## Facts

- Deep Rock Oil Corporation, a Delaware oil company, was dominated by Standard Gas & Electric Co., which owned nearly all of Deep Rock’s common stock and shared interlocking directors and officers with it.
- Deep Rock was undercapitalized from inception, heavily debt-financed, and dependent on continuing support from Standard to operate.
- Over years of control, Standard caused Deep Rock to engage in practices that benefited Standard and harmed Deep Rock, including paying dividends despite financial weakness and imposing burdensome intercompany charges.
- Preferred stockholders lacked effective control because the charter denied voting rights while dividends were paid; Standard caused dividends to be paid despite Deep Rock’s precarious condition.
- Deep Rock entered reorganization under § 77B of the Bankruptcy Act.
- Standard asserted a large open-account creditor claim arising from advances and intercompany dealings during its control.
- The district court approved a compromise of Standard’s claim and a reorganization plan based on that compromise, under which Standard would receive a majority of the new company’s common stock while old preferred stockholders would receive only a minority interest.
- The Tenth Circuit affirmed; the Supreme Court granted review.

## Issues

1. Whether the reorganization court abused its discretion by approving a compromise and § 77B plan that treated a controlling parent’s large insider creditor claim as enforceable on favorable terms, despite the parent’s undercapitalization and mismanagement of the subsidiary.
2. Whether, in equity and under § 77B, the parent’s claim should be subordinated to the claims of other creditors and the interests of publicly held preferred stockholders harmed by the parent’s conduct.

## Decision

- The Supreme Court reversed, holding that the district court abused its discretion in approving the compromise and the plan.
- The Court required that the reorganization proceed with equitable recognition of preferred stockholders’ position and with subordination of Standard’s insider claim to the extent warranted by Standard’s control and wrongdoing.
- The Court rejected the plan’s effect of allowing Standard to retain dominant control of the reorganized enterprise through its asserted creditor status.

## Legal Principles

- A court sitting in equity may disregard strict insistence on corporate separateness when doing so would work fraud or injustice, particularly where a controlling shareholder uses domination to injure minority interests.
- Section 77B authorizes reorganization plans that modify stockholder and creditor rights and permits equitable adjustment of priorities based on wrongful conduct by insiders who control the debtor.
- When a controlling parent undercapitalizes and grossly mismanages a subsidiary and then asserts an insider creditor claim arising from that relationship, the claim may be equitably subordinated to the claims of outside creditors and the rights of preferred stockholders.

## Conclusion

The Court held that equity and § 77B required rejection of a reorganization compromise and plan that would have allowed a controlling parent to profit as a creditor and retain control after years of undercapitalization and mismanagement; insider claims tied to such conduct may be subordinated to protect outside creditors and preferred shareholders.


Taylor v. Standard Gas & Electric Co., 306 U.S. 307 (1939)