More recently in in re Telegroup, however, the Third Circuit declined to adopt such a
restrictive interpretation of § 510(b). In Te/egroup, the court considered a claim seeking damages
related to Telegroup’s breach of an agreement to use its best efforts to ensure that the claimants’
stock was registered and freely tradeable. 281 F.3d at 135. The court found nothing in the
rationale behind § 51 0(b) that prevented its application to post-investment conduct. /d, According
to the court, the timing of the conduct is not as important as “the fact that the claims in this case
seek to recover a portion of claimants’ equity investment.” /d. at 142. The court explained that
“{b]ecause claimants retained the right to participate in corporate profits if Telegroup succeeded,
we believe that § 510(b) prevents them from using their breach of contract claim to recover the
value of their equity investment in parity with general unsecured creditors.” /d. The court also
obsenled that “[w]ere we to rule in claimants’ favor in this case, we would allow stockholders in
claimants’ position to retain their stock and share in the corporation’s profits if the corporation
succeeds, and to recover a portion of their investment in parity with creditors if the corporation
fails.” Id. Compare In re Mobile Tool Int'l, inc., __B.R. __, 2004 WL 415910, at *3 (Bankr. D. Del.
Mar. 4, 2004) (finding In re Montgomery Ward Holding consistent with /n re Telegroup to the extent
that “the nexus or causal connection required to employ section 510(b) exists where stock is
retained by the claimant” and not “[w]hen the stock is exchanged and a separate debt instrument
is issued by the debtor’).

Based on the legislative history and case law relating to § 510(b), the court concludes that
some causal link must exist between the purchase or sale and the claim at issue, but that the
causal link need. not arise contemporaneously with the purchase or sale of a security. in re

Telegroup, 281 F.3d at 144 n.2.

19


510(b) must begin with the 1973 law review article authored by Professors John J. Slain and Homer
Kripke”).

As the Third Circuit noted, Slain and Kripke understood the issue as “one of risk allocation”
and opined that “claims of shareholders alleging fraud or other illegality in the issuance of stock
should generally be subordinated to the claims of general unsecured creditors.” in re Telegroup,
281 F.3d at 139. In drawing this conclusion, the professors distinguished between two types of risk
accepted by investors and creditors: “(1) the risk of the debtor's insolvency and (2) the risk of
illegality in the issuance of the debtor's securities.” in re Granite Partners, 208 B.R. at 336 (citing
Slain and Kripke, at 286). Slain and Kripke explained in their article that investors and creditors
both accept the risk of insolvency, though that risk is different between the two. /d. In contrast,
investors alone bear the risk of illegality in the issuance of securities. 7

Creditors expect nothing more from the business than the repayment of a fixed debt,
regardless of whether the business prospers. Creditors also rely on the investment made by
stockholders to serve as an equity cushion for the repayment of their claims. /d. Investors, on the
other hand, share in the profits ‘of the business, a benefit not afforded to creditors. According to
Slain and Kripke, shareholders bear an enhanced risk of insolvency because of this unique right:
“the allocation of the risk, as between the investor and the creditor, is reflected in the absolute
priority rule, and should not be reallocated.” /d. (citing Slain and Kripke, at 286-87.) The “absolute
priority rule,” codified in 11 U.S.C. § 1129(b)(2)(B)(ii), assures that “stockholders seeking to recover
their investments cannot be paid before provable creditor claims have been satisfied in full.” Slain

and Kripke, at 261. See also Wilkow, 241 F.3d at 554 (under “absolute priority rule,” “unsecured
creditors must be paid off before equity holders retain an interest’).

" atthe heart of the Slain and Kripke proposal was a policy decision “to prevent disappointed
shareholders from recovering the value of their investment by filing bankruptcy claims predicated

on the issuer's unlawful conduct at the time of issuance, when the shareholders assumed the risk

13


Weissmann left Pre-Press the day he executed the Repurchase Agreement and became an
employee of Schawk. Pre-Press, in turn, named three additional company directors. (/d. at 3, 11.)
On December 31, 1998, Pre-Press paid the first $25,000 of the $100,000 down payment.
The company failed, however, to pay the remaining $75,000 due on January 31, 1999. (/d. at 5.)
Pre-Press did make substantial efforts to obtain financing for the Repurchase Agreement, but was
unable to do so. (/d. at 3-4.) In or about July 1999, Schawk sent another letter of intent to Pre-
Press, this time offering to purchase the company’s assets related to the pre-press business for
$6,500,000 on a debt-free basis. (/d. at 4.) If Pre-Press had accepted the terms of the offer, it
would have retained its commercial printing business, which made up 40 percent of its total
revenue. (/d.) As with the earlier offer, the shareholders rejected the July 1999 letter of intent.
(/d.)
In February 2000, Pre-Press was in need of capital and, as a result, authorized the issuance
of additional shares of stock to certain shareholders. Beevers purchased an additional 6,500
shares at $106.14 per share, increasing his percentage ownership of Pre-Press from 37.9 percent
to 87 percent. (/d.) Pre-Press did not give Weissmann the opportunity to purchase more shares
and, in fact, deliberately hid from Weissmann the fact that it was issuing additional stock. (/d.) As
a result, Weissmann’s ownership interest was reduced from 37.9 percent to 6.29 percent. (/d.)
Shortly thereafter, Weissmann made a demand to inspect certain corporate records. His request
‘was denied. (id.)
Notwithstanding the Repurchase Agreement, which released Weissmann from his covenant
not to compete and assured that he would be re-elected as a director of Pre-Press through 2000,
Weissmann was asked to resign as a director in July 2000 because of his conflicting employment
with Schawk. (Id.) The company called a shareholder's meeting for the express purpose of
removing Weissmann as a director, but he resigned his position in August 2000 before the
shareholders effected the removal themselves. (/d.)

