In re: TRISTAR ESPERANZA PROPERTIES, LLC, a California Limited Liability Company, 9th Cir. BAP...

7/25/2019 In re: TRISTAR ESPERANZA PROPERTIES, LLC, a California Limited Liability Company, 9th Cir. BAP (2013)

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KLEI N, Bankr upt cy J udge:

Thi s i s a mandat or y subor di nat i on case. The “damages”

cl ause of 11 U. S. C. § 510( b) mandat es subor di nat i on of cl ai ms f or“damages ar i si ng f r om t he pur chase or sal e” of a secur i t y of t he

debt or . The bankr upt cy cour t concl uded t hat § 510( b) mandatory

subor di nat i on appl i es t o t he cl ai m of appel l ant , who wi t hdr ew as

a member of t he debt or l i mi t ed l i abi l i t y company ( “LLC”) and

obt ai ned a j udgment val ui ng her equi t y i nt er est af t er t he LLC di d

not honor a pr ovi si on i n i t s oper at i ng agr eement r equi r i ng buy-

back of t he wi t hdr awi ng member ’ s i nt erest .

We agr ee wi t h t he bankr upt cy cour t t hat permi t t i ng a f ormer

equi t y hol der t o r ecover t he val ue of an equi t y- based cl ai m on a

par wi t h gener al unsecur ed cr edi t or s i s t he sor t of boot st r appi ng

t hat § 510( b) mandat or y subor di nat i on i s desi gned t o pr event .

Rej ect i ng appel l ant ’ s argument t hat “damages ar i si ng f r om t he

pur chase or sal e” of a secur i t y does not encompass cont r act - basedawar ds t o wi t hdr awi ng LLC member s, we AFFI RM.

FACTS

The debtor , Tr i st ar Esper anza Pr oper t i es, LLC, i s a

Cal i f or ni a l i mi t ed l i abi l i t y company whose sol e asset i s r eal

pr oper t y i n Or ange Count y, Cal i f or ni a. Tr i st ar ’ s or gani c

governi ng document i s i n t he f orm of an operat i ng agr eement .

Appel l ant J ane O’ Donnel l acqui r ed a member shi p i nt er est i n

Tr i st ar ( about 14 per cent ) i n 2005 by means of a $100, 000 capi t al

cont r i but i on made t hr ough her i nvest ment r et i r ement account wi t h

appel l ant Pensco Tr ust Company, whi ch ent i t y i s cont ent t o be

r epr esent ed by O’ Donnel l and has not appear ed i n i t s own r i ght .



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I n 2008, O’ Donnel l i nvoked t he Tr i st ar oper at i ng agr eement ’ s

wi t hdr awal pr ovi si on by gi vi ng wr i t t en not i ce of such i nt ent .

Under t he buy- back pr ovi si on i n t he Tr i st ar oper at i ng

agr eement , t he not i ce of wi t hdr awal t r i gger ed a pr ocess i n whi ch Tr i st ar and t he wi t hdr awi ng member woul d use best ef f or t s t o

agr ee upon t he f ai r mar ket val ue of t he subj ect i nt er est .

Tr i st ar pai d O’ Donnel l $60, 000 on account and, j oi nt l y wi t h

O’ Donnel l , r et ai ned an appr ai ser who det er mi ned t hat t he f ai r

mar ket val ue of O’ Donnel l ’ s i nt er est was $399, 918 ( $305/ sq. f t . )

as of t he t i me of her wi t hdr awal . Tr i st ar cont ends that t hi s

val ue i s “absur d” because i t was not adj ust ed t o r ef l ect $2. 69

mi l l i on i n secur ed debt agai nst i t s sol e asset , whi ch, i f

count ed, woul d have r educed t he r ecover y by about $377, 000.

Af t er Tr i st ar decl i ned t o accept t he val uat i on, O’ Donnel l

i ni t i at ed an ar bi t r at i on t hat concl uded i n 2010 wi t h a

determi nat i on t hat Tr i st ar was bound by the $399, 918 val ue.

The ar bi t r at or awar ded O’ Donnel l damages of $399, 918, l esst he $60, 000 t hat Tr i st ar had al r eady pai d.

The ar bi t r at i on awar d was conf i r med by a Cal i f or ni a super i or

cour t and r educed t o j udgment . The abst r act of j udgment was

r ecor ded i n Or ange County i n December 2010.

Tr i st ar f i l ed i t s chapt er 11 case i n t he Cent r al Di st r i ct of

Cal i f or ni a i n August 2011 and f i l ed t hi s adver sar y pr oceedi ng

agai nst O’ Donnel l and Pensco Tr ust , al l egi ng t hr ee cl ai ms f or

r el i ef : ( 1) mandat or y subor di nat i on under § 510( b) ; ( 2)

equi t abl e subor di nat i on under § 510( c) ; and ( 3) avoi dance of a

pr ef er ence under 11 U. S. C. § 547( b) .

The t r i al cour t di sposed of al l t hree cl ai ms f or r el i ef on



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cr oss- mot i ons f or summary j udgment . The net r esul t was that

Tr i st ar prevai l ed on t he mandator y subor di nat i on count , whi l e t he

ot her t wo count s wer e r esol ved agai nst Tr i st ar .

Wi t h r espect t o mandat ory subor di nat i on, t he cour t r easonedt hat t he scope of § 510( b) i s br oad and l eaves l i t t l e di scret i on

wher e l i t er al appl i cat i on i s not demonst r abl y at odds wi t h t he

i nt ent of Congr ess. I t expl ai ned t hat § 510( b) i s desi gned t o

pr event equi t y hol der s f r om di l ut i ng t he r ecover y of credi t or s

who deal wi t h t he debt or onl y on a cr edi t basi s wi t h no

expect at i on of shar i ng i n t he val ue of t he ent er pr i se and wi t h an

expect at i on of havi ng r i ght s seni or t o equi t y i nt er est s.

