Opinion ID: 2791080
Heading Depth: 2
Heading Rank: 2

Heading: Arising from the Purchase or Sale

Text: Next, O’Donnell argues that her claim does not arise from the purchase or sale of securities, because she converted her equity interest to a debt claim before Tristar filed its bankruptcy petition and thus subordination does not effectuate Congress’s intent in passing § 510(b). The status of a claim, she argues, must be judged from the date of the bankruptcy petition. It is true that O’Donnell was no longer an equityholder in Tristar when the bankruptcy petition was filed in 2011. In 2008, she exercised her contractual right to withdraw from the LLC, and Tristar exercised its contractual right to purchase her membership interest. After that time, O’Donnell no longer enjoyed the rights and privileges of LLC membership, including the right to share in the company’s profits. She was a creditor, not an equityholder, on the date of the petition. 3 If Congress wished to distinguish between fixed, liquidated claims and disputed, unliquidated claims for purposes of § 510(b), it could easily have done so. Instead, it merely used the term “claim.” “The term ‘claim’ means . . . right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured . . . .” 11 U.S.C. § 101(5)(A) (emphasis added). 8 IN RE TRISTAR ESPERANZA PROPERTIES At least one bankruptcy court has adopted O’Donnell’s position and held that the status of the claim on the date of the petition controls the subordination question. See In re MarketXT Holdings Corp., 361 B.R. 369, 389 (Bankr. S.D.N.Y. 2007). “It is black letter law,” the court reasoned, “that claims are analyzed as of the date of the filing of a petition, not as of a hypothetical date in the past.” Id. (citing 5 Lawrence P. King et al., Collier on Bankruptcy ¶ 506.04 (15th ed. rev. 2006)). Because the creditor held a judgment based on notes issued following the creditor’s exercise of the liquidation preference of its preferred stock, it was a creditor on the date of the petition and thus its claim was not subject to subordination. Id. at 389–90. Various other courts have followed similar reasoning in refusing to subordinate certain creditors’ claims even though their debt instruments or judgments derived from an equity interest. See, e.g., In re Cybersight LLC, No. 02-11033, Civ. A. 04-112 JJF, 2004 WL 2713098, at  (D. Del. Nov. 17, 2004); In re Swift Instruments, Inc., No. NC-11-1426-DHSa, 2012 WL 762833, at –8 (B.A.P. 9th Cir. Mar. 8, 2012); In re Mobile Tool Int’l, Inc., 306 B.R. 778, 782 (Bankr. D. Del. 2004). These cases suggest that to be subject to subordination, the claimant must, at the very least, enjoy the rights and privileges of equity ownership on the date of the bankruptcy petition. See Mobile Tool Int’l, 306 B.R. at 782. We rejected that principle in Betacom, holding that a claimant who bargained for an equity position was subject to subordination, even though he never enjoyed the benefits of equity ownership. Betacom, 240 F.3d at 829–30. Furthermore, we have suggested that the status of the claim on the date of the petition does not end the § 510(b) inquiry. In Betacom, the bankruptcy court subordinated IN RE TRISTAR ESPERANZA PROPERTIES 9 claims based on certain promissory notes without explanation, and the district court reversed the bankruptcy court without mentioning those claims. Id. at 827, 832. Even though the claims were based on promissory notes—fixed, admitted debts at the time of the petition—we remanded for determination of the origin of the notes, instructing the lower court that “[i]f the promissory note claims are linked to the [issuance of securities], they should be subordinated.” Id. at 832. And in American Wagering, we determined that a judgment based on contract claims of a consultant who never bargained for an equity position in the debtor was not subject to subordination. 