Court Opinion

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Opinions of the United
2002 Decisions                                                                                                             States Court of Appeals
                                                                                                                              for the Third Circuit

2-15-2002

In Re: Telegroup Inc
Precedential or Non-Precedential:

Docket 0-3823

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Recommended Citation
"In Re: Telegroup Inc" (2002). 2002 Decisions. Paper 127.
http://digitalcommons.law.villanova.edu/thirdcircuit_2002/127

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Filed February 15, 2002

UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT

No. 00-3823

IN RE: TELEGROUP, INC.

BARODA HILL INVESTMENTS, LTD.; LEHERON
CORPORATION, LTD.; KIMBLE JOHN WINTER, Appellants

v.

TELEGROUP, INC.

On Appeal From the United States District Court
For the District of New Jersey
(D.C. Civ. No. 00-cv-02730)
District Judge: Honorable Nicholas H. Politan

Argued: October 11, 2001

Before: BECKER, Chief Judge, SCIRICA and
GREENBERG, Circuit Judges.

(Filed February 15, 2002)

       J. BARRY COCOZIELLO, ESQUIRE
       ROBERT J. McGUIRE, ESQUIRE
        (ARGUED)
       Podvey, Sachs, Meanor, Catenacci,
       Hildner & Cocoziello
       One Riverfront Plaza
       Newark, NJ 07102

       Counsel for Appellants
       Baroda Hill Investments, Ltd.,
       LeHeron Corporation, Ltd., and
       Kimble John Winter
       JAMES A. STEMPEL, ESQUIRE
       JASON N. ZAKIA, ESQUIRE
        (ARGUED)
       Kirkland & Ellis
       200 East Randolph Drive
       Chicago, IL 60601

       Counsel for Appellee Telegroup, Inc.

OPINION OF THE COURT

BECKER, Chief Judge:

This bankruptcy appeal requires us to construe 11
U.S.C. S 510(b), which provides for the subordination of any
claim for damages "arising from the purchase or sale" of a
security of the debtor. The appeal arises out of a Chapter
11 Bankruptcy petition filed by appellee Telegroup, Inc.
Appellants Baroda Hill Investments, Ltd., LeHeron
Corporation, Ltd., and Kimble John Winter ("claimants" or
"appellants") are shareholders of Telegroup who filed proofs
of claim in the bankruptcy proceeding seeking damages for
Telegroup's alleged breach of its agreement to use its best
efforts to ensure that their stock was registered and freely
tradeable. Claimants appeal from an order of the District
Court affirming the Bankruptcy Court's order subordinating
their claims against the bankruptcy estate pursuant to
S 510(b).

Claimants argue that S 510(b) should be construed
narrowly, so that only claims for actionable conduct--
typically some type of fraud or other illegality in the
issuance of stock -- that occurred at the time of the
purchase or sale of stock would be deemed to arise from
that purchase or sale. Put differently, in claimants'
submission, a claim must be predicated on illegality in the
stock's issuance to be subordinated under S 510(b). Since
the actionable conduct in this case (Telegroup's breach of
contract) occurred after claimants' purchase of Telegroup's
stock, claimants contend that the District Court erred in
subordinating their claims.

                               2
Telegroup would read S 510(b) more broadly, so that
claims for breach of a stock purchase agreement, which
would not have arisen but for the purchase of Telegroup's
stock, may arise from that purchase, even though the
actionable conduct occurred after the transaction was
completed. Telegroup further argues that subordinating
appellants' claims advances the policies underlyingS 510(b)
by preventing disappointed equity investors from recovering
a portion of their investment in parity with bona fide
creditors in a bankruptcy proceeding.

We agree with Telegroup, and hold that a claim for
breach of a provision in a stock purchase agreement
requiring the issuer to use its best efforts to register its
stock and ensure that the stock is freely tradeable"arises
from" the purchase of the stock for purposes ofS 510(b),
and therefore must be subordinated. Accordingly, we will
affirm.

I.