I n par t i cul ar , t he cour t r ej ect ed t he ar gument t hat t he

conf i r med ar bi t r at i on awar d di d not const i t ut e a cl ai m f or

“damages” wi t hi n the meani ng of t he § 510(b) damages cl ause and

emphasi zed t hat t he ar bi t r at or f ound t hat t he debt or had br eached

i t s oper at i ng agr eement . Under t hese ci r cumst ances, t he cour t

concl uded t hat such an award qual i f i ed as § 510( b) “damages. ” Thi s t i mel y appeal , l i mi t ed t o t he § 510(b) i ssue, ensued.

J URI SDI CTI ON

Feder al subj ect - mat t er j ur i sdi ct i on exi st s under 28 U. S. C.

§ 1334( b) . The bankr upt cy j udge had aut hor i t y t o hear and

det er mi ne the mat t er under 28 U. S. C. §§ 157( b) ( 2) ( A) and ( O) ; no

par t y has quest i oned t hat aut hor i t y. We have j ur i sdi ct i on under

28 U. S. C. § 158( a) ( 1) .

I SSUES

1) Whet her a cont r act ual l y- r equi r ed buy- back of an LLC

membershi p i nt erest f r oma wi t hdr awi ng member const i t ut es a

“pur chase or sal e” of a “secur i t y” of t he debt or wi t hi n t he



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meani ng of 11 U. S. C. § 510( b) .

2) Whet her t he appel l ant s’ cl ai m i s f or “damages” wi t hi n t he

meani ng of 11 U. S. C. § 510( b) .

3) Whet her wi t hdr awal as an LLC member pr i or t o thebankrupt cy f i l i ng r ender s 11 U. S. C. § 510( b) i nappl i cabl e.

4) Whet her j udi ci al est oppel shoul d be i mposed.

STANDARD OF REVI EW

We r evi ew summar y j udgment de novo. Ghomeshi v. Sabban ( I n

r e Sabban) , 600 F. 3d 1219, 1221- 22 ( 9t h Ci r . 2010) ; Bendon v.

Reynol ds ( I n r e Reynol ds) , 479 B. R. 67, 71 ( 9t h Ci r . BAP 2012) .

De novo r evi ew per mi t s an appel l at e cour t t o subst i t ut e i t s

j udgment f or t hat of t he t r i al cour t . Bar cl ay v. Mackenzi e ( I n

r e AFI Hol di ng, I nc. ) , 525 F. 3d 700, 702 ( 9t h Ci r . 2008) . We

must det er mi ne whet her , vi ewi ng t he summary j udgment evi dence i n

t he l i ght most f avor abl e t o t he non- movi ng par t y, any genui ne

i ssue of mat er i al f act r emai ns f or t r i al and whet her Tr i st ar was

ent i t l ed t o a § 510( b) mandat or y subor di nat i on j udgment as amat t er of l aw. Gi l l v. St er n ( I n r e St er n) , 345 F. 3d 1036, 1040

( 9t h Ci r . 2003) .

DI SCUSSI ON

Thi s appeal r equi r es const r uct i on of 11 U. S. C. § 510(b) .

Af t er exami ni ng t he appl i cabl e l anguage of § 510( b) , we t our t he

st at ut e’ s l egi sl at i ve hi st or y and pol i cy obj ecti ves. Thi s

i nspect i on of t he st at ut e’ s under pi nni ngs conf i r ms t hat t he

ar bi t r at i on awar d f al l s i n t he zone of t r ansact i ons r equi r i ng

mandatory subordi nat i on under § 510( b) .

For us, t hi s i s a case of f i r st i mpr essi on i n t hat we deal

f or t he f i r st t i me wi t h t he § 510( b) “damages” cl ause i n t he



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cont ext of an LLC and an ar bi t r at i on st emmi ng f r omt he wi t hdr awal

pr ovi si on of t he LLC’ s oper at i ng agr eement . The ul t i mat e

quest i on i s: whether a j udgment debt , based on a conf i r med

ar bi t r at i on awar d enf or ci ng a buy- back pr ovi si on i n t he debt orLLC’ s oper at i ng agr eement , const i t ut es a cl ai m “f or damages

ar i si ng f r om t he pur chase or sal e of ” a “secur i t y” of t he debt or .

11 U. S. C. § 510( b) . I t does.

I

The Bankr upt cy Code provi des f or t hree di st i nct f or ms of

subor di nat i on: ( 1) subor di nat i on by agr eement ; ( 2) mandat or y

subor di nat i on of cer t ai n cl ai ms r el at ed t o a secur i t y; and

( 3) equi t abl e subor di nat i on. The f i r st i s a mat t er of cont r act ;

t he second a mat t er of t he nat ur e of a t r ansact i on; and t he t hi r d

a mat t er of i nequi t abl e conduct . We f ocus here on t he second.

Subor di nat i on demot es a cl ai m f r om i t s nomi nal pr i or i t y. A

subor di nat ed cl ai mant r ecei ves a di st r i but i on j uni or i n pr i or i t y

t o t he nomi nal cl ass. 4 COLLI ER ON BANKRUPTCY ¶ 510. 01 (Al an N.Resni ck & Henr y J . Sommer eds. , 16t h ed. ) ( “COLLI ER” ) .

As our pr i mar y t ask i s t o i nt er pr et § 510( b) de novo, we

begi n wi t h i t s l anguage:

( b) For t he pur pose of di st r i but i on under t hi st i t l e, a cl ai m ar i s i ng f r om r esci ssi on of a pur chase orsal e of a secur i t y of t he debt or or of an af f i l i at e of t he debt or , f or damages ar i si ng f r om t he pur chase orsal e of such a secur i t y, or f or r ei mbur sement or

cont r i but i on al l owed under sect i on 502 on account of such a cl ai m, shal l be subor di nat ed t o al l cl ai ms ori nt er est s t hat ar e seni or t o or equal t he cl ai m ori nt er est r epr esent ed by such secur i t y, except t hat i f such secur i t y i s common st ock, such cl ai m has t he samepr i or i t y as common st ock.

