UNITED STATES BANKRUPTCY APPELLATE PANEL FOR THE FIRST CIRCUIT _______________________________

BAP No. MB 99-030 _______________________________

IN RE: TOWN & COUNTRY CORPORATION, Debtor. _______________________________

TOWN & COUNTRY CORPORATION, Plaintiff-Appellant,

v.

HARE & CO., CEDE & CO., JUSTINE CLARKE, PAUL GREGORY BURNINGHAM AND LORI BURNINGHAM STATE STREET BANK & TRUST CO., AND BOSTON EQUISERVE, Defendants-Appellees.

_______________________________

Appeal from the United States Bankruptcy Court for the District of Massachusetts (Hon. William C. Hillman, U.S. Bankruptcy Judge)

_______________________________

Before Votolato, Lamoutte, Vaughn, U.S. Bankruptcy Judges _______________________________

Daniel C. Cohn, David B. Madoff and Cohn & Kelakos LLP, for the Appellant.

Domenic P. Aiello, Alicia M. Duff and Lyne, Woodworth & Evarts LLP, for the Appellee Hare & Co.

_______________________________

July 10, 2000 _______________________________ Vaughn, J.

Town & Country Corporation (“Town & Country” or “Appellant”),

the debtor in this Chapter 11 Bankruptcy Proceeding, appeals from

an order by the bankruptcy court granting summary judgment in favor

of defendants Hare & Co. et al. on its complaint seeking

subordination of claims and for other relief pursuant to

(c). For the reasons set for below, the bankruptcy court’s

order is affirmed.

APPELLATE JURISDICTION

This Court has jurisdiction of the subject matter and the

parties pursuant to

(a) and (c), and Rule

8001-1(d)(1) of the Local Rules for the Bankruptcy Appellate Panel

for the First Circuit.

(a) and (c) (1988 & Supp.

1998); 1S T CIR . B.A.P. R. 8001-1(d)(1) (1998). The parties, pursuant

to Rule 8001-1, have not elected to have their appeal heard by the

District Court for the District of Massachusetts. 1S T CIR . B.A.P. R.

8001-1(d)(1). Further, this proceeding constitutes a separate

proceeding within the context of the Debtor’s bankruptcy case, and

thus is appropriate for review. Smith v. Seaside Lanes (In re

Moody),

(5th Cir. 1987).

2 BACKGROUND

Town & Country is a holding company involved, through its

subsidiaries, in the manufacturing and marketing of jewelry. At

the time it voluntarily filed for bankruptcy protection, Town &

Country was publicly traded on the American Stock Exchange.

Defendants Hare & Co., Cede & Co., Justine Clarke, Paul Gregory

Burningham and Lori Burningham are holders of Exchangeable

Preferred Stock of Town & Country. Defendant State Street Bank is

the successor trustee under a trust agreement created to hold

certain shares of stock for the benefit of holders of the

Exchangeable Preferred Stock. Defendant Boston Equiserve is the

transfer agent for the stock held by the trustee State Street Bank.

In 1993, Hare & Co. was the holder of notes issued by Town &

Country that were in default after Town & Country failed to make

interest payments. As part of a financial restructuring Town &

Country established and issued shares of Exchangeable Preferred

Stock, which were exchanged for the notes. Hare & Co., as well as

Defendants Cede & Co, Clarke and the Burninghams, are the holders

of all shares of the Exchangeable Preferred Stock.

In order to insure the performance of Town & Country under the

arrangement, Town & Country created a trust (the “Little

Switzerland Trust”) in which it placed shares of Little

Switzerland, Inc. common stock equal in number to the outstanding

3 shares of Exchangeable Preferred Stock. Under the terms of the

arrangement, the trust was created “solely for the benefit of the

Holders of the Exchangeable Preferred Stock and the Corporation in

order to give the Holder a free and unfettered opportunity

(including, in the event the Corporation is in bankruptcy) to

exchange such shares of Exchangeable Preferred Stock for Little

Switzerland Common Stock . . . and to secure the performance of the

Corporation’s obligations under the terms of this Certificate of

Designation.” App. at 63-64. The Certificate of Designation

orders the trustee to hold the shares solely for the benefit of the

holders of the Exchangeable Preferred Stock and Town & Country.