4


IV, Application to Weissmann’s Claim

No court has yet addressed whether aclaim like Weissmann’s for shareholder oppression
and breach of fiduciary duty falls within the scope of § 510(b). Thus, not only is the proper scope
of § 510(b) one of first impression in this circuit, but the court is also writing on a completely blank
slate in résolving this matter. Appellees argue that Weissmann’s claim for shareholder oppression

~ meets the catisal nexus under § 510(b) because: (1) it arises from the failed Repurchase

Agreement; and (2) it results from the issuance of additional stock to dilute Weissmann’s ownership
interest in pre-prees. (MAN Br., at 8; Appellate Brief of Appellee, Pre-Press Graphics Company,
Inc., at 10.)

The court disagrees that Weissmann’s claim of stockholder oppression arises from the
failed Repurchase Agreement His only successful cause of action under that agreement was a
claim for $75,000 still due as part of Pre-Press’ promised down payment on Weissmann’s shares.
(Illinois Judgment, at 7.) Otherwise, the court found that Pre-Press did not breach the terms of the
Repurchase Agreement because it had complied with the “best efforts” clause in attempting to
obtain financing for the buy-out. Accordingly, the majority of Weissmann’s $1.3 million claim
cannot fairly be characterized as arising from the Repurchase Agreement.

The better theory is that Weissmann’s claim arises from Pre-Press’ oppressive conduct; i.e.,
(1) the secret issuance of stock to third parties for a greatly reduced price, which diluted
Weissmann’s ownership interest from 37.9 percent to just over 6 percent, and (2) the removal of
Weissmann as a director. As noted, in passing § 510(b), Congress adopted the reasoning set forth
by Slain and Kripke, who pointed out that the purpose of subordinating certain claims is to prevent
stockholders from reaping the benefits of the company when it performs well but then asserting

claims for fraud and enjoying unsecured creditor status when the company performs poorly. In

proposing what later became § 510(b), the authors sought to prevent a disaffected shareholder

20


likely that it will be able to pay creditors and distribute profits to investors. . . Yet under the absolute
priority rule, the creditors stand ahead of the investors on the receiving line”). Here, Pre-Press!
misconduct reslilted in Weissmann receiving a smaller percentage of profits from his 500 shares,
and those shares became worth less money. Atall times, however, Weissmann continued to enjoy
the benefit of sharing in the company’s success — and bore the risk of the company’s failure.
Weissmann disputes this, claiming that such right was extinguished “once the company agreed to
redeem the shares at a certain price.” (Reply Brief of Appellant Brian Weissmann, at 12.) But if
the court looks at the remedy ordered by the state court — repurchase of Weissmann’s stock at fair
value — there can be no doubt that his claim arises from the purchase or sale of securities.

As noted, it was not the intent of Congress to subordinate all claims raised by a stockholder.
Inre Telegroup, 281 F.3d at 144 n.2. For example, a shareholder's personal injury action against
the debtor would not be subject to § 510(b) merely because the individual owns stock in the
company. Weissmann’s oppression claim, however, arises from the purchase or sale of securities
and is properly subordinated under the statute. The court recognizes that Debtor's misconduct has
resulted in significant harm to Weissmann and that he likely will never recover under the state court
judgment. The court nevertheless concludes his claim is subject to mandatory subordination under
§ 510(b).

CONCLUSION

For the reasons stated above, the bankruptcy court’s order subordinating Weissmann’s

claim under § 510(b) of the Bankruptcy Code is affirmed.
ENTER:

Dated: nar 23, 25d4 Rheset AP edo
EBECCA R. PAL ER/

United States DistrictJudge.

22


The Tenth Circuit agreed that the claimant's post-investment claims were properly
subordinated in light of the “strong congressional disapproval of investor fraud claims in
bankruptcy.” 281 F.3d at 1179. The court reasoned:

[The claimant's] claim, at its essence, accuses Geneva of manipulating information

concerning his investment. He acquired and held that investment with the belief

that its value would increase, though he no doubt recognized that for any number

of reasons it might not; indeed, he recognized that it might even lose value. In

contrast, a mere creditor of [the debtor] could expect nothing more than to recoup

the value of goods or services supplied to the company. Yet now, having watched

his investment gamble turn sour, [the claimant] would shift his losses to those same

creditors. We think this effort clashes with the legislative policies that section

510(b) purports to advance.
fd. at 1180. In reaching this conclusion, the Tenth Circuit declined to follow the reasoning in
Amarex, finding that the court's “constricted interpretation of section 510(b) flows from a mistaken

\
reading of the statutory text, a reading that erroneously substituted the more restrictive term
‘issuance’ for the actual term ‘purchase.” /d. at 1182.

For similar reasons, the court does not find /n re Angeles Corp., 177 B:R. 920 (Bankr. C.D.
Cal. 1995) persuasive. In in re Angeles, a number of limited partners filed a claim against the
debtor alleging acts of mismanagement, fraud, breach of fiduciary duty, and other wrongful conduct
in relation to the debtor's management of the partnerships. /d. at 922. Relying on in re Amarex,
the court held that the limited partners’ claims alleging mismanagement, breach of fiduciary duty,
and fraud were not subject to mandatory subordination under § 510(b) because they resulted from
conduct that took place after the purchase of the securities. /d, at 926-27.

