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O'Donnell v. Tristar Esperanza Properties, LLC (In Re Tristar Esperanza Properties, LLC) ( 2013 )
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FILED 1 MAR 08 2013 2 SUSAN M SPRAUL, CLERK U.S. BKCY. APP. PANEL OF THE NINTH CIRCUIT 3 UNITED STATES BANKRUPTCY APPELLATE PANEL 4 OF THE NINTH CIRCUIT 5 In re: ) ) BAP No. CC-12-1340-KlPaDu 6 TRISTAR ESPERANZA PROPERTIES, ) LLC, a California Limited ) Bk. No. SA 11-21095-TA 7 Liability Company, ) ) Adv. No. SA 12-01041-TA 8 Debtor. ) ______________________________) 9 ) JANE O’DONNELL; PENSCO TRUST ) 10 COMPANY, a New Hampshire ) Company,* ) 11 ) Appellants, ) 12 ) v. ) OPINION 13 ) TRISTAR ESPERANZA PROPERTIES, ) 14 LLC, a California Limited ) Liability Company, ) 15 ) Appellee. ) 16 ______________________________) 17 Argued and Submitted on February 22, 2013 at Pasadena, California 18 Filed – March 8, 2013 19 Appeal from the United States Bankruptcy Court 20 for the Central District of California 21 Honorable Theodor Albert, Bankruptcy Judge, Presiding 22 Before: KLEIN,** PAPPAS, and DUNN, Bankruptcy Judges. 23 __________________ 24 * The caption is revised to reflect Jane O’Donnell as lead 25 appellant and real party in interest. Pensco Trust Company is not separately represented and has not appeared in its own right. 26 ** Hon. Christopher M. Klein, Chief Judge, U.S. Bankruptcy 27 Court, Eastern District of California, sitting by designation. 28 1 KLEIN, Bankruptcy Judge: 2 3 This is a mandatory subordination case. The “damages” 4 clause of
11 U.S.C. § 510(b) mandates subordination of claims for 5 “damages arising from the purchase or sale” of a security of the 6 debtor. The bankruptcy court concluded that § 510(b) mandatory 7 subordination applies to the claim of appellant, who withdrew as 8 a member of the debtor limited liability company (“LLC”) and 9 obtained a judgment valuing her equity interest after the LLC did 10 not honor a provision in its operating agreement requiring buy- 11 back of the withdrawing member’s interest. 12 We agree with the bankruptcy court that permitting a former 13 equity holder to recover the value of an equity-based claim on a 14 par with general unsecured creditors is the sort of bootstrapping 15 that § 510(b) mandatory subordination is designed to prevent. 16 Rejecting appellant’s argument that “damages arising from the 17 purchase or sale” of a security does not encompass contract-based 18 awards to withdrawing LLC members, we AFFIRM. 19 FACTS 20 The debtor, Tristar Esperanza Properties, LLC, is a 21 California limited liability company whose sole asset is real 22 property in Orange County, California. Tristar’s organic 23 governing document is in the form of an operating agreement. 24 Appellant Jane O’Donnell acquired a membership interest in 25 Tristar (about 14 percent) in 2005 by means of a $100,000 capital 26 contribution made through her investment retirement account with 27 appellant Pensco Trust Company, which entity is content to be 28 represented by O’Donnell and has not appeared in its own right. 2 1 In 2008, O’Donnell invoked the Tristar operating agreement’s 2 withdrawal provision by giving written notice of such intent. 3 Under the buy-back provision in the Tristar operating 4 agreement, the notice of withdrawal triggered a process in which 5 Tristar and the withdrawing member would use best efforts to 6 agree upon the fair market value of the subject interest. 7 Tristar paid O’Donnell $60,000 on account and, jointly with 8 O’Donnell, retained an appraiser who determined that the fair 9 market value of O’Donnell’s interest was $399,918 ($305/sq.ft.) 10 as of the time of her withdrawal. Tristar contends that this 11 value is “absurd” because it was not adjusted to reflect $2.69 12 million in secured debt against its sole asset, which, if 13 counted, would have reduced the recovery by about $377,000. 14 After Tristar declined to accept the valuation, O’Donnell 15 initiated an arbitration that concluded in 2010 with a 16 determination that Tristar was bound by the $399,918 value. 17 The arbitrator awarded O’Donnell damages of $399,918, less 18 the $60,000 that Tristar had already paid. 19 The arbitration award was confirmed by a California superior 20 court and reduced to judgment. The abstract of judgment was 21 recorded in Orange County in December 2010. 22 Tristar filed its chapter 11 case in the Central District of 23 California in August 2011 and filed this adversary proceeding 24 against O’Donnell and Pensco Trust, alleging three claims for 25 relief: (1) mandatory subordination under § 510(b); (2) 26 equitable subordination under § 510(c); and (3) avoidance of a 27 preference under
