22 T.C. 303">*303 The pleadings upon which this proceeding is based involve deficiencies determined by respondent in income, excess profits, and declared value excess-profits taxes of the petitioner, as follows:

Those issues raised in the petition filed herein pertaining principally to petitioner's1954 U.S. Tax Ct. LEXIS 209">*210 invested capital credit for the purpose of computing its excess profits taxes in the 2 years here involved and to petitioner's basis of certain assets received in a reorganization, were, upon motion of petitioner, severed and hearing thereon postponed pending a hearing and a ruling by this Court upon the question of whether petitioner acquired such assets through a nontaxable reorganization or exchange.

FINDINGS OF FACT.

All facts contained in the stipulation filed by the parties are so found and made a part hereof. Additional facts were adduced from exhibits received at the hearing.

The petitioner is a corporation organized under the laws of the State of Ohio on July 15, 1919, with its principal office at Youngstown, Ohio. The taxable years here involved are 1941 and 1942. Petitioner's returns for such years were filed with the collector of internal revenue for the eighteenth district of Ohio. Petitioner kept its books and filed its income and excess profits tax returns on the accrual basis for the calendar years 1941 and 1942.

From the date of its organization in 1919 until February 1, 1927, petitioner engaged in the limestone and cement business. On or about that date, petitioner1954 U.S. Tax Ct. LEXIS 209">*211 disposed of all its assets. Thereafter, it did not dissolve but remained dormant and inactive until the reorganization 22 T.C. 303">*304 here in controversy was effected on July 1, 1935, at which time petitioner was revived for the purpose of taking over the assets and succeeding to the business of The Bessemer Limestone and Cement Company, a Delaware corporation (hereinafter called Delaware).

On January 27, 1927, the Delaware corporation, having the same name as petitioner, was organized with an authorized capital of 50,000 shares of class "A" no-par-value stock, 100,000 shares of class "B" no-par-value stock, and $ 2,500,000 first mortgage 20-year 6 1/2 per cent sinking fund gold bonds.

On the same day that petitioner disposed of all of its assets, i. e., on or about February 1, 1927, a brokerage firm which had acquired such assets transferred them to the newly organized Delaware. Thereupon Delaware proceeded to engage in the limestone and cement business which the petitioner had formerly conducted. During the depression years Delaware experienced financial difficulties. On or about June 25, 1932, it defaulted on the sinking fund payment then due under the terms of the mortgage securing1954 U.S. Tax Ct. LEXIS 209">*212 its outstanding bonds aggregating $ 2,152,400. It defaulted on the installment of interest on such bonds which became due on or about August 1, 1932, as well as on all subsequent installments of interest and of sinking fund payments. A bondholders' protective committee, representing the owners of more than three-fourths of Delaware's outstanding bonds, was organized in August 1932. The trustee under the mortgage indenture declared the principal of the bonds to be due and payable on or about April 30, 1934, and then filed foreclosure actions against Delaware on June 6, 1934, in the United States District Court, Northern District of Ohio, Eastern Division, and in the United States District Court, Western District of Pennsylvania. The board of directors of Delaware thereupon adopted a resolution on December 8, 1934, directing the filing of a petition for reorganization under section 77B of the National Bankruptcy Act in the United States District Court.

On December 10, 1934, Delaware filed a petition in the United States District Court for the Northern District of Ohio, Eastern Division, for reorganization under section 77B of the Bankruptcy Act, alleging that it was unable to meet1954 U.S. Tax Ct. LEXIS 209">*213 its debts as they matured. On the same day the District Court entered an order approving such petition and on December 24, 1934, entered an order calling for the proposal of a plan of reorganization and a hearing thereon. A plan of reorganization having been filed with the District Court by Delaware, the court entered an order on January 8, 1935, continuing Delaware in possession and ordering the distribution to all interested parties of copies of the plan, together with a notice directing that a hearing on the plan be held before a special master on February 5, 1935.

22 T.C. 303">*305 The plan of reorganization so filed was formulated by the bondhonders' protective committee in collaboration with Delaware's officers and directors, and, as announced by the District Court, was accepted in writing by the following numbers of shareholders, creditors, and bondholders of Delaware:

(a) By note creditors owning notes in the principal amount of $ 251,684.86, being 100% of the claims of creditors of this class which were proved and allowed.

