United States District Court, N.D. Illinois, Eastern Division
June 24, 2004.
ANCHORAGE POLICE & FIRE RETIREMENT SYSTEM AND THE STATE OF LOUISIANA FIREFIGHTERS' RETIREMENT SYSTEM, Chapter 11 Appellants,
OFFICIAL COMMITTEE OF UNSECURED CREDITORS OF THE HOLDING COMPANY DEBTORS, Appellees. In re: CONSECO, INC., et al., Debtors.
The opinion of the court was delivered by: WAYNE ANDERSEN, District Judge
MEMORANDUM OPINION AND ORDER
This case is before the Court on Appellants' appeal from a
decision rendered by the United States Bankruptcy Court for the
Northern District of Illinois. For the following reasons, the
decision of the Bankruptcy Court is affirmed.
Prior to the December 17, 2002 filing of the Debtor Conseco,
Inc.'s bankruptcy cases, Plaintiffs filed class action lawsuits
against the Debtors and certain individual defendants in the
United States District Court for the Southern District of Indiana
for securities fraud relating to the purchase or sale of Conseco common stock. The parties to that
litigation reached a settlement pursuant to which the Plaintiffs
released all of their claims against the Debtors, the individual
defendants, and the underwriter defendants in exchange for
payments totaling $120 million. The settlement agreement was
memorialized in a written contract, titled Stipulation of
Settlement, signed and executed by the parties, including the
Debtors, on May 21, 2002.
On August 7, 2002, the Indiana District Court approved the
Stipulation of Settlement pursuant to an Order and Final
Judgment. As of December 17, 2002, at the time of the filing of
the Debtors' bankruptcy cases, Plaintiffs had not received full
payment pursuant to the Judgment and Stipulation of Settlement.
Plaintiffs sought to recover such payment by filing: 1) proofs of
claim and interests for over $25 million plus interest against
certain Debtors, respectively; and 2) an adversary proceeding
against every Debtor.
The Debtors and Plaintiffs agreed to a mediation of the claims,
adversary proceeding, and other related matters before Magistrate
Judge V. Sue Shields in the United States District Court for the
Southern District of Indiana. As a result of the mediation, the
Debtors and Plaintiffs agreed that Plaintiffs' claim would be
treated as an unsecured Class 8A claim in the reduced amount of
$17 million. Plaintiffs agreed to refrain from asserting their
interest in the Settlement fund. This compromise was subsequently
memorialized by a written agreement that was approved by the
Indiana District Court on May 19, 2003. The order approving that
agreement also preserved the Holding Company Committee's
("Committee") right to object to the classification of the
Plaintiffs asserted a general unsecured claim against the
Debtors in the bankruptcy case. By doing so, Plaintiffs sought to
share in the plan distribution to Class 8A Creditors, who are
expected to receive approximately 26.8% of their claims under the Holding
Company Debtors' confirmed plan or reorganization, while holders
of common stock shall receive nothing under such plan. The
Committee objected to the classification of the Plaintiffs'
claim, asserting that the claim must be subordinated to the
claims of other unsecured creditors pursuant to Section 510(b) of
the Bankruptcy Code, 11 U.S.C. § 510(b). On August 20, 2003, the
Bankruptcy Court sustained the Committee's objection, ruling that
Plaintiffs' claim arose from the purchase or sale of a security
and must, therefore, be subordinated pursuant to § 510(b).
Plaintiffs have appealed the Bankruptcy Court's decision.
At issue in this bankruptcy appeal is whether Plaintiffs' claim
"arises" from the purchase or sale of Conseco common stock. The
Bankruptcy Court sustained the objection of the Committee to
Plaintiffs' claim and held that § 510(b), which requires the
subordination of a claim for "damages arising from the purchase
or sale of . . . a security" of the debtor, mandates the
subordination of that claim to the level of Conseco common stock.
On appeal, Plaintiffs argue that the existence of the
Settlement Agreement, purportedly under the principles of
novation, has transformed the claim into one that does not
"arise" from the purchase or sale of a security.
The United States District Courts have jurisdiction over
appeals from final judgments and final orders in bankruptcy cases
pursuant to 28 U.S.C. § 158(a). We review the factual findings of
the Bankruptcy court for clear error, but review questions of law
de novo. F.R.Bankr.P. 8013; In re Rivinius, Inc.,
977 F.2d 1171, 1175 (7th Cir. 1992). Thus, there is no presumption of
correctness as to the Bankruptcy Court's conclusions of law. In re Luria
Steel and Trading Corp., 189 B.R. 418, 420 (N.D. Ill. 1995).