The trust is irrevokable.

Pursuant to the Certificate of Designation, holders of the

Exchangeable Preferred Stock were entitled to receive a dividend

beginning on the second anniversary of the stock’s issuance. In

addition, a mandatory redemption was established requiring Town &

Country to redeem all outstanding shares of the Exchangeable

Preferred Stock on December 31, 2000 for $14.59 per share (the

“Liquidation Value”). The redemption price could be paid in cash

or in shares of Little Switzerland stock. In addition, Town &

Country could elect for an optional redemption which allows the

corporation, after the second anniversary of their issuance, to

redeem the shares for a cash price set as a percentage of the

Liquidation Value; if during the period before the second

4 anniversary the sale price of the Little Switzerland stock rose to

$18.75 per share, Town & Country could redeem the Exchangeable

Preferred Stock, in whole, for the Liquidation Value.

After March 1, 1994, holders of the Exchangeable Preferred

Stock were given the right to exchange each share for one share of

the Little Switzerland Stock, subject to certain adjustments.1

1 The applicable characteristics of the Exchangeable Preferred Stock, as stated by the Bankruptcy Court, were as follows:

Each share of Exchangeable Preferred Stock will have a liquidation preference of $14.59, plus accrued and unpaid dividends (the “Liquidation Value”). . . . The Exchangeable Preferred Stock will be senior to all Junior Stock (as defined) . . . and will be subordinate in right of payment to all indebtedness of the Company....

No dividends will be paid on the Exchangeable Preferred Stock until after the second anniversary (the “Second Anniversary Date”) of the date on which shares of Exchangeable Preferred Stock are issued (the “Issuance Date”). Thereafter, holders of the shares of Exchangeable Preferred Stock will be entitled to receive, when and as declared by the Board of Directors of the Company, cumulative cash dividends at the rate of 6% per annum of the Liquidation Value thereof. . . . The amount of accrued and unpaid dividends shall be added to the Liquidation Value thereof. . . . The amount of accrued and unpaid dividends shall be added to the Liquidation Value. If and whenever two semi- annual dividend payments on the Exchangeable Preferred Stock are in arrears, then during the period commencing with such time and ending when all arrearages in dividends on the Exchangeable Preferred Stock shall have been paid (hereinafter called the “Class Voting Period”), the holders of the Exchangeable Preferred Stock . . . will be entitled to elect one or more additional directors equal to 30% of the entire Board of Directors of the Company. . . .

5 On November 17, 1997, Town & Country filed for relief under

Chapter 11 of the Bankruptcy Code. As part of its confirmed plan

of reorganization, all proceeds realized from preferential and

Except as set forth below, the Company may not redeem the Exchangeable Preferred Stock until the Second Anniversary Date. Thereafter, the Company may redeem the Exchangeable Preferred Stock, in whole at any time or in part from time to time, at a price equal to 100% of Liquidation Value, if redeemed during the twelve month period beginning on the Second Anniversary Date, and thereafter at prices declining annually to 100% of principal amount on or after the fifth anniversary of the Issuance Date. The Company is required to redeem the Exchangeable Preferred Stock on December 31,2000 at a price per share equal to the Liquidation Value thereof (“the Mandatory Redemption”). Notwithstanding the foregoing, in the event that during the period from the date of issuance until the Second Anniversary Date, the Closing Sale Price (as defined)for a share of common stock of Little Switzerland, Inc. (“Little Switzerland”) equals or exceeds $18.75 per share for 30 consecutive trading days, the Company may redeem the Exchangeable Preferred Stock in whole at a price per share equal to 100% of the Liquidation Value (a “Company Optional Redemption”). In the case of a Mandatory Redemption, the Company may pay any redemption price by delivering cash, shares of common stock of Little Switzerland (the “Little Switzerland Common Stock”), other Exchange Property (as defined), or other combination thereof. In all other cases, the Company shall pay the redemption price by delivering cash. . . .

