First Nat. Bank of Cincinnati v. Flershem

Background

The dispute involves National Radiator Corporation, a merged manufacturing company, a committee of its managers and bankers who proposed a Plan of Reorganization to cut debenture debt, and many debenture holders who refused to accept the plan. The company defaulted on interest while it still had ample cash. The Committee sued in federal court asking for receivers (court-appointed managers), a single sale of all assets, and a transfer of those assets to a new company under the Plan. The District Court appointed receivers, approved a sale at a low price to the Committee, and ordered transfer of the business free of prior creditor claims.

Reasoning

The Court addressed whether a federal court may be used to force non-consenting creditors into a reorganization when the company was solvent at the time it chose to default. The Justices found the suit lacked equity because the default and sale were means to coerce dissenting debenture holders and effect a transfer that would cut creditors’ legal rights. The Court held that appointing receivers and using a judicial sale to accomplish that purpose was improper, found the sale price grossly inadequate, reversed the decrees as to dissenting creditors, and remanded for a new appraisal to determine fair cash recovery.

Real world impact

Dissenting bondholders and banks are entitled to have the assets revalued as of the sale date and to receive the cash they would have obtained from a proper sale. The decision makes clear courts must investigate independently before approving sales that effectively force a reorganization, and later insolvency does not cure an earlier lack of equitable basis.