## Facts

- A parent corporation and two wholly owned subsidiaries entered reorganization proceedings under § 77B of the Bankruptcy Act.
- Each subsidiary had outstanding 6% mortgage bonds with substantial accrued and unpaid interest: Union Rock Co. ($1,877,000 principal; $403,555 interest) and Consumers Rock & Gravel Co. ($1,137,000 principal; $221,715 interest).
- The confirmed plan created a new corporation to take all assets of the three companies free of claims and distributed new securities.
- Subsidiary bondholders received (i) income bonds equal to 50% of principal and (ii) preferred stock equal to the other 50% of principal; accrued interest claims were extinguished without compensation.
- The parent’s preferred shareholders received new common stock; the parent’s common shareholders received warrants to buy new common stock.
- The subsidiaries held money claims against the parent under an operating agreement requiring payments/credits and final accountings; the agreement stated it was not for the benefit of third persons.
- The district court made no separate valuations for each subsidiary or a clear enterprise-wide valuation; it found asset value (excluding goodwill/going concern) exceeded bonded debt plus accrued interest, but total value (including goodwill/going concern) was insufficient to pay both that debt and the parent preferred stock’s liquidation preferences and accrued dividends.
- The Ninth Circuit reversed confirmation; the Supreme Court granted certiorari and reviewed whether the plan satisfied § 77B’s “fair and equitable” standard.

## Issues

1. Whether a plan is “fair and equitable” when bondholders are not accorded full recognition of secured claims (including accrued interest) yet the parent’s stockholders receive interests in the reorganized enterprise.
2. Whether confirmation is proper absent sound valuation findings allocating value to the enterprise and/or to the separate corporate estates whose creditors have distinct priority rights.
3. Whether subsidiary intercompany claims against the parent are assets that must be considered for bondholders’ benefit despite contractual language disclaiming third-party beneficiary rights.

## Decision

- The Supreme Court affirmed the court of appeals and held the plan could not be confirmed.
- The plan violated the absolute priority requirement because stockholders retained interests while bondholders were not fully compensated for principal and accrued interest.
- The district court’s valuation and allocation findings were inadequate to support equity participation and did not reliably determine whether any surplus existed above senior claims.
- Subsidiaries’ money claims against the parent were assets available to satisfy subsidiary bondholders before any value could pass to the parent or its stockholders.

## Legal Principles

- A reorganization plan must be “fair and equitable,” which requires application of the absolute priority rule: junior interests may not receive or retain value unless senior creditors receive the full value of their claims or consent to a permissible compromise.
- When mortgaged assets are insufficient to pay mortgage indebtedness (including accrued interest), secured creditors have prior recourse to unmortgaged assets of the debtor estate, including enforceable intercompany claims.
- Valuation supporting distributions must be evidence-based and tied to earning power and realistic appraisal; confirmation cannot rest on speculative assumptions used to justify participation by junior interests.
- Treating affiliated corporations as a single enterprise for operational reasons does not permit disregard of separate creditor priorities created by distinct debt instruments and corporate estates.
- Contract provisions disclaiming third-party beneficiary status do not allow a reorganization court to exclude debtor assets (such as subsidiary claims against a parent) from the pool available to satisfy the debtor’s creditors.

## Conclusion

The Court required strict observance of absolute priority and reliable valuation in corporate reorganizations: stockholders could not receive interests while subsidiary bondholders were denied full value (including accrued interest), and subsidiary intercompany claims against the parent had to be treated as assets available to satisfy the bondholders first.


Consolidated Rock Prods. Co. v. Du Bois, 312 U.S. 510 (1941)