NOTM's treasury for additions and betterments to the properties of GCL system. NOTM acted as banker for that system. The GCL subsidiaries were not in a position from 1925 to 1930 to finance their own improvements except out of earnings and by borrowing from NOTM. Most of their freight revenues were cleared through NOTM; as these items were received by NOTM, they were credited against the obligations created by the loans from NOTM to the subsidiaries. But since the total requirements of the subsidiaries for operating expenses, dividends and improvements were in excess of the receipts, the unpaid accounts mounted. Finally MOP had to begin loaning money to NOTM to cover these accounts. It is in this way that MOP's advances are said to have been directed toward the improvement program of the GCL system. [335 U.S. 211 , 242] It is vigorously denied that these MOP advances were in any way used to pay for the almost simultaneous dividends from NOTM to MOP, such a contention being termed 'superficial' and contrary to 'basic principles of accounting.' In support of that denial, an illustration is used. Assume that NOTM receives $200,000 cash from net earnings on January 31, when it is known that this amount will be needed to pay a bill for a new freight yard for a subsidiary. NOTM also knows that on April 1 a $100,000 cash dividend to MOP will be due. Instead of borrowing to pay for the new freight yard, NOTM uses the $200,000 cash for that purpose. Then, three days prior to the dividend date, NOTM borrows $100,000 from MOP to reimburse the NOTM treasury in part for the investment in the new freight yard. This saves NOTM about two months' interest on $100,000 of the money spent for the freight yard. The fact that a $100,000 cash dividend is paid three days after the $100,000 loan is thought to be a mere coincidence, the dividend and the loan having no connection.
But in this illustration it is obvious that NOTM has insufficient cash to finance both the $200,000 freight yard and the $100,000 dividend. It has to borrow money for one purpose or the other. But to say that it here borrows $100,000 to help pay for the freight yard is unrealistic. NOTM has enough cash to pay for the freight yard and it uses the cash just for that purpose. Two months later it has the choice of (1) borrowing $100, 000 and paying the dividend, or (2) not borrowing the money and not paying the dividend. It chooses the former course of action. By such action, NOTM has borrowed money to pay a dividend.
The foregoing illustration indicates what the record in this case amply demonstrates-namely, that the MOP advances found by the District Court to have been for the payment of GCL improvements were in reality ad- [335 U.S. 211 , 243] vances for the payment of dividends by NOTM, dividends which for the most part went to MOP. Considered as a separate entity, NOTM rarely had enough income from the time MOP acquired control in 1924 to the start of reorganization in 1933 to pay the regular dividends; loans were essential if MOP was to continue to receive its share of these dividends.
Year Net Income Dividends 
1925 $839,679.00 $1,038,198 1926 1,393,806.58 1,038,198 1927 937,098.90 1,038,198 1928 742,058.00 1,038,198 1929 1,153,257.54 1,038,198 1930 854,139.71 1,038,198 1931 * 399,487.80 1,038,198 1932 (- 951,607.76) None 
* After deduction of $3,155,000 for that portion of the dividends on Brownsville stock held by NOTM which was unpaid in 1931.
After studying these dividends from NOTM to MOP, the subcommittee of the Senate Committee on Interstate Commerce investigating railroads ( composed of Senators Wheeler and Truman) concluded as follows:
The consolidated pricture of NOTM and its GCL subsidiaries was equally indicative of the lack of an ability to pay dividends to MOP without borrowing.
Year Net Income Dividends 
1925 $2,547,633 $1,038,198 1926 1,783,287 1,038,198 1927 (- 202,438) 1,038,198 1928 956,433 1,038,198 1929 845,064 1,038,198 1930 674,950 1,038,198 1931 (- 1,122,422) 1,038,198 
Care was taken, however, to avoid the appearance of borrowing from MOP to pay dividends to MOP, a practice of doubtful legality. Whenever it was found that NOTM had inadequate income to meet a prospective dividend payment, MOP officers would direct Brownsville, NOTM's principal subsidiary, to take steps to declare a dividend on its stock, all of which was held by NOTM. Usually this dividend was the precise amount by which NOTM lacked money to pay its own dividend. 2 But Brownsville invariably was unable to [335 U.S. 211 , 245] make a cash payment of its dividends to NOTM and many of its pre-1931 dividend declarations were considered collected by NOTM only at the expense of leaving unpaid Brownsville's debts to NOTM for essential supplies. These paper dividend declarations were capped in 1931 when Brownsville was ordered to declare dividends to NOTM of $4,155,000; in that year Brownsville earned but $398,000. The Bureau of Accounts of the Interstate Commerce Commission in 1936 informed NOTM that these 1931 dividends were declared at a time when NOTM was aware that Brownsville 'was without funds to pay it, and even on the basis of past experience the earnings of the company, had business continued good, would not have been adequate to make the payment until some future date.' This fact rendered the divi- [335 U.S. 211 , 246] dends improper under Commission rules. And while it was too late to correct the income accounts of NOTM which had already been closed, NOTM was directed to write off the unpaid portion of the 1931 dividends (some $ 1,400,000) through profit and loss.