(b) By a Creditor by reason of endorsement of the Debtor in the amount of $ 350,000.00, being 100% of the claims of this class which were proved and allowed.

1954 U.S. Tax Ct. LEXIS 209">*214 (c) By holders of 43,711 "A" shares, being 87.5% of the issued and outstanding "A" shares of the Debtor.

(d) By holders of 100,000 "B" shares, being 100% of the issued and outstanding "B" shares of the Debtor.

(e) By holders of bonds in the principal amount of $ 1,833,200.00 which constitute 95% of the bonds on which proofs of claim were filed and allowed and 85.1% of the total amount of outstanding bonds.

The bondholders' protective committee and the committee for the "A" stockholders, each of which was represented by counsel who participated in the District Court proceedings, recommended the acceptance of the plan.

Copies of the plan of reorganization and of the notice of hearing were duly sent to all interested parties, and hearings on the plan were then held before the special master at which appraisals of the assets of Delaware were submitted, testimony was introduced, and objections to the plan were filed by certain interested parties. The special master then filed a report and a supplemental report recommending the approval of the plan, to both of which exceptions were taken by these objecting parties. Thereupon, after a hearing on the reports of the special master and the1954 U.S. Tax Ct. LEXIS 209">*215 exceptions filed thereto, the United States District Court overruled all objections and entered a decree dated April 29, 1935, confirming the plan of reorganization. In its decree of April 29, 1935, the court found that:

(1) Although Delaware had been unable to meet its obligations as they matured, the reasonable sound value of its assets exceeded its liabilities;

(2) The proposed Plan of Reorganization was fair and equitable, did not discriminate in favor of or against any class of creditors or stockholders, and was feasible; and that

(3) The Plan of Reorganization complied with all of the provisions of Section 77B of the Bankruptcy Act.

In addition, the decree contained the following finding:

(10) The detailed appraisal of all of the assets of the corporation which was filed by the Debtor was competently, carefully and honestly made. Said appraisal was originally completed in December, 1933 for the use of the Bondholders' Protective Committee in connection with their efforts to formulate a plan of reorganization and has thereafter been brought down to date and checked 22 T.C. 303">*306 and rechecked by the Debtor's department heads in the light of their own experience as to values supplemented1954 U.S. Tax Ct. LEXIS 209">*216 by estimates, appraisals and quotation by building contractors, construction engineers, machinery builders and equipment supply firms. A further appraisal by an independent company is unnecessary and would not justify the expense entailed.

An action to foreclose the mortgage securing the bond issue is now pending. By reason of the existing economic situation in the country in general and in the Cleveland, Youngstown, Pittsburgh District in particular, and the consequent certain absence of competition in bidding for the Debtor's assets, a very low return to bondholders or note creditors would necessarily result if the Debtor were liquidated and its assets sold for cash, either as a unit or otherwise.

The sound value of the Debtor's current assets, however, on the date of the filing of the Petition was, and today is, substantially that at which said assets were carried on its books. The probable sound value of the manufacturing plant, quarries owned in fee, manufacturing equipment and other real estate, exclusive of the Debtor's "Prepaid Royalties and Advance Stripping" accounts on said date, so far as can be reasonably determined, is equal to and perhaps slightly greater than the1954 U.S. Tax Ct. LEXIS 209">*217 amount of the Debtor's outstanding bonds, exclusive of any value to be attributed to good will, organization expense, or other real elements of value inherent in the existence of the enterprise as a growing concern. Such a valuation of its plant and real estate constitutes a write down of the book values of such assets of $ 1,500,000.00 or more than Forty Percent. A reasonable value of the Limestone leases of the company, upon which minimum advance royalties have been paid in the amount of $ 235,000.00, is $ 120,000.00 and the reasonable sound value added to the Debtor's Real Estate by the funds it has heretofore spent in advanced stripping operations, in uncovering limestone, is substantially the amount spent by the Debtor thereon, at which figure it has been carried on its books, to-wit, in round figures, $ 150,000.00.

