OPINION

Hon. David T. Thuma, United States Bankruptcy Court.

Three former employees filed claims based on the debtor's defunct employee stock ownership plan ("ESOP"). Debtor objected to the claims, arguing that the claimants were stockholders, not creditors, because the ESOP held debtor's stock in trust for them. As a general matter, the Court agrees with the proposition that employees of a corporation with an ESOP are equity security holders to the extent of their vested ESOP interests. On the other hand, the Court finds and concludes that former employees of the corporation, who were or should have been "cashed out" of their ESOP interest years before, are creditors rather than stockholders. As the three claims at issue fall in the latter category, the Court will overrule the objections.

I. FACTS

The Court finds:1

Debtor Indian Jewelers Supply Co., Inc. a New Mexico corporation founded in 1943, was a wholesale and catalog distributor of precious metal, semi-precious gem-stones, tools, equipment, and supplies used to make Indian and southwestern jewelry. Debtor was founded in 1943 and operated until July, 2017.

Pierce Notah, Riley Valentino, and Carolyn Bowen are former employees of the Debtor. Messrs. Notah and Valentino were laid off pre-petition, while Ms. Bowen retired pre-petition.

In 1976 the Debtor established an ESOP. As stated in the plan documents, the ESOP was to:

Pursuant to a related trust agreement, all of Debtor's stock in the ESOP was held in trust for participating employees. There was a vesting schedule. Once an employee was fully vested, she was entitled to receive her allocated shares of Debtor's stock after she retired, quit, or was laid off. The ESOP was governed by the federal Employee Retirement Income Security Act, 29 U.S.C. § 1001 et seq. ("ERISA").

The ESOP documents went through a number of revisions over the years. The Court does not have all the iterations of the plan documents. The record includes the following:

The ESOP also allowed for some diversification of an employee's account. Although most of the claimants' accounts held Debtor's stock, they each had relatively small amounts of cash or other investments.

The ESOP's rules about distributing shares to laid-off employees changed in 2014. The rule on January 1, 2009, was:

(emphasis added). This rule was re-written as of September 1, 2012:

(emphasis added). Debtor changed the rule again as of April 1, 2014:

(emphasis added).

Debtor's stock was not publicly traded. Because there was no ready market for the stock, the ESOP included a "put" option, which if exercised obligated the Debtor to buy the distributed shares from the former employee at their fair market value. Fair market value was determined by an independent appraiser. If the value of the "put" shares was more than $25,000, the Debtor had the right to pay for the shares over five years in equal annual payments.

The appraised value of the Debtor's stock declined dramatically between 2010 and 2016:5

  Valuation      Appraised        Total Shares     Value Per     Valuation
  Date           debtor value     Outstanding      Share         company

  3/31/2010      $3,405,000       1,034            $3,292        Prairie Capital

  3/31/2011      $3,918,000       1,034            $3,788        Prairie Capital

  3/31/2012      $3,867,000       1,034            $3,739        Prairie Capital

  3/31/2013      $1,624,000       1,034            $1,570        Prairie Capital

  3/31/2014      $1,381,000       1,034            $1,335        Prairie Capital

  12/31/2014     $406,000         1,034            $392          Prairie Capital

  12/31/2015     $472,000         1,034            $456          Valuation Advis.
                                                                 Services

  12/31/2016     $23,000          759              $30           Valuation Advis.
                                                                 Services

Carolyn Bowen was employed from 1993 until 2013. She participated and was fully vested in the ESOP. When Ms. Bowen retired in December 2013 at age 74, she asked for distributions of all Debtor shares and diversified investments. Ms. Bowen received some cash for her diversified accounts. In May 2015 the ESOP distributed her Debtor shares to her. Ms. Bowen exercised her right to "put" the shares to the Debtor and receive cash. The Debtor gave her a promissory note dated May 19, 2015 for $25,923.11, payable in five equal annual payment of $5,184.62, with the first payment due May 19, 2015.6 Because of the tax laws governing ESOP distributions, Ms. Bowen had to pay income tax on the entire $25,923.11 in 2015.

On October 24, 2017, Ms. Bowen filed a claim for $21,554.87. Her claim is based entirely on the unpaid balance of the promissory note she received in May 2015.