Upon (i) a Change of Control of the Company (as defined), (ii) a Change of Control of Little Switzerland (as defined), (iii) the voluntary or involuntary bankruptcy of the Company, (iv) upon receipt of a notice of a Company Optional Redemption, or (v) in any event after March 1, 1994, each holder of a share of Exchangeable Preferred Stock may exchange such share for one share of common stock of Little Switzerland (the “Exchange Rate”).

App. at 210-11.

6 fraudulent transfer actions are to be distributed to the general

unsecured creditors. After Hare & Co. sought to exercise its

rights of exchange under the Certificate of Designation following

Town & Country’s bankruptcy petition, Town & Country brought the

underlying action to subordinate the claims of the holders of the

Exchangeable Preferred Stock and to turn over the security interest

securing the claims. Hare & Co. agreed to a temporary injunction

enjoining the exchange pending a determination by the bankruptcy

court.

Count I of the complaint characterizes Town & Country’s

arrangement with the holders of the Exchangeable Preferred Stock as

a stock redemption agreement. Therefore, contends Town & Country,

the rights of the holders may be subordinated to the claims of

general unsecured creditors pursuant to 11 U.S.C. 510(c). Count II

seeks an injunction and declaratory judgment that the exchange of

Exchangeable Preferred Stock for the Little Switzerland Stock is a

distribution by Town & Country to a stockholder while the

corporation is insolvent, and thus unlawful under Massachusetts

law. Count III asks the court to declare the trust an unlawful

self-settled trust.

The court below granted summary judgment in favor of the

Defendants.2 The court’s decision turned on whether the holders of

2 Motions for summary judgment were brought by Town & Country and Hare & Co. only. However, following a status conference, is was agreed that the judgment should be granted in

7 the Exchangeable Preferred Stock are holders of a claim against the

bankruptcy estate or an equity interest. The court found that the

Exchangeable Preferred Stock is in the nature of an equity

interest. The court then found that the plain language of

(c) makes the provision inapplicable to this case as it allows

the court to subordinate claims to other claims and interests to

other interests, but does not allow the court to subordinate an

interest to a claim. As to Counts II and III, the court found that

Massachusetts law does not forbid the transactions.

STANDARD OF REVIEW

The Bankruptcy Appellate Panel reviews a bankruptcy court’s

grant of summary judgment de novo. Cumberland Farms, Inc., v.

Florida Department of Environmental Protection,

(1st

Cir. 1997); Adams Co-Operative Bank v. Greenberg (In re Greenberg),

(B.A.P. 1st. Cir. 1999). Rule 56 of the Federal

Rules of Civil Procedure, as made applicable by Rule 7056 of the

Federal Rules of Bankruptcy Procedure, provides that summary

judgment “shall be rendered forthwith if the pleadings,

depositions, answers to interrogatories, and admissions on file,

together with the affidavits, if any, show that there is no genuine

issue as to any material fact and that the moving party is entitled

to a judgment as a matter of law.” Fed. R. Civ. P. 56(c). Both

favor of all defendants.

8 parties moved for summary judgment, and agree that no material

facts are in dispute.

DISCUSSION

I. Application of Section 510(c).

Town & Country’s principal argument is that the Certificate of

Designation and the agreement between Town & Country and the

holders of the Exchangeable Preferred Stock is a stock redemption

agreement, by which the holders are given the right to require Town

& Country to redeem their shares of Exchangeable Preferred Stock

for shares of the Little Switzerland Stock held in the Little

Switzerland Trust. Town & Country argues that because the right of

redemption is a claim against the bankruptcy estate, it should be

subordinated pursuant to § 510(c) of the Bankruptcy Code. On the

other hand, the holders argue that they do not hold redemption

rights, but simply a right to exchange their Exchangeable Preferred

Stock for shares of Little Switzerland Stock. They claim that

because the Little Switzerland Stock is held in an irrevokable

trust and is not part of the Town & Country estate, they do not

hold a claim against the estate, and therefore, § 510(c) is

inapplicable.