As noted, /n re Amaréx is no longer good law in the Tenth Circuit. More importantly, a
recent Ninth Circuit decision appears to support a broader interpretation of § 510(b) than the one
espoused in /n re Angeles. The claimant in /n re Betacom of Phoenix, Inc.,.240 F.3d 823 (9th Cir.
2001) filed proofs of claim against the debtors for, among other things, breach of a merger
agreement and fraud. /d. at 826. The claimants asserted that their claim should not be subject to

mandatory subordination under § 510(b) because: (1) “§ 510(b) only applies to securities fraud

17


definition”). It also could result in similar claimants receiving different treatment based on the relief
granted by the state court.

in considering other portions of the Bankruptcy Code, the United States Supreme Court has
determined that it is permissible for a court to examine the underlying claims creating the claimant's
right to payment. in Brown v. Felsen, 442 U.S. 127 (1979), for example, Brown sued Felsen in
state court to recover money that Felsen had allegedly obtained by fraud. /d. at 128. The parties
settled the case by a stipulation that stated Felsen would pay Brown a certain amount.of money,
but did not indicate whether the payment was related to Felsen’s alleged fraud. /d. Felsen failed
to make payments in accordance with the stipulation and ultimately filed for bankruptcy, seeking
a discharge of his debt to Brown. /d. Brown asked the bankruptcy court to find the debt
nondisthargeable as a debt for money obtained by fraud. /d. at 129; 11 U.S.C. § 523(a)(2)(A) (a
debt is not dischargeable in bankruptcy “to the extent” it is “for money obtained by . . . false
pretenses, a false representation, or actual fraud”), The bankruptcy court refused, finding instead
that the debt was related to money owed pursuant to a stipulation, and the district court and the
Tenth Circuit affirmed. /d. at 130-31. The Supreme Court reversed, however, holding that the
lower courts should have looked beyond the stipulation to determine whether the debt arose from
fraud. /d. at 138-39. ,

More recently, in Archer v. Warner, 538 U.S. 314 (2003), Arlene and Leonard Warner sold
a manufacturing company to Elliott and Carol Archer for $610,000. Six months later, the Archers
sued the Warners for fraud and other claims in connection with the sale. /d. As part of a
subsequent settlement agreement, the Archers released substantially all their claims against the
Warners in exchange for $300,000. The Warners paid $200,000 immediately and executed a
promissory note for the remaining $100,000. /d. When the Warners failed to make the first
payment on the promissory note, the Archers sued for payment in state court. /d. at 317-18.
Before the matter was heard, the Warners filed for bankruptcy and the bankruptcy court ordered

9


On May 16, 2002, Weissmann filed a proof of claim against the Debtor's estate in the
amount of $1,365,000.‘ (Proof of Claim, Ex. to Appellant Br.) On September 30, 2002, Pre-Press
filed its proposed plan of reorganization, placing Weissmann’s claim in a class that is subordinate
to the claims of unsecured creditors. (Plan of Reorganization, Ex. J to Appellant Br.) Consistent
with that proposed plan; on October 15, 2002, the Debtor and its largest creditor, MAN Capital
Corporation (“MAN Capital’), filed objections to Weissmann’s claim on the grounds that it arises
from the sale of securities and, thus, must be subordinated under § 510(b) of the Bankruptcy Code.

The bankruptcy court considered the objections and, in an oral ruling on December 17,
2002, found in favor of Debtor and MAN Capital. The court determined that Weissmann’s “theory
and causes of action were merged in the state court judgment.” (T1 ranscript of Bankruptcy Court
Procebdings in the Pre-Press Bankruptcy Case, (“Bankruptcy Decision”), Exhibit E to Appellant Br.,
at 51.) Weissmann’s “claim” under the Bankruptcy Code, the court held, consists of what he
received from the Illinois judgment — i.e., the forced repurchase of his shares. In the bankruptcy
court's view, such aclaim is “inextricably intertwined with [Weissmann’s] shareholder status” and,
thus, fits within § 510(b) and must be subordinated to the claims of unsecured creditors. (Id, at 51-
52.)

DISCUSSION ,
I. Standard of Review and Jurisdiction

This court has subject matter jurisdiction over Weissmann’s appeal from the bankruptcy
court pursuant to 28 U.S.C. § 158(a)(1), which vests the district court with jurisdiction over appeals
from “final judgments, orders and decrees” issued by the bankruptcy court. The district court

functions as an appellate court when reviewing bankruptcy court decisions. Bielecki v. Nettleton,

4 It is not clear how Weissmann arrived at the $1,365,000 figure. Notably, throughout
his appellate brief, Weissmann refers to his claim as amounting to $1.3 million.

6


On September 6, 2000, Weissmann filed a lawsuit in the Circuit Court of Cook County
alleging minority shareholder oppression, breach of fiduciary duty by certain directors and
shareholders, and breach of the Repurchase Agreement. (/d. at 5.) The court determined that
Pre-Press committed both shareholder oppression and breach of fiduciary duty — claims the court
found “inextricably intertwined” — by the following acts: (1) demanding in July 1999 that Weissmann
resign as a ditector; (2) conducting secret capital transactions in 2000 which resulted in the
reduction of Weissmanh’s ownership interest; and (3) deciding to accept a share valuation of
$106.14 per share despite receiving offers ranging from $2,000 to more than $9,000 as a per share
price. (/d. at7, 12, 15-16.) The Circuit Court found that Pre-Press did not breach the “best efforts” *
clause of the Repurchase Agreement by failing to obtain financing, but it did breach that agreement
by failing to pay Weissmann the $75,000 “additional down payment” it owed him. (id. at 7.)

As a remedy for the shareholder oppression and breach of fiduciary duty, the court ordered
Pre-Press to repurchase Weissmann’s 500 shares at “fair value,” which the court determined was
$4 383,350, The court subtracted from that amount the $25,000 partial down payment Weissmann
had already received from the company and, if paid, the additional $75,000 down payment awarded
for Pre-Press’ breach of the Repurchase Agreement. (/d. at 19-24.) The court also awarded
Weissmann $10,000 for Pre-Press’ refusal to allow Weissmann to examine the corporate records
in violation of the Illinois Business Corporation Act, 805 ILCS 5/7.75. (id. at 24.)

