MEMORANDUM OF OPINION REGARDING THE TREATMENT AND VALUATION OF THE CLAIM OR INTEREST OF THE MINORITY VOTING TRUST [DOCKET 592]

GERALDINE MUND, Bankruptcy Judge.

This valuation arises from a dissolution action of the Debtor corporation. Pursuant to Cal. Corp.Code § 2000, on November 21, 2008, after extensive litigation, the Superior Court entered a value of the Minority Voting Trust's interest (hereafter "Minority") in the amount of $4,906,475, plus interest to the date of judgment for a total of $5,249,928. This represented 40.25 percent of the total value of the Debtor corporation.1 Once that was determined, the Debtor could either pay that amount or liquidate. This ruling was appealed by the Majority.2

The Majority failed to obtain a stay from the Court of Appeal and on January 22, 2009, just before the time to pay the purchase price, it filed this bankruptcy case. The Minority filed claim #73 on May 14, 2009, asserting a liquidated total of $6,008,424.75 ($5,249,928 per the Superior Court judgment and $758,496.75 in pre-petition legal fees), and it also noted that it was claiming an amount to be determined for post-petition fees under Cal. Corp.Code § 2000(c).

In the first amended plan, the Debtor classified the Minority as an equity holder, who would receive nothing under the plan. I agreed with this classification, which the Minority appealed. Later the confirmation order and the objection to claim were also appealed to the District Court and were combined in one ruling, which was favorable to the Minority.3 The Debtor then appealed to the Ninth Circuit, which dismissed that appeal as interlocutory, noting that "the bankruptcy court has not yet had the opportunity to exercise its fact-finding power and value the claims at issue; by dismissing the appeal, we avoid addressing the legal questions on an underdeveloped record."4

While this Court wishes that the Ninth Circuit would have resolved the critical legal issue of whether the status of the Minority is that of a holder of an unsecured claim or whether it holds a equity interest (which probably would have resolved all of the other issues), this did not occur. So, once again, the Debtor seeks an order that the Minority holds an equity interest and is not an unsecured creditor, but with a new twist. The Debtor argues that the effect of the Dissolution Order and the District Court Order is to create a forced purchase and this is controlled by 11 USC § 510(b), which subordinates this claim to the same priority as that of common stock.5 This issue was not dealt with in the District Court Opinion, which concerned my prior ruling that the classification of the Minority's interest depended on whether the right to payment had matured or become non-contingent prior to the filing of the bankruptcy. Whether the District Court was correct on its ruling as to the effect and timing of maturity will have to await resolution by the Ninth Circuit at some later date.

Does 11 USC § 510(b) Require that the Minority Claim Be Treated As If It Were Common Stock?

Section 510(b) of the Bankruptcy Code provides:

11 U.S.C. § 510(b).

The question is whether the Dissolution Order and the District Court Order have created a forced purchase, thus calling § 510(b) into action.

Ninth Circuit and Other Courts of Appeal Decisions

Decisions in the Ninth Circuit interpreting § 510(b) start with Am. Broad. Sys. v. Nugent (In re Betacom), 240 F.3d 823 (9th Cir.2001). While the facts of Betacom are not directly analogous to the present case (claim for damages under merger agreement pursuant to which target/debtor shareholders should have received stock of acquirer/debtor but did not; claim against acquirer in jointly administered cases), Betacom has been widely cited for the Ninth Circuit's expansive reading of § 510(b). In deciding to subordinate the claim under § 510(b), the court stated that § 510(b) was not limited to cases of shareholder fraud, that the subordinated claimant need not actually be a shareholder and that an actual sale of a security is not required. Betacom, 240 F.3d at 828-31. The court's decision rested on the policy behind § 510(b):

Betacom, 240 F.3d at 829-830.

The Ninth Circuit decided a subsequent case under § 510(b), Racusin v. Am. Wagering, Inc. (In re Am. Wagering, Inc.), 493 F.3d 1067 (9th Cir.2007), in which it restated its expansive reading of § 510(b), but declined to subordinate a claim under § 510(b). The claimant was not a shareholder and had not contracted to be a shareholder; he had merely contracted to be paid for his services on the basis of share price.