The Panel agrees with the court below that the Little

Switzerland Stock is not property of the estate. It further agrees

that the holders of the Exchangeable Preferred Stock hold an equity

9 interest rather than a claim against the Town & Country bankruptcy

estate.

Section 510(c) of the bankruptcy code provides:

Notwithstanding subsections (a) and (b) of the section, after notice and 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 subordinated claim be transferred to the estate.

(c).

The starting point for a bankruptcy court in determining the

application of § 510(c) is determining whether a party holds a

claim against the estate or an equity interest in the nature of a

capital contribution. See Diasonics Inc., v. Ingalls,

(Bankr.N.D.Fla. 1990). Where a party holds an equity

interest, then the interest, by its nature, is subordinated and the

court need not reach the issue of whether to equitably subordinate,

since “the essential nature of a capital interest is a fund

contributed to meet the obligations of a business and which is to

be repaid only after all other obligations have been satisfied.”

(quoting Herzog and Zweibel, The Equitable Subordination of

Claims in Bankruptcy, 15 Vand.L.R. 83 (1961)). See also Central

Cooperatives, Inc. v. Irwin (In re Colonial Poultry Farms),

(Bankr.W.D.Mo. 1995)(quoting same).

10 The Panel agrees with the bankruptcy court that the holders of

the Exchangeable Preferred Stock hold an interest rather than a

claim against the estate. Town & Country’s argument is based on

the contention that the holders were exercising their rights of

redemption when they attempted to exchange their Exchangeable

Preferred Stock for the Little Switzerland Stock, and that the

right of redemption created a claim against the estate. However,

in order to find that the transaction was a redemption, the Panel

must first find that the shares of Little Switzerland Stock held in

the Little Switzerland Trust are part of the bankruptcy estate.

Like the court below, we find that the shares of Little Switzerland

Stock held by the Little Switzerland Trust are not property of the

estate.

Property of the estate includes “all legal or equitable

interests of the debtor in property as of the commencement of the

case.”

(a)(1). The scope of property that comes

within this definition is necessarily broad as it serves the basic

framework of the bankruptcy system: to create a bankruptcy estate

that is subject to the jurisdiction of the bankruptcy court which

can in turn effectuate a fresh start for the debtor and create a

systematic distribution for creditors according to their relative

priority as defined by the Bankruptcy Code. However, despite the

broad definition of “property of the estate” the Bankruptcy Code

does not vest the bankruptcy estate with any more rights in

11 property than the debtor held prior to the filing of the petition.

See, L. King, 5 Collier on Bankruptcy, ¶ 541.11 (15th Ed. Rev.

2000).

What is and what is not property of the estate is a question

of federal law, however courts look to the applicable state law to

determine the debtor’s equitable and legal interests in property.

Marrs-Winn Company v. Giberson Electric, Inc. (In re Marrs-Winn

Company),

(7th Cir. 1996). An express trust

“creates a fiduciary relationship with respect to property,

subjecting the person by whom the title to the property is held to

equitable duties to deal with the property for the benefit of

another person, which arises as a result of a manifestation of an

intention to create it.” Restatement (Second) of Trusts § 2

(1959). There is no question that an express trust was created in

this case, placing title in the hands of a third party trustee for

the benefit of the stockholders and Town & Country. However,

because the bankruptcy estate can establish no greater rights to

the corpus of the trust than was held by Town & Country at the

commencement of the case, the question becomes what interest does

Town & Country have in the trust?

In determining whether Town & Country is the true owner of the

trust property, and thus the Little Switzerland Stock is property

of the estate, we find guidance in the approach taken by the

district court in In re Medalion Realty Trust,

(D.Mass. 1990). In that case the court endeavored to determine

whether an entity ostensibly a business trust was in reality a

partnership. The court looked to the discretion and control of the

beneficiary of the trust, holding that the more power the

beneficiary of the trust holds and exercises over the affairs of

the entity the more likely it is that the business trust is a

partnership.

