Opinion ID: 162082
Heading Depth: 1
Heading Rank: 4

Heading: OTHER DECISIONS INTERPRETING SECTION 510(b)

Text: 42 A recent Ninth Circuit decision bolsters our decision to subordinate Allen's claim. See Am. Broadcasting Sys., Inc. v. Nugent (In re Betacom of Phoenix, Inc. ), 240 F.3d 823 (9th Cir.2001). That case stemmed from the merger of two corporations. For several convoluted reasons (including litigation), a group of shareholders from the acquired corporation never received delivery of the stock certificates for the acquiring corporation, stock promised to them as consideration for the merger. Id. at 826. The shareholders sued for breach of the merger agreement. While their lawsuit was pending, the merged corporation filed a Chapter 11 bankruptcy petition. The shareholders responded by repackaging their breach of contract action as a proof claim in the bankruptcy court. Id. at 827. 43 The debtor corporation sought to subordinate the investors' claims under section 510(b). The bankruptcy court agreed, but the district court reversed, holding that an actual purchase or sale of a security is required to trigger the statute. The district court reasoned that because the merger agreement had never been consummated (since the shares in the acquiring entity had never been delivered), there had been no purchase or sale of the debtor's securities; hence section 510(b) did not apply. Id. 44 Rejecting the shareholders' efforts to avoid the reach of section 510(b), the Ninth Circuit reversed the district court. The appellate court concluded that the statute is not limited to fraud claims, i.e., that it reaches certain breach of contract claims; and it concluded as well that the statute is implicated, at least in some instances, without an actual purchase or sale of a security. Id. at 828, 830-31. The court relied heavily on the same concepts we employ to subordinate Allen's fraudulent retention claim. Citing Professors Slain and Kripke, as well as Granite Partners, it reasoned that shareholders bargained for substantially more risk than creditors, and that it would be unfair to dilute creditor claims when those creditors looked for repayment to the equity cushion that invested capital provides. Id. at 829-30. Consequently, it mattered little that the investors' claim arose from a breach of contract. What is important is the potential effect of the claim: it would dilute the capital available to repay general creditors. Id; see also In re NAL Fin. Group, Inc., 237 B.R. 225, 232, 234 (Bankr.S.D.Fla. 1999) (agreeing with Granite Partners and subordinating post-investment claims pursuant to section 510(b), stating there is no distinction between fraud committed during the purchase of securities and fraud... committed subsequent thereto that adversely affects one's ability to sell those securities).
45 Some courts, we recognize, have accepted Allen's narrow interpretation of section 510(b) and have held that the statute does not reach fraudulent retention claims. Indeed one of them is from within this circuit: Ltd. Partners' Comm. of Amarex v. Official Trade Creditors' Comm. of Amarex, Inc. (In re Amarex, Inc.), 78 B.R. 605 (W.D.Okla.1987). That case, which arose from the failure of an oil and gas drilling partnership, involved post-investment fraud claims brought by hundreds of the limited partners against the general partner. Id. at 606. Appearing in the bankruptcy proceedings, the limited partners charged, among other things, that the general partner wasted company assets, breached its fiduciary duties, and committed various acts of common law fraud. Id. 46 The limited partners resisted subordination under section 510(b) by arguing that their claims were not related to the purchase or sale of a security. Id. at 608. Disagreeing, the bankruptcy court ruled they would have no claims against the debtor but for their purchase of the limited partnership interests (which the bankruptcy code defines as securities). The court also invoked the risk allocation rationale advanced by Professors Slain and Kripke. Id. 47 The district court reversed. After reviewing the statute's text and legislative history, it concluded, Section 510(b) reveals a Congressional desire to shift to the shareholders the risk of fraud in the issuance and sale of the security — no more. Id. at 609-10 (italics in original). It also accused the bankruptcy court of ignor[ing] the clear language of section 510(b), its underlying policies and the purposes for which it was enacted. Id. at 610. And it emphasized that the statute 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 after this event. Id. (emphasis added). 48 We respectfully decline to follow this reasoning, not least because it rests on a small but significant error in reading the statutory language. As the italicized terms above show, the district court read section 510(b) as limited to the issuance and sale of a debtor's security. In fact, the statute contains no such restriction; it bars claims arising from the purchase or sale of a security. The word issuance does not appear in the statutory language, and indeed, as courts have held, the statute is not limited to issuance-related claims. See, e.g., In re Betacom, 240 F.3d at 828-29; In re Lenco, Inc., 116 B.R. 141, 144 (Bankr.E.D.Mo.1990). We fear that the district 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. 5