The relevant facts are undisputed, and can be succinctly
summarized. Appellant LeHeron Corporation, Ltd. sold to
Telegroup the assets of certain businesses that it owned in
exchange for shares of Telegroup's common stock and a
small amount of cash. As amended on June 5, 1998, the
stock purchase agreements required Telegroup to use its
best efforts to register its stock and ensure that the shares
were freely tradeable by June 25, 1998. On February 10,
1999, Telegroup filed a voluntary Chapter 11 Bankruptcy
petition, and on June 7, 1999, appellants filed proofs of
claim against the bankruptcy estate alleging that Telegroup
breached its agreement to use its best efforts to register its
stock. Claimants sought damages on the theory that had
Telegroup performed its obligation under the contract, they
would have sold their shares as soon as Telegroup's stock
became freely tradeable, thereby avoiding the losses
incurred when Telegroup's stock subsequently declined in
value.

Telegroup filed objections to these claims, asking the
Bankruptcy Court to subordinate the claims pursuant to
S 510(b), which provides that any claim for damages

                               3
"arising from the purchase or sale" of common stock shall
have the same priority in the distribution of the estate's
assets as common stock. The Bankruptcy Court filed a
written opinion and order subordinating appellants' claims,
holding that because appellants' claims would not exist but
for their purchase of Telegroup's stock, the claims arise
from that purchase for purposes of S 510(b). The District
Court affirmed, and claimants filed this appeal.

The District Court had jurisdiction pursuant to 28 U.S.C.
S 158(a), and we have jurisdiction pursuant to 28 U.S.C.
S 158(d). Because the District Court sat below as an
appellate court, this Court conducts the same review of the
Bankruptcy Court's order as did the District Court. See In
re O'Brien Envtl. Energy, Inc., 188 F.3d 116, 122 (3d Cir.
1999). As the relevant facts are undisputed, this appeal
presents a pure question of law, which we review de novo.
See id.

II.

A.

Section 510(b) of the Bankruptcy Code provides:

       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.

In this case, the question is whether appellants' breach of
contract claim is "a claim . . . for damages arising from the
purchase or sale of . . . a security [of the debtor]." Id.
Claimants concede that the securities that they purchased
from Telegroup are common stock. Therefore, if their claims
"arise from" the purchase of that stock, then under S 510(b)
their claims would have the same priority as common

                               4
stock, and would be subordinated to the claims of general
unsecured creditors.

The question of the scope of S 510(b) presents this Court
with a matter of first impression. Those courts that have
considered the issue appear divided on how broadly the
phrase "arising from the purchase or sale of . . . a security"
should be construed. Compare, e.g., In re Amarex, Inc., 78
B.R. 605, 610 (W.D. Okla. 1987) (holding that under
S 510(b), a claim does not arise from the purchase or sale
of a security if it is predicated on conduct that occurred
after the security's issuance), with In re NAL Fin. Group,
Inc., 237 B.R. 225 (Bankr. S.D. Fla. 1999) (holding that
claims for breach of the debtor's agreement to use its best
efforts to register its securities arise from the purchase of
those securities, for purposes of S 510(b)).

In construing S 510(b), we begin, as we must, with the
text of the statute. See Robinson v. Shell Oil Co., 519 U.S.
337, 340 (1997) ("[The] first step in interpreting a statute is
to determine whether the language at issue has a plain and
unambiguous meaning with regard to the particular dispute
in the case."). The inquiry "must cease if the statutory
language is unambiguous and the statutory scheme is
coherent and consistent." Id. (internal quotation marks and
citations omitted).

Claimants argue that their claims do not arise from the
purchase or sale of Telegroup's common stock because a
claim "aris[es] from the purchase or sale of . . . a security"
only if the claim alleges that the purchase or sale of the
security was itself unlawful. According to claimants, a claim
does not arise from the purchase or sale of a security if it
is predicated on conduct that occurred after the purchase
or sale. See In re Amarex, Inc., 78 B.R. 605, 610 (W.D.
Okla. 1987) (holding that a claim for breach of a
partnership agreement, because it is based on conduct that
occurred after the issuance and sale of the partnership
units, does not arise from the purchase or sale of those
units); In re Angeles Corp., 177 B.R. 920, 926 (Bankr. C.D.
Cal. 1995) (holding that claims for breach of fiduciary duty
do not arise from the purchase or sale of limited
partnership interests where the wrongful conduct occurred
after the sale of those interests); see also In re Montgomery

                               5
Ward Holding Corp., No. 97-1409, 2001 Bankr. LEXIS 158
at *20 (Bankr. D. Del. Jan. 16, 2001) (holding that a claim
arises from the purchase or sale of a security only if there
is "an allegation of fraud in the purchase, sale or issuance
of the . . . instrument"). Since the actionable conduct in
this case includes Telegroup's alleged post-sale breach of
contract, in claimants' submission the claim does not arise
from the purchase or sale of debtor's stock, and therefore
should not be subordinated under S 510(b).