The Circuit Court entered this judgment on February 1, 2002. (/d.) Although Pre-Press had
the opportunity to appeal the decision within thirty days, it opted not to do so. Instead, on March 4,
2002, Pre-Press filed a voluntary Chapter 11 bankruptcy case in the Northern District of Illinois.
(Voluntary Petition, Ex. B to Appellant Br.) Any opportunity for Pre-Press to appeal the state court

judgment has now passed and the judgment is final.


claims’; (2) the'claimants “never enjoyed the ‘rights and privileges’ of stock ownership”; and (3) “the
Merger Agreement never closed, and, therefore, there was not.an actual sale or purchase of
securities that vould trigger mandatory subordination.” /d. at 828. The Ninth Circuit rejected all of
these arguments and found that the claim was properly subordinated under § 510(b):

The district court’s interpretation of § 510(b) to require an actual stock purchase

might be valid in some situations, but not in a situation like the one faced by the

[debtors'] creditors who relied on the [claimants’] contribution when they-decided to
extend credit.

Id. at 831. Thé court was not moved by the fact that the claimants never took possession of the
stock, noting that the claimants were “experienced businesspeople who traded their equity in
Betacom for a chance at greater earnings with ABS after its initial public offering,” and they
understood that they “faced the risk that ABS's IPO could fail and that ABS might go bankrupt.”
Id. at 830. In reaching this decision, the court did not expressly address In re Angeles, but it is
clear that the Ninth Circuit interprets § 510(b) in a broader manner than the lower court.

‘That leaves In re Montgomery Ward Holding Corp., 272 B.R. 836 (Bankr. D. Del. 2001),
Weissmann’s final case, in which the court considered whether “a claim based solely on the
nonpayment of a promissory note issued by a debtor to consummate .the repurchase of its own
stock is one for damages ‘arising from’ the purchase or sale of its securities.” /d. at 841. The court
found that this type of claim is not properly subordinated under § 510(b) because it does not
directly concern the stock transaction itself... /d. at 842. The claimant was not “an equity holder
trying to better his position by undoing the purchase transaction witha rescission or damage claim.”
Id. at 843. Nor was there any allegation that the shares of stock were issued illegally. Rather, the
claimant sought to enforce a debt based on the debtor's repurchase of its stock. /d. The court held
that “absent an allegation of fraud in the purchase, sale or issuance of the debt instrument, §
510(b) does not apply to a claim seeking simple recovery of an unpaid debt due upon a promissory

note.” /d. at 844.

18


“absolute priority tule,” “unsecured creditors must be paid off before equity holders retain an
interest’). Ifit does not, the claim will be treated as one belonging to an unsecured creditor. See,
eg., Inre Jolie} Wil County Community Action Agency, 847 F.2d 430, 434 (7th Cir. 1988) (tort
claimants are treated as unsecured creditors in bankruptcy). Thus, the classification of
Weissmann’s claim will have a significant impact on his potential distribution in Debtor's bankruptcy
, proceedings. |

il. Weissmann’s Bankruptcy Claim

Before addressing whether Weissmann’s claim arises from the purchase or sale of
securities, the court considers the proper characterization of that,claim. Appellees argue that
Weissmann’s claim is the right to payment of the judgment he submitted to the bankruptcy court;
ie., the state court order requiring Pre-Press to purchase Weissmann’s 500 shares for
approximately $1.3 million. Appellees insist that it is this.“claim” which must be evaluated under
§ 510(b). Weissmann, on the other hand, argues that the court must define his claim by looking
at the substantive claims he raised in state court (stockholder oppression and breach of fiduciary
duty). . In the court’s view, Weissmann’s is the better-reasoned approach.

Under § 101(A)(5) of the Bankruptcy Code, “claim” is defined as a “right to payment,
whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent,
matured, unmatured, disputed, undisputed, legal, equitable, secured, orunsecured....” 11
U.S.C. § 101(A)(5)._ In arguing {that Weissmann’s “claim” is for the forced repurchase of his Pre-
Press shares, Appellees assert that this court is bound by the relief granted by the state court and
cannot examine the underlying substantive claims. This interpretation, however, conflicts with the
broad definition above, which indicates that a claim exists prior to judgment. See F.C.C. v.
NextWave Personal Communications Inc., 537 U.S. 293, 302 (2003) (quoting Johnson v. Home

State Bank, 501 U.S. 78, 83 (1991)) (“[wle have said that ‘claim’ has ‘the broadest available



‘Minute Order Form (06/97) ,

4 l United States District Court, Northern District of Iinois
‘Name of Assigned Judge Sitting Judge if Other
or Magistrate Judge "| | Reb allmeyer than Assigned Judge .
“W 7
CASE NUMBER |} ; 03 C21(03,C 264 DATE 3/23/2004
CASE . Weissman vs. Pre-Press Graphics
TITLE
[in the fotlowing box (a) indicate the party filing the motion, ¢.g,, plaintiff, defendant, 3rd party plaintiff, and (b) state briefly the nature
MOTION: of the motion being presented, ]
DOCKET ENTRY: i
qd) o Filed motion of { use listing in “Motion” box above.]
(2) o Brief in support of motion due
(3) o Answer brief to motion due. . Reply to answer brief due.
(4) im) Ruling/Hearing on set for at
(5) a Status hearing[held/continued to] [set for/re-set for] on set for at
(6) i) Pretrial conference[held/continued to] [set for/re-set for] on set for at .
(7) a Trial[set for/re-set for] on at
(8) o [Bench/Jury trial] [Hearing] held/continued to at
(9) Oo This case is dismissed [with/without] prejudice and without costs[by/agreement/pursuant to]

COFRCP4(m) Ci Local Rule 41.1 CFRCP41(a)(1)  FRCP41(a)(2).

ao Wf (Other docket entry} Enter Memorandum Opinion and Order. For the reasons stated therein, the
December 17, 2002 order of the bankruptcy court is affirmed.

dad ff [For further detail see order'attached to the original minute order.]

