In re Ual Corp.

Decision Date21 June 2005
Docket NumberNo. 04-4128.,04-4128.
Citation412 F.3d 775
PartiesIn the Matter of: UAL CORPORATION, Debtor. State Street Bank And Trust Company, Appellant.
CourtU.S. Court of Appeals — Seventh Circuit

Brian D. Sieve, Michael B. Slade (argued), Kirkland & Ellis, Chicago, IL, for Debtor.

George M. Cheever (argued), Kirkpatrick & Lockhart Nicholson Graham, Pittsburgh, PA, for Appellant.

Before EASTERBROOK, KANNE, and SYKES, Circuit Judges.

EASTERBROOK, Circuit Judge.

When United Airlines entered bankruptcy in December 2002, workers owned slightly more than half of its stock through an Employee Stock Ownership Plan. Fearing that the ESOP might sell this stock and that the Internal Revenue Service would deem the sale a change of control, which might jeopardize United's ability to use net operating losses as tax deductions in future years, see 26 U.S.C. § 382, United asked the court to forbid sales by the ESOP. Chief Bankruptcy Judge Wedoff granted this motion on the date the bankruptcy began and continued the injunction after a hearing two months later. The court did not require United to post a bond to protect the ESOP against loss (compare Fed.R.Civ.P. 65(c) with Fed. R. Bankr.P. 7065) or direct United to provide "adequate protection" of the investors' interests under 11 U.S.C. § 362(d)(1). State Street Bank and Trust Company, the Trustee of the ESOP, did not ask the district court (or this court) to require security or adequate protection, though it did file an appeal that lingered on the district judge's calendar for almost two years.

While that appeal was pending, the IRS issued a regulation that permits ESOPs to pass shares through to the employees, who may hold or sell them without jeopardizing the issuer's ability to use loss carry-forwards to offset future profits. 26 C.F.R. § 1.382-10T. United terminated the ESOP on June 27, 2003, and the Trustee distributed the shares to their beneficial owners, who have since been entitled to hold or sell as they please. The bankruptcy judge's injunction lapsed—it was not formally vacated, but the ESOP it addressed had ceased to exist, so it no longer had any effect. United asked the district judge to dismiss the proceedings as moot. Surprisingly, the judge brushed aside that request and proceeded to affirm on the merits. The Trustee has appealed—though its brief does not explain what relief we could afford given the ESOP's termination—and United has renewed its mootness argument.

Responding to United's position, the Trustee concedes that the underlying dispute was resolved in July 2003 by the shares' distribution to individual investors. Nonetheless, the Trustee contends, the dispute is live because the investors deserve compensation for the loss they suffered between the time of the bankruptcy court's order (when United's stock traded for $1.06 per share) and the dissolution of the ESOP (when the market price had fallen to 76¢ per share). Although the price has since risen (it was $2.02 the day before this appeal was argued), that gain is independent of the litigation: anyone who thought United a good investment could have purchased its stock in the open market. The injury was suffered by those who thought it a bad investment and sold as quickly as they could in June 2003; they lost 30¢ per share (plus the return on investments available between December 2002 and July 2003) compared with the financial position they would have enjoyed had the bankruptcy judge allowed them to sell earlier. As United sees things, however, this loss is not compensable because there is neither an injunction bond nor an adequate-protection agreement. If monetary relief is unavailable, then the controversy is moot.

The lack of financial security for the investors is unfortunate. The bankruptcy judge apparently believed that the investors were protected by the stock market, which was as likely to rise as to fall during the freeze on sales. That may well be so—in an efficient market today's price is the best estimate of the value of future events, a proposition no less true of bankrupt firms than of flourishing ones — but loss of liquidity is an immediate and independent injury; investors will pay more for tradable shares than for instruments that can be sold only with someone else's sufferance years in the future. The injunction also left investors underdiversified, and thus bearing uncompensated risk. Although the ESOP was deliberately non-diversified, with employees taking investment risk in exchange for control over the issuer, the exchange was no longer worthwhile with control in judicial (and managerial) rather than stockholders' hands. For investors who needed (or wanted) cash rather than certificates, or who wanted to reduce risk by diversifying their holdings, the court's order imposed an inevitable injury.

Requiring investors to bear the costs of illiquidity and underdiversification was both imprudent and unnecessary. United wants to preserve the value of tax deductions that, it contends, are worth more than $1 billion should it return to profitability. There is no reason why investors who need liquidity should be sacrificed so that other investors (principally today's debt holders) that will own United after it emerges from bankruptcy can reap a benefit; bankruptcy is not supposed to appropriate some investors' wealth for distribution to others. United should have been told to back up its assertions with cash, so that put-upon shareholders could be made whole. If United's views are right, it would not have had any trouble borrowing to underwrite a bond or other form of protection; and if lenders would not make such loans, that would have implied to the court that United's contentions are hot air. See In re Kmart Corp., 359 F.3d 866, 873 (7th Cir.2004).

A carefully drafted adequate-protection agreement could have protected stockholders against an erosion of their position while requiring them to indemnify United if the market price of the stock should rise, and the expense of a bond or other security turn out to have been unnecessary. Because there were gains from trade in this situation, United and the ESOP could have made a mutually beneficial deal outside of bankruptcy. Instead of cramming one side's position down the throat of the other in bankruptcy, the judge should have crafted a mutual-protection covenant that mirrored the likely non-bankruptcy transaction. See In re James Wilson Associates, 965 F.2d 160 (7th Cir.1992); In re Boomgarden, 780 F.2d 657 (7th Cir.1985).

Lack of security is doubly regrettable because the bankruptcy judge's injunction is problematic on the merits. The weaker the claim behind the injunction, the greater the investors' uncompensated risk of injury. The bankruptcy court relied on 11 U.S.C. § 105(a) plus § 362, the automatic-stay provision. The former is a means to enforce the Code rather than an independent source of substantive authority, see Kmart, 359 F.3d at 871 (citing cases), and the latter speaks to the matter indirectly if at all. Section 362(a)(3), the only arguably pertinent provision, blocks "any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate". Whether or not tax benefits are "property" under the Bankruptcy Code's capacious definition, see In re Prudential Lines Inc., 928 F.2d 565, 571-73 (2d Cir. 1991), an ESOP's sale of stock does not "obtain possession ... or exercise control" (emphasis added) over that interest.

Although a sale of stock could affect United's interest in its loss carry-forwards, this would not occur because of anything the ESOP possessed or controlled. Prudential Lines, the principal authority invoked in support of the bankruptcy court's decision, dealt with a distinct problem. A family of related corporations had filed consolidated tax returns until one of the firms entered bankruptcy. One non-bankrupt member of the group then proposed to take a worthless-stock deduction on account of its investment in the bankrupt entity; that tax benefit would have come in lieu of the corporate family's accumulated operating losses. Prudential Lines holds that taking the deduction would have exercised control over the debtor's operating losses; there is no equivalent example of control (or consumption) of a loss...

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