In re Telegroup, Inc.

• Citation: 281 F.3d 133
• Decision Date: 15 February 2002
• Docket Number: No. 00-3823.,00-3823.
• Parties: In re TELEGROUP, INC. Baroda Hill Investments, Ltd.; Leheron Corporation, Ltd.; Kimble John Winter, Appellants, v. Telegroup, Inc.
• Court: United States Courts of Appeals. United States Court of Appeals (3rd Circuit)

281 F.3d 133

In re TELEGROUP, INC.

Baroda Hill Investments, Ltd.; Leheron Corporation, Ltd.; Kimble John Winter, Appellants, v. Telegroup, Inc.

No. 00-3823.

United States Court of Appeals, Third Circuit.

Argued October 11, 2001.

Filed February 15, 2002.

COPYRIGHT MATERIAL OMITTED

J. Barry Cocoziello, Robert J. McGuire (Argued), Podvey, Sachs, Meanor, Catenacci, Hildner & Cocoziello, Newark, NJ, Counsel for Appellants Baroda Hill Investments, Ltd., LeHeron Corporation, Ltd., and Kimble John Winter.

James A. Stempel, Jason N. Zakia (Argued) Kirkland & Ellis, Chicago, IL, Counsel for Appellee Telegroup, Inc.

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

OPINION OF THE COURT

BECKER, Chief Judge.

This bankruptcy appeal requires us to construe 11 U.S.C. § 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 § 510(b).

Claimants argue that § 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 § 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.

Telegroup would read § 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 underlying § 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 of § 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 § 510(b), which provides that any claim for damages "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 § 510(b). The District Court affirmed, and claimants filed this appeal.

The District Court had jurisdiction pursuant to 28 U.S.C. § 158(a), and we have jurisdiction pursuant to 28 U.S.C. § 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 § 510(b) their claims would have the same priority as common stock, and would be subordinated to the claims of general unsecured creditors.

The question of the scope of § 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 § 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 § 510(b)).

In construing § 510(b), we begin, as we must, with the text of the statute. See Robinson v. Shell Oil Co., 519 U.S. 337, 340, 117 S.Ct. 843, 136 L.Ed.2d 808 (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 Ward Holding Corp., No. 97-1409, 2001 WL 1752566, at *7, 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 § 510(b).

Telegroup responds that claims arising from the purchase or sale of a security under § 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 § 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...