This 1931 incident grew out of the fact that NOTM was operating that year at a great loss. It began that year with a profit-and-loss balance of only $709,000 and operated at a loss of $606,000. It also had to charge off $875,000 to correct its former inadequate depreciation accruals. By the end of 1931, NOTM would have shown a debit profit-and-loss balance of $ 772,000 or more. MOP, of course, was demanding payment of the usual $1,038, 000 dividend for the year. 'The problem was solved as it had been solved in previous years-by milking the Brownsville. But this time the milking would have to be thorough. * * * The solution found was to cause the Brownsville to declare an extraordinary dividend of $3,500,000-a dividend seven times the par value of the stock upon which it was declared. Other Brownsville dividends to the N.O.T & M. brought the total for the year to $ 4,155,000, enough to fill up the N.O.T.M.'s profit-and-loss deficit and to enable the latter to declare a $1,038,000 dividend in favor chiefly of the Missouri Pacific.' S.Rep. No. 25, Part 9, 76th Cong., 3d Sess., p. 10.
Thus the Brownsville dividend declarations gave NOTM earned surpluses on paper without giving it any cash with which to pay its dividends to MOP. Dividends declared by Brownsville were entered as income to NOTM even though they were not paid. An ostensible legal basis was thereby established for a declaration of dividends to MOP. NOTM would then borrow money from MOP to pay for those dividends. This again was largely a paper transaction. The earned surplus upon which the Court today places great reliance in affirming the District Court's findings was but a figment of the [335 U.S. 211 , 247] MOP imagination. 'The intricate accounting devices evolved by railroad and holding company officials in an attempt to legalize dividend payments unjustified by earnings resulted, both in 1930 and 1931, in the payment of N.O.T. & M. devidends out of capital, a procedure disguised in 1930 behind faulty bookkeeping and in 1931 behind an out-and-out violation of Interstate Commerce Commission accounting regulations.' S.Rep. No. 25, Part 9, 76th Cong., 3d Sess., p. 14.
By advancing to NOTM $2,795,000, MOP received back $2,654,000 in dividends within a few days after the various loans, making a total net advance of $141,000. MOP's cash position was unaffected by these various transactions, the NOTM dividends merely giving it a paper profit and loss balance out of which to declare its own dividends. Hence MOP, like NOTM, was forced to borrow money; it did so from outside sources. Yet MOP now seeks to claim nearly all of the $2,795,000 plus interest, an aggregate of about $4,795,000, for engaging in these bookkeeping transactions and for extending credit to the extent of $141,000.
NOTM's fiscal affairs in this respect have certainly not 'been conducted with an eye single to its own interests' within the meaning of the Deep Rock doctrine. Taylor v. Standard Gas & Electric Co., supra, 306 U.S. at page 323, 59 S.Ct. at page 550. Now can these transactions be said to meet the test of 'inherent fairness' and the requirement of an 'arm's length bargain,' which are essential ingredients of that doctrine. Pepper v. Litton, supra, 308 U.S. at pages 306, 307, 60 S.Ct. at page 245. Here, as in the Taylor case, dividends were declared in the face of the fact the NOTM had not the cash available to pay them and was, at the time, borrowing in large amounts from MOP. And see In re Commonwealth Light & Power Co., Cir., 141 F.2d 734, 738. Compelling a subsidiary to pay dividends under these circumstances is the type of mismanagement by a parent which leads to the subordination of the resulting indebtedness. [335 U.S. 211 , 248] IV.