No notices required, advised in open court.

bo

No notices required.

W | Notices mailed by judge’s staff.

Notified counsel by telephone.

Docketing to mail notices.

v Mail AO 450 form.

Copy to judge/magistrate judge.

date mailed notice

courtroom = }
ETV deputy’s EV
initials

Date/time received in ; 7
! central Clerk’s Office roaling deputy initials



conduct by the Debtor. Under such a construction, § 510(b) does not subordinate Weissmann's
tort claims for shareholder oppression and breach of fiduciary duty because they arose ten years
after his purchase of stock in Pre-Press. Appeliees press for a broader reading of the statute.
They recognize that the phrase “arises from” requires “some causal relationship between a
purchase or sale and the claim,” but they argue that § 510(b) does not contemplate “an immediate,
contemporaneous connection” with the purchase or sale of stock. (Brief of Appellee MAN Capital
Corporation (hereinafter “MAN Br.”), at 8) (emphasis in original).

A. Statutory Language

In assessing these arguments, the court starts with the text of the statute itself. Robinson
v. Shell Oil Co., 519 U.S. 337, 340 (1997). Where a statute is unambiguous, the court “must
enfored the plain meaning of the language enacted by Congress.” Matter of Voelker, 42 F.3d 1050,
1051 (7th Cir. 1994) (quoting Family & Children's Ctr., Inc. 'v. School City of Mishawaka, 13 F.3d
1052, 1060 (7th Cir. 1994)). The court “will look beyond the express language of a statute only
where that statutory language is ambiguous or where a literal interpretation would lead to an absurd
result or thwart the purpose of the overall statutory scheme.” United States v. One Parcel of Real
Estate Commonly Known as 916 Douglas Ave., 903 F.2d 490, 492 (7th Cir. 1990).

In this court’s view, the plain wording of the statute is not instructive regarding the scope
of § 510(b) because the phrase “arising from the purchase or sale” is reasonably susceptible to
more than one interpretation. As the Tenth Circuit recently explained, “[a] literal reading implies
that the injury must flow from the actual purchase or sale [of securities]; a broader reading
suggests that the purchase or sale must be part of the causal link although the injury may flow from
a subsequent event.” /n re Geneva Steel, 281 F.3d at 1178-79 (quoting /n re Granite Partners,
LP., 208 B.R. 332, 339 (Bankr. S.D.N.Y. 1997)). See also in re Telegroup, Inc., 281 F.3d 133, 138

(3d Cir. 2002) (recognizing two possible interpretations of the phrase “arising from”). Indeed,

11


liquidation under Chapter 7.of the Bankruptcy Code. /d. at 318. The Archers timely filed a claim
before the bankrupt court asking the court to find that the $100,000 debt the Warners owed them
was nondischatgeable as “money . . . obtained by. .. fraud.” /d.; 11 U.S.C. § 523(a)(2)(A). The
lower courts found that the $100,000 debt was dischargeable because the settlement agreement
had worked a «hovation.” Id. Specifically, the new debt arising from the settlement agreement had
replaced the prior potential debt the Warners owed the Archers, and only that prior debt had been
based on fraud, Id. The'Supreme Court reversed, holding that even if the settlement had “worked
a kind of novation,” that did not bar the Archers from showing that the settlement debt “arose out
of ‘false pretenses, afalse representation, or actual fraud” such thatitwas nondischargeable under ‘
§ 523(a)(2)(A).: fd, at 322-23.

In both of these cases, the Supreme Court found that in determining whether a debt is for
money obtained by fraud, courts may look beyond the terms of a settlement agreement or consent
decree and examine the underlying substantive claims. Here, the court is confronted with a similar
question: whether Weissmann’s substantive claims of oppression and breach of fiduciary duty
were replaced by the state court judgment ordering the forced repurchase of Weissmann’s stock.
Given the broad definition of “claim” and the Supreme Court's willingness to look to the substance
of claims in assessing whether they are nondischargeable in bankruptcy due to fraud, the. court
finds that for purposes of § 510(b), Weissmann’s “claim” should be determined according to the
substance of his state court claims and not limited to the type of relief granted by the state court.
Wl. The Scope of § 510(b)

The next question is whether Weissmann’s shareholder oppression and breach of fiduciary
duty claims are claims “for damages arising from the purchase or sale” of securities of the Debtor.

11 U.S.C. § 510(b). Weissmann argues that the court should construe § 510(b) narrowly and find

that it applies only to claims that arise from a stock transaction, and not to any post-investment

10


183 BR. 143, 145 (N.D. Ill. 1995) (citing Feb. R. BANKR. P. 8013). Ina bankruptcy appeal, the
court examines the “bankruptcy court’s factual findings for clear error and its legal conclusions de
novo.” Meyer l, Rigdon, 36 F.3d 1375, 1378. (7th Cir. 1994). The parties in this case raise
exclusively questions of law, which the court will review de novo.

|

This cage presents an issue of first impression in the Seventh Circuit; namely, the proper
scope of § 510{b) ‘of the Bankruptcy Code. Section 510(b) states:

For the purpose of distribution under this title, a claim arising from rescission of a

purchase or sale of a security of'the debtor or of an affiliate of the debtor, for

damages arising from the purchase or sale of such a security, or for reimbursement

or contribution allowed under section 502 on account of such a claim, shall be

subordinated to all claims or interests that are senior to or equal the claim or interest

tepresented by such security, except that if such security is common stock, such

claim has the same priority as common stock.