11 U. S. C. § 510( b) ( emphasi s suppl i ed) .

Thus, § 510(b) cont empl at es t hree t ypes of cl ai ms –



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r esci ssi on, damages, and r ei mbur sement / cont r i but i on – t hat al l

have a nexus wi t h t he pur chase or sal e of a secur i t y. Al l en v.

Geneva St eel Co. ( I n r e Geneva St eel Co. ) , 281 F. 3d 1173, 1177

( 10t h Ci r . 2002) ; see al so COLLI ER ¶ 510. 04. Onl y t he damagescl ause i s i nvol ved i n t hi s appeal .

A

At t he t hr eshol d l i es t he quest i on whether a membershi p

i nt er est i n an LLC i s a “secur i t y” as def i ned by Bankrupt cy Code

§ 101( 49) . 11 U. S. C. § 101( 49) .

That st at utor y def i ni t i on of “secur i t y” does not provi de a

f uncti onal descr i pt i on. Rat her , i t mer el y l i st s posi t i ve and

negat i ve exampl es. Ther e i s a f i f t een- i t em l i st of exampl es of

secur i t i es. 11 U. S. C. § 101( 49) ( A) . And, t her e ar e seven

exampl es of what i s not a secur i t y. 11 U. S. C. § 101( 49) ( B) .

Nei t her l i st ment i ons a membershi p i nt er est i n an LLC.

But , t he omi ss i on of ment i on of a LLC membershi p i nt erest

f r om t he exampl es of “secur i t y” at § 101( 49) ( A) i s not f at al t ot he st at us of such an i nt er est as a “secur i t y” because t he

oper at i ve ver b at t he begi nni ng of t he l i st i s “i ncl udes”: “The

t er m ‘ secur i t y’ – ( A) i ncl udes —. . . . ” 11 U. S. C. § 101( 49) ( A) .

Sect i on 102 of t he Bankr upt cy Code pr ovi des a st at ut or y rul e

of const r uct i on wher eby the t er m “i ncl udes” i s not r est r i ct i ve.

See 11 U. S. C. § 102( 3) ( “I n t hi s t i t l e — . . . ( 3) ‘ i ncl udes’ and

‘ i ncl udi ng’ ar e not l i mi t i ng”) . Ther ef or e, t he st at ut or y l i st of

what i s a “secur i t y” at § 101( 49) ( A) i s non- excl usi ve.

Si nce t he f i f t een- i t em l i st of what const i t ut es a “secur i t y”

i s non- excl usi ve, we l ook f or an anal ogous ent r y on t he l i st . I n

t hi s r egar d, t he st at ut e i s expr ess t hat t he “i nt er est of a



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l i mi t ed par t ner i n a l i mi t ed par t ner shi p” i s a “secur i t y. ”

11 U. S. C. § 101( 49) ( A) ( xi i i ) .

The si mi l ar i t i es bet ween t he i nter est of a l i mi t ed par t ner

i n a l i mi t ed par t ner shi p and a member shi p i nt er est i n an LLC ar esubst ant i al . For exampl e, each owns an i nt er est i n t he

ent er pr i se and shar es i n net r evenues and i ncr eases i n val ue, and

t hose who extend cr edi t t o the ent er pr i se do so i n t he

expect at i on t hat t hei r cl ai ms wi l l be pai d bef or e any

di st r i but i on t o l i mi t ed par t ner s or LLC member s.

I t f ol l ows t hat , i f t he i nt er est of a l i mi t ed par t ner i n a

l i mi t ed par t ner shi p i s a “secur i t y” under t he Bankrupt cy Code,

t hen t he i nt er est of a member i n an LLC i s al so a “secur i t y” f or

pur poses of t he Bankr upt cy Code.

Accordi ngl y, an i nt er est of a member i n an LLC i s a

“secur i t y, ” t he pur chase or sal e of whi ch i s vul ner abl e t o

§ 510( b) mandatory subordi nat i on.

BAppel l ant s argue t hat t he conf i r med ar bi t r at i on awar d i s not

“f or damages” wi t hi n t he scope of § 510( b) , but r at her i s a cl ai m

based on a j udgment f or “f i xed debt . ” They f ur t her cont end t hat ,

what ever t he char act er i zat i on of t he cl ai m may be, t he r i ght t o

payment di d not ar i se f r om t he pur chase or sal e of Tr i st ar ’ s

secur i t i es. Thi s necessi t at es a r evi ew of t he meani ng of

§ 510( b) i n gener al and t he damages cl ause i n par t i cul ar .

1

The st ar t i ng poi nt i s t he t ext of t he st at ut e. Lami e v.

Uni t ed St at es Tr . , 540 U. S. 526, 534 ( 2004) . Pl ai n meani ng

shoul d be concl usi ve, except when l i t er al appl i cat i on wi l l



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pr oduce a r esul t demonst r abl y at odds wi t h t he i nt ent i ons of i t s

dr af t er s. Uni t ed St at es v. Ron Pai r Ent er s. , I nc. , 489 U. S. 235,

242 ( 1989) ; Snavel y v. Mi l l er ( I n r e Mi l l er ) , 397 F. 3d 726, 730

( 9t h Ci r . 2005) . I f t he t ext of a st at ut e i s ambi guous, wer esor t t o canons of const r uct i on, l egi sl at i ve hi st or y, and t he

st at ut e’ s pur pose t o di scer n Congr ess’ s i nt ent . J ames v. Ci t y of

Cost a Mesa, 700 F. 3d 394, 399 n. 8 ( 9t h Ci r . 2012) .

2

The l anguage of § 510(b) provi des t hat “damages” r equi r i ng

subor di nat i on must ar i se f r om t he pur chase or sal e of t he

debt or ’ s secur i t i es, but i t does not ot her wi se pur por t t o

descri be t he nat ur e of t he cl ai m f or r el i ef or t he t ypes of

damages t hat may be r ecover ed.

“Damages” i s not a def i ned t erm i n t he Bankr upt cy Code, but

i t has a wel l - under st ood gener al def i ni t i on i n t he l aw. I t

general l y means money “cl ai med by, or ordered t o be pai d to, a

per son as compensat i on f or l oss or i nj ur y. ” BLACK ’ S LAW DI CTI ONARY,

445 ( 9th ed. 2009) ( “Damages”) .

