Opinion ID: 3010612
Heading Depth: 1
Heading Rank: 3

Heading: the right to relief

Text: Before ordering equitable subordination, most courts have required a showing involving three elements: (1) the claimant must have engaged in some type of inequitable conduct, (2) the misconduct must have resulted in injury to the creditors or conferred an unfair advantage on the claimant, and (3) equitable subordination of the claim must not be inconsistent with the provisions of the bankruptcy code. U.S. v. Noland, 116 S. Ct. 1524 (1996) (describing existing case law as consistent with the three part test identified in In re Mobile Steel Co., 563 F.2d 692, 700 (5th Cir. 1977)).2 _________________________________________________________________ 1. The bankruptcy court had jurisdiction over this adversary proceeding pursuant to 28 U.S.C. SS 157(b) & 1334(b). The district court had appellate jurisdiction over the bankruptcy court'sfinal judgment pursuant to 28 U.S.C. S 158(a)(1). We have jurisdiction over the final decision of the district court pursuant to 28 U.S.C.S 158(d). See In re Indian Palms Associates, Ltd., 61 F.3d 197, 199 n. 2 (3d Cir. 1995). 2. This court, in In re Burden, 917 F.2d 115, 120 (3d Cir. 1990), concluded that creditor misconduct is not [always] a prerequisite for equitable subordination. Burden involved subordination of a tax penalty in the absence of government misconduct. The Supreme Court, in two recent cases regarding the standards for tax penalty subordination, has refused to decide whether misconduct is required under S 510(c), resolving each case on the principle that categorical subordination is not permissible. See United States v. Reorganized CF & I Fabricators of Utah, Inc., 518 U.S. 213, 229 (1996); Noland, 517 U.S. at 543. We need not here resolve the issue of whether misconduct is always a prerequisite to equitable subordination because the bankruptcy court properly found misconduct. 9

Bankruptcy Court CVC acknowledges that it and its representative, Muqaddam, owed a fiduciary duty to Papercraft and its creditors at all times relevant here. It asserts, however, that neither breached a fiduciary duty. It insists that it is not improper per se for a fiduciary to purchase claims against the debtor in a bankruptcy at a discount and it stresses that the bankruptcy court made no finding that the prices paid for the Papercraft notes were unfair or inequitable at the time of the purchases. We accept, arguendo, that the purchase of notes at a discount by a fiduciary of a debtor in bankruptcy is not improper under all circumstances,3 and we acknowledge the absence of a finding on the fairness of the purchase price. The bankruptcy court found, however, that the Papercraft notes (1) were purchased for the dual purpose of making a profit for CVC on the notes and of being able to influence the reorganization in its own self-interest, (2) were purchased with the benefit of non-public information acquired as a fiduciary, and (3) were acquired without disclosure of its purchasing plans to the bankruptcy court, the Papercraft board, the Committee, or the selling note holders. The bankruptcy court further pointed out that under Brown v. Presbyterian Ministers, 484 F.2d 998, 1005 (3d Cir. 1973), the opportunity to purchase the notes was a corporate opportunity of which CVC could not avail itself, consistent with its fiduciary duty, without giving the corporation and its creditors notice and an opportunity to participate. _________________________________________________________________ 3. There is authority arguably to the contrary, but, in light of the findings of the bankruptcy court, we need not, and do not, resolve the issue here. In Manufacturers Trust Co. v. Becker, 338 U.S. 304, 313-14 (1949) the court observed, . . . [I]f it is clear [as it is] that a fiduciary may ordinarily purchase debt claims in fair transactions during the solvency of the corporation, the lower federal courts seem agreed that he cannot purchase after judicial proceedings for the relief of a debtor are expected or have begun. (citing cases). 10 CVC primarily protests that the bankruptcy court's findings of fact concerning inequitable conduct on its part are clearly erroneous. We will address that contention in the following section. We hold here, however, that the above noted findings reflect ample inequitable conduct to support a subordination remedy. Indeed, those findings make this a paradigm case of inequitable conduct by a fiduciary as that concept has been developed in the case law, and we believe further elaboration is not required. Before turning to an analysis of the record support for these findings, we will only comment briefly on two of CVC's justifications for its conduct. CVC insists that the opportunity to purchase the notes was not a corporate opportunity, and that notice to Papercraft's Board and the Committee was not required because Papercraft could not have purchased the notes at discount and the members of the Committee had no interest in doing so. We agree with the Committee, however, that CVC's argument is fundamentally at odds with our decision in Brown. In Brown, we held that the availability of claims for purchase at a discount constitutes a corporate opportunity. After noting that a director of a solvent corporation may take advantage of a corporate