O'Donnell v. Tristar Esperanza Props., LLC (In re Tristar Esperanza Props., LLC)

• Decision Date: 08 March 2013
• Docket Number: Adversary No. SA 12–01041–TA.,Bankruptcy No. SA 11–21095–TA.,BAP No. CC–12–1340–KlPaDu.
• Citation: 488 B.R. 394
• Parties: In re TRISTAR ESPERANZA PROPERTIES, LLC, a California Limited Liability Company, Debtor. Jane O'Donnell; Pensco Trust Company, a New Hampshire Company, Appellants, v. Tristar Esperanza Properties, LLC, a California Limited Liability Company, Appellee.
• Court: U.S. Bankruptcy Appellate Panel, Ninth Circuit

488 B.R. 394

In re TRISTAR ESPERANZA PROPERTIES, LLC, a California Limited Liability Company, Debtor.Jane O'Donnell; Pensco Trust Company, a New Hampshire Company,^* Appellants,

v.Tristar Esperanza Properties, LLC, a California Limited Liability Company, Appellee.

BAP No. CC–12–1340–KlPaDu.

Bankruptcy No. SA 11–21095–TA.

Adversary No. SA 12–01041–TA.

United States Bankruptcy Appellate Panel of the Ninth Circuit.

Argued and Submitted Feb. 22, 2013.

Decided March 8, 2013.

Nancy S. Goldenberg, Santa Ana, CA, United States Trustee, U.S. Trustee.

Ian Landsberg, Landsberg & Associates APC, Woodland Hills, CA, for Debtor.

Before KLEIN,^**PAPPAS, and DUNN, Bankruptcy Judges.

OPINION

KLEIN, Bankruptcy Judge.

This is a mandatory subordination case. The “damages” clause of 11 U.S.C. § 510(b) mandates subordination of claims for “damages arising from the purchase or sale” of a security of the debtor. The bankruptcy court concluded that § 510(b) mandatory subordination applies to the claim of appellant, who withdrew as a member of the debtor limited liability company (“LLC”) and obtained a judgment valuing her equity interest after the LLC did not honor a provision in its operating agreement requiring buy-back of the withdrawing member's interest.

We agree with the bankruptcy court that permitting a former equity holder to recover the value of an equity-based claim on a par with general unsecured creditors is the sort of bootstrapping that § 510(b) mandatory subordination is designed to prevent. Rejecting appellant's argument that “damages arising from the purchase or sale” of a security does not encompass contract-based awards to withdrawing LLC members, we AFFIRM.

FACTS

The debtor, Tristar Esperanza Properties, LLC, is a California limited liability company whose sole asset is real property in Orange County, California. Tristar's organic governing document is in the form of an operating agreement.

Appellant Jane O'Donnell acquired a membership interest in Tristar (about 14 percent) in 2005 by means of a $100,000 capital contribution made through her investment retirement account with appellant Pensco Trust Company, which entity is content to be represented by O'Donnell and has not appeared in its own right.

In 2008, O'Donnell invoked the Tristar operating agreement's withdrawal provision by giving written notice of such intent.

Under the buy-back provision in the Tristar operating agreement, the notice of withdrawal triggered a process in which Tristar and the withdrawing member would use best efforts to agree upon the fair market value of the subject interest.

Tristar paid O'Donnell $60,000 on account and, jointly with O'Donnell, retained an appraiser who determined that the fair market value of O'Donnell's interest was $399,918 ($305/sq.ft.) as of the time of her withdrawal. Tristar contends that this value is “absurd” because it was not adjusted to reflect $2.69 million in secured debt against its sole asset, which, if counted, would have reduced the recovery by about $377,000.

After Tristar declined to accept the valuation, O'Donnell initiated an arbitration that concluded in 2010 with a determination that Tristar was bound by the $399,918 value.

The arbitrator awarded O'Donnell damages of $399,918, less the $60,000 that Tristar had already paid.

The arbitration award was confirmed by a California superior court and reduced to judgment. The abstract of judgment was recorded in Orange County in December 2010.

Tristar filed its chapter 11 case in the Central District of California in August 2011 and filed this adversary proceeding against O'Donnell and Pensco Trust, alleging three claims for relief: (1) mandatory subordination under § 510(b); (2) equitable subordination under § 510(c); and (3) avoidance of a preference under 11 U.S.C. § 547(b).

The trial court disposed of all three claims for relief on cross-motions for summary judgment. The net result was that Tristar prevailed on the mandatory subordination count, while the other two counts were resolved against Tristar.

With respect to mandatory subordination, the court reasoned that the scope of § 510(b) is broad and leaves little discretion where literal application is not demonstrably at odds with the intent of Congress. It explained that § 510(b) is designed to prevent equity holders from diluting the recovery of creditors who deal with the debtor only on a credit basis with no expectation of sharing in the value of the enterprise and with an expectation of having rights senior to equity interests.