Telegroup responds that claims arising from the
purchase or sale of a security under S 510(b) include claims
predicated on post-issuance conduct. See In re Geneva
Steel Co., 260 B.R. 517 (B.A.P. 10th Cir. 2001) (holding that
claims alleging that the debtor fraudulently induced the
claimants to retain securities they had purchased from the
debtor arise from the purchase or sale of those securities,
for purposes of S 510(b)); In re Granite Partners, L.P., 208
B.R. 332, 333-34 (Bankr. S.D.N.Y. 1997) (holding that
claims that debtor fraudulently induced claimants to retain
debtor's securities arise from the purchase or sale of those
securities); see also In re Lenco, Inc., 116 B.R. 141 (Bankr.
E.D. Mo. 1990) (holding that claims for ERISA violations
arose from the purchase or sale of debtor's securities).

Telegroup contends that appellants' claims "arise from"
the purchase or sale of Telegroup's common stock because
they allege a breach of the purchase agreement whereby
claimants acquired shares of Telegroup stock, which
required Telegroup to use its best efforts to register its
stock. See In re NAL Fin. Group, Inc., 237 B.R. 225 (Bankr.
S.D. Fla. 1999) (holding that claims for breach of debtor's
agreement to use its best efforts to register its securities
arise from the purchase of those securities, for purposes of
S 510(b)); see also In re Betacom of Phoenix, Inc., 240 F.3d
823 (9th Cir. 2001) (holding that a claim for breach of a
provision in a merger agreement arises from the purchase
or sale of the debtor's securities); In re Int'l Wireless
Communications Holdings, Inc., 257 B.R. 739, 746 (Bankr.
D. Del. 2001) (disapproving Angeles and Amarex, supra,
and holding that claims against the debtor for breach of a
supplement to a share purchase agreement arise from the
purchase or sale of those securities); In re Kaiser Group

                               6
Int'l, Inc., 260 B.R. 684 (Bankr. D. Del. 2001) (holding that
claims for breach of a merger agreement arise from the
purchase or sale of debtor's securities). Therefore, in
Telegroup's submission, the Bankruptcy Court correctly
subordinated appellants' claims pursuant to S 510(b).

We conclude that the phrase "arising from" is ambiguous.
For a claim to "aris[e] from the purchase or sale of . . . a
security," there must obviously be some nexus or causal
relationship between the claim and the sale of the security,
but S 510(b)'s language alone provides little guidance in
delineating the precise scope of the required nexus. On the
one hand, it is reasonable, as a textual matter, to hold that
the claims in this case do not "arise from" the purchase or
sale of Telegroup's stock, since the claims are predicated on
conduct that occurred after the stock was purchased. On
the other hand, it is, in our view, more natural, as a textual
matter, to read "arising from" as requiring some nexus or
causal relationship between the claims and the purchase of
the securities, but not as limiting the nexus to claims
alleging illegality in the purchase itself. In particular, the
text of S 510(b) is reasonably read to encompass the claims
in this case, since the claims would not have arisen but for
the purchase of Telegroup's stock and allege a breach of a
provision of the stock purchase agreement.

Although we believe that Telegroup's reading ofS 510(b)
is the more comfortable reading of the provision as a
textual matter, we acknowledge that the language "arising
from" is nonetheless susceptible to claimants' construction.
Because the text of S 510(b) is ambiguous as applied to the
claims in this case, we turn to the provision's legislative
history and the policies underlying the provision, to
determine whether the claims "arise from" the purchase of
Telegroup's stock, and therefore must be subordinated.

B.

Both the House Report on the 1978 Bankruptcy
Revisions and the Report of the Commission on Bankruptcy
Laws, whose proposed legislation was largely adopted by
the 1978 enactment of the Bankruptcy Code, suggest that
in enacting S 510(b), Congress was focusing on claims

                               7
alleging fraud or other violations of securities laws in the
issuance of the debtor's securities. See Report of the
Committee on the Judiciary, Bankruptcy Law Revision,
H.R. Rep. No. 95-595, at 194 (1977) ("A difficult policy
question to be resolved in a business bankruptcy concerns
the relative status of a security holder who seeks to rescind
his purchase of securities or to sue for damages based on
such a purchase: Should he be treated as a general
unsecured creditor based on his tort claim for rescission, or
should his claim be subordinated?"); Report of the
Commission on the Bankruptcy Laws of the United States,
H.R. Doc. No. 93-137, pt. 2, at 116 (1973) (commenting
that the proposed provision "subordinates claims by
holders of securities of a debtor corporation that are based
on federal and state securities legislation, rules pursuant
thereto, and similar laws").