The Court finds that, although the Debtor has been entirely unable to meet its obligations as they have matured since August 1, 1932, and although on liquidation a relatively small percentage of their claims would probably be realized by its creditors, the reasonable sound value of its assets exceeds its liabilities.

Subsequently, on May 29, 1935, the District Court1954 U.S. Tax Ct. LEXIS 209">*218 entered another decree approving the proposed procedure for consummation of the plan of reorganization and found therein that the amendments of its articles of incorporation filed by petitioner with the Secretary of State of Ohio had "properly qualified it as the instrumentality through which to effect the Reorganization of the Debtor, the Delaware Corporation of the same name." The decree further directed that Delaware convey its assets to the petitioner "on May 31, 1935 or as reasonably soon thereafter as the same may be done" and that the terms of the plan of reorganization be carried out "concurrently therewith and in consideration thereof."

The reorganization of Delaware was begun and was effective as of July 1, 1935. On that date, pursuant to the decree of the United States District Court, Delaware transferred all of its assets to petitioner by warranty deeds; the Dollar Savings and Trust Company, as trustee of the mortgage securing Delaware's indenture, executed and delivered to Delaware a satisfaction and release of such mortgage; 22 T.C. 303">*307 petitioner executed and delivered to the Dollar Savings and Trust Co., as trustee, a new trust deed mortgage securing petitioner's new1954 U.S. Tax Ct. LEXIS 209">*219 indenture and it executed and delivered to Delaware an agreement pursuant to which it assumed and agreed to pay the debts and liabilities incurred by Delaware after commencement of the District Court proceedings, the expenses of the reorganization proceedings, and the amounts of cash required to be paid under the plan of reorganization, and to issue its securities and carry out the terms of the plan in every respect.

On June 30, 1935, Delaware had stock issued and outstanding and was indebted to bondholders and note creditors, as follows:

The plan of reorganization, as approved by the United States District Court, provided that the bondholders, note creditors, and shareholders of Delaware receive from the petitioner, in exchange for their respective bonds, notes, and shares of Delaware, the following:

(a) Each bondholder to 1954 U.S. Tax Ct. LEXIS 209">*220 receive in exchange for Delaware's bonds, together with all interest coupons maturing on and after August 1, 1932, (1) petitioner's 6 per cent 20-year gold bonds equal to 50 per cent of the amount of principal of the existing obligation, (2) petitioner's preferred stock, having a par value of $ 50 a share equal to 50 per cent of the amount of the principal of the existing obligation, and (3) three shares of petitioner's $ 1 par value common stock for each $ 100 of the principal of the existing obligation.

(b) Each note creditor to receive in satisfaction of his claim against Delaware (1) 50 per cent of the principal obligation in petitioner's bonds, (2) 50 per cent in petitioner's preferred stock, and (3) one share of petitioner's common stock for each $ 6.32 of interest due and unpaid on such notes on January 1, 1935.

(c) Each holder of Delaware class "A" stock to receive 1.06 shares of petitioner's common stock in exchange for each share of such class "A" stock.

(d) Each holder of Delaware class "B" stock to receive one-eighth of one share of petitioner's common stock in exchange for each share of such class "B" stock.

In addition, the plan provided (1) that no fractional share or1954 U.S. Tax Ct. LEXIS 209">*221 fractional bonds or scrip representing either of them be issued, (2) that 22 T.C. 303">*308 a distributee who would otherwise be entitled to a fractional part of a bond be paid therefor in cash, (3) that one who would otherwise be entitled to a fractional part of a preferred share receive only the number of full shares to which he is entitled, and (4) that a distributee who would otherwise be entitled to one-half or greater fraction of a share of common stock receive a full share but if less than one-half share that he receive nothing therefor.

Commencing July 1, 1935, and pursuant to the decree of the United States District Court, the Dollar Savings and Trust Co., as the distributing agent designated by the court, delivered to the bondholders, note creditors, and shareholders of Delaware the new bonds, common stock, and preferred stock of the petitioner in exchange for their respective bonds, notes, and shares of Delaware as provided in the plan of reorganization approved by the court.