opportunity only if he discloses the opportunity to the corporation, we further held that a director of a corporation in bankruptcy owes a fiduciary duty to creditors and cannot seize a corporate opportunity without disclosure to the creditors or their representative. Even though the director in Brown had purchased a note at discount with the consent of the corporation and its stockholders, we concluded that a breach of fiduciary duty had occurred: The opportunity should have been disclosed to the receiver as representative of the creditors. Id. at 1005. CVC contends that Brown is distinguishable because Papercraft was not in a financial or legal position to purchase the notes and because the members of the Committee must have been well aware that a market existed in Papercraft debt. It necessarily follows, according to CVC, that neither could have been injured by its purchases. We believe this argument more relevant to the 11 remedy issue than to whether a breach of fiduciary duty occurred. That duty required that it share everything that it knew with Papercraft's board and the Committee before commencing its purchases. Its failure to do so would alone support a subordination depriving it of its profit from the note transactions. The absence of a disclosure in circumstances of this kind makes it extremely difficult to say with confidence what would have happened had no breach of duty occurred4 and that, in itself, is a compelling reason for insisting on disclosure. CVC also argues that its failure to disclose its identity to note sellers was not inequitable because its identity was not material to the purchases. It stresses that no note sellers have thus far complained. We agree with the bankruptcy court, however, that CVC's identity and purchasing plans were clearly material to the purchase transaction. The fact that CVC, a party with access to inside information, was seeking to purchase over $10 million in Papercraft debt and to steer the reorganization towards a sale to it of Papercraft's assets would certainly have been of interest to a creditor considering a CVC offer to purchase in the summer of 1991. In short, we agree with the bankruptcy court, the district court, and the Committee that CVC violated its fiduciary duty in a number of significant respects. 2. Record Support for the Bankruptcy Court's Findings CVC's most fundamental challenge to the factual findings of the bankruptcy court relates to the disclosure issue. It asserts that the court clearly erred in concluding that CVC anonymously purchased the Papercraft notes. While CVC makes no claim that it acted affirmatively to notify anyone _________________________________________________________________ 4. If the attention of the Papercraft board and the Committee had been focused on the potential CVC perceived in its note purchases, it is not at all clear that Papercraft or its creditors would have been unable to tap additional resources, just as CVC did. Either or both might have been able to seize or participate in the opportunity through borrowing, court approved purchases or amendment to the plan of reorganization to include a cash-out option. See, e.g., In re Cumberland Farms, Inc., 181
12 of its purchases prior to the consummation of its purchasing plan, it maintains that the sophisticated investors on the Committee knew that CVC was buying claims and chose to keep quiet about it in order to gain a litigation windfall by filing suit once CVC announced its position. Specifically, CVC claims that the courts below clearly erred in finding that the Committee had no knowledge of CVC's claims purchases until after CVC announced its competing reorganization plan. To support its argument, CVC relies upon minutes of a conference call held by the Committee on April 15, 1991. Those minutes reflect that there was mention of the fact that American Money [a creditor of Papercraft] had sold its notes to Citicorp. App. at 1558. In addition, CVC points to testimony of the Committee's chair, Pamela Cascioli, that she had been made aware of rumors that CVC had purchased American Money's claims. However, the minutes of the conference call and the testimony of Cascioli were illuminated by witnesses at trial, who testified that the discussion during the conference call lasted thirty seconds and that such rumors are commonplace, generally unfounded, and would not normally warrant additional inquiry. The bankruptcy court credited this testimony and specifically found that, other than the rumor, the committee heard no more about [claims purchasing activity] until CVC made its asset purchase offer in September of 1991. 187 B.R. at 492. It appears that the bankruptcy court weighed the effect of the rumor in light of the explanatory testimony and credited the Committee's explanation. CVC provides no convincing reason to conclude that this determination was clearly erroneous.5 CVC next challenges the court's finding as to its motive in purchasing the notes. It suggests that it was acting in the best interest of the company by offering a cash-out _________________________________________________________________ 5. CVC strenuously argues that the bankruptcy court should not be allowed to simply rest on a credibility determination when documentary evidence supports a different conclusion. However, in this case the documentary evidence was explained by the testimony at trial, which the court found credible. There is nothing unusual about a court finding credible one plausible explanation of the significance of documentary evidence. 