Gernsbacher v. Campbell (In re Equip. Equity Holdings, Inc.)

• Citation: 491 B.R. 792
• Decision Date: 12 April 2013
• Docket Number: Adversary No. 11–03362–sgj.,Bankruptcy No. 09–38306–sgj–7.
• Parties: In re EQUIPMENT EQUITY HOLDINGS, INC., Debtor. Harold Gernsbacher, Andrew Scruggs, James Scruggs, Lee Scruggs, William Scruggs, Robert Zintgraff, David Campbell, Reed Jackson, Cynthia Jackson, Lynda Campbell, Jeff Grandy, Jeffrey Vreeland, Walter Eskuri, Roger Vang, Reuben Palm, James Palm, Richard Palm, Mark Palm, Michael Palm, Thomas Palm, Shannon Palm, Susan Palm, Maureen Palm, Pamela Palm, Kristen Palm, Gene Lee, Stephen Howze and Stephen Reynolds, Plaintiffs, v. David Campbell, S. Reed Jackson, Robert N. Zintgraff, Andrew Scruggs, Walter Eskuri, Harold Gernsbacher, Glencoe Growth Closely–Held Business Fund, L.P., Stockwell Fund, L.P., Massachusetts Mutual Life Insurance Company, MassMutual High Yield Partners II LLC, Glencoe Capital Partners II L.P., Thomas M. Garvin, Glencoe Capital Partners II, Thomas L. Bindley Revocable Trust, Kevin Bruce, Ed Poore, and Bill Aisenberg, Defendants.
• Court: United States Bankruptcy Courts. Fifth Circuit. U.S. Bankruptcy Court — Northern District of Texas

491 B.R. 792

In re EQUIPMENT EQUITY HOLDINGS, INC., Debtor.Harold Gernsbacher, Andrew Scruggs, James Scruggs, Lee Scruggs, William Scruggs, Robert Zintgraff, David Campbell, Reed Jackson, Cynthia Jackson, Lynda Campbell, Jeff Grandy, Jeffrey Vreeland, Walter Eskuri, Roger Vang, Reuben Palm, James Palm, Richard Palm, Mark Palm, Michael Palm, Thomas Palm, Shannon Palm, Susan Palm, Maureen Palm, Pamela Palm, Kristen Palm, Gene Lee, Stephen Howze and Stephen Reynolds, Plaintiffs,

v.David Campbell, S. Reed Jackson, Robert N. Zintgraff, Andrew Scruggs, Walter Eskuri, Harold Gernsbacher, Glencoe Growth Closely–Held Business Fund, L.P., Stockwell Fund, L.P., Massachusetts Mutual Life Insurance Company, MassMutual High Yield Partners II LLC, Glencoe Capital Partners II L.P., Thomas M. Garvin, Glencoe Capital Partners II, Thomas L. Bindley Revocable Trust, Kevin Bruce, Ed Poore, and Bill Aisenberg, Defendants.

Bankruptcy No. 09–38306–sgj–7.

Adversary No. 11–03362–sgj.

United States Bankruptcy Court,

N.D. Texas,

Dallas Division.

April 12, 2013.

J. Robert Forshey, Julie C. John, Lynda L. Lankford, Jeff P. Prostok, Forshey & Prostok, LLP, Ft. Worth, TX, for Debtor.

Robert A. Simon, Spencer D. Solomon, Barlow Garsek & Simon, LLP, Fort Worth, TX.

Shannon Palm, Wayzata, MN, pro se.

Erik Kyle Martin, Ian T. Peck, Haynes and Boone, LLP, Fort Worth, TX, Derek J. Meyer, Jason D. Strabo, McDermott, Will & Emery LLP, Los Angeles, CA, Nathan F. Coco, McDermott Will & Emery, LLP, Chicago, IL, Maurice K. Guinn, Gentry Tipton & McLemore, Knoxville, TN, for Defendants.