Pursuant thereto the old bondholders, note creditors, and shareholders of Delaware received the following securities of petitioner in the exchange:

1954 U.S. Tax Ct. LEXIS 209">*222 The number of shares of petitioner's common stock received by the bondholders of Delaware was 64,508 instead of 64,572 as set forth in the plan of reorganization. Delaware bonds in the principal amount of $ 700 never were surrendered for exchange, thereby accounting for 21 shares, and some bonds were submitted without "all interest coupons maturing after August 1, 1932," as specified in the plan, thus accounting for the remaining 43 shares. The common shares received by Delaware's bondholders, whose claims constituted 100 per cent of the secured claims, represented 46.88 per cent of petitioner's voting stock distributed. The par value of petitioner's preferred stock and the amount of petitioner's bonds received by the bondholders of Delaware was $ 1,075,850, instead of $ 1,076,200 as set forth in the plan of reorganization, because Delaware bonds in the principal amount of $ 700 never were surrendered for exchange. The aggregate par value of the common and preferred shares received by the bondholders represented 75.4 per cent of the total par value of petitioner's stock distributed. The number of shares of petitioner's common stock received 22 T.C. 303">*309 by the note creditors and1954 U.S. Tax Ct. LEXIS 209">*223 by the holder of the Goff-Kirby notes was 5,293 shares and 2,269 shares, respectively, instead of 5,288 shares and 2,312 shares, respectively, as set forth in the plan of reorganization, because of the provision in such plan that any distributee of new common shares who otherwise would be entitled to one-half or greater fraction of a share should receive a full share, while any distributee entitled to a fraction of a share less than one-half should receive nothing for the share; and also because of adjustments in the computation of accrued interest on the obligations involved. The common shares so received by Delaware's unsecured note creditors represented 5.4 per cent of petitioner's voting stock distributed. Such note creditors received common and preferred shares of petitioner aggregating 15.4 per cent of the total par value of the stock distributed. The number of shares of petitioner's common stock received by the holders of class "A" shares of Delaware was 53,013 shares instead of 53,000 shares as set forth in the plan of reorganization because of the provision in such plan with respect to fractional shares. The 50,000 shares of Delaware's class "A" stock, which were entitled1954 U.S. Tax Ct. LEXIS 209">*224 to preferences over the class "B" stock of $ 45 per share in the case of voluntary and $ 31 per share in the case of involuntary liquidation, dissolution, or winding up of the debtor, plus accumulated unpaid preferential dividends amounting to $ 525,000 on January 1, 1935, were exchanged for 38 per cent of petitioner's voting stock, representing 3.7 per cent of the total par value of petitioner's stock. The holders of class "B" shares, for which there was no book value at the time the 77B proceedings were instituted if effect were given to the class "A" preferences, received 9 per cent of petitioner's voting stock, representing slightly less than 1 per cent of the total par value of petitioner's stock. The sum of $ 42.44 in cash paid by petitioner to note creditors of Delaware, as provided in the plan of reorganization, was due to the provision therein that no fractional bond would be issued, and that any distributee who otherwise would be entitled to a fractional part of a $ 50 bond would be paid that fractional part in cash.

The condensed balance sheet of Delaware as of the close of business on December 9, 1934, was as follows:

22 T.C. 303">*310 (Note A) The Company was contingently liable at December 10, 1934, as co-endorser with The Standard Slag Company on notes payable of The Goff-Kirby Company, Cleveland, Ohio, in the amount of $ 350,000.

(Note B) Unpaid cumulative dividends on Class "A" capital stock to January 1, 1935, amount to $ 525,000.

The balance sheets of Delaware and petitioner at June 30, 1935, and July 1, 1935, respectively, reveal the following: On June 30, 1935, Delaware possessed total assets in the amount of $ 5,103,366.15, including 22 T.C. 303">*311 excess plant values above cost in the amount of $ 1,473,204.69. Its liabilities to creditors aggregated $ 3,190,789.12. The petitioner's assets on July 1, 1935, after appraisal of capital assets by the board of directors, totaled $ 3,138,935.20. No item relating to goodwill was included therein. Its liabilities to creditors were recorded at $ 1,445,423.94.

Each share of class "A" and class "B" stock of Delaware had voting rights but of the stock issued by the petitioner under the plan of reorganization only the common stock had voting rights.