13 option to creditors that was not available under the BDK plan. As we have noted, however, the court found that CVC intended to profit not only from the purchase of the notes at discount but also from gaining control of the reorganization. These findings were supported, inter alia, by the testimony of CVC's own people. Muqaddam admitted that he expected to make a profit from the note purchases, and the chairman of CVC stated that those purchases would help CVC influence something. Id. at 495-96, 500. The evidence clearly permits an inference that CVC was primarily motivated by its own self-interest in purchasing claims. Accordingly, the court did not clearly err in drawing that inference. CVC also contests the court's determination that its access to material, non-public information as an insider influenced its purchases of Papercraft notes. The court relied upon evidence establishing that Papercraft's thenChief Financial Officer, Frank Kane, conducted valuations of the company based on CVC's proposed asset purchase -- analyses that were not provided to the Committee. In addition, the court found that some of CVC's information was not public when received, and that CVC was given priority treatment by Papercraft in responding to requests for information. As the court accurately put it,CVC had virtually unrestricted access to inside information and significant assistance from [Papercraft] through its employees and staff and its control over employees. Id. at 496. CVC argues that though it was an insider, the information it received did not differ materially from that available to the other creditors, who were all sophisticated institutional investors. The bankruptcy court's conclusion to the contrary is supported, however, by evidence that CVC obtained special financial information andfinancial and tax valuations in order to evaluate its own asset purchase proposal, which was itself directly supported by the note purchases. CVC's argument that the special analyses it received were immaterial rings hollow in light of its use of that information in purchasing claims and preparing its asset purchase offer. 14 In short, our review of the record convinces us that the crucial findings we have referenced as demonstrating inequitable conduct are not clearly erroneous. B. Injury or Unfair Advantage As we have noted, the bankruptcy court identified three areas of injury or unfair advantage suffered by the Committee and Papercraft as a result of CVC's secret purchase of claims at a discount. First, the court found that selling note holders were deprived of the ability to make a fully informed decision to sell their claims. Second, the court concluded that CVC diluted the voting rights of members of the Committee. Though CVC ultimately did not vote its claims, the court indicated that its purchased claims secured a position of influence over the reorganization negotiations. Finally, the court held that CVC's actions created a conflict of interest which jeopardized its ability to make decisions in the best interest of the company, free from its competing profit motive. The district court also found these injuries and unfair advantages to be sufficient to warrant an equitable subordination remedy. It emphasized that CVC had engaged in a comprehensive information collection effort made possible by its position on Papercraft's Board . . . and then used this information to prepare its own asset purchase offer which directly competed with the BDK plan. Op. at 21. While the district court makes no express reference to it, the Committee points us to trial testimony from its financial advisor indicating that this competing reorganization plan and CVC's associated objections to the BDK plan resulted in confirmation delay that inflicted substantial injury on Papercraft's non-selling creditors. The bankruptcy court did not attempt to quantify the harms caused in economic terms, and CVC characterizes them as noneconomic harms. We do not agree with this characterization, however, and, like the bankruptcy and district courts, we conclude that they are sufficient to justify subordination. 15
Finally, a remedy of equitable subordination under S 510(c) must not be inconsistent with other provisions of the bankruptcy code. This requirement has been read as a `reminder to the bankruptcy court that although it is a court of equity, it is not free to adjust the legally valid claim of an innocent party who asserts the claim in good faith merely because the court perceives the result is inequitable.'  Noland, 517 U.S. at 539 (quoting DeNatale & Abram, The Doctrine of Equitable Subordination as Applied to Nonmanagement Creditors, 40 Bus. Law 417, 428 (1985). CVC makes the argument that other provisions of the bankruptcy code, including those related to voting of claims and transfer of claims, provide all the remedy necessary for inappropriate insider activity. While these provisions may also be applicable, we perceive no reason why the availability of alternative remedies makes equitable subordination under S 510(c) incompatible with the Code under the circumstances of this case.