11 U.S.C, § 510(b). Section 510(b) functions to subordinate three types of claims: “(1) an actual
attempt to rescind a purchase or sale of a security issued by the debtor or one of its affiliates; (2)
a claim for damages arising from a purchase or sale of a security; and (3) a claim for
reimbursement or contribution for a purchase or sale of such a security under section 502 of the
Code.” In re Geneva Steel Co., 281 F.3d 1173, 1177 (10th Cir. 2002).

The parties do not dispute that Weissmann owned securities (500 shares) of Debtor for
purposes of § 510(b), The parties agree, further, that Weissmann’s claims are not an attempt to
rescind the purchase of his securities, nor to obtain reimbursement or contribution related to his
purchase of stock. Instead, the core of the parties’ dispute is whether Weissmann's claim for
stockholder oppression “arises from” the purchase or.sale of Debtor's securities.© See In re
Geneva Steel, 281 F.3d at 1177-78. If it does, the claim will be treated as an equity interest that

does not get paid in the bankruptcy distribution until the claims of all unsecured creditors have been

paid in full. 11 U.S.C. § 510(b); Wilkow v. Forbes, Inc., 241 F.3d 552, 554 (7th Cir. 2001) (under

§ Weissmann acknowledges that his claim related to Debtor's breach of the
Repurchase Agreement arises from the purchase or sale of securities.

7


from recouping his or her investment ahead of unsecured creditors. In the court's view, that is
exactly what Weissmann is trying to do here.

When Weissmann and Robert Beevers founded Pre-Press in 1989, they each owned a 50
percent interest in the company. Weissmann later reduced his ownership interest to accommodate
additional shareholders, leaving him with a 37.9 percent ownership interest in 1998. Without
Weissmann’s knowledge or approval, Pre-Press diluted Weissmann’s ownership interest down to
just over 6 percent by secretly issuing additional stock at an unreasonably low price. The company
also removed Weissmann as a director. The court concludes that Weissmann must be viewed as
a disaffected shareholder who brought suit because the value of his. stock was diluted by the
improper issuance of thousands of additional shares at well below market value. Though he also
suffered a reduction in ownership which, in turn, significantly diminished his potential share of
future profits, he was at ail times a shareholder (owning 500 shares) with ownership benefits.
Those shares simply became less valuable due to Pre-Press’ misconduct. Nothing in the
legislative history of § 510(b) or the case law suggests that the rationale for subordinating
shareholder claims —i.e., that shareholders bear a greater risk of insolvency because they enjoy
the benefit of sharing in the profits - does not apply where shareholders own a relatively small
number or percentage of shares. See in re Telegroup, 281 F.3d at 142 (“because claimants
retained the right to participate in corporate profits if Telegroup succeeded, we believe that § 510(b)
prevents them from using their breach of contract claim to recover the value of their equity
investment in parity with general unsecured creditors”).

Moreover, in the fraud cases discussed earlier, the shareholders presumably suffered a loss
of profits in addition to a reduction in the value of their shares; a company that is not performing
well and has devalued stock is not likely to distribute dividends. See, e.g., In re Granite Partners,
208 B.R. at 332 (mismanagement, waste, and breach of fiduciary duty indirectly harm both
investors and creditors because “the wrongful conduct erodes the entity's assets, making it less

21


(/d.) At that point, Weissmann and Beevers each held 37.9 percent of the shares. The remaining
shares were divided among six additional shareholders.” (/d.) —

During 4997 and 1998; Pre-Press entered negotiations with Schawk Incorporated, a publicly
traded pre-press company, regarding a possible sale of Pre-Press to Schawk. (/d.) In October
1998, Schawk | rovided a letter of intent to purchase all of Pre-Press’ stock for $13 million on a
“debt-free basis” or, in the alternative, to purchase the stock of any tendering shareholder at a pro-
rated price. (id. at 3.) Weissmann was in favor of accepting the offer, but the remaining
shareholders rejected the proposal. (/d.) Weissmann then offered to sell his stock to Pre-Press
for $5.5 million but the shareholders rejected his offer as well. (/d.) Weissmann still wanted to sell
his stock to Schawk in accordance with the October 1998 letter of intent, but the Pre-Press
stockholders prevented the sale by exercising their right of first refusal.> (/d.)

On December 1, 1998, Pre-Press and Weissmann executed a stock repurchase agreement
(‘Repurchase Agreement”). (/d.) Pursuant to that agreement, Pre-Press was to purchase

. Weissmann’s 37.9 percent interest in the company (500 shares) for the sum of $4,725,000 ($9,450
per share), subject to a financing contingency. (/d.) The financing contingency required Pre-Press
“to make every effort possible or necessary to obtain financing.” (/d. at 6.) The Repurchase
Agreement also required Pre-Press to make a'down payment to Weissmann of $100,000 that was
not contingent on Pre-Press' obtaining financing. (/d. at 5.) As for Weissmann’s involvement with
the company, the agreement provided that he would continue to serve as:a director for two years.

He was released, however, from the non-competition provisions of the Shareholders’ Agreement,

and was therefore: free to work for, and become a shareholder of, Schawk. Accordingly,

2 The record does not explain how Weissmann’s ownership interest was reduced from
45 percent to 37.9 percent, nor identify the new shareholders.

3 The record is unclear as to why the Pre-Press shareholders’ rejection of
Weissmann’s first offer to sell at $5.5 million did not satisfy the right of first refusal.