Several other Courts of Appeals have also adopted expansive readings of § 510(b), in each case concluding that the language of § 510(b)("arising from the purchase or sale") is ambiguous and turning to legislative history and policy considerations, just as the Ninth Circuit did in Betacom. In Allen v. Geneva Steel Co. (In re Geneva Steel Co.), 281 F.3d 1173 (10th Cir.2002), the Tenth Circuit subordinated a shareholder's "fraudulent retention" claim (that debtor's fraud caused the shareholder to retain shares). The court concluded that § 510(b) bars claims arising from the purchase or sale of a security and "is not limited to issuance related claims." Id. at 1182. In Baroda Hill Inv., Inc. v. Telegroup, Inc. (In re Telegroup, Inc.), 281 F.3d 133 (3d Cir.2002), the Third Circuit subordinated shareholder's breach of contract claims based on the debtors' failure to use their best efforts to ensure stock was registered and freely tradable. The court declined to distinguish claims based on actionable conduct occurring after purchase of the security from claims based on actionable conduct occurring at the time of the purchase. In Rombro v. Dufrayne (In re Med Diversified, Inc.), 461 F.3d 251 (2d Cir.2006), the Second Circuit subordinated a breach of contract claim by a former employee for debtor's failure to issue its shares: "we interpret section 510(b) broadly to require subordination of the claim at issue." Id. at 259.

The Fifth Circuit's decision in SeaQuest Diving, LP v. S & J Diving, Inc. (In re SeaQuest Diving, LP), 579 F.3d 411 (5th Cir.2009) is the most factually similar Court of Appeals decision to the Orange County Nursery one, because it subordinated a claim based on a state court judgment enforcing a contract for the debtor to repurchase partnership interests in itself. However, the SeaQuest Diving contract "rescinded" the claimants' purchase of partnership interests. The Fifth Circuit distinguished this rescission-based claim, which was subject to § 510(b) subordination, from a claim based on redemption of ownership interests, which might not be. (The opinion examined several decisions refusing to subordinate promissory notes issued by debtors to repurchase their own stock, Montgomery Ward Holding Corp. v. Schoeberl (In re Montgomery Ward Holding Corp.), 272 B.R. 836, 844-45 (Bankr. D.Del.2001), abrogated on other grounds by Telegroup, 281 F.3d at 142; Official Comm. of Unsecured Creditors v. Am. Capital Fin. Servs. (In re Mobile Tool Int'l, Inc.), 306 B.R. 778, 782 (Bankr. D.Del.2004), which are discussed below, but declined to speak to whether they were correctly decided. SeaQuest, 579 F.3d at 423.) The Fifth Circuit focused on the underlying nature of a claim:

Id. at 425.

While these Circuit decisions are not on all fours with the instant case, they share an expansive reading of § 510(b) and set the ground rules for interpreting the statue. The Fifth Circuit's summary is particularly instructive:

SeaQuest, 579 F.3d at 421-422.

Under this expansive interpretation and these ground rules, the Minority's claim should be subordinated. There is the required causal relationship between the claim and the purchase/sale of stock: the claim is payment from the sale of the Minority's share of the equity. The "underlying nature" of the claim is the recovery the Minority's equity investment and the disregard of the absolute priority rule, triggering "the most important policy consideration" behind § 510(b): equity should not be able to recover its investment pari passu with creditors and disregard the absolute priority rule.