11 U.S.C. § 547(b). 28 The trial court disposed of all three claims for relief on 3 1 cross-motions for summary judgment. The net result was that 2 Tristar prevailed on the mandatory subordination count, while the 3 other two counts were resolved against Tristar. 4 With respect to mandatory subordination, the court reasoned 5 that the scope of § 510(b) is broad and leaves little discretion 6 where literal application is not demonstrably at odds with the 7 intent of Congress. It explained that § 510(b) is designed to 8 prevent equity holders from diluting the recovery of creditors 9 who deal with the debtor only on a credit basis with no 10 expectation of sharing in the value of the enterprise and with an 11 expectation of having rights senior to equity interests. 12 In particular, the court rejected the argument that the 13 confirmed arbitration award did not constitute a claim for 14 “damages” within the meaning of the § 510(b) damages clause and 15 emphasized that the arbitrator found that the debtor had breached 16 its operating agreement. Under these circumstances, the court 17 concluded that such an award qualified as § 510(b) “damages.” 18 This timely appeal, limited to the § 510(b) issue, ensued. 19 JURISDICTION 20 Federal subject-matter jurisdiction exists under 28 U.S.C. 21 § 1334(b). The bankruptcy judge had authority to hear and 22 determine the matter under
28 U.S.C. §§ 157(b)(2)(A) and (O); no 23 party has questioned that authority. We have jurisdiction under 24
28 U.S.C. § 158(a)(1). 25 ISSUES 26 1) Whether a contractually-required buy-back of an LLC 27 membership interest from a withdrawing member constitutes a 28 “purchase or sale” of a “security” of the debtor within the 4 1 meaning of
11 U.S.C. § 510(b). 2 2) Whether the appellants’ claim is for “damages” within the 3 meaning of
11 U.S.C. § 510(b). 4 3) Whether withdrawal as an LLC member prior to the 5 bankruptcy filing renders
11 U.S.C. § 510(b) inapplicable. 6 4) Whether judicial estoppel should be imposed. 7 STANDARD OF REVIEW 8 We review summary judgment de novo. Ghomeshi v. Sabban (In 9 re Sabban),
600 F.3d 1219, 1221-22 (9th Cir. 2010); Bendon v. 10 Reynolds (In re Reynolds),
479 B.R. 67, 71 (9th Cir. BAP 2012). 11 De novo review permits an appellate court to substitute its 12 judgment for that of the trial court. Barclay v. Mackenzie (In 13 re AFI Holding, Inc.),
525 F.3d 700, 702 (9th Cir. 2008). We 14 must determine whether, viewing the summary judgment evidence in 15 the light most favorable to the non-moving party, any genuine 16 issue of material fact remains for trial and whether Tristar was 17 entitled to a § 510(b) mandatory subordination judgment as a 18 matter of law. Gill v. Stern (In re Stern),
345 F.3d 1036, 1040 19 (9th Cir. 2003). 20 DISCUSSION 21 This appeal requires construction of
11 U.S.C. § 510(b). 22 After examining the applicable language of § 510(b), we tour the 23 statute’s legislative history and policy objectives. This 24 inspection of the statute’s underpinnings confirms that the 25 arbitration award falls in the zone of transactions requiring 26 mandatory subordination under § 510(b). 27 For us, this is a case of first impression in that we deal 28 for the first time with the § 510(b) “damages” clause in the 5 1 context of an LLC and an arbitration stemming from the withdrawal 2 provision of the LLC’s operating agreement. The ultimate 3 question is: whether a judgment debt, based on a confirmed 4 arbitration award enforcing a buy-back provision in the debtor 5 LLC’s operating agreement, constitutes a claim “for damages 6 arising from the purchase or sale of” a “security” of the debtor. 7