3


of business. failure by investing in equity rather than debt instruments.” /n re Telegroup, 281 F.3d
i
at 140-41 (citing Slain’ and Kripke, at 261, 267-68). “Section 510(b) thus represents ‘a
Congressional judgment that, as between shareholders and general unsecured creditors, it is
shareholders who, should bear the tisk of illegality in the issuance of stock in the event that issuer
|
_ enters bankruptey.” /d.
In reaching their conclusion, Stain and Kripke focused on fraudulent issuance claims. The
authors did not, however, limit their analysis to the subordination of claims arising at the time of
| \ ‘
issuance. Instead, their article reflects an intent to address a broader concern; namely, the
subordination of claims by investors seeking to reclaim their lost investment. Specifically, Slain and
Kripke stated:
We are only incidentally concerned with the precise predicate of a disaffected
stockholder’s efforts to recapture his investment from the corporation. For present
purposes it suffices to say that when the basis of the stockholder’s disaffection is
either the issuer's failure to comply with registration requirements or the issuer’s
material misrepresentations, one or more state or federal claims may be made. Our
purpose is to consider the impact of such claims on the distribution of the
corporation's assets in bankruptcy and the development of a plan of reorganization
under Chapter X.
In re Granite Partners, 208 B.R. at 337 (quoting Slain and Kripke, at 267). In the court's view, this.
language suggests that the Slain and Kripke rationale underlying § 510(b) applies to claims beyond
those arising at the time stock is issued, To the extent Slain and Kripke were primarily concerned
with disappointed shareholders attempting to better their positions in bankruptcy by filing lawsuits
to reclaim a portion of their equitl investment, their article properly extends to claims beyond those
arising at the time of issuance.
At the same time, “Congress did not intend to subordinate every claim brought by a
shareholder, regardless of the nature of the claim.” /n re Telegroup, 281 F.3d at 144.n.2. Indeed,

the parties agree that a claim is not automatically subordinated merely because the claimant is a

shareholder of the debtor:

14


after this event.” Id. at 610. The court thus declined to subordinate those common law claims
which arose from debtor conduct subsequent to the issuance of the securities. /d. _
Contrary to Weissmann’s assertion, the reasoning in Amarex is not instructive in this case
because the decision has been abrogated by /n re Geneva Steel Co., 260 B.R. 517 (B.A.P. 10th
Cir. 2001), offal 281 F.3d 1173 (10th Cir. 2002).° In In re Geneva Steel, a bondholder of the debtor
filed a claim in the bankruptcy proceedings alleging that the debtor's fraud caused him to retain his
debt securities. Id. at 519. The Bankruptcy Appellate Panel of the Tenth Circuit subordinated the
claim under § 510(b) even though the allegations of fraud arose after the stock was issued. /d. at
523. The court explained that at the time the claimant accepted the notes “he accepted the same
risks as [debtor's] other investors.” /d. In the court's view, “[t]he fact that the value of the Notes
declined while [claimant] held them, even if his allegations of fraud are true, should not enable him
to ‘eviscerate the absolute priority rule, and shift to creditors the investment risk assumed by the
[note holders]. /d. (quoting /n re Granite Partners, 208 B.R. at 342). The court found that §
510(b) requires “a causal connection between the purchase or sale of the securities and the
damages alleged,” and that the link exists when “the holder of securities alleges post-investment
fraud.” Id. See also in re NAL Financial Group, Inc., 237 B.R. 225, 232 (Bankr. S.D. Fla. 1999)
(adopting broader interpretation of § 510(b) and finding “no distinction between fraud committed

during the purchase of securities and fraud (or a wrongful act) committed subsequent thereto that

adversely affects one’s ability ‘9 sell those securities”).

6 MAN Capital has filed a motion under Bankruptcy Rule 8011 for leave to cite
supplemental authority in connection with this bankruptcy appeal to clarify the holding of the Tenth
Circuit in In re Geneva Steel. MAN Capital objects to Weissmann’s. assertion that it
“misrepresented” that /n re Geneva Stee/ has “overruled” Amarex in the Tenth Circuit. (Motion for
Leave to Cite Supplemental Authority, at 2.) Essentially, the parties dispute the meaning of the
terms “overruled” and “abrogated.” The court agrees with MAN Capital that the Tenth Circuit
intended to, and did in fact, abrogate Amarex. See in re Geneva Steel, 281 F.3d at 1182 n. 5
(‘[hJaving rejected the holding of Amarex, we similarly decline to follow in re Angeles’).
Accordingly, the court grants MAN Capital’s motion.

16



under § 510(b) because it arises from the purchase or sale of Debtor's securities. The bankruptcy
court agreed and Weissmann appealed to this court. For the reasons set forth here, the decision
of the bankruptcy court is affirmed.

BACKGROUND

Both sides agree on the factual issues relevant to this appeal and raise strictly legal
arguments regarding the proper scope of 11 U.S.C. § 510(b). The court will nonetheless provide
a brief factual background to place the legal dispute in context.

In 1989, Weissmann and Robert Beevers founded Pre-Press and served as the company’s
initial shareholders and directors, each holding a 50 percent interest in the company. (Weissmann
v. Pre-Press Graphics Co., 00 CH 13071 (Feb. 1, 2002) (hereinafter “Illinois Judgment”), Exhibit
H to Brief of Appellant Brian Weissmann (hereinafter “Appellant Br.”), at 1.) Pre-Press provides
printing and pre-press services to advertising agencies and commercial clients, such as converting
an image into a digital format before reproducing it on a printing press. (/d.) Initially, Weissmann
provided Pre-Press with most of its business contacts and sales expertise, while Beevers
contributed his financial background and resources. (/d.) In 1992, both Beevers and Weissmann
reduced their ownership interest in Pre-Press to 45 percent each, transferring the remaining 10
percent of the company’s stock to two new shareholders, Shirlee Kay-Myers and Albert Myers."
(/d. at 2.) After the transfer, Weissmann remained one of the two primary shareholders in Pre-
Press. (/d.)

On January 1, 1998, Pre-Press adopted a Shareholder’s Agreement which placed

restrictions on the transfer of shares and included a non-competition provision for shareholders.