. The approach taken by the court in

Medallion has been applied by bankruptcy courts in determining

whether trust property is property of the estate under section 541

of the Bankruptcy Code. See In re Simon,

(Bankr.D.Mass. 1995); In re Eastmere Development Corp.,

(Bankr.D.Mass. 1993).

Applying this approach to the Little Switzerland Trust, we

find that the legal title to the subject shares of Little

Switzerland Stock is held by the trustee, and the trustee is

forbidden from transferring any of the shares except as expressly

set out in the agreement. Id. at 95, 96. The trust agreement

further provides that the only manner in which Town & Country can

regain title to the shares is if it redeems or otherwise acquires

all of the outstanding shares of the Exchangeable Preferred Stock.

Id. at 99. Finally, the trust is irrevokable. Id. at 95.

The terms of the trust agreement and the Certificate of

Designation make clear that Town & Country exercises little if any

control over the Little Switzerland Stock. As described earlier,

13 Town & Country’s only discretionary power over the Little

Switzerland Stock is an option to order the trustee to use the

stock to pay the holders the Exchangeable Preferred Stock under

either the optional or mandatory redemption provisions set out

under the Certificate of Designation.

Moreover, the trust fails to meet the definition of a nominee

trust, under which courts have held that the beneficiaries are the

true owners of the trust property. See In re Rosencranz,

(Bankr.D.Mass. 1996); In re Eastmare Development,

. Under a nominee trust, the trustee exercises little or no

control over the trust assets, but acts at the direction of the

beneficiaries.3 Instead, as we have noted, the Trustee of the

Little Switzerland Trust holds the stock for the primary benefit of

the holders of the Exchangeable Preferred Stock, and is permitted

by the terms of the trust agreement and the Certificate of

3 The features of a nominee trust are as follows: (1) the names of the beneficiaries are filed with the trustees rather than being publicly disclosed; (2) a trustee may serve simultaneously as a beneficiary; (3) the trustees lack power to deal with their trust property except as directed by the beneficiaries; (4) a third party may rely on the disposition of trust property pursuant to any instrument signed by the trustee, without having to inquire as to whether the terms of the trust have been complied with; and (5) the beneficiaries may terminate the trust at any time, thereby receiving legal title to the trust property as tenants in common in proportion to their beneficial interest.

In re Grand Jury Subpoena,

(1st Cir. 1992).

14 Designation to dispose of the stock only upon the holders’ election

to exchange their shares of Exchangeable Preferred Stock or upon

one of the redemption events specified. Thus, we find that Town &

Country’s lack of discretion or control over the Little Switzerland

Stock supports the bankruptcy court’s finding that it is not

property of the bankruptcy estate.

Because we find that the Little Switzerland Stock is not

property of the bankruptcy estate, we hold that the holders of the

Exchangeable Preferred Stock do not hold a claim in the form of

redemption rights against Town & Country, but rather an equity

interest. We agree with Town & Country that an equity interest is

subordinate to claims. However, it is important to note that the

interest represented by the Exchangeable Preferred Stock is not

extinguished. Rather, upon exchange it will be in the hands of the

trustee, where it will remain subordinate to claims. Because the

property for which the Exchangeable Preferred Stock will be

exchanged is not property of the estate, there will be no effect on

the bankruptcy distribution scheme.

Furthermore, we find nothing in the language of § 510(c), or

any other provision of the Bankruptcy Code, which would prevent the

holders of the Exchangeable Preferred Stock from exercising their

rights of exchange for property that is not property of the estate.

Rather, § 510(c) is designed simply to deal with equitable

subordination of claims to other claims or interests to other

15 interests. It’s language does not extend to treatment of interests

vis a vis claims because, as discussed supra, equity interests are

already subordinate to claims. However, the fact that equity

interests are subordinate to claims does not alter the result here

as the equity interest will still remain, just in the hands of the

trustee.

The Panel will not import some other interpretation to §510(c)

when its language is clear and unambiguous on its face. It is “a

fundamental canon that statutory interpretation begins with the

language of the statute itself.” Pennsylvania Department of Public

Welfare v. Davenport,

(1990). The Appellant

has presented no authority to suggest that the statute should or

can be interpreted in any manner other than how it plainly reads.