Petitioner's bonds were distributed to the bondholders, note creditors, and the holder of the1954 U.S. Tax Ct. LEXIS 209">*226 Goff-Kirby notes of Delaware at the times and in the amounts as follows:

Petitioner's preferred stock was distributed to the bondholders, note creditors, and the holder of the Goff-Kirby notes of Delaware at the times and in the amounts as follows:

Petitioner's common stock was distributed to the bondholders, note creditors, the holder of the Goff-Kirby notes, and the class "A" and "B" shareholders of Delaware at the times and in the amounts1954 U.S. Tax Ct. LEXIS 209">*227 set forth below.

The bonds, preferred stock, and common stock of the petitioner were distributed as the old bonds, stock, and notes of Delaware were surrendered for exchange.

22 T.C. 303">*312 Petitioner agreed to assume and pay all expenses which the United States District Court approved in connection with the plan of reorganization, including the fees and expenses of the bondholders' protective committee, the trustee, the depositary, the "A" shareholders' committee, and their respective counsel. The total amount of such expenses paid by petitioner in 1935 was $ 25,790.

Delaware transferred its assets to the petitioner subject to its remaining liabilities after the mortgage lien thereon was released pursuant to the order of the District Court in the 77B proceeding. Delaware received no stock or securities of the petitioner in the reorganization. The values of Delaware's assets1954 U.S. Tax Ct. LEXIS 209">*228 were carried on its books substantially in excess of their actual appraised value.

Delaware paid no dividends on its class "A" stock, which was entitled to a preferred dividend over the class "B" of $ 3 per share per annum, for the 3 1/2 years preceding the institution of the 77B proceedings. Delaware had an annual average loss in the amount of $ 338,758.54 for the 5 1/2 years preceding the effective date of the plan of reorganization, and for the 5 1/2 years subsequent thereto petitioner's average annual earnings amounted to $ 158,173.87.

OPINION.

The question is whether the exchanges effected incident to the 77B reorganization pursuant to which petitioner was revived to take over and continue the business of Delaware, the latter being forthwith dissolved, constituted a tax-free transaction under section 112 (b) (5) of the Revenue Act of 1934, ¹ as contended by petitioner.

1954 U.S. Tax Ct. LEXIS 209">*229 Petitioner was first organized in 1919. It actively engaged in the limestone and cement business until February 1, 1927, on or about which date all of its assets were indirectly transferred to Delaware, which corporation had been formed on January 27, 1927, to continue petitioner's business. After the transfer, petitioner was not dissolved but remained dormant while Delaware continued operation of petitioner's former business. In 1932, Delaware, having experienced financial difficulties, defaulted on certain payments due on its bonded indebtedness and thereafter remained in default. The bonds were declared due and payable in 1934, and a foreclosure action was instituted 22 T.C. 303">*313 against Delaware by and on behalf of the bondholders. Delaware then filed a petition for reorganization under 77B of the Bankruptcy Act. In the proceedings which followed, a plan of reorganization was conceived and carried on under the guidance of the United States District Court for the Northern District of Ohio, Eastern Division. Pursuant to this plan, petitioner was revived to be the transferee of Delaware's assets and successor to its business; Delaware's bondholders and mortgage holders received1954 U.S. Tax Ct. LEXIS 209">*230 stock and securities of petitioner in certain amounts in exchange for their evidences of Delaware's indebtedness; and the holders of Delaware's class "A" and class "B" stock received agreed-upon allotments of petitioner's common stock in exchange for their respective shares.

It is respondent's position that the foregoing exchanges failed to come within the scope of the statute relied upon, and that the entire transaction is to be considered as taxable.

To qualify as a tax-free exchange under the statute in controversy, compliance must be had with three conditions. First, property must be transferred "* * * solely in exchange for stock or securities * * *." Second, the transferors of such property must be in control of the corporation immediately after the exchange. For the purposes of this requirement, "control" is defined in section 112 (h) of the 1934 Act as meaning 80 per cent of the voting stock and at least 80 per cent of all other classes of the corporate stock. The third requirement is that the stock and securities received by each transferor must be "* * * substantially in proportion to his interest in the property prior to the exchange." See Hartford-Empire Co. v. Commissioner, 137 F.2d 540,1954 U.S. Tax Ct. LEXIS 209">*231 affirming 43 B. T. A. 113. Of the three statutory requisites, there appears to be serious dispute here only as to the third requirement.