Another Stock Repurchase Case

Weissmann v. Pre-Press Graphics Co. (In re Pre-Press Graphics Co.), 307 B.R. 65 (N.D.Ill.2004), is a District Court decision on similar facts. The court subordinated a shareholder's claim under a court order requiring debtor to repurchase 500 of its shares at a court determined "fair value" of $1,383,500 (as a remedy for breach of fiduciary duty and shareholder oppression). Like the Courts of Appeals, the Pre-Press Graphics court concluded that the statute was ambiguous, looked at policy considerations, adopted a broad reading of the statute and required a "causal link" between the claim and the purchase or sale of the stock, but that causal link need not arise contemporaneously with the purchase or sale. The court concluded that the claim arose from the debtor's oppressive conduct that was remedied with the judgment, which was causally linked to the purchase or sale of debtor's stock. "In proposing what later became § 510(b), [Slain and Kripke] sought to prevent a disaffected shareholder from recouping his or her investment ahead of unsecured creditors. In the court's view, that is exactly what [the claimant] is trying to do here." Pre-Press Graphics, 307 B.R. at 79.

Like the claimant in Pre-Press Graphics, the Minority are disaffected shareholders seeking to recoup their investment at the expense of unsecured creditors. Section 510(b) was created to subordinate just such disaffected shareholders seeking to end run the absolute priority rule and recoup their investment in the debtor ahead of other shareholders and pari passu with creditors.

Promissory Note Cases

One line of cases, primarily from the District of Delaware, has held that claims arising out of a promissory note issued prior to the petition date in exchange for stock, are not subject to § 510(b) subordination: Wu v. Stephen H. Swift Trust (In re Swift Instruments, Inc.), 2012 WL 762833 (9th Cir. BAP Mar. 8, 2012); In re Montgomery Ward Holding Corp., 272 B.R. 836, 844-45 (Bankr.D.Del.2001), abrogated on other grounds by Telegroup, 281 F.3d at 142; In re Mobile Tool Int'l, Inc., 306 B.R. 778, 782 (Bankr.D.Del.2004). The U.S. District Court for Delaware has extended this reasoning to a pre-petition judgment ordering the debtor to repurchase its stock from a shareholder. Burtch v. Gannon (In re Cybersight), 2004 WL 2713098 (D.Del.2004). The reasoning of these cases is that the note or the judgment extinguished the claimant's right to participate in profits. Once the shareholder became a creditor, the rationales behind § 510(b) — dissimilar risk and return expectations of shareholders and creditors and the reliance of creditors on an equity cushion — no longer applied to justify subordination.

These promissory note cases seem premised on the issuance of a tangible debt instrument. Mobile Tool court distinguished In re Alta + Cast, LLC, 301 B.R. 150 (Bankr.D.Del.2003), where claim against debtor for failure to purchase its stock from former employee was subordinated under § 510(b), because no debt instrument had ever issued. Mobile Tool, 306 B.R. at 782.

In the Ninth Circuit B.A.P. decision in Swift, the debt instruments were several promissory notes that had been issued by debtor between 1997 and 2003 under a 1952 agreement requiring the debtor to repurchase its shares upon the death of certain shareholders. The B.A.P. upheld the bankruptcy court's decision not to subordinate these notes in a bankruptcy case commenced in 2006. In doing so, the court characterized the Ninth Circuit decision in Betacom as holding that a promissory note claim may be subordinated under § 510(b) but not specifying what circumstances justify subordination. The B.A.P. then determined that the noteholders at issue in Swift held only the risk and return expectations of creditors and that no creditors had relied on the equity that had been replaced by the notes in deciding whether to grant credit to the debtor.

This Court declines to apply the reasoning of these decisions to this case, primarily because the Minority shareholder's "claims" are quite different from the promissory notes and the judgment in these decisions. In each of these decisions, the claimant had received a tangible debt instrument (or judgment, in Cybersight) effectuating an exchange of equity for a sum certain obligation. Each claimant released its equity in exchange for debt: they had irrevocably traded the risks and rewards of equity for the risks and rewards of debt. (This is particularly essential to the Swift case, where the exchanges had occurred as many as nineteen and no fewer than three years prior to bankruptcy.)

