Opinion ID: 1249444
Heading Depth: 3
Heading Rank: 1

Heading: The Statute Plain Language, Purpose and Policies

Text: Section 510(b) reads as follows: § 510. Subordination . . . (b) 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 represented 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) serves to effectuate one of the general principles of corporate and bankruptcy law: that creditors are entitled to be paid ahead of shareholders in the distribution of corporate assets. The principles behind corporate and bankruptcy laws generally do not favor shifting the risk of loss from shareholders to creditors, even if the shareholders are blameless. One of the primary purposes of section 510(b), therefore, is to prevent disappointed shareholders, sometimes the victims of corporate fraud, from recouping their investment in parity with unsecured creditors. Although many subordination cases sound in fraud, the scope of section 510(b) has been broadened over the years to include claims based on contract law and other actions. The majority of courts in recent years that have confronted the scope of § 510(b), including this one, have concluded that the phrase arising from should be read broadly to encompass claims other than fraud claims, such as claims for breach of contract. See, e.g., In re Telegroup, 281 F.3d 133, 144 (3d Cir. 2002) (breach of stock purchase agreement); In re Betacom of Phoenix, Inc., 240 F.3d 823, 829 (9th Cir.2001) (breach of merger agreement); In re Int'l Wireless Communications Holdings, Inc., 257 B.R. 739, 746 (Bankr.D.Del.2001), aff'd, 279 B.R. 463 (D.Del.2002), aff'd, 2003 WL 21466898 (3d Cir.2003) (breach of stock purchase agreement); In re PT-1 Communications, Inc., 304 B.R. 601, 608 (Bankr.E.D.N.Y. 2004) (tortious interference). That the claim is for breach of contract is not sufficient alone to prevent subordination. As noted above, a number of courts, including this one, have held that breach of contract claims may be subordinated under section 510(b) where there exists some nexus or causal relationship between the claim and the purchase of the securities. . . . Telegroup, 281 F.3d at 138; Betacom, 240 F.3d at 829; Int'l Wireless, 257 B.R. at 746; In re NAL Fin. Group, Inc., 237 B.R. 225, 234 (Bankr.S.D.Fla.1999). These opinions make clear that they were concerned with claims that tried to recharacterize or restate what would otherwise be subordinated securities claims. As a remedial statute, section 510(b) should be interpreted broadly in order to effectuate the intent of Congress. This principle was recognized in our earlier opinion, American Broadcasting Sys., Inc. v. Nugent (In re Betacom of Phoenix, Inc.), 240 F.3d 823 (9th Cir.2001), which examined the scope of section 510(b) and is the governing precedent on section 510(b) in the Circuit. In Betacom, the claimants held shares in a corporation that entered into a merger agreement with the debtor. The agreement called for the claimants to receive stock of the surviving company in exchange for their shares in the acquired company. The merger agreement never closed and claimants never accepted their tendered shares, which remained in escrow. We held that the claim should be subordinated under section 510(b). Betacom identifies two main reasons for subordination of a claim pursuant to section 510(b): (1) dissimilar risk and return expectations of creditors and shareholders and (2) the reliance of creditors on the equity cushion provided by shareholder investment. Betacom focused on the fact that investors expect to take more risks than creditors when they deal with a corporate entity, but we also made clear that a claim should only be subordinated when it will accomplish the purposes of section 510(b). Neither rationale applies here. Racusin was not in a position analogous to the claimants in Betacom. There, the claimants were entitled to receive shares in the combined company; they were offered the shares but refused to accept. Here, although Recusing's compensation was to be valued on the basis of the debtors' share price upon completion of the IPO, the contract did not provide for that compensation in the form of shares. His potential to earn greater profits as a shareholder thus did not exist. [2] Moreover, from the outset of his dispute with the debtors over compensation for his consulting services, Racusin sought to reduce his contract claim to a money judgment. He did not attempt to recover stock, and he never became a shareholder. A look at the plain language of the statute demonstrates its inapplicability to the circumstances here. Under the plain language of the statute a claim must be subordinated if it is one for damages arising from rescission of a purchase or sale of a security of the debtor. Racusin's claim arises from the fact that the value of the stock on the date of the public offering was simply the basis for calculating his compensation. He has never been a shareholder, has never attempted to recover an investment loss and since 1996 he has only sought to collect compensation owed for services he performed pursuant to a contract that the debtors breached. In In re Alta+Cast, 301 B.R. 150 (Bankr.D.Del.2003), a case relied on by the Bankruptcy Appellate Panel, the debtor sought to subordinate a former employee's claim. There, the debtor and claimant had an agreement by which the debtor agreed to repurchase its stock from the claimant if he was terminated for cause. When the debtor did not repurchase the securities after terminating claimant for cause, the claimant obtained a judgment against the debtor. The bankruptcy court held that the judgment arose from an agreement for the sale or purchase of a security because the claimant retained the risk of ownership by holding the stock until his termination  the claimant actually obtained an equity interest and the lawsuit arose from the debtor's refusal to repurchase the equity interest. Id. at 155. Here, Racusin never obtained stock in debtors, and his lawsuit arose from the refusal to pay him the monetary value of the stock at the time of the IPO as compensation for services rendered. Racusin received a money judgment for services rendered nine years before the bankruptcy; he has never sought an award of an equity interest in debtors' companies. Racusin therefore contends that because the claim is based on a prepetition money judgment it simply is not subject to subordination under section 510(b). Our earlier decision reversing a stock award to Racusin makes clear that his underlying claim is a debt claim, not an equity claim. Racusin did not sue debtors as an equity investor seeking monetary damages for fraud or breach of contract related to their mishandling of shareholders' economic investment in the company. He sued as an agent who did not receive compensation promised in an employment agreement. The money judgment awarded at the direction of our Court in its earlier opinion established a fixed, pre-petition debt due and owing Racusin as a creditor, not the risk/return position of an equity investor in the now-bankrupt corporation. For the foregoing reasons, we reverse the judgment of the Bankruptcy Appellate Panel and remand for further proceedings. Reversed and Remanded.