11 U.S.C. § 510(b). It does. 8 I 9 The Bankruptcy Code provides for three distinct forms of 10 subordination: (1) subordination by agreement; (2) mandatory 11 subordination of certain claims related to a security; and 12 (3) equitable subordination. The first is a matter of contract; 13 the second a matter of the nature of a transaction; and the third 14 a matter of inequitable conduct. We focus here on the second. 15 Subordination demotes a claim from its nominal priority. A 16 subordinated claimant receives a distribution junior in priority 17 to the nominal class. 4 COLLIER ON BANKRUPTCY ¶ 510.01 (Alan N. 18 Resnick & Henry J. Sommer eds., 16th ed.) (“COLLIER”). 19 As our primary task is to interpret § 510(b) de novo, we 20 begin with its language: 21 (b) For the purpose of distribution under this title, a claim arising from rescission of a purchase or 22 sale of a security of the debtor or of an affiliate of the debtor, for damages arising from the purchase or 23 sale of such a security, or for reimbursement or contribution allowed under section 502 on account of 24 such a claim, shall be subordinated to all claims or interests that are senior to or equal the claim or 25 interest represented by such security, except that if such security is common stock, such claim has the same 26 priority as common stock. 27
11 U.S.C. § 510(b) (emphasis supplied). 28 Thus, § 510(b) contemplates three types of claims – 6 1 rescission, damages, and reimbursement/contribution – that all 2 have a nexus with the purchase or sale of a security. Allen v. 3 Geneva Steel Co. (In re Geneva Steel Co.),
281 F.3d 1173, 1177 4 (10th Cir. 2002); see also COLLIER ¶ 510.04. Only the damages 5 clause is involved in this appeal. 6 A 7 At the threshold lies the question whether a membership 8 interest in an LLC is a “security” as defined by Bankruptcy Code 9 § 101(49).
11 U.S.C. § 101(49). 10 That statutory definition of “security” does not provide a 11 functional description. Rather, it merely lists positive and 12 negative examples. There is a fifteen-item list of examples of 13 securities.
11 U.S.C. § 101(49)(A). And, there are seven 14 examples of what is not a security.
11 U.S.C. § 101(49)(B). 15 Neither list mentions a membership interest in an LLC. 16 But, the omission of mention of a LLC membership interest 17 from the examples of “security” at § 101(49)(A) is not fatal to 18 the status of such an interest as a “security” because the 19 operative verb at the beginning of the list is “includes”: “The 20 term ‘security’ – (A) includes —... .”
11 U.S.C. § 101(49)(A). 21 Section 102 of the Bankruptcy Code provides a statutory rule 22 of construction whereby the term “includes” is not restrictive. 23 See
11 U.S.C. § 102(3) (“In this title — ... (3) ‘includes’ and 24 ‘including’ are not limiting”). Therefore, the statutory list of 25 what is a “security” at § 101(49)(A) is non-exclusive. 26 Since the fifteen-item list of what constitutes a “security” 27 is non-exclusive, we look for an analogous entry on the list. In 28 this regard, the statute is express that the “interest of a 7 1 limited partner in a limited partnership” is a “security.” 2
11 U.S.C. § 101(49)(A)(xiii). 3 The similarities between the interest of a limited partner 4 in a limited partnership and a membership interest in an LLC are 5 substantial. For example, each owns an interest in the 6 enterprise and shares in net revenues and increases in value, and 7 those who extend credit to the enterprise do so in the 8 expectation that their claims will be paid before any 9 distribution to limited partners or LLC members. 10 It follows that, if the interest of a limited partner in a 11 limited partnership is a “security” under the Bankruptcy Code, 12 then the interest of a member in an LLC is also a “security” for 13 purposes of the Bankruptcy Code. 14 Accordingly, an interest of a member in an LLC is a 15 “security,” the purchase or sale of which is vulnerable to 16 § 510(b) mandatory subordination. 17 B 18 Appellants argue that the confirmed arbitration award is not 19 “for damages” within the scope of § 510(b), but rather is a claim 20 based on a judgment for “fixed debt.” They further contend that, 21 whatever the characterization of the claim may be, the right to 22 payment did not arise from the purchase or sale of Tristar’s 23 securities. This necessitates a review of the meaning of 24 § 510(b) in general and the damages clause in particular. 25 1 26 The starting point is the text of the statute. Lamie v. 27 United States Tr.,
540 U.S. 526, 534 (2004). Plain meaning 28 should be conclusive, except when literal application will 8 1 produce a result demonstrably at odds with the intentions of its 2 drafters. United States v. Ron Pair Enters., Inc.,