AMENDED¹MEMORANDUM OPINION IN SUPPORT OF JUDGMENT: (1) DENYING PLAINTIFFS' CLAIMS FOR (A) SUBORDINATION UNDER SECTION 510 AND (B) RECHARACTERIZATION; BUT (2) TREATING CERTAIN PLAINTIFFS/SELLER NOTEHOLDERS AS PARI PASSU WITH THE DEFENDANTS/NEW NOTEHOLDERS

STACEY G. JERNIGAN, Bankruptcy Judge.

“ Equity is a roguish thing. For law we have a measure, know what to trust to; Equity is according to the conscience of him that is Chancellor, and as that is larger or narrower, so is Equity.”

–John Selden²

The above-referenced adversary proceeding (“Adversary Proceeding”) involves the doctrines of equitable subordination (as set forth in section 510 of the Bankruptcy Code) and recharacterization (a doctrine created in case law). Specifically, the Adversary Proceeding involves a dispute within a chapter 7 bankruptcy case between two different, sophisticated creditor groups wherein one creditor group (the plaintiffs) seeks to have the claims of the other creditor group (the defendants) either equitably subordinated to the plaintiffs' claims or recharacterized as equity. A chapter 7 trustee holds a pot of money (millions of dollars) that he cannot disburse until this Adversary Proceeding is resolved. As will be explained in detail below, the claims of the plaintiff-group, against the debtor-entity, originated first in time—having originated in connection with a so-called “roll up” of the plaintiffs' former, separate companies into the debtor-entity ( i.e., the debtor-entity was created in order to buy the plaintiffs' former companies, creating one big company, and the plaintiffs were each paid cash, notes payable, and stock for the purchase of their companies). The claims of the defendant-group that are sought to be subordinated or recharacterized were created much later, when the defendants made loans to the debtor-entity at a time when the debtor-entity was in serious financial distress ( i.e., unfortunately, the “roll up” did not create the synergies or profitable company that had been anticipated); moreover, the defendant-group loans were documented in such a way to entitle them to payment ahead of the plaintiff-group.

The court held a trial in the Adversary Proceeding over nine days in 2012. The court has decided to deny the requests for subordination and recharacterization. However, the court has decided that a subset of the Plaintiffs (who never executed certain documents—as later described herein) should be treated pari passu with the Defendants. The following are the court's findings of fact and conclusions of law pursuant to Fed. R. Bankr.P. 7052. Any finding of fact more appropriately regarded as a conclusion of law should be treated as such, and vice versa.

I. INTRODUCTION

This litigation began with the filing of an involuntary bankruptcy petition. On December 1, 2009, six creditors ³ filed an involuntary chapter 7 bankruptcy petition against Equipment Equity Holdings, Inc., formerly named Strategic Equipment and Supply Corporation (referred to interchangeably herein as the “Debtor” or “SESC” or the “debtor-entity”). After initial opposition, the Debtor consented to an Order for Relief on May 25, 2010. As of the Petition Date, the Debtor was no longer an operating company, as it had sold substantially all of its assets more than four years earlier. Thus, upon the commencement of the bankruptcy case, the Debtor held, as its only remaining assets: (a) approximately $3.6 million in cash; (b) certain alleged potential causes of action for fraudulent transfers and alleged breaches of fiduciary duty; and (c) a small minority equity interest in the Debtor's successor-in-interest, also known as Strategic Equipment and Supply Corporation (“New SESC”). New SESC is an operating restaurant and supply company, based in Dallas, and is majority owned by an affiliate of Brazos Private Equity Partners (“Brazos”).