The judgment in this case does not purely trade equity for debt. It provides that the Minority will receive either the payment specified in the judgment or their share of the proceeds of dissolution. If the debtor does not make the payment specified in the judgment, the Minority will be equity holders. So while the judgment may have given rise to a "claim," these claimants continue to have some expectation of sharing in the risks and rewards of the debtor as equity. Furthermore, creditors undoubtedly relied on the Minority's participation in the Debtor as 40.25% equity, rather than as the holder of a multi-million dollar claim. The rationales behind § 510(b) continue to apply in this case to justify subordination.

Even if the facts of this case were to fit the Delaware theory, these decisions are inconsistent with the broad interpretation of § 510(b) by the Ninth Circuit in Betacom, and the other Courts of Appeals that have considered § 510(b). These courts look at the underlying nature of the claim and have required only a causal connection between the claim and the purchase of stock. The fact that a claimant may have obtained a pre-petition note or a judgment on account of that equity interest does not change the fact that the claim arose out of the sale of an equity security and does not negate the fundamental unfairness of allowing some shareholders to elevate themselves at the expense of creditors and other shareholders. (As the Fifth Circuit noted, if a pre-petition judgment renders § 510(b) inapplicable, then securities fraud claims could be exempted from § 510(b) subordination simply by obtaining a pre-petition judgment, which is "contrary to the text and legislative history of the statute." SeaQuest, 579 F.3d at 425.)

Valuation of the Minority's Claim

The subordination of the Minority's claim under § 510(b) renders the issues of valuation irrelevant because equity will not receive any recovery under the Debtor's plan. However since an appeal is certain and this case has already been dealt with in a piecemeal fashion, the Court will rule on these issues at this time.

Two issues are raised as to the valuation procedure for the Minority's Claim. First is the date of the valuation. Second is the method. As to the method, the Debtor asserts in its state court appeal that the Superior Court failed to consider costs of sale and taxes on that sale. But it also argues before this Court that even if the valuation date used by the Superior Court is the correct one, the Bankruptcy Court must reevaluate the Superior Court order to take these items into account.

What is the Valuation Date of the Minority Claim?

The Minority argues that the value of its claim should be measured under § 502(b) as of the date of the filing of the petition, since it arises from a prepetition judgment, which was a contingent unliquidated claim. Once the sixty day extension granted by 11 USC § 108 expired, the Minority's claim was no longer contingent and since it could easily by mathematically calculated it also was no longer unliquidated. Nonetheless it must be estimated under § 502(c)(2) for purposes of allowance under the plan because the Minority's right to payment arises from a right to an equitable remedy due to the Debtor's breach of performance. And the date for such estimation is the petition date.

The Debtor argues that because the claim is to be the same priority as common stock, it must be valued as of the confirmation date (February 18, 2010) to determine whether the plan violates the absolute priority rule, since this is a plan in which that rule is applicable. It states that the petition date is not the correct date because this is not a typical unsecured claim since the claim arises from Cal. Corp.Code § 2000 which deals solely with its equity status and the forced repurchase of its shares. And even though the District Court ruled that the Minority held a "claim," it did not exclude the fact that the claim arose from the Minority's equity interest since — but for the equity interest — there could be no claim by the Minority.

The Court agrees with the Minority that its claim should be valued as of the Petition Date. Bankruptcy Code § 502(b) is crystal clear that the amount of unsecured claims should be determined "as of the date of the filing of the petition." 11 U.S.C. § 502(b). Accordingly, the estimation of claims under § 502(c) should be as of the petition date. See, e.g., In re Fed-Mogul Global, Inc., 330 B.R. 133, 155 (D.Del.2005); Eagle-Picher Indus., Inc., 189 B.R. 681, 682 (Bankr.S.D.Ohio 1995)("This is not a complicated question.").