Petitioner urges that the exchanges in controversy here took place incident to a genuine adversary proceeding wherein the creditors and stockholders of Delaware are to be deemed to have been transferors; that as such they each received stock and securities substantially in proportion to their respective interests in the property prior to the exchange; and that they were in control of the petitioner immediately after the transfer. To support its contentions, petitioner cites and relies upon such cases as Gage Bros. & Co., 13 T.C. 472; Alexander E. Duncan, 9 T.C. 468; Montgomery Building Realty Co., 7 T.C. 417; Taylor-Wharton Iron & Steel Co., 5 T.C. 768; Miller & Paine, 42 B. T. A. 586, and others of like import wherein the exchanges involved were held by us to be tax free.

Respondent maintains that the pertinent evidence of probative value shows Delaware to be insolvent1954 U.S. Tax Ct. LEXIS 209">*232 at the time the 77B proceedings were instituted; that, therefore, the equitable interest of the stockholders effectively passed to the creditors upon the institution of such proceedings; 22 T.C. 303">*314 and that, since the creditors did not receive all of petitioner's stock, they did not receive stock or securities substantially in proportion to their respective interests prior to the exchange.

In cases of the nature of the one before the District Court, two differing meanings may be connoted by the term "insolvent." As defined in the Bankruptcy Act, the term means an excess of liabilities over assets at a fair valuation. 11 U.S. C., sec. 1 (10); Collier Bankruptcy Manual, sec. 1.09. An entirely different test of insolvency is the so-called equity test which is merely an inability to pay debts as they become due. Collier Bankruptcy Manual, supra. Thus, if a debtor is unable to meet his obligations as they mature, he is insolvent in the equity sense. He is not insolvent in the bankruptcy sense unless at that time his property at a fair valuation is insufficient to pay his indebtedness. Duncan v. Landis, 106 F. 839">106 F. 839.1954 U.S. Tax Ct. LEXIS 209">*233

In the instant case, Delaware filed its petition for reorganization under section 77B of the Bankruptcy Act because of its inability to pay its debts as they became due. Hence, it was insolvent in the equity sense. The corporate balance sheet as of the date of the petition shows an excess of assets over liabilities, and that Delaware stock still had a book value in excess of $ 1,800,000, exclusive of any value to be attributed thereto on account of goodwill or going concern value. It is admitted in this connection that the fixed assets of Delaware, i. e., its plant and real estate, were listed in the balance sheet at approximately $ 1,500,000 over the fair value thereof. But, even after a write-down of the assets specified by the District Court is made, there still remains some equity of value in the stock. The corporate balance sheet as of June 30, 1935, the day preceding the effective date of the reorganization, after reflecting such write-down in assets value, likewise shows that the corporate stock still possessed some equity of value. Furthermore, the plan of reorganization was submitted to and accepted in writing by a majority of Delaware's stockholders as is required 1954 U.S. Tax Ct. LEXIS 209">*234 by statute if the debtor was not found to be insolvent. See 11 U.S. C., sec. 579. Such acceptance by the stockholders was unnecessary had Delaware been insolvent in the bankruptcy sense. The fact that acceptance of the stockholders was sought and obtained is some indication that Delaware was not insolvent in the bankruptcy sense at the time its petition was filed. Robert Dollar Co., 18 T.C. 444.

On this record, after due consideration of all pertinent criteria, we have come to the conclusion that while Delaware was admittedly insolvent in the equity sense when it filed its petition for reorganization, it was not insolvent in the bankruptcy sense at such date. Since the stock shares of Delaware still possessed some equity of value, the holders thereof had an equitable interest which did not pass to the creditors upon initiation of the reorganization proceedings, which 22 T.C. 303">*315 interest entitled the stockholders to a proportionate interest in petitioner. Therefore, we disagree with respondent's contention that the bondholders, in not receiving the entire issue of petitioner's stock, were, by that fact, denied 1954 U.S. Tax Ct. LEXIS 209">*235 an interest substantially in proportion to their interest in the property prior to the exchange.