In particular, the court rejected the argument that the confirmed arbitration award did not constitute a claim for “damages” within the meaning of the § 510(b) damages clause and emphasized that the arbitrator found that the debtor had breached its operating agreement. Under these circumstances, the court concluded that such an award qualified as § 510(b) “damages.”

This timely appeal, limited to the § 510(b) issue, ensued.

JURISDICTION

Federal subject-matter jurisdiction exists under 28 U.S.C. § 1334(b). The bankruptcy judge had authority to hear and determine the matter under 28 U.S.C. §§ 157(b)(2)(A) and (O); no party has questioned that authority. We have jurisdiction under 28 U.S.C. § 158(a)(1).

ISSUES

1) Whether a contractually-required buy-back of an LLC membership interest from a withdrawing member constitutes a “purchase or sale” of a “security” of the debtor within the meaning of 11 U.S.C. § 510(b).

2) Whether the appellants' claim is for “damages” within the meaning of 11 U.S.C. § 510(b).

3) Whether withdrawal as an LLC member prior to the bankruptcy filing renders 11 U.S.C. § 510(b) inapplicable.

4) Whether judicial estoppel should be imposed.

STANDARD OF REVIEW

We review summary judgment de novo. Ghomeshi v. Sabban (In re Sabban), 600 F.3d 1219, 1221–22 (9th Cir.2010); Bendon v. Reynolds (In re Reynolds), 479 B.R. 67, 71 (9th Cir. BAP 2012). De novo review permits an appellate court to substitute its judgment for that of the trial court. Barclay v. Mackenzie (In re AFI Holding, Inc.), 525 F.3d 700, 702 (9th Cir.2008). We must determine whether, viewing the summary judgment evidence in the light most favorable to the non-moving party, any genuine issue of material fact remains for trial and whether Tristar was entitled to a § 510(b) mandatory subordination judgment as a matter of law. Gill v. Stern (In re Stern), 345 F.3d 1036, 1040 (9th Cir.2003).

DISCUSSION

This appeal requires construction of 11 U.S.C. § 510(b). After examining the applicable language of § 510(b), we tour the statute's legislative history and policy objectives. This inspection of the statute's underpinnings confirms that the arbitration award falls in the zone of transactions requiring mandatory subordination under § 510(b).

For us, this is a case of first impression in that we deal for the first time with the § 510(b) “damages” clause in the context of an LLC and an arbitration stemming from the withdrawal provision of the LLC's operating agreement. The ultimate question is: whether a judgment debt, based on a confirmed arbitration award enforcing a buy-back provision in the debtor LLC's operating agreement, constitutes a claim “for damages arising from the purchase or sale of” a “security” of the debtor. 11 U.S.C. § 510(b). It does.

I

The Bankruptcy Code provides for three distinct forms of subordination: (1) subordination by agreement; (2) mandatory subordination of certain claims related to a security; and (3) equitable subordination. The first is a matter of contract; the second a matter of the nature of a transaction; and the third a matter of inequitable conduct. We focus here on the second.

Subordination demotes a claim from its nominal priority. A subordinated claimant receives a distribution junior in priority to the nominal class. 4 Collier on Bankruptcy ¶ 510.01 (Alan N. Resnick & Henry J. Sommer eds., 16th ed.) (“Collier”).

As our primary task is to interpret § 510(b) de novo, we begin with its language:

(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) (emphasis supplied).

Thus, § 510(b) contemplates three types of claims—rescission, damages, and reimbursement/contribution—that all have a nexus with the purchase or sale of a security. Allen v. Geneva Steel Co. (In re Geneva Steel Co.), 281 F.3d 1173, 1177 (10th Cir.2002); see alsoCollier ¶ 510.04. Only the damages clause is involved in this appeal.

A

At the threshold lies the question whether a membership interest in an LLC is a “security” as defined by Bankruptcy Code § 101(49). 11 U.S.C. § 101(49).

That statutory definition of “security” does not provide a functional description. Rather, it merely lists positive and negative examples. There is a fifteen-item list of examples of securities. 11 U.S.C. § 101(49)(A). And, there are seven examples of what is not a security. 11 U.S.C. § 101(49)(B). Neither list mentions a membership interest in an LLC.

But, the omission of mention of a LLC membership interest from the examples of “security” at § 101(49)(A) is not fatal to the status of such an interest as a “security” because the operative verb at the beginning of the list is “includes”: “The term ‘security’—(A) includes—....” 11 U.S.C. § 101(49)(A).

Section 102 of the Bankruptcy Code provides a statutory rule of construction whereby the term “includes” is not restrictive. See11 U.S.C. § 102(3) (“In this title—... (3) ‘includes' and ‘including’ are not limiting”). Therefore, the statutory list of what is a ...