In fact, the legislative history suggests the Congress was

cognizant of the separate treatment of claims and interests: “After

notice and a hearing, the court may, under principles of equitable

subordination, subordinate for the 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. As a matter of equity, it is reasonable that a

court subordinate claims to claims and interests to interests.”

124 Cong. Rec. H 11,095 (Sept. 28, 1978; S 17,412 (Oct. 6,

1978)(emphasis added).

The creation of the trust and the exchange rights may well

16 have been the fruits of careful bankruptcy planning. However, this

does not alter our conclusion that the property held by the Little

Switzerland Trust is not property of the estate, and thus the

holders of the Exchangeable Preferred Stock do not hold claims, in

the form of redemption rights, which may be subordinated to the

claims of unsecured creditors.

II. Voidness of the Little Switzerland Trust.

Town & Country also argues that the Little Switzerland Trust

is void under Massachusetts law as a self-settled trust. Town &

Country relies on Merchants National Bank of New Bedford v.

Morrissey,

(Mass. 1953), which stated that a self-

settled trust is void against creditors of the settlor.

.

Town & Country asks this panel to extend Merchants National Bank,

which involved an individual who transferred assets to a

spendthrift trust for his own benefit, to a corporation which

places assets in trust for the benefit of its shareholders. Like

the court below, we reject this argument.

We agree with Town & Country that the rule in Massachusetts is

that a settlor who establishes a trust for the settlor’s own

benefit and reserves the ability to amend, revoke or invade the

corpus of the trust cannot protect the trust from the reach of

creditors. See Aylward v. Landry (In re Landry),

(Bankr.D.Mass. 1998); In re Rosencranz,

, 633

17 (Bankr.D.Mass. 1996); In re Kellogg,

(Bankr.D.Mass. 1995). However, the Little Switzerland Trust,

which was created by Town & Country, was not created for the sole

benefit of the corporation, but rather was created for the benefit

of the holders of the Exchangeable Preferred Stock. The bankruptcy

court held that to find that the Little Switzerland Trust was a

self-settled trust would require the court to pierce the corporate

veil, that is, find that there was no distinction between the

stockholders and the corporation. We agree with the bankruptcy

court.

Town & Country offers no authority for the proposition that we

should refuse to recognize a distinction between the corporation

and the stockholders. To treat the corporation and the

shareholders as one, as Town & Country proposes, would be to ignore

one of the central tenets of corporate law: the corporate entity is

separate and distinct from its shareholders. See Spaneas v.

Travelers Indemnity Company,

(Mass. 1996); Zora

v. State Ethics Commission,

(Mass. 1993); In re

Plantation Realty Trust,

(Bankr.D.Mass. 1999).

Without piercing the corporate veil and finding that the

distinction between the stockholders and the corporation should be

disregarded, we can find no justification for finding the Little

Switzerland Trust is a self-settled trust.

18 III. Violation of Massachusetts Corporate Law.

The final argument of Town & Country is that the exchange

constitutes an unlawful stock redemption in violation of the

Massachusetts statute forbidding corporations from making

distributions while the corporation is insolvent. Mass. Gen. Laws

ch. 156B, §45. However, to find that the exchange was an improper

distribution would require us to find that the exchange was a stock

redemption. We have already determined that the exchange does not

constitute a stock redemption. Therefore, this argument fails as

well.

CONCLUSION

The Panel finds that because the Little Switzerland Stock is

not property of the bankruptcy estate the holders of the

Exchangeable Preferred Stock do not hold a claim against the

estate, but an equity interest. Section 510(c) of the Bankruptcy

Code cannot be utilized to prevent the holders of this Exchangeable

Preferred Stock from exchanging this interest for property that is

not property of the estate. Furthermore, the Little Switzerland

Trust is not void as a self-settled trust, and the exchange rights

of the holder of the Exchangeable Preferred Stock do not violate

Massachusetts law. Accordingly, the judgment of the bankruptcy

court is affirmed.

19