Whether the stock and securities of petitioner which were actually received by Delaware bondholders as well as its note creditors and the stock in petitioner that was issued to its stockholders were substantially in proportion to their respective interests in the property prior to the exchange is the next and controlling question.

The so-called "full and absolute priority" rule of Northern Pacific Ry. Co. v. Boyd, 228 U.S. 482">228 U.S. 482, and Case v. Los Angeles Lumber Products Co., 308 U.S. 106">308 U.S. 106, applies with equal force to the reorganization of solvent companies as well as those which are insolvent either in the equity sense or the bankruptcy sense. Consolidated Rock Co. v. Du Bois, 312 U.S. 510">312 U.S. 510. Under this rule, the creditors of the company being reorganized must be fully compensated for the entire bundle of rights which they surrender. The bondholders are entitled to have the interest accrued on the bonds which they hold accorded the same priority as the principal thereof. Further, if the1954 U.S. Tax Ct. LEXIS 209">*236 bondholders receive securities of an inferior grade -- "* * * inferior in the sense that the interest rate has been reduced, a contingent return has been substituted for a fixed one, the maturities have been in part extended and in part eliminated by the substitution of preferred stock * * *" -- they have by virtue of having lost their former strategic position lost certain property rights of value, for which they must be made whole. 312 U.S. 510">Consolidated Rock Co., supra.In effecting such full compensation, practical adjustments subordinate the use of rigid formulae. Thus, the method to be employed will vary depending upon the peculiar facts, circumstances, and requirements of each case. If the creditors receive securities equal in value to the amount of their respective claims "* * * the formula employed rests in the informed discretion of the court * * *," under whose guidance the reorganization is effected. See 312 U.S. 510">Consolidated Rock Co., supra, in which the Supreme Court further pointed out that:

The absolute priority rule does not mean that bondholders cannot be given inferior grades of securities, or even securities of the1954 U.S. Tax Ct. LEXIS 209">*237 same grade as are received by junior interests. Requirements of feasibility of reorganization plans frequently necessitate it in the interests of simpler and more conservative capital structures. And standards of fairness permit it. This was recognized in Kansas City Terminal Ry. Co. v. Central Union Trust Co., 271 U.S. 445">271 U.S. 445. This Court there said (p. 455) that though "to the extent of their debts creditors are entitled to priority over stockholders against all the property" of the debtor company, "it does not follow that in every reorganization the securities offered to general creditors must be superior in rank or grade to any which stockholders may obtain. It is not impossible to accord to the creditor his superior rights in 22 T.C. 303">*316 other ways." And the Court went on to say (p. 456), "No offer is fair which does not recognize the prior rights of creditors . . .; but circumstances may justify an offer of different amounts of the same grade of securities to both creditors and stockholders." Thus it is plain that while creditors may be given inferior grades of securities, their "superior rights" must be recognized. Clearly, those prior rights1954 U.S. Tax Ct. LEXIS 209">*238 are not recognized, in cases where stockholders are participating in the plan, if creditors are given only a face amount of inferior securities equal to the face amount of their claims. They must receive, in addition, compensation for the senior rights which they are to surrender. If they receive less than that full compensatory treatment, some of their property rights will be appropriated for the benefit of stockholders without compensation. That is not permissible. The plan then comes within judicial denunciation because it does not recognize the creditors' "equitable right to be preferred to stockholders against the full value of all property belonging to the debtor corporation." 271 U.S. 445">Kansas City Terminal Ry. Co. v. Central Union Trust Co., supra, p. 454.

The face amount of the inferior securities of petitioner, which were issued to Delaware's bondholders, was substantially equal to the principal of their claims. In addition thereto, for loss of status and for interest accrued on the bonds to January 1, 1935, the bondholders received 64,508 shares, or 46.88 per cent, of petitioner's common stock. Delaware's note creditors received 50 per cent1954 U.S. Tax Ct. LEXIS 209">*239 of the principal amount of their claims in bonds of petitioner and 50 per cent thereof in petitioner's preferred stock.