In enacting S 510(b), Congress relied heavily on a law
review article written by Professors John J. Slain and
Homer Kripke, The Interface Between Securities Regulation
and Bankruptcy -- Allocating the Risk of Illegal Securities
Issuance Between Securityholders and the Issuer's
Creditors, 48 N.Y.U. L. Rev. 261 (1973). See H.R. Rep. No.
95-595, at 196 (summarizing the argument in the
Slain/Kripke article and stating that "[t]he bill generally
adopts the Slain/Kripke position"); id. at 194 ("The
argument for mandatory subordination is best described by
Professors Slain and Kripke."); In re Betacom of Phoenix,
Inc., 240 F.3d 823, 829 (9th Cir. 2001) ("Congress relied
heavily on the analysis of two law professors in crafting the
statute."); In re Granite Partners, L.P., 208 B.R. 332, 336
(Bankr. S.D.N.Y. 1997) ("Any discussion of section 510(b)
must begin with the 1973 law review article authored by
Professors John J. Slain and Homer Kripke . . . .").

Slain and Kripke argued 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, conceptualizing the issue as one of
risk allocation. See generally Elizabeth Warren, Bankruptcy
Policy, 54 U. Chi. L. Rev. 775, 777 (1987) ("[B]ankruptcy
policy becomes a composite of factors that bear on a better
answer to the question, `How shall the losses be

                               8
distributed?' "). Slain and Kripke argued that"[t]he
situation with which we are concerned involves two risks:
(1) the risk of business insolvency from whatever cause;
and (2) the risk of illegality in securities issuance." Slain &
Kripke, supra, at 286.

Analyzing the first risk -- that of business insolvency --
Slain and Kripke observed that the absolute priority rule
allocates this risk to shareholders. Under the absolute
priority rule, "stockholders seeking to recover their
investments cannot be paid before provable creditor claims
have been satisfied in full." Id. at 261; see generally Consol.
Rock Prods. Co. v. Dubois, 312 U.S. 510, 520-21 (1941)
(holding that stockholders cannot participate in a plan of
reorganization unless creditors' claims have been satisfied
in full); Case v. Los Angeles Lumber Prods. Co. , 308 U.S.
106 (1939) (same); see also Caplin v. Marine Midland Grace
Trust Co., 406 U.S. 416, 436 n.2 (1972) (Douglas, J.,
dissenting) (discussing the history of the absolute priority
rule).

The rationale for the absolute priority rule rests on the
different risk-return packages purchased by stockholders
and general creditors:

       In theory, the general creditor asserts a fixed dollar
       claim and leaves the variable profit to the stockholder;
       the stockholder takes the profit and provides a cushion
       of security for payment of the lender's fixed dollar
       claim. The absolute priority rule reflects the different
       degree to which each party assumes a risk of
       enterprise insolvency . . . .

Slain & Kripke, supra, at 286-87; see also Warren, supra,
at 792 ("An almost axiomatic principle of business law is
that, because equity owners stand to gain the most when a
business succeeds, they should absorb the costs of the
business's collapse -- up to the full amount of their
investment."). Thus, argued Slain and Kripke, the absolute
priority rule allocates to stockholders the risk of business
insolvency, and "no obvious reason exists for reallocating
that risk." Slain & Kripke, supra, at 287.

Analyzing the second risk -- the risk of illegality in the
issuance of stock -- Slain and Kripke argued that this risk,

                               9
too, should be born by shareholders. "It is difficult to
conceive of any reason for shifting even a small portion of
the risk of illegality from the stockholder, since it is to the
stockholder, and not to the creditor, that the stock is
offered." Id. at 288. Slain and Kripke therefore concluded
that shareholder claims alleging illegality in the issuance of
stock should be subordinated to the claims of general
unsecured creditors.