Another part of the $10,565,226.78 MOP claim related to an intercompany adjustment of $1,261,009.84 made during October, 1932, at the height of the depression and shortly before the 77 proceedings began.
The International-Great Northern Railroad Co. (hereinafter called the I-GN) was a subsidiary of NOTM, although not deemed a part of the GCL system. I-GN had advanced cash or delivered materials to ten of NOTM's GCL subsidiaries; as of October 31, 1932, these ten companies were indebted to I-GN in the sum of $1,261,009.84 on account of these transactions. On the same date, I-GN was indebted to MOP in an amount in excess of $1,261,009. 84.
It was known at this time that the I-GN claims against the NOTM subsidiaries were presently uncollectible. It was also apparent that NOTM was in better financial health than I-GN. MOP, which was then in need of loans from outside sources, sought to improve its own financial condition by shifting debtors. It did this by increasing its claim against NOTM by $ 1,261,009.84 and by decreasing its claim against I-GN by that same figure. To make this bookkeeping shuffle possible, I-GN credited NOTM and its other subsidiaries with the payment of the $1,261,009.84 debt which those subsidiaries owed. MOP then credited I-GN with payment of a like amount, crediting it against I-GN's debt to MOP. NOTM thereby found itself obligated to pay MOP an additional $1,261,009.84. Appropriate entries were made, of course, in the journals of the affected companies.
NOTM had not previously been liable to pay this amount to MOP; nor did it receive anything of value from MOP in return for assuming the debt. Yet no valid reason is suggested why NOTM should have been forced to shoulder this obligation, thereby decreasing the assets available to its creditors and stockholders. Cer- [335 U.S. 211 , 249] tainly it was not essential, as has been claimed, that NOTM acquire the debt to protect its ownership and control of its GCL subsidiaries. NOTM was invulnerable in that respect, owning all the securities of the subsidiaries, and the addition of this debt added no new protection. The contention is also made that NOTM owed a fiduciary obligation to I-GN, its subsidiary, and that it was NOTM's duty to relieve I-GN of any uncollectible items owed by other NOTM subsidiaries. The fiduciary obligation grows out of the fact that NOTM owned all the securities of its GCL subsidiaries. This contention is closely allied to the theory that NOTM and the subsidiaries are a single financial entity and that it is immaterial which company within that entity is liable for the debt. But the close relationship of NOTM and its GCL subsidiaries does not legitimatize the intercompany adjustment from an equitable point of view. In this situation, we are dealing with the rights of creditors and stockholders who are directly interested in the financial well-being of NOTM as an enterprise separate and distinct from its subsidiaries. Hence it is necessary here to recognize and give effect to the corporate distinctions between NOTM and its GCL subsidiaries.
The resulting picture is one of a bookkeeping write-up of NOTM indebtedness at a time when NOTM was on the threshold of reorganization. NOTM received nothing whatever to compensate for the increase in its debt structure. The increase served only to enable MOP, the parent, to possess what was thought to be a more favorable vorable creditor's position. Such treatment of a subsidiary's debt structure does not square with a parent's fiduciary position. A subsidiary is entitled to be saddled by a parent only with those debts which may fairly be allocated to it, debts which grow out of legitimate business transactions. To transfer debts promiscuously from one subsidiary to another merely to augment the parent's [335 U.S. 211 , 250] creditor status is to inflict an injustice upon the creditors and stockholders of the subsidiary to which the debt is shifted. It is a type of mismanagement of a subsidiary which properly calls the Deep Rock doctrine into operation, causing the subordination of the parent's claim for the amount of the transferred debt.
The remainder of the $10,565,226.78 claim concerned the advances made by MOP to NOTM to acquire five Texas 'feeder' railroad lines at a cost of over $5,500,000.
Comstock's contention in this respect is that the acquisition of these lines was for the sole benefit of MOP and I-GN, rather than for NOTM or the GCL system. Reference is made to a statement of the Interstate Commerce Commission that these 'feeder' lines 'were really acquired for the benefit of the entire MOP system. They have usually been operated at a deficit since acquisition.' Missouri Pacific R. Co. Reorganization, 239 I. C.C. 7, 71. Moreover, some of the 'feeder' lines are said not to connect at all with the lines of NOTM or its GCL subsidiaries. And it is thought that some of the MOP advances were used to cover operating deficits of the acquired property. Such is the basis of the objection to the recognition of MOP's claim against NOTM for the cost of the 'feeder' lines.