The cases cited by the Debtor in support of a confirmation date valuation are inapposite. The cases cited by the Debtor in its most recent brief used a confirmation date valuation of the debtor for § 1129 purposes — not for determining or estimating a claim under § 502. The Debtor cites Beneficial Homeowner Serv. Corp. v. Moreau (In re Moreau), 140 B.R. 943 (N.D.N.Y.1992) for the proposition that the court should take note of changes in the economy and conduct a new valuation if warranted. But Moreau, like some cases cited previously by the Debtor as authority for a confirmation date valuation, concerned secured claims and collateral. To the extent the Minority has claim, it is undisputedly unsecured and governed by § 502. The Debtor has not cited any authority for its argument that the claim's origins in equity somehow exempts it from the clear mandate of § 502(b). Without any applicable authority to the contrary, the claim must be measured as of the petition date, pursuant to § 502.

How is the Value to be Computed?

The Debtor argues that the Minority's claim is based on the equity in the Debtor corporation, since it arises from the value of the shares which are being bought out. Thus the value is the liquidation value.6 The amount that should have been awarded by the Superior Court is what the Minority would have received had their involuntary dissolution action been allowed to proceed to conclusion.7 The sale expenses must be taken into account, as well as the sale price and the taxes that would arise from the disposition of the assets.

While the Minority asserts that the value should be that awarded by the Superior Court, it argues, in the alternative, that if this Court feels that there needs to be a new valuation, that value "should be derived from the net going-concern value of the Debtor as of the petition date (as computed from the Debtor's Schedules), which would be $2,512,601.98, plus damages for the diminution in value of the Minority's court-ordered right to payment for its shares."8 This arises under the provisions of Cal. Corp.Code § 2000(a), which provides in part that the "fair value shall be determined on the basis of the liquidation value as of the valuation date but taking into account the possibility, if any, of sale of the entire business as a going concern in a liquidation." Because the Debtor has always intended to operate this business as a going concern, the net going-concern value of the Debtor as of the petition date is the proper measure of value.

As with any claim in bankruptcy, the value of Minority's claim should be determined in accordance with the underlying substantive law that gave rise to the claim, in this case Cal. Corp.Code § 2000(a). Section 2000(a) specifies a liquidation value that takes into account the possibility of liquidating by sale of the business as going-concern. Both Minority and Debtor cite the same standard for applying this sentence of § 2000(a): the dissenting shareholders should receive "the liquidation value they would have received had their dissolution action been allowed to proceed to a successful conclusion." Trahan v. Trahan, 99 Cal.App.4th 62, 75, 120 Cal.Rptr.2d 814 (2002); see also Brown v. Allied Corrugated Box Co., 91 Cal.App.3d 477, 489, 154 Cal.Rptr. 170 (1979). Had the Debtor been dissolved under § 2000, a going-concern sale of the Debtor would have maximized the return to all shareholders and would undoubtedly have been sought by all parties involved. (Although, as the Debtor points out, determining what dissenting shareholders would have received in a "going concern" liquidation does require the deduction of any costs of a going-concern sale from the going-concern valuation.) As the Debtor has continued to operate its business as a going-concern, a going-concern valuation is also consistent with notions of fair play and equity.

The state court judgment did value the debtor using a going concern methodology, but did so several months prior to the petition date. (The Minority also cites the asset and liability values in the Debtor's schedules, but these do not value the Debtor's business as a going concern.) Given that the issues of valuation may never prove relevant, the parties may wish to avoid the expenditure of substantial time and money that would be required for a full evidentiary hearing resolving this possibly hypothetical issue. If the parties wish to stipulate to the value of the Minority's claim, the Court invites them to do so in the next 30 days. Otherwise, the Court will use the state court judgment as a starting point for valuing the Minority's claim and continue this matter for an evidentiary hearing updating that valuation to the petition date and deducting relevant expenses of a going-concern sale.

Ruling

The Minority's claim is hereby subordinated pursuant to 11 U.S.C. § 510(b). The Minority's claim is to be valued based on the going-concern value of the Debtor as of the petition date. This matter will be continued until October 9, 2012 at 10:00 a.m. for a status conference to set an evidentiary hearing on the value of the Minority's claim, which will update the state court valuation to the petition date and deduct relevant expenses of a going-concern sale.