The focus of the Slain/Kripke article suggests that
Congress considered claims alleging fraud or other illegality
in the issuance of securities to be at the core of claims that
"aris[e] from the purchase or sale of . . . a security" for
purposes of S 510(b). See Slain & Kripke, supra, at 267
("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."). Indeed, the title of their article --
"The Interface Between Securities Regulation and
Bankruptcy -- Allocating the Risk of Illegal Securities
Issuance Between Securityholders and the Issuer's
Creditors" -- indicates that Slain and Kripke were primarily
concerned with actionable conduct occurring in the
issuance of the debtor's securities, as opposed to post-
issuance conduct.

This focus in the legislative history on fraud or other
illegality in the securities' issuance supports claimants'
argument that their claims do not arise from the purchase
or sale of Telegroup's stock because the actionable conduct
(the breach of Telegroup's agreement to use its best efforts
to register its stock) occurred after the sale was completed,
and did not involve any fraud or violation of securities laws
in the issuance itself. Although we thus agree with
claimants that claims alleging illegality in the issuance of
securities fall squarely within the intended scope of
S 510(b), we cannot find anything in the legislative history
indicating that Congress intended to limit the scope of
S 510(b) to only such claims. In fact, Slain and Kripke
explicitly declined to delineate the exact boundary between
those shareholder claims that should be subordinated and
those that should not. See Slain & Kripke, supra, at 267

                               10
("We are only incidentally concerned with the precise
predicate of a disaffected stockholder's efforts to recapture
his investment from the corporation."). We therefore read
the specific types of claims referred to in the legislative
history as "arising from" the purchase or sale of a security
as illustrative, not exhaustive, examples of claims that
must be subordinated pursuant to S 510(b).

While the legislative history fails to define explicitly the
intended scope of S 510(b), the legislative history, by
adopting the Slain/Kripke argument, sheds light on the
policies animating S 510(b), which provide guidance in
deciding whether the claims in this case arise from the
purchase of Telegroup's stock. Ultimately, the Slain and
Kripke proposal that inspired S 510(b) appears intended 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 of
business failure by investing in equity rather than debt
instruments. See Slain & Kripke, supra , at 267 (framing the
problem in terms of "a disaffected stockholder's efforts to
recapture his investment from the corporation"); id. at 261
("In these cases, a dissatisfied investor may rescind his
purchase of stock or subordinated debt by proving that the
transaction violated federal or state securities laws."); id. at
268 ("[I]nvestors in stock or in subordinated debentures
may be able to bootstrap their way to parity with, or
preference over, general creditors even in the absence of
express contractual rights.").

Section 510(b) thus represents a Congressional judgment
that, as between shareholders and general unsecured
creditors, it is shareholders who should bear the risk of
illegality in the issuance of stock in the event the issuer
enters bankruptcy. See H.R. Doc. No. 93-137, pt. 1, at 22
(1973) (recommending "that claims by stockholders of a
corporate debtor for rescission or damages, which if allowed
will promote them to the status of creditors, be
subordinated to the claims of the real creditors"). With
these policies in mind, we now turn to the application of
S 510(b) to the claims at issue in this case.

                               11
C.

1.

Claimants' reading of S 510(b) as requiring the
subordination of only those claims alleging fraud or
actionable conduct in the issuance not only is plausible as
a textual matter, see supra Section II.A, but also has some
appeal at an abstract level, as noted in the margin. 1
Nonetheless, the distinction that claimants' reading of
S 510(b) draws between actionable conduct that occurred at
the time of the purchase of the security and actionable
conduct that occurred after the purchase seems to us to
lack any meaningful basis as a matter of Congressional
policy, and therefore provides an inadequate resolution of
the ambiguity in the text of S 510(b) as applied to the
claims in this case. As discussed above, Congress enacted
S 510(b) to prevent disappointed shareholders from
_________________________________________________________________

1. Because appellants' claims are for breach of a contractual provision
intended to limit their investment risk, their claims are arguably
analogous to unsecured creditors' claims on promissory notes, and
therefore should enjoy the same priority. In both cases, the claims are
for breach of a contractual provision -- in the case of claimants suing on
a promissory note, the contractual provision requires the debtor to repay
the loan, and in this case, the contractual provision requires the debtor
to use its best efforts to register its stock. In both cases the
contractual
provision limits the claimants' investment risk-- in the case of a
promissory note, the contractual provision ensures that noteholders will
be paid before any profits are distributed to shareholders, and in this
case, the contractual provision ensures that stockholders can sell their
stock if the corporation begins to fail, thereby recovering at least a
portion of their investment.