In addition, 5.4 per cent of petitioner's common stock was issued to the note creditors for any loss in status suffered, and for interest accrued to January 1, 1935, on the notes held by them. For the interest accrued on Delaware's indebtedness, bonded and otherwise, under the plan of reorganization from January 1, 1935, to July 1, 1935, the effective date of the plan, petitioner issued its promissory notes in the amount of $ 38,685. Moreover, the creditors were given voting control of petitioner, since the common stock issued to bondholders and note holders aggregated 52.5 per cent of petitioner's common stock. The holders of both types of Delaware's common stock received in exchange therefor 65,513 shares of petitioner's common stock, or 47.6 per cent thereof. Those holding Delaware's class "A" stock were issued, in exchange therefor together with the dividends accrued thereon, 53,013 shares of petitioner's common stock. To the holders of class "B" Delaware stock, and in exchange therefor, petitioner issued 12,500 shares, or 9 per cent of its common stock. 1954 U.S. Tax Ct. LEXIS 209">*240 At this juncture, there arises the question as to whether the class "B" shareholders had any equity whatsoever remaining in Delaware so as to warrant their being given a nominal interest in petitioner.

Although the foregoing distribution was approved by the District Court as being fair and equitable to all concerned, it does not necessarily follow, as respondent points out, that the stock and securities so received by the respective parties were in substantial proportion 22 T.C. 303">*317 to their interests in Delaware. Claridge Apartments Co., 1 T.C. 163, reversed on other issues 323 U.S. 141">323 U.S. 141. Nor does such approval foreclose our inquiry into the value of the assets involved. Robert Dollar Co., supra.

Competent, though not conclusive, evidence as to the value of such assets, exclusive of any to be attributed thereto for good will or going concern value, is to be found in the balance sheets set out above. Such evidence has some probative force. Wessel v. United States, 49 F.2d 137. See also Doyle v. Mitchell Bros. Co., 247 U.S. 179">247 U.S. 179.1954 U.S. Tax Ct. LEXIS 209">*241 The District Court, which had all the pertinent facts before it and whose duty it was to find what equities existed and to see that fair and equitable recognition was properly accorded thereto, approved a plan of reorganization which recognized the existence of some equity remaining in the class "B" stockholders.

As we have heretofore stated, the finding by the District Court that the amount of recognition so given such stockholders was fair and equitable does not mean that it was necessarily in substantial proportion to their equitable interest in Delaware. Nevertheless, we think that the court's finding of such equity and its action in granting recognition thereto represents credible evidence as to the existence thereof. Furthermore, the record indicates that the plan so submitted to and approved by the District Court was the result of protracted arm's-length negotiations between the conflicting economic interests with the referee as moderator. Thus, it appears that persons who were most conversant with the equities involved and the values thereof, after taking all these factors into consideration, determined an allocation of stock and securities that was mutually satisfactory. 1954 U.S. Tax Ct. LEXIS 209">*242 From this fact it might safely be assumed that the allocation so worked out provided each transferor with an interest in petitioner substantially in proportion to the amount of the property to be surrendered by each in exchange therefor, and that no equities were recognized that did not in fact exist. Taylor-Wharton Iron & Steel Co., supra.See also Mertens, Law of Federal Income Taxation, sec. 20.44. As was said by this Court in Gage Bros. & Co., supra:

the fact that the transfers here were the result of arm's length dealings between conflicting interests is, on this record, adequate to satisfy us that within the meaning of section 112 (b) (5) the securities received by each were substantially in proportion to his interest in the property prior to the exchange. * * *

The foregoing is appropriate here. Albeit the evidence is not as complete as an ideal situation would require, the preponderating force of the evidence before us establishes that the 77B negotiations were an arm's-length transaction between conflicting interests and is sufficient to satisfy us in this case that the securities received by the shareholders1954 U.S. Tax Ct. LEXIS 209">*243 were substantially in proportion to their interests in the property 22 T.C. 303">*318 prior to the exchange. This being true, we accordingly find that the reorganization was a tax-free reorganization under the pertinent statute.

In view of the foregoing, we answer the question posed in the affirmative and hold that the transaction with which we are here concerned constituted an exchange upon which no gain or loss will be recognized under the provisions of section 112 (b) (5), supra.

An appropriate order will be entered.