The cl ass i c hor nbook on damages l i kewi se descr i bes “damages”

as “pr i mar i l y how much can be recover ed” on any basi s f or

l i abi l i t y and as t he pr ef er r ed r emedy over speci f i c per f or mance.

Char l es T. McCor mi ck, HANDBOOK OF THE LAWOF DAMAGES § 1 ( 1935) .

Prof essor McCor mi ck adds t hat an agr eement t o ar bi t r at e al l

cont r over si es ar i si ng f r om deal i ngs under a cont r act empower s t he

ar bi t r at or t o det er mi ne al l cl ai ms f or damages, di r ect and

consequent i al , f r om any br each of cont r act . I d. at § 4.

We percei ve no ambi gui t y i n t he use of t he t erm “damages” i n

§ 510( b) . Not hi ng has been pr esent ed t o us t o suggest t hat t he



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t er m has a nar r ower or speci al i zed meani ng i n § 510( b) .

I n par t i cul ar , we ar e not per suaded by the appel l ant s’

argument t hat § 510( b) “damages” connote some sor t of act i onabl e

wr ongdoi ng or mal f easance and not merel y enf orci ng a cont r actt er m. The deci si on t hey ci t e f or t he pr oposi t i on mer el y hel d

t hat si mpl e recover y of pr i nci pal due under t he pr omi ssory not e

i n quest i on di d not const i t ut e § 510( b) “damages” even t hough a

“not e” may be wi t hi n t he Bankr upt cy Code def i ni t i on of a

“secur i t y. ” I n r e Bl ondhei m Real Est at e, I nc. , 91 B. R. 639, 640

( Bankr . D. N. H. 1988) . We do not r ead t hat deci si on t o nar r ow t he

meani ng of “damages” and, i n any event , are not per suaded t hat

§ 510( b) “damages” r equi r e wr ongdoi ng or mal f easance.

3

Havi ng concl uded t hat § 510( b) “damages” i ncl ude al l f orms

of “damages” known t o t he l aw so l ong as t hey ar i se f r omt he

pur chase or sal e of a secur i t y of t he debt or , t he quest i on

becomes whether , on our f act s, t here ar e § 510( b) “damages. ”O’ Donnel l acqui r ed her member shi p i nt er est i n Tr i st ar i n

exchange f or cash. Thi s was t he pur chase of a secur i t y. She

l at er i nvoked t he buy- back pr ocess est abl i shed by the Tr i st ar

operat i ng agr eement f or wi t hdrawal by members f r om t he LLC. The

subsequent di sagreement over t he pur chase pr i ce determi ned by a

j oi nt l y r et ai ned apprai ser l ed t o t he ar bi t r at i on proceedi ngs.

Af t er consi der i ng t he det ai l s of t he par t i es’ cour se of

conduct , i ncl udi ng t he appl i cabl e l anguage of Tr i st ar ’ s oper at i ng

agr eement , t he ar bi t r at or det er mi ned t hat Tr i st ar was obl i gat ed

t o r epur chase t he appel l ant s’ equi t y i nt er est f or t he appr ai sed

pr i ce. The ar bi t r at or f ound t hat Tr i st ar had br eached t he



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1 Ni nt h Ci r cui t cases on t he scope of § 510( b) mandat or ysubor di nat i on ar e: Racusi n v. Am. Wager i ng, I nc. ( I n r e Am.Wager i ng, I nc. ) , 493 F. 3d 1067, 1073 ( 9t h Ci r . 2007) ( r esci ssi onof a pur chase or sal e of a secur i t y of debt or ) ; Am. Br oad. Sys. ,

( cont i nued. . . )

11

operat i ng agr eement and awarded the appel l ant s “damages”

commensur at e wi t h t he appr ai sal . When Tr i st ar st i l l di d not pay

what was due, t he appel l ant s obt ai ned a st ate- cour t j udgment

conf i r mi ng t he ar bi t r at i on awar d.Gi ven that t he ar bi t r at i on award was an order t o pay money

t o the appel l ant s as a mat t er of cont r act ual r i ght , and achi eved

t he st atus of a j udgment debt once t he award was conf i r med, t he

arbi t r at i on award and j udgment qual i f y as § 510( b) “damages. ”

The r ecor d al so shows t he ar bi t r at or concl uded t hat Tr i st ar

br eached bot h “t he l et t er and spi r i t ” of t he Tr i st ar oper at i ng

agr eement , and, f or t hat r eason, was bound by t he appr ai ser ’ s

det er mi nat i on. I t i s i mmat er i al t hat appel l ant s di d not st yl e

t he ar bi t r at i on demand as bei ng f or br each of cont r act , f r aud, or

any other wr ongf ul conduct . The pur pose of t he pr oceedi ng was to

enf or ce a cont r act i n ci r cumst ances i n whi ch Tr i st ar ’ s

r ecal ci t r ance const i t ut ed br each of cont r act .

C The next quest i on i s whether t he appel l ant s’ cl ai m ar i ses

f r om t he “pur chase or sal e” of Tr i st ar ’ s secur i t i es.

