Liquidating Trust Comm. of the Del Biaggio Liquidating Trust v. Freeman (In re Del Biaggio)

• Decision Date: 06 January 2016
• Docket Number: No. 13–17500,13–17500
• Citation: 834 F.3d 1003
• Parties: In re William James Del Biaggio, III, Debtor, Liquidating Trust Committee of the Del Biaggio Liquidating Trust, Plaintiff–Appellee, v. David Freeman, Defendant–Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

834 F.3d 1003

In re William James Del Biaggio, III, Debtor,Liquidating Trust Committee of the Del Biaggio Liquidating Trust, Plaintiff–Appellee,

v.David Freeman, Defendant–Appellant.

No. 13–17500

United States Court of Appeals, Ninth Circuit.

Submitted January 6, 2016*, San Francisco, California

Merle C. Meyers and Michele Thompson, Meyers Law Group, P.C., San Francisco, California, for Defendant–Appellant.

Michael M. Lauter, Michael H. Ahrens and Steven B. Sacks, Sheppard, Mullin, Richter & Hampton LLP, San Francisco, California, for Plaintiff–Appellee.

Before: Alex Kozinski, John T. Noonan, and Diarmuid F. O'Scannlain, Circuit Judges.

OPINION

O'SCANNLAIN

, Circuit Judge:

A provision of the Bankruptcy Code requires that damages claims arising from the purchase or sale of the security of a debtor be subordinated to other claims senior to or equal to it. We must decide whether such treatment applies where the debtor is an individual.

I

A

The Nashville Predators are a National Hockey League (“NHL”) team in Nashville, Tennessee. As of 2007, the Predators were owned by Craig Leipold and his family. During that year, however, David Freeman learned that Leipold intended to sell the team to a third party who wanted to move the Predators to another state. As a result, Freeman began organizing a group of Nashville investors to buy the team. Leipold talked with Freeman about purchasing the Predators, but was also in conversation with other potential buyers, including William Del Biaggio, III. Eventually, Leipold and the NHL Commissioner suggested to Freeman that his group of investors join forces with Del Biaggio to make a joint bid to buy the team. In so suggesting, Leipold related previous assertions made to him by Del Biaggio that stressed Del Biaggio's ability to fund the purchase and his experience with professional hockey.

During the summer and fall of 2007, Freeman and Del Biaggio engaged in negotiations concerning the acquisition of the Predators. Del Biaggio confirmed his ability to fund a $70 million share in the investment, and told Freeman he had connections in the NHL and hoped to become a major owner of a second NHL team. Freeman and his investors ultimately reached an agreement with Del Biaggio to purchase the Predators from Leipold for $193 million. Before the closing date, however, Del Biaggio contacted Freeman and informed him he could only invest $25 million, not the $70 million he originally promised. He proposed to replace the remainder with a $40 million increase in a loan from CIT Bank. Del Biaggio reported that he personally guaranteed the loan and that he would pay all the interest accrued on account of the loan increase. He also agreed to provide a personal guarantee to underwrite the Predators' lease obligations up to $10 million.

The sale of the Predators to Freeman and his cohort of investors, including Del Biaggio, closed on December 7, 2007. As a result of the sale, the Predators became wholly owned and operated by Nashville Hockey Club Limited Partnership, LLC, which is in turn wholly owned by Predators Holdings, LLC (“Holdings”).

B

Freeman invested $31 million to obtain 31 Common Units of Holdings. Common Units were subject to capital calls and not afforded a liquidation preference, unlike the other form of equity investment in Holdings, the Series A Units. Freeman also made a $5 million subordinated loan to Holdings in exchange for its promissory note.

Del Biaggio invested in Holdings through an entity called Forecheck Investments, LLC (“Forecheck”). Forecheck paid $30 million to obtain all 30 Series A Units of Holdings. These Series A Units gave Forecheck 32.6% of the voting units in Holdings. Del Biaggio in turn invested $25 million to acquire an 83.33% interest in Forecheck. As a result, Del Biaggio controlled roughly 27% of the voting securities of Holdings.

C

Several months after the sale, Freeman learned that Del Biaggio never had the funds to support his guarantees and that the $25 million Del Biaggio already invested was in fact money he had embezzled from his clients. Del Biaggio filed for Chapter 11 bankruptcy which gave rise to the current proceeding. He was later indicted and convicted for various financial frauds and sentenced to an eight-year prison term.