I. The Plain Language Of Section 510(b), Congressional
Intent And Case Law Require That Plaintiffs' Claim Be
In their appeal, Plaintiffs argue: (a) that the Settlement
Agreement and the accompanying judgment, purportedly through the
principles of novation, have removed the claim from the scope of
the statute; and (b) that § 510(b) does not apply to fraud. We
will address each of these arguments in turn.
A. The Language Of § 510(b) Is Unambiguous
It is clear that subordination pursuant to § 510(b) is
mandatory, and the wording of the statute is plain and
[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 added). Statutory interpretation
starts with the language of the statute, and when statutory
language is clear and unambiguous, the inquiry must cease.
Connecticut Nat'l Bank v. Germain, 503 U.S. 249, 253-54 (1992).
In this case, the language of the statute is not only clear, but
also broad and encompassing. Thus, if any claim, including the
claim of the Plaintiffs, arises from the purchase or sale of a
security, the claim shall be subordinated under the plan of
reorganization. See, e.g., In re Basin Resources Corp.,
190 B.R. 824, 826 (Bankr. N.D.Tex. 1996). There is no language
limiting the nature of the securities related claims subject to
subordination. In this case, the facts are undisputed that the claim
originated and resulted from the purchase or sale of a security.
Plaintiffs have stipulated that "several securities fraud class
actions for damages arising from the purchase and sale of
Conseco, Inc. common stock were filed. . . ." Joint Stip. at ¶
3 (R. at #3). Thus, the claim "arose" from the purchase or sale
of a security within the meaning of the statute: were it not for
the securities fraud claim relating to the purchase or sale of
the common stock, there would have been no settlement and no
judgment approving it. Thus, it is incontrovertible that there is
a nexus and causal relationship between the claim and the
purchase of Conseco common stock. See, e.g., In re Telegroup,
Inc., 281 F.3d 133
, 138 (3d Cir. 2002). As such, the plain
language of § 510(b) requires that Plaintiffs' claim be
subordinated to the level of the other holders of Conseco's
common stock, and the Bankruptcy Court was correct as a matter of
law in so holding.
B. The Plaintiffs' Novation Argument Must Fail
In an effort to avoid the natural operation of § 510(b),
Plaintiffs argue that, while the litigation arose from the
purchase or sale of a security, the claim is based on the
Judgment and the Stipulation of Settlement. This attempted
sleight of hand ignores the plain meaning of the statute,
including the plain meaning of the operative term "arising."
Moreover, Plaintiffs' interpretation is at odds with the remedial
purpose of the statute.
While Plaintiffs attempt to discredit the case law relied on by
the Bankruptcy Court, Plaintiffs cite no authority, whether
Seventh Circuit or otherwise, when a court has held that a claim
that arose from the purchase or sale of a security is removed
from the scope of § 510(b) based on a novation theory or the
presence of a judgment. Indeed, if Plaintiffs' novation theory
were accepted, it would be an easy way around the statute,
undoubtedly leading to every pre-bankruptcy settlement of a securities fraud suit being characterized as a novation.
This, in turn, would make the application of the statute
dependent upon whether a group of Plaintiffs were or were not
able to settle their claims prior to the commencement of the
debtor's bankruptcy case. Plaintiffs offer no persuasive
explanation as to why that happenstance should determine the
priority treatment of the underlying claim in bankruptcy.
Similarly, the Plaintiffs never explain how entering into a
settlement prior to the filing of the bankruptcy petition truly
alters the origin of the underlying claim or the policies
underlying § 510(b). Nor could they. Had Conseco filed its
bankruptcy petition prior to the securities fraud settlement, the
claim would certainly be subordinated pursuant to § 510(b). See,
e.g., In re Cincinnati Microwave, Inc., 210 B.R. 130, 133
(Bankr. S.D. Ohio 1997). There is no rational explanation why a
settlement agreement consummated just months prior to bankruptcy
should dramatically alter the nature, let alone the treatment, of
the underlying claim, particularly given the plain terms and
purpose of § 510(b).