Moreover, in both cases, the contractual provision limiting the
investment risk is acquired in exchange for a lower rate of return -- in
the case of noteholders, the promissory note provides only a fixed rate of
return, and in this case, the issuer's agreement to use its best efforts
to
register its stock presumably increased the price claimants paid for the
stock, thereby decreasing their expected return. This analogy between
the claims of unsecured creditors suing on promissory notes and the
claims of shareholders suing for breach of the issuer's agreement to use
its best efforts to register its stock therefore suggests that appellants'
claims should not be subordinated under S 510(b), and should be given
the same priority as the claims of general unsecured creditors.

                               12
recovering their investment loss by using fraud and other
securities claims to bootstrap their way to parity with
general unsecured creditors in a bankruptcy proceeding.
Nothing in this rationale would distinguish those
shareholder claims predicated on post-issuance conduct
from those shareholder claims predicated on conduct that
occurred during the issuance itself. Cf. In re Granite
Partners, L.P., 208 B.R. 332, 342 (Bankr. S.D.N.Y. 1997)
("[T]here is no good reason to distinguish between allocating
the risks of fraud in the purchase of a security and post-
investment fraud that adversely affects the ability to sell (or
hold) the investment; both are investment risks that the
investors have assumed.").

More important than the timing of the actionable
conduct, from a policy standpoint, is the fact that the
claims in this case seek to recover a portion of claimants'
equity investment. In enacting S 510(b), Congress intended
to prevent disaffected equity investors from recouping their
investment losses in parity with general unsecured
creditors in the event of bankruptcy. Since claimants in
this case are equity investors seeking compensation for a
decline in the value of Telegroup's stock, we believe that the
policies underlying S 510(b) require resolving the textual
ambiguity in favor of subordinating their claims. Put
differently, because claimants retained the right to
participate in corporate profits if Telegroup succeeded, we
believe that S 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. Were
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.

Claimants argue that they never intended to retain their
equity investment and share in Telegroup's profits, and
submitted affidavits asserting that they intended to
liquidate their shares as soon as Telegroup registered its
stock and the stock became publicly tradeable. See
Appellants' Brief at 26 ("The Claimants had no desire to
become long-term investors in the Debtor. They accepted

                               13
the shares as a cash substitute and intended immediately
to sell those shares once the shares were registered.").

We have difficulty believing that if Telegroup's business
prospects had suddenly improved and its profits had gone
through the roof, claimants would nonetheless have
liquidated their shares as soon as they became publicly
tradeable. No profit-maximizing shareholder would liquidate
her shares if the shareholder believed the expected return
would exceed the shares' market value. Indeed, had
claimants intended to liquidate their shares as soon as
possible, they would have filed breach of contract claims
immediately on June 25, 1998, when the contract was
initially breached, rather than waiting until June 7, 1999,
nearly a year later, to file their claims. Furthermore, if as
claimants now contend, they never intended to assume any
of the investment risks of equity-holders, it is unclear why
they did not purchase non-equity securities with a fixed
rate of return. The fact that claimants chose to invest in
equity rather than debt instruments suggests that they
preferred to retain the right to participate in profits, and
with it, the risk of losing their investment if the business
failed.

To be sure, it could be argued that this analysis does not
warrant subordinating appellants' claims because the
claims seek compensation for a risk that appellants did not
assume. In particular, although claimants, as equity
investors, assumed the risk of business failure, they did not
assume the risk that Telegroup's stock would not be
publicly tradeable, since they allocated that risk by contract
to Telegroup. This objection to subordinating appellants'
claims, however, proves too much, as it would apply equally
to shareholders' claims for fraud in the issuance. Although
shareholders do not assume risks that are fraudulently
concealed from them, shareholder claims alleging fraud in
the issuance nonetheless fall squarely within the intended
scope of S 510(b). See supra Section II.B.

2.

A comparison of appellants' claims with claims for fraud
or other illegality in the issuance of the debtor's securities,

                               14
which appellants concede must be subordinated pursuant
to S 510(b), further supports the subordination of
appellants' claims. The policy considerations underlying the
Congressional judgment in S 510(b) that those who
purchase the debtor's stock, rather than general unsecured
creditors, should bear the risk of loss caused by illegality in
the issuance of the stock, seem to us to apply equally to the
claims in this case. In both cases, the claim would not exist
but for claimants' purchase of debtor's stock. In both cases,
the claim seeks compensation for a decline in the stock's
value caused by actionable conduct on the debtor's part.
And in both cases, because the stockholder, as an equity
investor, assumed the risk of business failure, the
stockholder must bear the risk, in the event of bankruptcy,
of any unlawful conduct on the debtor's part that causes
the stock's value to drop.