Pierce Notah worked for Debtor from 1981 until 2012. According to a letter Mr. Notah filed with the Court on July 27, 2018:

Mr. Notah was laid off in October 2012. He was 59 at the time. The last statement sent to Mr. Notah from the ESOP, for the period 4/1/2011 through 3/31/2013, showed:

              Beginning     Contributions     Earnings     Shares           Shares          Ending
              balance                                      released         reallocated     balance
                                                           due to
                                                           contribution

  Money       $1,881.81     $2,475.59         ($48.40)                      ($238.54)       $4,070.47
  market
  account

  Company     37.656                                       1.072            0.052           38.780
  stock
  account

  Total value of company stock (price per share:     $144,999.23
  $3,739.01)

  Total Money Market Account                         $4,070.47

  Total Account Balance as of March 31, 2012         $149,069.69

  Total Vested Account Balance as of March 31,       $149,069.69
  2012

  Vesting Percentage                                 $100.00%

The ESOP did not comply with the plan requirement to distribute Mr. Notah's Debtor shares "as soon as practicable" after he was laid off. In fact, no stock distributions were made to Mr. Notah in the nearly five years that elapsed between his termination and Debtor's bankruptcy filing.

Mr. Notah attempted from time to time to receive payment on his ESOP account. He stated in his July 27, 2018, filing:

On October 2, 2017, Mr. Notah filed a claim for $149,069.69. The stated basis of the claim is "retirement claim." Attached are annual ESOP statements from 3/31/2008 through 3/31/2012.

Riley Valentino, a former employee, was laid off on May 29, 2014. He never received a distribution of his vested Debtor shares. Mr. Valentino filed a proof of claim for $23,133.92 on October 5, 2017.

In the years leading up to the bankruptcy filing, the Debtor began delaying the purchase of shares "put" to it by retiring or laid off employees. On December 20, 2011, the Debtor suspended making distributions entirely until it could re-value its stock. Distributions were resumed on September 1, 2012. On February 7, 2014, the Debtor notified Ms. Bowen that it would buy her "put" shares over time rather than in a lump sum.7 In a January 8, 2015, letter to ESOP participants, the Debtor said that it "is currently exploring options for funding distributions and diversifications to eligible participants." In a February 27, 2015 letter to participants, the Debtor notified them that stock payouts would be by promissory note. The Debtor began issuing promissory notes to buy stock rather than pay cash.8 In March 2017, Debtor defaulted on its promissory note obligations to former employees.9

Debtor filed this case on July 21, 2017, immediately after terminating its employees ceasing all business operations.

On July 11, 2018, Debtor objected to all ESOP-related claims (the "Equity Security Objection"), including the Bowen, Notah, and Valentino claims, arguing that the claimants hold equity securities, not debt. Bowen, Notah, and Malentino responded to the claim objection. On the same date, Debtor objected to the claims of Ms. Bowen and two other former employees who were given promissory notes by the Debtor (the "Noteholder Objection"). In the Noteholder Objection the Debtor asks the Court to "correctly classify" Ms. Bowen's interest as an equity security interest rather than a debt claim.

Mr. Valentino did not attend the preliminary hearing on the claim objection and the Court entered a default order disallowing his claim (the "Default Order"). Mr. Valentino filed a motion to set aside the Default Order, saying he was ill on the preliminary hearing date and could not attend. Mr. Valentino appeared at the final hearing on the claim objection. The Court took under advisement his request to set aside the Default Order and allowed Mr. Valentino to participate in the final hearing.

II. DISCUSSION

A. Debtor's Claim Objection.

The claim objection states:

Thus, Debtor is not asking the Court to equitably subordinate the claims, see, e.g., In re Mobile Steel Co., 563 F.2d 692 (5th Cir. 1977) (oft-cited case on equitable subordination), nor to recharacterize the debt claims as equity, see generally In re S.M. Acquisition Co., 2006 WL 2290990, at *8 (N.D. Ill. June 7, 2006) (discussing the elements needed to recharacterize debt as equity), but simply to rule that the claimants hold equity securities. Debtor cites 11 U.S.C. § 101(16) and (17), which provide:

B. Treatment of ESOP Claims in Bankruptcy.

Employees of a debtor who files bankruptcy may be equity security holders to the extent they participate in the debtor's ESOP. See, e.g., In re Mansfield Ferrous Castings, Inc., 96 B.R. 779, 781 (Bankr. N.D. Ohio 1988) (as participants in and beneficiaries of the ESOP Trust which holds the debtor's stock, employees are equity security holders); In re Merrimac Paper Co., 420 F.3d 53, 64 (1st Cir. 2005) (during period of employment, an ESOP participant is functionally a stockholder); see generally Matter of Envirodyne Indus., Inc., 79 F.3d 579 (7th Cir.1996) (stock redemption claims are in essence equity security claims).