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Sect i on 510( b) i s l i mi t ed t o cl ai ms “ar i si ng f r om t he

pur chase or sal e of ” a debt or ’ s secur i t i es. What const i t ut es

“ar i si ng f r om” has been consi dered and f ound ambi guous by t he

Second, Thi r d, Fi f t h, Ni nt h, and Tent h Ci r cui t s. 1 No ci r cui t has



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1( . . . cont i nued)I nc. v. Nugent ( I n r e Bet acom of Phoeni x, I nc. ) , 240 F. 3d 823,828 ( 9t h Ci r . 2001) ( f ai l ur e to del i ver st ock pur suant t o mer geragr eement ) . Ot her ci r cui t s have addr essed § 510( b) : SeaQuest

Di vi ng, LP v. S&J Di vi ng, I nc. ( I n r e SeaQuest Di vi ng, LP) , 579F. 3d 411, 419 ( 5t h Ci r . 2009) ( r esci ssi on ar i si ng f r om post -i ssuance conduct ) ; Rombr o v. Duf r ayne ( I n r e Med Di ver si f i ed,I nc. ) , 461 F. 3d 251, 258- 59 ( 2d Ci r . 2006) ( exchange of st ockpr ovi si on i n t er mi nat i on agr eement ) ; Bar oda Hi l l I nvs. , Ltd. v. Tel egr oup, I nc. ( I n r e Tel egr oup, I nc. ) , 281 F. 3d 133, 144 ( 3dCi r . 2002) ( pr ovi si on i n st ock pur chase agr eement t o use bestef f or t s t o r egi st er st ock) ; Geneva St eel , 281 F. 3d at 1178 ( 10t hCi r . ) ( f r audul ent r et ent i on) .

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t aken a cont r ary vi ew.

The f act ual scenar i os i n whi ch i nvest or cl ai ms have ar i sen

f r om t he pur chase or sal e of a debt or ’ s secur i t i es ar e di ver se.

The LLC member shi p i nter est i n t hi s appeal i s a new wr i nkl e. The appel l ant s char act er i ze t hei r cl ai m as an or di nar y debt

obl i gat i on. They emphasi ze t hat O’ Donnel l wi t hdr ew as a member

wel l bef ore t he bankrupt cy pr oceedi ngs, shed her equi t y st at us,

and t her eaf t er became a gener al cr edi t or of t he debt or . Al t hough

appel l ant s argue t hat t he cl ai m i s not one “st emmi ng f r om al l eged

f r aud or wr ongdoi ng r el at i ng t o t he pur chase or sal e of a

secur i t y, ” t he wei ght of pr ecedent has appl i ed a br oader

const r uct i on of t he “ar i si ng f r om” l anguage.

The ambi gui t y i n § 510( b) per mi t s compet i ng nar r ow and broad

i nt er pr et at i ons. A nar r ow r eadi ng woul d r equi r e t hat t he i nj ur y

f l ow f r om t he act ual pur chase or sal e. A br oad r eadi ng woul d

r equi r e t hat t he pur chase or sal e be par t of a causal l i nk even

t hough t he i nj ur y may f l ow f r om a subsequent event . Fai rar gument s suppor t each vi ew. An i nf l uent i al case adopt i ng t he

br oad vi ew i s I n r e Gr ani t e Par t ner s, L. P. , 208 B. R. 332, 339



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( Bankr. S. D. N. Y. 1997) .

The Ni nth Ci r cui t f avors t he broad vi ew and has expr essed

i t s appr oval of t he Gr ani t e Par t ner s anal ysi s. Bet acom, 240 F. 3d

at 828, ci t i ng wi t h appr oval , Gr ani t e Par t ner s, 208 B. R. at 333.I t has concl uded t hat § 510' s l egi sl at i ve hi st or y does not r eveal

an i nt ent t o t i e mandat or y subor di nat i on excl usi vel y t o

secur i t i es f r aud cl ai ms. I d. at 829. Accor di ngl y, we appl y t he

br oad vi ew as t he l aw of t he ci r cui t .

We now t ur n t o t he l egi sl at i ve hi st or y.

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I n dr af t i ng § 510( b) , Congr ess r el i ed on an i nf l uent i al

ar t i cl e by J ohn J . Sl ai n and Homer Kr i pke: J ohn J . Sl ai n & Homer

Kr i pke, The I nt er f ace Bet ween Secur i t i es Regul at i on and

Bankr upt cy — Al l ocat i ng t he Ri sk of I l l egal Secur i t i es I ssuance

Bet ween Secur i t yhol der s and t he I ssuer ’ s Cr edi t or s, 48 N. Y. U. L.

REV. 261 ( 1973) ( “Sl ai n and Kr i pke”) . The House Commi t t ee Report

cont ai ns an extended di scussi on of Sl ai n and Kr i pke i n connect i onwi t h § 510( b) . H. R. Rep. No. 95- 595, 1st Sess. , at 194- 96

( 1977) , r epr i nt ed i n 1978 U. S. C. C. A. N. at 6154- 56 ( “House

Repor t ”) , ci t ed wi t h appr oval , Bet acom, 240 F. 3d at 829.

Conf r ont i ng t he hi st or i cal pr obl em of i nvest or s r ecover i ng

f r aud cl ai ms par i passu wi t h gener al cr edi t or s i n bankrupt cy

cases, Sl ai n and Kr i pke emphasi zed t he di ssi mi l ar expect at i ons of

i nvest or s and cr edi t or s. They r ecogni zed t hat bot h cr edi t or s and

i nvest or s “accept t he r i sk of ent er pr i se f ai l ur e. ” Sl ai n and

Kr i pke at 286. The t wo const i t uent r i sks, however , ar e based on

di f f er ent assumpt i ons. I n t he event of i nsol vency, t he credi t or

expect s hi gher pr i or i t y vi s- a- vi s t he i nvest or , but , unl i ke t he



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i nvest or , does not expect t o par t i ci pat e i n t he pr of i t s of t he

ent er pr i se. House Repor t at 194- 96; Bet acom, 240 B. R. at 830- 31.

The Ni nth Ci r cui t t akes t hese di ssi mi l ar expect at i ons i nto

account i n set t i ng a st andar d f or mandat or y subor di nat i on becausei t i s unf ai r t o shi f t al l of t he r i sk t o credi t or s who ext end

cr edi t i n r el i ance on t he cushi on of i nvest ment pr ovi ded by the

shar ehol ders. Betacom, 240 F. 3d at 829- 31.

Sect i on 510( b) was spawned by uncer t ai nt y under pr i or l aw

whet her cl ai ms r el at i ng t o secur i t i es t r ansact i ons shoul d enj oy

an equal f oot i ng wi t h t he cl ai ms of gener al unsecur ed cr edi t or s:

a “di f f i cul t pol i cy quest i on” i n busi ness bankrupt cy concer ns t he

r el at i ve st at us of a secur i t y hol der who seeks t o r esci nd a

pur chase of secur i t i es or t o sue f or damages based on such a

pur chase and want s t o be t r eated as a gener al unsecur ed credi t or .