493 F.3d at 1072–73. We took time to clarify that the judgment—clearly a debt claim at the time of the petition—did not derive from an equity interest, and we implied that the “conversion of an equity interest into a money judgment” would render the claim subject to subordination. Id. at 1072 n.2. The critical question for purposes of § 510(b), then, is not whether the claim is debt or equity at the time of the petition, but rather whether the claim arises from the purchase or sale of a security. The claim must be subordinated if there is a sufficient “nexus or causal relationship between the claim and the purchase” or sale of securities. Am. Wagering, 493 F.3d at 1072 (quoting Telegroup, 281 F.3d at 138). The primary weakness in O’Donnell’s argument is that, in her attempt to effectuate her vision of congressional intent, she overlooks the statutory text. Section 510(b) does not ask what the claim is, but what it arises from. We have long interpreted “arises from” broadly, and not as the “snapshot in time” that O’Donnell urges: 10 IN RE TRISTAR ESPERANZA PROPERTIES The word “arising” connotes, in ordinary usage, something broader than causation . . . . “Arising out of” are words of much broader significance than “caused by.” They are ordinarily understood to mean “originating from,” “having its origin in,” “growing out of” or “flowing from” or in short, “incident to, or having connection with . . . .” Underwriters at Lloyd’s of London v. Cordova Airlines, Inc., 283 F.2d 659, 664 (9th Cir. 1960) (latter alteration in original) (quoting Red Ball Motor Freight, Inc. v. Emp’rs Mut. Liab. Ins. Co. of Wis., 189 F.2d 374, 378 (5th Cir. 1951)); see also Cont’l Cas. Co. v. City of Richmond, 763 F.2d 1076, 1080 (9th Cir. 1985) (reviewing case law that interprets “arising from” more broadly than “caused by”). With this definition established, it is clear that O’Donnell’s claim arises from the sale of a security of the debtor. Her claim originates from the failed sale of her membership interest and Tristar’s breach of the operating agreement’s provisions regarding repurchase of membership interests. The direct causal link between O’Donnell’s claim and the purchase and sale of an equity interest leaves no doubt as to whether her claim for damages “flows from” the purchase or sale of a security of the debtor. Our straightforward reading of the “arises from” language in § 510(b) comports with congressional intent. As we have said, “[t]here are two main rationales for mandatory subordination: 1) the dissimilar risk and return expectations of shareholders and creditors; and 2) the reliance of creditors IN RE TRISTAR ESPERANZA PROPERTIES 11 on the equity cushion provided by shareholder investment.” Betacom, 240 F.3d at 830. Although O’Donnell did not enjoy the benefits of equity ownership on the date of the petition, she bargained for an equity position and thus embraced the risks that position entails. See Am. Wagering, 493 F.3d at 1071–72 (“One of the primary purposes of section 510(b) . . . is to prevent disappointed shareholders . . . from recouping their investment in parity with unsecured creditors.”). And O’Donnell’s investment was a part of Tristar’s equity cushion on which creditors would have relied in choosing to extend credit. Thus, we conclude that O’Donnell’s claim is among those Congress sought to reach in enacting § 510(b). If Congress had intended for subordination to turn on a claim’s status at the time of the bankruptcy filing, rather than the claim’s origin, it could easily have written § 510(b) to reflect that “snapshot” intent. It did not, and it had good reasons for that.4 4 We note that our decision today does not address the BAP’s assumption that a claim arising from an “old and cold” transaction converting an equity interest into debt may avoid subordination if the claim had “long been treated as part of the enterprise’s debt structure.” Tristar Esperanza Props., 488 B.R. at 404. In her briefing and at oral argument, O’Donnell abandoned any argument that her claim was too “old and cold” to be subordinated. She argued only that so long as the claimant held a fixed, admitted debt at the time of the petition, § 510(b) could not apply. Furthermore, we find no error in the BAP’s determination that O’Donnell’s claim was never considered as part of Tristar’s debt structure, but rather was “sufficiently proximate in time” to the bankruptcy filing “to warrant the conclusion that this is an effort by equity to capture . . . profits via a judgment for money damages.” Id. We need not determine whether an equity-to-debt conversion may ever be so “old and cold” that the causal link to the purchase or sale of securities is severed and the claim no longer arises from the purchase or sale. 12 IN RE TRISTAR ESPERANZA PROPERTIES Because O’Donnell’s claim arises from the purchase or sale of a security of the debtor, the bankruptcy court properly subordinated it. AFFIRMED.