489 U.S. 235, 3 242 (1989); Snavely v. Miller (In re Miller),
397 F.3d 726, 730 4 (9th Cir. 2005). If the text of a statute is ambiguous, we 5 resort to canons of construction, legislative history, and the 6 statute’s purpose to discern Congress’s intent. James v. City of 7 Costa Mesa,
700 F.3d 394, 399 n.8 (9th Cir. 2012). 8 2 9 The language of § 510(b) provides that “damages” requiring 10 subordination must arise from the purchase or sale of the 11 debtor’s securities, but it does not otherwise purport to 12 describe the nature of the claim for relief or the types of 13 damages that may be recovered. 14 “Damages” is not a defined term in the Bankruptcy Code, but 15 it has a well-understood general definition in the law. It 16 generally means money “claimed by, or ordered to be paid to, a 17 person as compensation for loss or injury.” BLACK’S LAW DICTIONARY, 18 445 (9th ed. 2009) (“Damages”). 19 The classic hornbook on damages likewise describes “damages” 20 as “primarily how much can be recovered” on any basis for 21 liability and as the preferred remedy over specific performance. 22 Charles T. McCormick, HANDBOOK OF THE LAW OF DAMAGES § 1 (1935). 23 Professor McCormick adds that an agreement to arbitrate all 24 controversies arising from dealings under a contract empowers the 25 arbitrator to determine all claims for damages, direct and 26 consequential, from any breach of contract. Id. at § 4. 27 We perceive no ambiguity in the use of the term “damages” in 28 § 510(b). Nothing has been presented to us to suggest that the 9 1 term has a narrower or specialized meaning in § 510(b). 2 In particular, we are not persuaded by the appellants’ 3 argument that § 510(b) “damages” connote some sort of actionable 4 wrongdoing or malfeasance and not merely enforcing a contract 5 term. The decision they cite for the proposition merely held 6 that simple recovery of principal due under the promissory note 7 in question did not constitute § 510(b) “damages” even though a 8 “note” may be within the Bankruptcy Code definition of a 9 “security.” In re Blondheim Real Estate, Inc.,
91 B.R. 639, 640 10 (Bankr. D.N.H. 1988). We do not read that decision to narrow the 11 meaning of “damages” and, in any event, are not persuaded that 12 § 510(b) “damages” require wrongdoing or malfeasance. 13 3 14 Having concluded that § 510(b) “damages” include all forms 15 of “damages” known to the law so long as they arise from the 16 purchase or sale of a security of the debtor, the question 17 becomes whether, on our facts, there are § 510(b) “damages.” 18 O’Donnell acquired her membership interest in Tristar in 19 exchange for cash. This was the purchase of a security. She 20 later invoked the buy-back process established by the Tristar 21 operating agreement for withdrawal by members from the LLC. The 22 subsequent disagreement over the purchase price determined by a 23 jointly retained appraiser led to the arbitration proceedings. 24 After considering the details of the parties’ course of 25 conduct, including the applicable language of Tristar’s operating 26 agreement, the arbitrator determined that Tristar was obligated 27 to repurchase the appellants’ equity interest for the appraised 28 price. The arbitrator found that Tristar had breached the 10 1 operating agreement and awarded the appellants “damages” 2 commensurate with the appraisal. When Tristar still did not pay 3 what was due, the appellants obtained a state-court judgment 4 confirming the arbitration award. 5 Given that the arbitration award was an order to pay money 6 to the appellants as a matter of contractual right, and achieved 7 the status of a judgment debt once the award was confirmed, the 8 arbitration award and judgment qualify as § 510(b) “damages.” 9 The record also shows the arbitrator concluded that Tristar 10 breached both “the letter and spirit” of the Tristar operating 11 agreement, and, for that reason, was bound by the appraiser’s 12 determination. It is immaterial that appellants did not style 13 the arbitration demand as being for breach of contract, fraud, or 14 any other wrongful conduct. The purpose of the proceeding was to 15 enforce a contract in circumstances in which Tristar’s 16 recalcitrance constituted breach of contract. 17 C 18 The next question is whether the appellants’ claim arises 19 from the “purchase or sale” of Tristar’s securities. 20 1 21 Section 510(b) is limited to claims “arising from the 22 purchase or sale of” a debtor’s securities. What constitutes 23 “arising from” has been considered and found ambiguous by the 24 Second, Third, Fifth, Ninth, and Tenth Circuits.1 No circuit has 25 26 1 Ninth Circuit cases on the scope of § 510(b) mandatory subordination are: Racusin v. Am. Wagering, Inc. (In re Am. 27 Wagering, Inc.),