Del Biaggio's fraud became headline news in Nashville, and as a result Predators revenues stagnated. To keep the business afloat, Holdings made capital calls to holders of the company's Common Units, including Freeman. Freeman satisfied this first capital call with a payment of $2,632,075. To prevent termination of the CIT Bank loan and the Predators' lease, he also replaced Del Biaggio's guarantees with his own. Freeman alleges he was unable to satisfy later capital calls because of these guarantees, and that as a result, his membership units in Holdings became “heavily diluted and virtually worthless.”

D

In October 2008, Freeman filed a general unsecured claim against Del Biaggio's bankruptcy estate seeking damages of an undetermined amount arising from his fraud in the Holdings transaction.¹ In a later amended proof of claim, Freeman sought damages of $38,632,075. This amount included Freeman's initial $31 million investment in Holdings securities, the $5 million of subordinated debt he issued to Holdings in exchange for the promissory note, and the $2,632,075 paid in the first capital call. In response, the Liquidating Trust Committee of the Del Biaggio Liquidating Trust, the entity charged with prosecuting claims objections in Del Biaggio's bankruptcy, filed a counterclaim against Freeman and sought summary judgment. The counterclaim sought subordination and disallowance of Freeman's claim based on 11 U.S.C. § 510(b)

.

E

The bankruptcy court granted the Committee's motion for summary judgment, finding Freeman's claim was subject to mandatory subordination under § 510(b)

. After determining that Holdings was an “affiliate” of Del Biaggio via his ownership in Forecheck the court concluded that § 510(b) applied to Freeman's fraud claim because the plain language of the statute covers claims arising from the purchase of the securities of a debtor's affiliate. The bankruptcy court further reasoned that subordinating Freeman's claim under § 510(b) served the purposes of the statute, because as an investor in Holdings, he bargained for both a greater share of profits and a greater share of risks than Del Biaggio's unsecured creditors. The court also determined that the claims of Del Biaggio's other creditors were senior to Freeman's claim based on its conclusion that notes or shares issued by a subsidiary create no claim to the assets of a parent. Freeman appealed to the district court, which in turn affirmed the order and judgment of the bankruptcy court. Freeman timely appealed here.

II

We review a district court's decision on appeal from a bankruptcy court de novo, and apply the same standards applied by the district court without deference to that court. In re Thorpe Insulation Co. , 677 F.3d 869, 879 (9th Cir. 2012)

. When considering a bankruptcy court's grant of summary judgment, we apply the regular summary judgment standard in order to “determine whether there are any genuine issues of material fact and whether the bankruptcy court correctly applied the substantive law.” In re Caneva , 550 F.3d 755, 760 (9th Cir. 2008)

(quoting In re Bakersfield Westar Ambulance, Inc. , 123 F.3d 1243, 1245 (9th Cir. 1997) ).

III

Freeman first contends that the bankruptcy court and the district court erred in applying Bankruptcy Code Section 510(b)

to his claim against Del Biaggio.

Section 510(b)

reads as follows:

§ 510. Subordination

....

(b) 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.

11 U.S.C. § 510(b)

. The statute operates in two steps. First, it commands that specific types of claims relating to securities, including claims “for damages arising from the purchase or sale” of a debtor's securities or the securities of an affiliate “shall be subordinated.” See

In re Betacom of Phoenix, Inc. , 240 F.3d 823, 828–29 (9th Cir. 2001) (observing that subordination of qualifying claims under § 510(b) is mandatory). Second, it identifies other claims to which a qualifying claim must be subordinated—“all claims or interests that are senior to or equal the claim or interest represented by” the debtor's security or the security of his affiliate. Considered as a whole, § 510(b) “effectuate[s] one of the general principles of corporate and bankruptcy law: that creditors are entitled to be paid ahead of shareholders in the distribution of corporate assets.” In re Am. Wagering, Inc. , 493 F.3d 1067, 1071 (9th Cir. 2007). This principle is broadly known as the absolute priority rule. See, e.g. , In re Telegroup, Inc. , 281 F.3d 133, 139–40 (3d Cir. 2002) (explaining the absolute priority rule and its relation to § 510(b) ).

It is undisputed that Freeman's claim is a damages claim. Freeman also admits that his Holdings investments are securities² and that Holdings is an affiliate³ of Del Biaggio. At this first step, Freeman argues only that the bankruptcy court and the district court erred in applying § 510(b)

to his claim against Del Biaggio because his claim is not one “arising from the purchase or sale” of Holdings.

A

Beginning with the statute's plain text, we observe that § 510(b)

's “arising from” language reaches broadly to subordinate damage claims involving qualifying securities. The phrase “arising from” as employed in § 510(b) “connotes, in ordinary...