1 The record does not indicate the respective percentage ownership interests of
Shirlee Kay-Myers and Albert Myers.


UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF ILLINOIS

EASTERN DIVISION (PO Reva
Bg? n H FA
In re: ) MAR 9 4 2004
PRE-PRESS GRAPHICS COMPANY, )
INC., )
)
Debtor. )
)
BRIAN WEISSMANN, )
) Nos. 03 C 0021/03 C 264
Appellant, )
) Judge Rebecca R. Pallmeyer
ve ) :
)
PRE-PRESS GRAPHICS COMPANY, )
INC., MAN CAPITAL CORPORATION, )
)
Appellees. )

MEMORANDUM OPINION AND ORDER

Appellant Brian Weissmann appeals a December 17, 2002 order of the bankruptcy court
requiring that Weissmann’s claim against Debtor Pre-Press Graphics Company (“Pre-Press” or
“Debtor’) be subordinated to the claims of unsecured creditors pursuant to 11 U.S.C. § 510(b).
Weissmann’s claim is based on an Illinois state court judgment. In that state action, Weissmann,
a shareholder and former director of Pre-Press, alleged that his fellow directors engaged ‘in
stockholder oppression and breach of fiduciary duty when they removed him from his position on
the board and secretly issued additional stock which significantly diluted his ownership interest in
Debtor. Weissmann prevailed in that action and the state court ordered that Debtor purchase
Weissmann's shares for $1,383,350. Without appealing the state court's ruling or complying with
the judgment, on March 4, 2002, Pre-Press declared voluntary Chapter 11 bankruptcy.
Weissmann filed his claim (based on the state court judgment) before the bankruptcy court, over
objections from both Debtor and MAN Capital Corporation (collectively “Appellees”), Debtor's

largest creditor. Appellees argued that Weissmann’s claim is subject to mandatory subordination

5



courts have adopted both approaches in deciding the proper scope of the “arising from” language.
Compare, e.g. ! In re Montgomery Ward Holding Corp., 272 B.R. 836, 842 (Bankr. D. Del. 2001)
; (‘[t]he plain language of § 510(b) .. . applies only to a claim that directly concerns the stock ;

transaction itself, ie., the actual purchase and sale of the debtor's security must give rise to the
contested claim") (emphasis in original), and /n re Amarex, Inc., 78 B.R. 605, 610 (W.D. Okla.
1987) (“the Court finds that only claims which are based upon alleged violations of securities laws
and which arise from the purchase and sale of such securities fall within the scope of Section
510(b)”), with h re Geneva Steel, 281 F.3d at 1182 (the statute is not limited to issuance-related
claims’), and /n re Granite Partners, 208 B.R. at 333-34 (claim that debtor fraudulently induced !
claimant to retain securities arose from purchase or sale of securities for purposes of § 510(b)).

In light of these conflicting interpretations, there can be little doubt that § 510(b) is
ambiguous. Thus, the court must look to the legislative history of the provision and to the policies
underlying it to determine whether Weissmann’s claim “arises from” the purchase of Pre-Press’
stock.

B. Legislative History

In enacting § 510(b), Congress relied heavily on a law review article drafted in 1973 by John
J. Slain and Homer Kripke, entitled The interface Between Securities Regulation and Bankruptcy -
- Allocating the Risk of Illegal Securities Issuance Between Securityhoiders and the Issuer's
Creditors, 48 N.Y.U. L. Rev. 261 (1973) (“Slain and Kripke”). This court's review of the legislative
history of § 510(b) will begin at that article. See Report of the Committee on Judiciary,
Bankruptcy Law Revision, H.R. Rep. No. 95-595, at 196 (1977) (discussing the Slain/Kripke article
and stating that “the bill generally adopts the Slain/Kripke Position”). See also /n re Telegroup, 281

F.3d at 139 (‘in enacting § 510(b), Congress relied heavily on a law review article written by John

J. Slain and Homer Kripke”); in re Granite Partners, 208 B.R. at 336 (“[a]ny discussion of section

12


Nothing in our rationale would require the subordination of a claim simply because

the identity of the claimant happens to be a shareholder, where the claim lacks any

causal relationship to the purchase or sale of stock and when subordinating the

claims would not further the policies underlying § 510(b), which was intended to

prevent shareholders from recovering their equity investment in parity with general

unsecured creditors.
Id. (See also MAN Br., at 13; Appellant Br., at 14.) As the Telegroup court thus observed, the
legislative history of § 510(b) reflects an intent to require some causal link between a claim and the
purchase or sale of securities.

Cc. Case Law

Courts that have considered this issue have reached conflicting conclusions as to whether
§ 510(b) should be broadly or narrowly construed. Weissmann directs the court to three decisions
supporting the narrow approach: /n re Amarex, 78 B.R. 605 (W.D. Okla. 1987), In re Angeles
Corp., 177 B.R. 920 (Bankr. C.D. Cal. 1995), and /n re Montgomery Ward Holding Corp., 272 BR.
836 (Bankr. D. Del. 2001). The statutory interpretation set forth in these cases, however, has been
called into doubt by recent decisions from the Third, Ninth, and Tenth Circuits.

In In re Amarex, certain limited partners of a debtor corporation filed a claim in the
bankruptcy proceeding, charging that the general partner violated federal securities laws in
connection with the issuance of the limited partnership units, mismanaged the partnership, and
committed breach of contract, breach of fiduciary duty, negligence, and common law fraud. 78
B.R. at 606. The bankruptcy court subordinated ail of the limited partners’ claims under § 510(b)
because claimants “would have no claims against the debtor but for their purchase of the
securities, and had the purchase not occurred they would not have the pendent common law
claims.” id. at 608. In rejecting the bankruptcy court's interpretation, the district court found that

§ 510(b) “pertains only to claims based upon the alleged wrongful issuance and sale of the security

and does not encompass claims based upon conduct by the issuer of the security which occurred

15