493 F.3d 1067, 1073 (9th Cir. 2007) (rescission 28 of a purchase or sale of a security of debtor); Am. Broad. Sys., (continued...) 11 1 taken a contrary view. 2 The factual scenarios in which investor claims have arisen 3 from the purchase or sale of a debtor’s securities are diverse. 4 The LLC membership interest in this appeal is a new wrinkle. 5 The appellants characterize their claim as an ordinary debt 6 obligation. They emphasize that O’Donnell withdrew as a member 7 well before the bankruptcy proceedings, shed her equity status, 8 and thereafter became a general creditor of the debtor. Although 9 appellants argue that the claim is not one “stemming from alleged 10 fraud or wrongdoing relating to the purchase or sale of a 11 security,” the weight of precedent has applied a broader 12 construction of the “arising from” language. 13 The ambiguity in § 510(b) permits competing narrow and broad 14 interpretations. A narrow reading would require that the injury 15 flow from the actual purchase or sale. A broad reading would 16 require that the purchase or sale be part of a causal link even 17 though the injury may flow from a subsequent event. Fair 18 arguments support each view. An influential case adopting the 19 broad view is In re Granite Partners, L.P.,
208 B.R. 332, 339 20 21 1 (...continued) 22 Inc. v. Nugent (In re Betacom of Phoenix, Inc.),
240 F.3d 823, 828 (9th Cir. 2001) (failure to deliver stock pursuant to merger 23 agreement). Other circuits have addressed § 510(b): SeaQuest 24 Diving, LP v. S&J Diving, Inc.(In re SeaQuest Diving, LP),
579 F.3d 411, 419 (5th Cir. 2009) (rescission arising from post- 25 issuance conduct); Rombro v. Dufrayne (In re Med Diversified, Inc.),
461 F.3d 251, 258-59 (2d Cir. 2006) (exchange of stock 26 provision in termination agreement); Baroda Hill Invs., Ltd. v. Telegroup, Inc. (In re Telegroup, Inc.),
281 F.3d 133, 144 (3d 27 Cir. 2002) (provision in stock purchase agreement to use best 28 efforts to register stock); Geneva Steel,
281 F.3d at 1178(10th Cir.) (fraudulent retention). 12 1 (Bankr. S.D.N.Y. 1997). 2 The Ninth Circuit favors the broad view and has expressed 3 its approval of the Granite Partners analysis. Betacom,
240 F.3d 4at 828, citing with approval, Granite Partners,
208 B.R. at 333. 5 It has concluded that § 510's legislative history does not reveal 6 an intent to tie mandatory subordination exclusively to 7 securities fraud claims. Id. at 829. Accordingly, we apply the 8 broad view as the law of the circuit. 9 We now turn to the legislative history. 10 2 11 In drafting § 510(b), Congress relied on an influential 12 article by John J. Slain and Homer Kripke: John J. Slain & Homer 13 Kripke, The Interface Between Securities Regulation and 14 Bankruptcy — Allocating the Risk of Illegal Securities Issuance 15 Between Securityholders and the Issuer’s Creditors, 48 N.Y.U. L. 16 REV. 261 (1973) (“Slain and Kripke”). The House Committee Report 17 contains an extended discussion of Slain and Kripke in connection 18 with § 510(b). H.R. Rep. No. 95-595, 1st Sess., at 194-96 19 (1977), reprinted in 1978 U.S.C.C.A.N. at 6154-56 (“House 20 Report”), cited with approval, Betacom,
240 F.3d at 829. 21 Confronting the historical problem of investors recovering 22 fraud claims pari passu with general creditors in bankruptcy 23 cases, Slain and Kripke emphasized the dissimilar expectations of 24 investors and creditors. They recognized that both creditors and 25 investors “accept the risk of enterprise failure.” Slain and 26 Kripke at 286. The two constituent risks, however, are based on 27 different assumptions. In the event of insolvency, the creditor 28 expects higher priority vis-a-vis the investor, but, unlike the 13 1 investor, does not expect to participate in the profits of the 2 enterprise. House Report at 194-96; Betacom, 240 B.R. at 830-31. 3 The Ninth Circuit takes these dissimilar expectations into 4 account in setting a standard for mandatory subordination because 5 it is unfair to shift all of the risk to creditors who extend 6 credit in reliance on the cushion of investment provided by the 7 shareholders. Betacom,