House Repor t , at 195.

Embr aci ng t he Sl ai n and Kr i pke anal ysi s, Congr ess expl i ci t l y

r esol ved t he di l emma i n f avor of subor di nat i on when i t enact ed§ 510( b) . I t was per suaded t hat i t was appr opr i at e t o f ocus on

t he r i sk of i nsol vency as wel l as t he r i sk of unl awf ul i ssuance

of t he debt or ’ s secur i t i es. I d. at 196. The i nt ent was t o

subor di nat e t he di st r i but i on pr i or i t y of r esci ssi on cl ai ms t o al l

cl ai ms t hat ar e seni or t o t he cl ai m or i nt er est on whi ch t he

r esci ssi on cl ai ms ar e based. I d.

Al t hough Congr ess f ocused on r esci ssi on cl ai ms, i t enact ed

more compr ehensi ve l anguage. The Ni nt h Ci r cui t has descr i bed how

t he scope of § 510( b) has gradual l y expanded t o i ncl ude cl ai ms

based on cont r act l aw and ot her act i ons. Am. Wager i ng, I nc. , 493

F. 3d at 1072. Beyond t he r eal m of r esci ssi on and i nvest or f r aud



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cl ai ms, t her e i s j udi ci al consensus t hat t he phr ase “ar i si ng

f r om” i n § 510( b) shoul d be const r ued br oadl y t o encompass cl ai ms

ot her t han f r aud cl ai ms, such as cl ai ms f or br each of cont r act .

I d. ( col l ect i ng cases) ; Bet acom, 240 F. 3d at 828- 29. The broad i nter pret at i on of § 510(b) was cement ed i nto t he

l aw of t he Ni nt h Ci r cui t i n Bet acom. Ther e, shar ehol der s of t he

debt or , who were t o recei ve t hei r shar es t hr ough a merger

agr eement ent ered i nt o between the debt or and another ent i t y,

br ought a pr e- pet i t i on act i on agai nst t he debt or f or t he debt or ’ s

f ai l ur e t o del i ver t he st ock as r equi r ed by the mer ger agr eement .

Bet acom, 240 F. 3d at 826. The cour t hel d t he cl ai m shoul d be

subor di nat ed under § 510( b) . I d. at 832.

Cent r al t o the Bet acom cour t ’ s anal ysi s was a car ef ul

consi der at i on of t he r at i onal es i dent i f i ed i n t he l egi sl at i ve

hi st or y. The Ni nt h Ci r cui t expl ai ned t hat t her e ar e t wo mai n

r at i onal es f or mandat or y subor di nat i on: “( 1) t he di ssi mi l ar r i sk

and r et ur n expect at i ons of shar ehol der s and cr edi t or s; and ( 2)t he rel i ance of cr edi t or s on t he equi t y cushi on pr ovi ded by

shar ehol der i nvest ment . ” I d. at 830. As t o t he r el i ance

r at i onal e, t he cour t pr oposed, wi t hout deci di ng t he i ssue, t hat

cr edi t or s of a di st r essed ent er pr i se be pr esumed t o have r el i ed

upon each pr i or i nvest ment i n equi t y and j uni or debt , subj ect t o

r ebut t al t o t he ext ent t hat t he i nvest or can pr ove nonr el i ance.

I d. at 831 n. 3.

The Bet acom precedent di ct at es t hat we r ej ect t he

appel l ant s’ ar gument t hat , t o be subor di nat ed, t hei r cl ai m must

sound i n f r aud or some sor t of act i onabl e wr ongdoi ng. We cannot

i gnor e t he Ni nt h Ci r cui t ’ s r easoni ng i n Bet acom t hat not hi ng i n



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t he Sl ai n and Kr i pke anal ysi s suggest s t hat Congr ess’ s concer n

wi t h cr edi t or expect at i ons and equi t abl e r i sk al l ocat i on was

l i mi t ed t o cases of debt or f r aud. I d. at 829.

Li kewi se, i n Am. Wager i ng, t he Ni nt h Ci r cui t l ookedf avor abl y upon a l i nki ng t est r equi r i ng a nexus or causal

r el at i onshi p bet ween t he cl ai m and t he pur chase or sal e of t he

secur i t i es. Am. Wager i ng, 493 F. 3d at 1072. I n i t s vi ew, t hi s

t est showed t hat cour t s wer e concer ned wi t h cl ai ms t hat t r i ed t o

r echar act er i ze what woul d ot her wi se be subor di nat ed secur i t i es.

I d. Boot st r appi ng t o a hi gher st at us i n t he bankrupt cy

di st r i but i on scheme i s bl ocked by § 510( b) .

Appl yi ng t he two rat i onal es under l yi ng § 510( b) t o the f act s

pr esent ed her e, we concl ude t hat t he appel l ant s’ cl ai m i s subj ect

t o mandat or y subor di nat i on. O’ Donnel l was i n f act an equi t y

hol der bef ore she wi t hdr ew. Dur i ng her t enur e as a member of

Tr i st ar , she enj oyed t he pot ent i al f or prof i t based on t he val ue

of r eal est at e. I n f act , she enj oyed a consi der abl e r et ur n: shecont r i but ed $100, 000 i ni t i al l y and r ecei ved an ar bi t r at i on awar d

f or near l y $400, 000. The conf i r med ar bi t r at i on awar d i s di r ect l y

l i nked t o her owner shi p of a member shi p i nt er est i n t he debt or ;

i ndeed, i t i s not hi ng ot her t han her cashi ng out her equi t y (at a

val ue t hat t he debt or i nsi st s i s hi ghl y i nf l at ed) .