That the same policy considerations applicable to claims
alleging fraud in the issuance of securities apply with equal
force here is illustrated by considering a hypothetical case
in which Telegroup did not contractually agree to use its
best efforts to register its stock, but instead misrepresented
to buyers at the time of the purchase that Telegroup was
currently using its best efforts to register the stock. In such
a case, the stockholders' fraud claims against Telegroup
would clearly arise from the purchase of Telegroup's stock,
and therefore would be subordinated pursuant toS 510(b).
The only difference between that hypothetical and this case
is that here, instead of fraudulently misrepresenting to
buyers that it was using its best efforts to register its stock,
Telegroup breached its contractual obligation to use its best
efforts to register its stock.

Given that the text of S 510(b) may be reasonably read to
apply to both claims alleging fraud in the issuance and the
claims in this case, see supra Section II.A, we see no reason
as a matter of policy why a fraud claim against Telegroup
for misrepresenting to buyers that it was using its best
efforts to register its stock should be subordinated under
S 510(b), but a contract claim against Telegroup for
breaching its agreement to use its best efforts to register its
stock should not. See In re Int'l Wireless Communications
Holdings, Inc., 257 B.R. 739, 746 (Bankr. D. Del. 2001)

                               15
("Many claims of `defrauded' shareholders could be
characterized as either [contract or tort claims]. Were we to
limit the applicability of section 510(b) to tort claims,
shareholders could easily avoid its effect by asserting that
a debtor's fraudulent conduct in the sale of its securities
was a breach of the sales contract."); In re NAL Fin. Group,
Inc., 237 B.R. 225, 232 (Bankr. S.D. Fla. 1999) ("[T]he
subsequent [breach of contract] is no different than a fraud
committed during the purchase for purposes of determining
whether [a claim] . . . should be subordinated under
S 510(b)."). See generally In re Betacom of Phoenix, Inc., 240
F.3d 823, 829 (9th Cir. 2001) ("There is nothing in the
Slain and Kripke analysis to suggest that Congress's
concern with creditor expectations and equitable risk
allocation was limited to cases of debtor fraud."); In re Pub.
Serv. Co. of N.H., 129 B.R. 3, 5 (Bankr. D.N.H. 1991)
("Although the claim in this case is largely based on fraud,
the language of 510(b) is broad enough to include breach of
contract and related actions as well.").

III.

For the foregoing reasons, we hold that a claim for a
breach of a provision in a stock purchase agreement
requiring the issuer to use its best efforts to register its
stock arises from the purchase or sale of the stock, and
therefore must be subordinated pursuant to S 510(b).2
Accordingly, the order of the District Court will be affirmed.
_________________________________________________________________

2. Claimants argue that to subordinate their claims in this case "renders
most of the language of S 510(b) superfluous," since it would mean that
"any claim by an equity holder should be subordinated." Appellants'
Reply Br. at 4. In particular, claimants rely on In re Angeles Corp., 177
B.R. 920 (Bankr. C.D. Cal. 1995), which stated that:

       If Congress had wanted to subordinate all claims of security
holders
       to an equity position, regardless of the source of the claim,
Congress
       would have worded Section 510(b) to say: "All claims made by
       security holders, regardless of the source of the claim, shall be
       subordinated to an equity class . . ." However, Bankruptcy Code
       Section 510(b) does not say this. Thus, Section 510(b)'s
       subordination of claims "arising from the sale or purchase of a
       security" must mean subordinating less than every claim of a
       security holder, regardless of how that claim arises.

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A True Copy:
Teste:

       Clerk of the United States Court of Appeals
       for the Third Circuit
_________________________________________________________________

Id. at 927. We agree that in enacting S 510(b), Congress did not intend
       to subordinate every claim brought by a shareholder, regardless of
the
       nature of the claim. We disagree with claimants, however, that the
       subordination of all claims brought by shareholders is a logical
       consequence of our holding that claims for the breach of a stock
       purchase agreement requiring the issuer to use its best efforts to
register
       its stock must be subordinated pursuant to S 510(b). 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
       S 510(b), which was intended to prevent shareholders from
recovering
       their equity investment in parity with general unsecured creditors.

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