240 F.3d at 829-31. 8 Section 510(b) was spawned by uncertainty under prior law 9 whether claims relating to securities transactions should enjoy 10 an equal footing with the claims of general unsecured creditors: 11 a “difficult policy question” in business bankruptcy concerns the 12 relative status of a security holder who seeks to rescind a 13 purchase of securities or to sue for damages based on such a 14 purchase and wants to be treated as a general unsecured creditor. 15 House Report, at 195. 16 Embracing the Slain and Kripke analysis, Congress explicitly 17 resolved the dilemma in favor of subordination when it enacted 18 § 510(b). It was persuaded that it was appropriate to focus on 19 the risk of insolvency as well as the risk of unlawful issuance 20 of the debtor’s securities. Id. at 196. The intent was to 21 subordinate the distribution priority of rescission claims to all 22 claims that are senior to the claim or interest on which the 23 rescission claims are based. Id. 24 Although Congress focused on rescission claims, it enacted 25 more comprehensive language. The Ninth Circuit has described how 26 the scope of § 510(b) has gradually expanded to include claims 27 based on contract law and other actions. Am. Wagering, Inc., 493 28 F.3d at 1072. Beyond the realm of rescission and investor fraud 14 1 claims, there is judicial consensus that the phrase “arising 2 from” in § 510(b) should be construed broadly to encompass claims 3 other than fraud claims, such as claims for breach of contract. 4 Id. (collecting cases); Betacom,
240 F.3d at 828-29. 5 The broad interpretation of § 510(b) was cemented into the 6 law of the Ninth Circuit in Betacom. There, shareholders of the 7 debtor, who were to receive their shares through a merger 8 agreement entered into between the debtor and another entity, 9 brought a pre-petition action against the debtor for the debtor’s 10 failure to deliver the stock as required by the merger agreement. 11 Betacom,
240 F.3d at 826. The court held the claim should be 12 subordinated under § 510(b). Id. at 832. 13 Central to the Betacom court’s analysis was a careful 14 consideration of the rationales identified in the legislative 15 history. The Ninth Circuit explained that there are two main 16 rationales for mandatory subordination: “(1) the dissimilar risk 17 and return expectations of shareholders and creditors; and (2) 18 the reliance of creditors on the equity cushion provided by 19 shareholder investment.” Id. at 830. As to the reliance 20 rationale, the court proposed, without deciding the issue, that 21 creditors of a distressed enterprise be presumed to have relied 22 upon each prior investment in equity and junior debt, subject to 23 rebuttal to the extent that the investor can prove nonreliance. 24 Id. at 831 n.3. 25 The Betacom precedent dictates that we reject the 26 appellants’ argument that, to be subordinated, their claim must 27 sound in fraud or some sort of actionable wrongdoing. We cannot 28 ignore the Ninth Circuit’s reasoning in Betacom that nothing in 15 1 the Slain and Kripke analysis suggests that Congress’s concern 2 with creditor expectations and equitable risk allocation was 3 limited to cases of debtor fraud. Id. at 829. 4 Likewise, in Am. Wagering, the Ninth Circuit looked 5 favorably upon a linking test requiring a nexus or causal 6 relationship between the claim and the purchase or sale of the 7 securities. Am. Wagering,
493 F.3d at 1072. In its view, this 8 test showed that courts were concerned with claims that tried to 9 recharacterize what would otherwise be subordinated securities. 10