The second r at i onal e f or subor di nat i ng i nvest or cl ai ms i s

t he r el i ance of credi t or s on t he so- cal l ed “equi t y cushi on”

cr eat ed by an i nvest or ’ s cont r i but i on of capi t al . We pr esume

t hat credi t or s r el i ed on t hi s equi t y cushi on i n deci di ng t o

ext end cr edi t t o t he debt or . By wi t hdr awi ng as a member and

l i qui dat i ng her i nt er est , O’ Donnel l al t er ed t he Tr i st ar bal ance



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sheet by ext r act i ng or , mor e appr opr i at el y, at t empt i ng t o ext r act

her i ni t i al cont r i but i on. Thi s woul d ef f ecti vel y def l at e t he

equi t y cushi on t o whi ch t r ade cr edi t or s and t he l i ke woul d l ook

i n r ecover i ng t hei r cl ai ms f or f i xed debt . The cr edi t or s of Tr i st ar , by vi r t ue of t hei r st at us, wer e never t o enj oy t he

r et ur ns of i ncr eased val ue.

The appel l ant s have not at t empted t o r ebut t he presumpt i on

t hat credi t or s of Tr i st ar r el i ed on O’ Donnel l ’ s cont r i but i on as a

sour ce of r ecover y. As such, t he second r at i onal e i s al so

appl i cabl e. But even i f appel l ant s had ar gued t hat t her e was a

l ack of r el i ance, t he pr esence of mer el y one of t he dual

r at i onal es i s suf f i ci ent . Wal t zer v. Ni ssel son ( I n r e Mar ket XT

Hol di ngs Cor p. ) , 346 Fed. Appx. 744, 746 ( 2d Ci r . 2009) .

We hol d t hat § 510( b) i s suf f i ci ent l y br oad to encompass a

cl ai m t hat ar ose f r om t he wi t hdr awal of a member f r om an LLC,

whi ch wi t hdr awal t r i ggered a r epur chasi ng pr ocess whereby the

debt or - i ssuer was t o buy back t he i nt er est f r om t he i nvest or .I I

The appel l ant s, urgi ng t hat t he wi t hdr awal f r om t he LLC and

t he f i xi ng of t he cl ai m bef or e bankrupt cy shoul d pr event

mandat or y subor di nat i on, br and t hei r cl ai m as a “f i xed debt . ”

Thi s i s a f ami l i ar st r at egy f or equi t y hol der s ( cur r ent or

f or mer ) i n t he bankrupt cy ar ena. The appel l ant s asser t t hat

O’ Donnel l t r aded t he r i sks and r ewar ds of an equi t y hol der f or

t he r i sks and r ewar ds of a gener al cr edi t or .

To be sure, t he appel l ants ar e “cr edi t or s” who have “cl ai ms”

agai nst Tr i st ar . A “cr edi t or ” i ncl udes anyone who hol ds a

“cl ai m” agai nst t he debt or t hat ar ose bef or e t he or der f or



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r el i ef . 11 U. S. C. § 101( 10) ( A) .

The j udgment conf i r mi ng t he ar bi t r at i on awar d r equi r i ng t he

debt or t o pay t he f ai r market val ue of t he f ormer membershi p

i nt er est i s a “cl ai m. ” See 11 U. S. C. § 101( 5) . The pur pose of subor di nat i on, however , i s t o adj ust t he

pl ace i n l i ne of cer t ai n cl ai ms i n t he bankr upt cy di st r i but i on

scheme. Bankrupt cy pol i cy af f or ds a pr i or i t y t o gener al

credi t or s t hat i s super i or t o equi t y i nt er est s. As Pr of essor s

Sl ai n and Kr i pke expl ai ned i n t hei r semi nal ar t i cl e, appr opr i at e

al l ocat i ons of r i sk among gener al cr edi t or s and equi t y- t ype

credi t or s shoul d r ef l ect t he di ssi mi l ar r i sks regar di ng

ent er pr i se i nsol vency t hose cr edi t or s under t ake. Gr ani t e

Par t ner s, 208 B. R. at 336.

Whatever mi ght be sai d of a t r ansf or mat i on of equi t y i nt o

debt i n a t r ansact i on t hat i s ol d and col d and t hat has l ong been

t r eat ed as par t of t he ent er pr i se’ s debt st r uctur e, t hi s i s not

such a case. Rat her , t he buy- back t r ansact i on was a di sput edi ssue unt i l shor t l y bef or e t he chapt er 11 case was f i l ed and was,

doubt l ess, a mat er i al f act or i n t he need f or chapt er 11 r el i ef .

The di sput e over t he buy- back amount and t he chapter 11 f i l i ng

wer e suf f i ci ent l y pr oxi mat e i n t i me t o war r ant t he concl usi on

t hat t hi s i s an ef f or t by equi t y to capt ur e paper ( and ar guabl y

myt hi cal ) pr of i t s vi a a j udgment f or money damages.

Tr eat i ng an equi t y i nvest or on a par wi t h unsecur ed

credi t or s di sr egar ds t he pr i nci pl es under l yi ng t he absol ut e

pr i or i t y rul e i n a manner t hat under mi nes t hi s basi c bankrupt cy

concept . Gr ani t e Par t ner s, 208 B. R. at 344; 11 U. S. C.

§ 1129( b) ( 2) ( B) ( i i ) .



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The appel l ant s’ ar gument t hat t hey ext r i cat ed t hemsel ves

f r om t he equi t y posi t i on bef or e t he bankrupt cy f i l i ng does not

necessar i l y mi l i t at e agai nst t he appl i cat i on of mandat or y

subor di nat i on. The Bankrupt cy Code def i ni t i on of “secur i t y”extends f ar beyond hol der s of st ock. 11 U. S. C. § 101( 49) ( A) .

The t ext of § 510(b) does not r equi r e t hat a subor di nat ed

cl ai mant be a sharehol der . Betacom, 240 F. 3d at 829. What

mat t er s i s t he t ype of cl ai m, not t he t ype of cl ai mant . I d.

I n shor t , t he cl ai m i s so f i r ml y r oot ed i n O’ Donnel l ’ s

equi t y st at us t hat subor di nat i on i s mandat or y.

