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In re Envirodyne Industries

March 15, 1996




Appeals from the United States District Court for the Northern District of Illinois, Eastern Division. Nos. 95 C 1624, 95 C 1625, and 95 C 1723--Suzanne B. Conlon, Judge.

Before CUMMINGS, RIPPLE and EVANS, Circuit Judges.

CUMMINGS, Circuit Judge.



Defendants in this case failed to tender shares of stock in a corporation entering a shortform merger under Delaware law. Their equity interest was thus converted into debt and they retained the right to redeem their canceled shares for a specified amount without interest. They failed to do so, however, before the newly formed corporation filed for Chapter 11 bankruptcy, and Defendants now complain that the Bankruptcy Court improperly subordinated their claims to those of other general unsecured creditors. We affirm the decision to subordinate Defendants' claims under 11 U.S.C. sec. 510(c).

In 1989, organizers formed Emerald Acquisition Corporation ("Emerald") and Emerald Sub One, Inc. ("Emerald Sub"), a wholly owned subsidiary of Emerald, for the purpose of acquiring Envirodyne Industries, Inc. ("Former Envirodyne"). Emerald Sub was organized specifically to purchase the outstanding shares of common stock of Former Envirodyne. These entities entered into a merger agreement whereby Emerald Sub purchased tendered shares of Former Envirodyne at $40 per share. Emerald Sub purchased 13,104,980 shares tendered and not withdrawn out of approximately 18,382,324 shares issued and outstanding. On June 1, 1989, Emerald Sub and Former Envirodyne were merged under Delaware General Corporation Law, section 253, with current Envirodyne as the surviving entity.

Shareholders had a right to redeem their stock at $40 per share or dissent from the merger and obtain an appraisal under Delaware law. As of the effective date of the merger, however, Former Envirodyne's stock was canceled, and non-tendering shareholders ceased to be equity holders and instead became creditors of current Envirodyne. In essence, non-tendering shareholders were "cashed-out." The merger agreement provided that these cashed-out shareholders were entitled to receive $40 per share of Former Envirodyne stock upon demand, but without interest. Each of the Defendants before this Court is a non-tendering stockholder of Former Envirodyne or a representative or successor in interest thereof. It is unclear from the record why Defendants failed to redeem their non-interest-bearing shares of Former Envirodyne for over three years after the merger.

On January 7, 1993, Envirodyne filed voluntary petitions for Chapter 11 bankruptcy. Its balance sheet reflected liabilities of $2,175,520 due to non-tendering, cashed-out shareholders of Former Envirodyne. Under the reorganization plan, general unsecured creditors received 32.28 shares of common stock in reorganized Envirodyne for each $500 of allowed claims (which was estimated to be approximately two-thirds of the allowed amount of their claims), and Envirodyne agreed to seek to subordinate the claims of non-tendering shareholders of Former Envirodyne. Pursuant to the plan and on September 23, 1993, Envirodyne commenced an adversary proceeding in Bankruptcy Court seeking equitable subordination of the non-tendering shareholders' claims to those of other general unsecured creditors. Subordination was granted by the Bankruptcy Court on cross-motions for summary judgment, In re Envirodyne Indus., Inc., 176 B.R. 825 (Bankr. N.D. Ill. 1995), and the district court later affirmed. Thereafter, Envirodyne's stock declined in value and, as a result, the general unsecured creditors received distributions amounting only to about one-third of the allowed amount of their claims; the Defendants received no distribution.

The sole issue on appeal is whether the Bankruptcy Court properly subordinated Defendants' claims to those of other general unsecured creditors under Section 510(c) of the Bankruptcy Code, 11 U.S.C. sec. 510(c), without requiring proof of wrongful conduct on the part of Defendants. The Bankruptcy Code provides as follows:

Notwithstanding subsections (a) and (b) of this section, after notice and a 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 a subordinated claim be transferred to the estate. 11 U.S.C. sec. 510(c).

Exactly what "principles of equitable subordination" Congress had in mind is not clear from the Bankruptcy Code, but we have previously held based on the legislative history that Congress intended courts to develop the appropriate principles, which might be broader than the principles existing prior to Section 510(c)'s enactment. In re Virtual Network Servs. Corp., 902 F.2d 1246, 1249-1250 (7th Cir. 1990); Kham & Nate's Shoes No. 2, Inc. v. First Bank of Whiting, 908 F.2d 1351, 1356 (7th Cir. 1990). Defendants' primary contention is that, at a minimum, equitable subordination requires inequitable conduct on the part of the creditor. But Virtual Network has disposed of that issue as well:

In sum, we conclude that sec. 510(c)(1) authorizes courts to equitably subordinate claims to other claims on a case-by-case basis without requiring in every instance inequitable conduct on the part of the creditor claiming parity among other unsecured general creditors. 902 F.2d at 1250; see also In re Vitreous Steel Prods. Co., 911 F.2d 1223, 1237 (7th Cir. 1990) (the Section 510(c) inquiry is to be made on a case-by-case basis focusing on fairness to other creditors). Accord In re CF&I Fabricators of Utah, Inc., 53 F.3d 1155 (10th Cir. 1995), certiorari granted, 116 S. Ct. 558 (Dec. 1, 1995); In re First Truck Lines, Inc., 48 F.3d 210 (6th Cir. 1995), ...

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