Id.Bootstrapping to a higher status in the bankruptcy 11 distribution scheme is blocked by § 510(b). 12 Applying the two rationales underlying § 510(b) to the facts 13 presented here, we conclude that the appellants’ claim is subject 14 to mandatory subordination. O’Donnell was in fact an equity 15 holder before she withdrew. During her tenure as a member of 16 Tristar, she enjoyed the potential for profit based on the value 17 of real estate. In fact, she enjoyed a considerable return: she 18 contributed $100,000 initially and received an arbitration award 19 for nearly $400,000. The confirmed arbitration award is directly 20 linked to her ownership of a membership interest in the debtor; 21 indeed, it is nothing other than her cashing out her equity (at a 22 value that the debtor insists is highly inflated). 23 The second rationale for subordinating investor claims is 24 the reliance of creditors on the so-called “equity cushion” 25 created by an investor’s contribution of capital. We presume 26 that creditors relied on this equity cushion in deciding to 27 extend credit to the debtor. By withdrawing as a member and 28 liquidating her interest, O’Donnell altered the Tristar balance 16 1 sheet by extracting or, more appropriately, attempting to extract 2 her initial contribution. This would effectively deflate the 3 equity cushion to which trade creditors and the like would look 4 in recovering their claims for fixed debt. The creditors of 5 Tristar, by virtue of their status, were never to enjoy the 6 returns of increased value. 7 The appellants have not attempted to rebut the presumption 8 that creditors of Tristar relied on O’Donnell’s contribution as a 9 source of recovery. As such, the second rationale is also 10 applicable. But even if appellants had argued that there was a 11 lack of reliance, the presence of merely one of the dual 12 rationales is sufficient. Waltzer v. Nisselson (In re MarketXT 13 Holdings Corp.),
346 Fed. Appx. 744, 746 (2d Cir. 2009). 14 We hold that § 510(b) is sufficiently broad to encompass a 15 claim that arose from the withdrawal of a member from an LLC, 16 which withdrawal triggered a repurchasing process whereby the 17 debtor-issuer was to buy back the interest from the investor. 18 II 19 The appellants, urging that the withdrawal from the LLC and 20 the fixing of the claim before bankruptcy should prevent 21 mandatory subordination, brand their claim as a “fixed debt.” 22 This is a familiar strategy for equity holders (current or 23 former) in the bankruptcy arena. The appellants assert that 24 O’Donnell traded the risks and rewards of an equity holder for 25 the risks and rewards of a general creditor. 26 To be sure, the appellants are “creditors” who have “claims” 27 against Tristar. A “creditor” includes anyone who holds a 28 “claim” against the debtor that arose before the order for 17 1 relief.
11 U.S.C. § 101(10)(A). 2 The judgment confirming the arbitration award requiring the 3 debtor to pay the fair market value of the former membership 4 interest is a “claim.” See
11 U.S.C. § 101(5). 5 The purpose of subordination, however, is to adjust the 6 place in line of certain claims in the bankruptcy distribution 7 scheme. Bankruptcy policy affords a priority to general 8 creditors that is superior to equity interests. As Professors 9 Slain and Kripke explained in their seminal article, appropriate 10 allocations of risk among general creditors and equity-type 11 creditors should reflect the dissimilar risks regarding 12 enterprise insolvency those creditors undertake. Granite 13 Partners,
208 B.R. at 336. 14 Whatever might be said of a transformation of equity into 15 debt in a transaction that is old and cold and that has long been 16 treated as part of the enterprise’s debt structure, this is not 17 such a case. Rather, the buy-back transaction was a disputed 18 issue until shortly before the chapter 11 case was filed and was, 19 doubtless, a material factor in the need for chapter 11 relief. 20 The dispute over the buy-back amount and the chapter 11 filing 21 were sufficiently proximate in time to warrant the conclusion 22 that this is an effort by equity to capture paper (and arguably 23 mythical) profits via a judgment for money damages. 24 Treating an equity investor on a par with unsecured 25 creditors disregards the principles underlying the absolute 26 priority rule in a manner that undermines this basic bankruptcy 27 concept. Granite Partners,
208 B.R. at 344; 11 U.S.C. 28 § 1129(b)(2)(B)(ii). 18 1 The appellants’ argument that they extricated themselves 2 from the equity position before the bankruptcy filing does not 3 necessarily militate against the application of mandatory 4 subordination. The Bankruptcy Code definition of “security” 5 extends far beyond holders of stock.