This Adversary Proceeding was filed on June 10, 2011, almost a year after the Order for Relief was entered. The AdversaryProceeding, at its core, as alluded to above, is a dispute over the priority of payment among two groups of creditors: (a) the individual holders of certain “Seller Notes” (the “Plaintiffs”); ⁴ and (b) the individual holders of certain “New Notes” (the “Defendants”).⁵

The “Seller Notes” (herein so called) are those certain 9% Junior Subordinated Promissory Notes, issued by SESC. SESC issued Seller Notes in the aggregate principal amounts of $8,213,999.99 on or about January 14, 2000, then another $1,957,018.84 on or about September 12, 2000, and then another $5,111,816.73 on or about March 14, 2002, for a total of $15,282,825.70. The total outstanding balance of the Seller Notes as of May 25, 2010 (the date of the Order for Relief) was $28,097,714.31. The Plaintiffs collectively hold 100% of the Seller Notes.⁶

The “New Notes” (herein so called) are those certain 15% Junior Subordinated Promissory Notes issued by SESC on or about March 8, 2002, in the aggregate principal amount of $6 million (the “New Notes”). The total outstanding balance of the New Notes as of May 25, 2010 (the date of the Order for Relief) was $31,759,850.84. The Defendants collectively hold 100% of the New Notes, but one aspect of this is noteworthy. Six of the Plaintiffs that are, obviously, Seller Note holders ( i.e., Harold Gernsbacher, Jr., Robert N. Zintgraff, David Campbell, Reed Jackson, Andrew Scruggs and Walter Eskuri) also hold New Notes representing 7.35% of the outstanding balance of the New Notes. These individuals are named as nominal Defendants in their capacities as holders of both types of notes at issue in the Adversary Proceeding. However, these individuals have already agreed to the relief sought by the Plaintiffs in this Adversary Proceeding and are not adverse to the Plaintiffs. In other words, regardless of the outcome of this Adversary Proceeding, these individuals request that their New Notes be afforded the same treatment as Defendants' New Notes. For the avoidance of doubt, the Defendants who are not also Plaintiffs hold 92.65% of the outstanding balance of the New Notes.

With regard to this dispute over priority of payment, the holders of the Seller Notes have asserted three specific causes of action against the holders of the New Notes.⁷First, the holders of the Seller Notes have sought to recharacterize the New Notes as equity pursuant to the Fifth Circuit's holding in Grossman v. Lothian Oil, Inc. (In the Matter of Lothian Oil, Inc.), 650 F.3d 539 (5th Cir.2011). As to the second and third causes of action, the holders of the Seller Notes further contend that the New Notes should be subordinated to the Seller Notes pursuant to sections 510(b) and (c) of the Bankruptcy Code. Additionally, the holders of the Seller Notes have requested a declaration that the underlying documentation evidencing the New Notes, which effectively subordinated the Seller Notes to the New Notes, is unenforceable against the holders of the Seller Notes.⁸

For the reasons articulated below, the court holds that the New Notes are properly characterized as debt and, thus, should not be “recharacterized” (under case law such as Lothian Oil ) and are not subject to subordination under either section 510(b) or (c) of the Bankruptcy Code. As to the Plaintiff's declaratory judgment request, the court holds that certain of the Plaintiffs are, in fact, entitled to pari passu treatment with the New Notes, due to the fact that certain of these Plaintiffs did not execute an acceptable form of written consent to effectuate the subordination of the Seller Notes to New Notes. However, to the extent a Plaintiff gave adequate consent to the subordination of the Seller Notes to the New Notes and signed documentation evidencing such consent (in this case, through the execution of the Amended and Restated Securities Purchase Agreement), the court believes that such Plaintiff consented to the subordination of its Seller Notes to the New Notes and, thus, his/her Seller Notes will be treated as such.

II. JURISDICTION

Bankruptcy subject matter jurisdiction exists in this Adversary Proceeding, pursuant to 28 U.S.C. § 1334(b). This bankruptcy court has authority to exercise such subject matter jurisdiction, pursuant to 28 U.S.C. § 157(a) and the Standing Order of Reference of Bankruptcy Cases and Proceedings (Misc. Rule No. 33), for the Northern District of Texas, dated August 3, 1984. “Core”...