There is nothing in the record to support an application of the Deep Rock doctrine to this aspect of MOP's claim. The use of NOTM to acquire subsidiary rail lines which have subsequently been operated at a loss does not necessarily indicate improper action by MOP; a mere mistake in business judgment may be all that was involved. And the fact that the acquisition may have been primarily for the benefit of some part of the MOP system other than the GCL companies does not necessarily mean that the [335 U.S. 211 , 251] acquisition was outside the legitimate scope of the functions of NOTM, a holding company in the MOP system.
Indeed, the main thrust of Comstock's objection to this segment of the MOP claim is directed toward the entire history of MOP's management of NOTM. The thought is that the relationship of the parent and the subsidiary has been so complex and so saturated with mismanagement as to warrant subordination of the entire claim of the parent without bothering to differentiate between particular transactions. See Taylor v. Standard Gas & Electric Co., supra, 306 U.S. at page 323, 59 S.Ct. at page 550. But the record does not support such an approach to the MOP-NOTM relationship. There have been, as we have seen, two examples of mismanagement on MOP's part that warrant the application of the Deep Rock doctrine. But those situations are separable in nature from the other transactions between MOP and NOTM. And the Deep Rock doctrine is not one that operates to bar an entire parental claim if only a separable portion of it is inequitable. It is only where, as in the Taylor case, the parent-subsidiary relationship has been so complex that it is impossible to restore the subsidiary to the position it would have been in but for the parent's mismanagement that the entire claim may be subordinated without distinguishing the good transactions from the bad. Such is not the situation in this case.
From the findings of the District Court and the uncontested facts in the record, I can only conclude that of the $10,565,226.78 MOP claim, the portion of the $2,795,000 relating to dividend advances during the period in question and the $1,261,009.84 relating to the intercompany bookkeeping transaction should be subordinated to the claims of the pledgees of NOTM stock. In holding otherwise, the District Court committed an error which this Court should not overlook.
[ Footnote 1 ] "* * * that the issue by the New Orleans, Texas & Mexico Railway Company of a note or notes in an aggregate amount not exceeding $7,456,726. 78, as aforesaid, (2) is for a lawful object within its corporate purposes, and compatible with the public interest, which is necessary and appropriate for and consistent with the proper performance by it of service to the public as a common carrier, and which will not impair its ability to perform that service, and (b) is reasonably necessary and appropriate for such purpose.' New Orleans, Texas & Mexico Railway Company Notes, Finance Docket No. 9817; 189 I.C.C. 600, 601, (1933) (R. 20839─ 20840).'
[ Footnote 2 ] 'The exhibit 'A' also included excerpts from a report of a sub- committee of the United States Senate on the subject of Missouri Pacific System─Inter Company Dividends and Advances, published about July 29, 1940, which criticized Missouri Pacific management of the New Orleans.'
[ Footnote 3 ] 'There was also at all times a substantial minority stockholding interest in the New Orleans with means to keep informed of the affairs of the regulated railroad corporation.'
[ Footnote 1 ] The leading party opposing Comstock on this appeal was the Group of Institutional Investors, holding first and refunding mortgage bonds of MOP. This group represented less than 10% of such bonds and admitted that it had 'no financial interest in the controversy revolving about' the MOP claim, its only interest being to expedite a reorganization plan then under consideration. But this group offered the only evidence in the District Court in support of the MOP claim. Another party was the NOTM mortgage and income bondholders committee, which also admitted it had no direct interest in the MOP claim litigation. Other parties included MOP, the MOP common and preferred stockholders committees, the MOP trustee, Alleghany Corporation, and certain groups of creditors and indenture trustees. These parties are now respondents before us.
[ Footnote 2 ] The method by which MOP would bring about the Brownsville declaration of dividends is shown by the following typical exchange of letters between NOTM and MOP officials:
The reply to the foregoing letter follows:
M r. Safford: Referring to your letter of January 10th, file 482─2, with reference to declaring dividend out of the surplus of the St. Louis, Brownsville & Mexico Railway Company in favor of the New Orleans, Texas & Mexico Railway Company.
On June 17, 1931, Brownsville declared a dividend of $316,188.85, the precise amount of the NOTM deficit; the dividend was declared effective as of November 30, 1930, one day prior to the dividend date for NOTM's stock.