11 U.S.C. § 101(49)(A). 6 The text of § 510(b) does not require that a subordinated 7 claimant be a shareholder. Betacom,
240 F.3d at 829. What 8 matters is the type of claim, not the type of claimant.
Id.9 In short, the claim is so firmly rooted in O’Donnell’s 10 equity status that subordination is mandatory. 11 III 12 Finally, we reject the arguments that the appellee is barred 13 by principles of judicial estoppel from asserting that the claim 14 is for § 510(b) “damages” and that Tristar filed for bankruptcy 15 as a bad faith collateral attack on the arbitration award. 16 A 17 The appellants posit that Tristar’s statement in the 18 arbitration that it “still owes O’Donnell money to complete the 19 liquidation of her membership interest” should now estop Tristar 20 from asserting that the claim is for § 510(b) “damages.” 21 This is an assertion of the form of the equitable doctrine 22 of judicial estoppel known as the estoppel of inconsistent 23 positions, which prevents one from gaining advantage by taking 24 one position and later seeking to reap another advantage from an 25 inconsistent position. New Hampshire v. Maine,
532 U.S. 742, 26 749-51 (2001); United States v. Ibrahim,
522 F.3d 1003, 1009 (9th 27 Cir. 2008); Hamilton v. State Farm Fire & Cas. Co.,
270 F.3d 778, 28 782-85 (9th Cir. 2001); Alary Corp. v. Sims (In re Associated 19 1 Vintage Grp., Inc.),
283 B.R. 549, 565-67 (9th Cir. BAP 2002). 2 While there are not inflexible prerequisites for judicial 3 estoppel, the Supreme Court has emphasized the importance of a 4 “clearly inconsistent” position, coupled with acceptance of the 5 first position in circumstances that would create the perception 6 that one of the tribunals was misled, plus some form of unfair 7 advantage or detriment. New Hampshire v. Maine,
532 U.S. at750- 8 51; Alary Corp.,
283 B.R. at 566. 9 The appellants claim that Tristar is “playing fast and loose 10 with the courts” by admitting a debt obligation in one instance, 11 and later arguing that the obligation is one for “damages.” 12 There are two flaws in this argument. 13 The first flaw is that there is no material inconsistency 14 between the concession that something remains to be paid to 15 complete the liquidation of the membership interest and the 16 assertion that whatever sum is owed to liquidate that interest 17 constitutes § 510(b) “damages.” This amounts to missing the 18 forest for the trees; here, “damages” refers to a forest, not a 19 single tree. 20 Second, and independently fatal, is the absence of any 21 advantage that was gained by Tristar in the earlier arbitration 22 on account of the putatively inconsistent statement. New 23 Hampshire v. Maine,
532 U.S. at 750-51. 24 We perceive no material inconsistency between an admission 25 that a debt is owed and claiming that the debt owed is one for 26 § 510(b) “damages.” Nothing suggests that the appellee gained 27 any advantage by the first statement. Nor do we perceive an 28 unfair advantage or unfair detriment. Hence, we reject the 20 1 appellants’ argument based on judicial estoppel. 2 B 3 We also reject the appellants’ claim -- first raised in the 4 reply brief -- that the appellee filed its chapter 11 case with 5 the sole intent of avoiding paying the remainder of the value of 6 O’Donnell’s membership interest. Debtors have numerous motives 7 for filing a bankruptcy case. The goal of the federal bankruptcy 8 laws is the adjustment of the debtor-creditor relationship. The 9 resulting adjustment -- in this case subordination -- may not be 10 welcomed by the appellants. But it is certainly permitted. 11 Nor is chapter 11 an impermissible collateral attack on the 12 validity of a state court judgment. The amount that is owed is 13 not questioned. The issue is priority and terms of payment. 14 Hence, there is no genuine issue of material fact that there 15 was an arbitration award, confirmed by judgment, for that amount. 16 CONCLUSION 17 The bankruptcy court correctly granted summary judgment in 18 favor of the appellee on its § 510(b) claim. There is no genuine 19 issue of material fact and the appellee is entitled to judgment 20 as a matter of law. The appellants’ right to payment, based on a 21 confirmed arbitration award valuing the membership interest in 22 the LLC, constitutes a claim for damages arising from the sale of 23 the appellee’s securities that is subject to mandatory 24 subordination by virtue of § 510(b). We AFFIRM. 25 26 27 28 21
Document Info
Docket Number: BAP CC-12-1340-KlPaDu; Bankruptcy SA 11-21095-TA; Adversary SA 12-01041-TA
Judges: Klein, Pappas, Dunn
Filed Date: 3/8/2013
Precedential Status: Precedential
Modified Date: 3/2/2024