The claims of terminated or retired employees are different. The leading case on this point is Merrimac Paper. In Merrimac Paper the debtor brought an adversary proceeding to equitably subordinate the claim of a retired employee. The former employee's claim was based on a stock redemption note he received from the debtor when he "put" his ESOP shares to the debtor for purchase. The bankruptcy court and the district court ruled that his note claim should be equitably subordinated. The First Circuit reversed, holding:

420 F.3d at 64. The Court finds Merrimac Paper's analysis persuasive. Employees are not typical investors. Retired and terminated employees, in particular, view their ESOP accounts as retirement accounts whose value is fixed on the date of termination, especially when their former employer is obligated to buy the ESOP shares at fair market value.

C. Whether the Objections Should be Sustained as to Bowen, Notah, and Valentino.

1. Ms. Bowen. In Ms. Bowen's case, Debtor's objection must be overruled. Ms. Bowen does not hold an equity security; she holds a promissory note. While it would be possible for the Debtor to file an adversary proceeding to recharacterize or equitably subordinate Ms. Bowen's note, it has not done so.10 Whether such a proceeding would be successful is questionable, given the Merrimac Paper analysis.11 The relief Debtor has sought, i.e., disallowance of the claim because Ms. Bowen holds an equity security, cannot be granted. Ms. Bowen holds a debt instrument.

2. Mr. Notah. Mr. Notah's situation is different, but the Court concludes that the result should be the same. There is no question that Mr. Notah would have "put" his shares to the Debtor had he been given the chance to do so. Through no fault of his own, the Debtor refused to distribute Mr. Notah's vested shares to him, even though the Debtor was obligated to do so "as soon as practicable." It would be unfair to treat Mr. Notah's situation differently than Ms. Bowen's simply because the Debtor complied with the ESOP distribution rules in her case but not in his.12 The Court finds and concludes that Mr. Notah's claim against the Debtor is a debt claim, not an equity claim.

3. Mr. Valentino. The Court rules that Mr. Valentino's motion to set aside the Default Order is well taken and should be granted, based on Mr. Valentino's excusable neglect. See Bankruptcy Rules 9014 and 7054 and Fed. Rules of Civ. Pro. 54 and 60(b)(1). The Court finds credible Mr. Valentino's testimony that he was ill on the day of the preliminary hearing and could not attend. The Court makes some allowance for the fact that Mr. Valentino is pro se, is not sophisticated in legal matters, responded to the claim objection timely, promptly filed the motion to set aside the Default Order, and attended the final hearing on the claim objection.

The Court finds that, on the merits, the Debtor's objection to Mr. Valentino's claim should be overruled. Mr. Valentino was laid off more than three years before Debtor filed this case. Debtor changed the ESOP language about distributions to laid off employees less than two months before firing Mr. Valentino. The language went from "as soon as practicable but not later than" to "not later than...." The Court questions whether the Debtor can unilaterally reduce an employee's vested retirement rights ex post facto and without consent. Under New Mexico law (see § 10.4 of the Plan), there is an implied covenant of good faith and fair dealing. See, e.g., Bogle v. Summit Investment Co., LLC, 137 N.M. 80, 87-88, 107 P.3d 520 (Ct. App. 2005). The Court finds and concludes that it would violate the implied covenant of good faith and fair dealing to take a long-term employee's vested ESOP right to be paid "as soon as practicable" and change it to "five years after being laid off" right before firing him.

Third, the Court finds that the plan language is ambiguous. "No later than" could mean "probably not until," or it could mean "within a reasonable time but no later than." The Court will construe the ambiguity against the drafter. See, e.g., Heye v. American Golf Corp., Inc., 134 N.M. 558, 563, 80 P.3d 495 (Ct. App. 2003) Long before Debtor filed this case, it should have purchased Mr. Valentino's distributed ESOP shares and paid him cash and/or a note.

Finally, even if was not a breach of contract for the ESOP to refuse to distribute Mr. Valentino's shares, upon termination Mr. Valentino's interest in the ESOP changed from a plan participant to a frustrated creditor, trying to collect his retirement benefits from the Debtor. Given all of the circumstances of this case, it would not be fair to treat Mr. Valentino as an equity security holder.

III. CONCLUSION

Former employees with claims that arise under a debtor's ESOP should not necessarily be viewed as equity security holders. In Ms. Bowen's case, it is clear she holds a note, not stock. Equitably subordinating or recharacterizing the note would be an uphill battle, given Merrimac Paper, but Debtor has not sought those remedies. Mr. Notah's and Mr. Valentino's claims should have been the same as Ms. Bowen's, but for the ESOP's inexcusable refusal to distribute their vested shares after Debtor laid them off. Separate orders will be entered overruling Debtor's claim objections and granting Mr. Valentino's motion to set aside the Default Order.