The novation theory was explicitly rejected in In re Permian
Producers Drilling, Inc., 263 B.R. 510 (W.D. Tex. 2000). In
Permian, the court determined that, as a remedial statute, §
510(b) must be interpreted broadly in order to effectuate the
intent of Congress and, thus, must apply notwithstanding the
executed pre-petition settlement agreement:
[S]ection 510(b) prevents a shareholder from
converting his interest into a claim and sharing
pari passu with other unsecured creditors. The fact
that [a claim] is predicated on [a] settlement
agreement does not alter the fact that the underlying
claim is a claim for damages arising from the
purchase of a security. Id. at 520, quoting, In re Granite Partners, L.P., 208 B.R. 332,
341 (Bankr. S.D.N.Y. 1997). Therefore, the court determined
that the claim was properly subordinated pursuant to § 510(b).
Id. See also Sendmygift.com, Inc., 280 B.R. 667 (Bankr. D.
Minn. 2002); In re Cincinnati Microwave, Inc., 210 B.R. 130
(Bankr. S.D. Ohio 1997).
For these reasons, we find that Plaintiffs cannot avoid the
operation of § 510(b) under a novation theory and that the
existence of the Judgment and Stipulation of Settlement is of no
significance in interpreting that statute.
C. Section 510(b) Is Clearly Applicable To Claims Based On
Plaintiffs next argue that § 510(b) is inapplicable to claims
arising from fraud in the purchase or sale of securities. We find
this argument to be without merit. First, a number of courts that
have clearly stated that § 510(b) is applicable to securities
fraud claims. See, e.g., In re Betacom of Phoenix, Inc.,
240 F.3d 823, 829 (9th Cir. 2001); In re NAL Financial Group, Inc.,
237 B.R. 225, 232 (Bankr. S.D. Fla. 1999); In re Vista Eyecare,
Inc., 283 B.R. 613, 626 (Bankr. N.D. Ga. 2002); In re Geneva
Steel Co., 281 F.3d 1173, 1177 (10th Cir. 2002); In re
Washington Bancorp., 1996 WL 148533, at *19 (D.D.C. March 19,
Both the provisions of the statute and the legislative history
are unambiguous. Congress enacted § 510(b) primarily to
subordinate securities fraud claims and confirm that the risk of
illegality was to be borne by equity holders and not creditors.
See, e.g., Telegroup, 281 F.3d at 141 (citing H.R. Doc. No.
93-137, pt. 1, at 22 (1973)). It is clear that when Congress
enacted § 510(b), it intended that creditors be treated more
favorably than equity holders under all circumstances. Congress
determined that it is inappropriate for investors, regardless of
their claims relating to the purchase or sale of their
securities, to stand on the same footing as creditors for the
purposes of distribution of the estate. See generally Telegroup, 281 F.3d
at 133; Vista Eyecare, Inc., 283 B.R. at 613. In short, §
510(b) represents a Congressional judgment that, as between
shareholders and general unsecured creditors, it is the
shareholders who should bear the risk of illegality in the
purchase and sale of stock in the event that the issuer enters
bankruptcy. Telegroup, 281 F.3d at 141. Thus, it is clear that
§ 510(b) applies to security fraud claims.
II. The Plaintiffs' Purported Policy Arguments Cannot Change
the Result Mandated by 510(b)
Plaintiffs next argue that the policy arguments underlying §
510(b) do not warrant the subordination of fraud claims and that
there are better policy arguments to the contrary. First and
foremost, these policy arguments are irrelevant. Courts do not
have the discretion to ignore the plain meaning of the statute,
as reinforced by its accompanying legislative history, and, in
effect, amend a statute by judicial fiat.
Second, there are persuasive policy arguments as to why
Plaintiffs should have their fraud claims subordinated to the
level of Conseco common stock. Those arguments are applicable in
this very case. Under the confirmed plan of reorganization, the
Class 8A unsecured creditors will not receive payment in full of
their claims, but are projected to receive only approximately
26.8% of their claims. However, if the provisions of § 510(b) are
ignored and the Plaintiffs' claim is allowed as a Class 8A claim,
this 26.8% dividend will be diluted by a claim asserted on behalf
of persons who were entitled to receive the benefits of common
stock ownership when times were good and who would now be
permitted to avoid the risks of common stock ownership when times
are bad, exactly the result that § 510(b) was intended to
For the foregoing reasons, the August 20, 2003 decision of the
Bankruptcy Court is affirmed. This is a final and appealable
order. This case is hereby terminated.
It is so ordered.
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