I I I

Fi nal l y, we r ej ect t he ar gument s t hat t he appel l ee i s bar r ed

by pr i nci pl es of j udi ci al est oppel f r om asser t i ng t hat t he cl ai m

i s f or § 510( b) “damages” and t hat Tr i st ar f i l ed f or bankrupt cy

as a bad f ai t h col l at er al at t ack on t he ar bi t r at i on awar d.

A

The appel l ant s posi t t hat Tr i st ar ’ s st at ement i n t hear bi t r at i on t hat i t “st i l l owes O’ Donnel l money t o compl et e t he

l i qui dat i on of her member shi p i nt er est ” shoul d now est op Tr i st ar

f r om asser t i ng t hat t he cl ai m i s f or § 510( b) “damages. ”

Thi s i s an asser t i on of t he f or m of t he equi t abl e doct r i ne

of j udi ci al est oppel known as t he est oppel of i nconsi st ent

posi t i ons, whi ch pr event s one f r om gai ni ng advant age by t aki ng

one posi t i on and l at er seeki ng t o r eap anot her advant age f r om an

i nconsi st ent posi t i on. New Hampshi r e v. Mai ne, 532 U. S. 742,

749- 51 ( 2001) ; Uni t ed St at es v. I br ahi m, 522 F. 3d 1003, 1009 ( 9t h

Ci r . 2008) ; Hami l t on v. St at e Far m Fi r e & Cas. Co. , 270 F. 3d 778,

782- 85 ( 9t h Ci r . 2001) ; Al ar y Cor p. v. Si ms ( I n r e Associ at ed



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Vi nt age Gr p. , I nc. ) , 283 B. R. 549, 565- 67 ( 9t h Ci r . BAP 2002) .

Whi l e t her e ar e not i nf l exi bl e pr er equi si t es f or j udi ci al

est oppel , t he Supr eme Cour t has emphasi zed t he i mpor t ance of a

“cl ear l y i nconsi st ent ” posi t i on, coupl ed wi t h accept ance of t hef i r st posi t i on i n ci r cumst ances t hat woul d cr eat e t he per cept i on

t hat one of t he t r i bunal s was mi sl ed, pl us some f or m of unf ai r

advant age or det r i ment . New Hampshi r e v. Mai ne, 532 U. S. at 750-

51; Al ar y Cor p. , 283 B. R. at 566.

The appel l ant s cl ai m t hat Tr i st ar i s “pl ayi ng f ast and l oose

wi t h t he cour t s” by admi t t i ng a debt obl i gat i on i n one i nst ance,

and l at er ar gui ng t hat t he obl i gat i on i s one f or “damages. ”

Ther e ar e t wo f l aws i n t hi s ar gument .

The f i r st f l aw i s t hat t her e i s no mat er i al i nconsi st ency

between t he concessi on t hat somethi ng r emai ns t o be pai d t o

compl et e t he l i qui dat i on of t he member shi p i nt er est and t he

asser t i on t hat what ever sum i s owed t o l i qui dat e t hat i nt er est

const i t ut es § 510( b) “damages. ” Thi s amount s t o mi ssi ng t hef or est f or t he t r ees; her e, “damages” r ef er s t o a f or est , not a

si ngl e t r ee.

Second, and i ndependent l y f at al , i s t he absence of any

advant age t hat was gai ned by Tr i st ar i n t he ear l i er ar bi t r at i on

on account of t he put at i vel y i nconsi st ent s t at ement . New

Hampshi r e v. Mai ne, 532 U. S. at 750- 51.

We percei ve no mater i al i nconsi st ency between an admi ss i on

t hat a debt i s owed and cl ai mi ng t hat t he debt owed i s one f or

§ 510( b) “damages. ” Nothi ng suggest s t hat t he appel l ee gai ned

any advant age by t he f i r st st atement . Nor do we percei ve an

unf ai r advant age or unf ai r det r i ment . Hence, we r ej ect t he



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appel l ant s’ ar gument based on j udi ci al est oppel .

B

We al so r ej ect t he appel l ant s’ cl ai m - - f i r st r ai sed i n t he

r epl y br i ef - - t hat t he appel l ee f i l ed i t s chapt er 11 case wi t ht he sol e i nt ent of avoi di ng payi ng t he remai nder of t he val ue of

O’ Donnel l ’ s membershi p i nt erest . Debt ors have numerous mot i ves

f or f i l i ng a bankrupt cy case. The goal of t he f eder al bankrupt cy

l aws i s t he adj ust ment of t he debt or - credi t or r el at i onshi p. The

r esul t i ng adj ust ment - - i n t hi s case subor di nat i on - - may not be

wel comed by t he appel l ant s. But i t i s cer t ai nl y per mi t t ed.

Nor i s chapt er 11 an i mper mi ssi bl e col l at er al at t ack on t he

val i di t y of a st at e cour t j udgment . The amount t hat i s owed i s

not quest i oned. The i ssue i s pr i or i t y and t er ms of payment .

Hence, t her e i s no genui ne i ssue of mat er i al f act t hat t her e

was an arbi t r at i on award, conf i r med by j udgment , f or t hat amount .

CONCLUSI ON

The bankrupt cy cour t cor r ect l y grant ed summar y j udgment i nf avor of t he appel l ee on i t s § 510( b) cl ai m. Ther e i s no genui ne

i ssue of mat er i al f act and t he appel l ee i s ent i t l ed t o j udgment

as a mat t er of l aw. The appel l ant s’ r i ght t o payment , based on a

conf i r med ar bi t r at i on awar d val ui ng t he member shi p i nt er est i n

t he LLC, const i t ut es a cl ai m f or damages ar i si ng f r om t he sal e of

t he appel l ee’ s secur i t i es t hat i s subj ect t o mandat or y

subor di nat i on by vi r t ue of § 510( b) . We AFFI RM.

In re: TRISTAR ESPERANZA PROPERTIES, LLC, a California Limited Liability Company, 9th Cir. BAP...

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Transcript of In re: TRISTAR ESPERANZA PROPERTIES, LLC, a California Limited Liability Company, 9th Cir. BAP...