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

O'Donnell v. Tristar Esperanza Properties, LLC (In re Tristar Esperanza Properties, LLC), BAP No. CC-12-1340-KlPaDu (9th Cir. BAP March 9, 2013) (for publication)
The Ninth Circuit BAP AFFIRMED the bankruptcy court's granting of summary judgment to the Appellee with respect to its section 510(b) claim, holding that a right to payment arising from a judgment supporting an arbitration award valuing a membership interest in an LLC is a claim for damages arising from the sale of securities and therefore subject to mandatory subordination.
Procedural context:
Individual Appellant acquired a membership interest in the Debtor/Appellee LLC via a capital contribution in 2005. In 2008, Appellant withdrew and invoked a buy-back provision in the Appellee’s operating agreement. The parties disagreed about the value of the Appellant’s interest and went to arbitration. Arbitration resulted in an award of damages to the Appellant, who reduced it to a judgment in 2010 when the Appellee refused to pay. In 2011, the Appellee filed under Chapter 11. Appellee brought an adversary proceeding against Appellant for, inter alia, mandatory subordination under section 510(b). The court held that 510(b) exists to prevent equity holders from diluting general unsecured creditors’ recovery. The Appellant appealed the 510(b) issue to the Ninth Circuit BAP.
Section 510(b) requires subordination of a claim for damages arising from purchase or sale of a security of the debtor. First, the Circuit determined that an interest of a member in an LLC, although not explicitly enumerated in the statutory definition of “security,” is analogous to the interest of a limited partner in a partnership. Therefore, sale or purchase of the interest of a member in an LLC is vulnerable to mandatory subordination under section 510(b). Next, the Circuit adopted the generally accepted broad meaning of “damages” to include all forms known to law, provided, in this context, they arise from the purchase or sale of the security of a debtor. In finding that the judgment qualifies as damages under section 510(b), the Circuit considered the history of the judgment. Specifically, the Circuit noted the Appellant purchased security in the form of a membership interest in the Appellee in exchange for cash, invoked a buy-back process for withdrawal of members established by an operating agreement, went to arbitration which resulted in an award of damages and a finding that the Appellee breached the operating agreement, and obtained judgment when the Appellee did not pay the Appellant the damages award. Turning to whether the claim arose from the purchase or sale of the Appellee’s securities, the Circuit applied the broad view that the purchase or sale need only be part of the causal link, even if the injury flows from a subsequent event. As applied to the facts here, the claim is subject to mandatory subordination, as the Appellant enjoyed an equity holder’s potential to share in profits of the Appellee, and the creditors presumably relied on the equity cushion created by the Appellant’s cash infusion when they extended credit. Further, the Circuit rejected the Appellant’s argument that its claim is a fixed debt, holding that subordination is mandatory to avoid undermining absolute priority, as the claim is firmly rooted in the Appellant’s equity status. Likewise, the Circuit rejected a judicial estoppel argument, noting there is no material inconsistency in the Appellee admitting a debt obligation in arbitration then asserting a claim for damages in bankruptcy, and regardless, there was no unfair advantage or detriment as a result of the two statements.
Albert, Klein (sitting by designation), Pappas, and Dunn, United States Bankruptcy Judges

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