Shareholder once, shareholder always: subordination of valuation rights under article 510 (b) | Dechert LLP


Should a claim for valuation rights brought by a former shareholder of a Chapter 11 debtor be subordinated under Section 510 (b) of the Bankruptcy Code? According to the Delaware District Bankruptcy Court, the answer is yes. See In re: RTI Holding Co., LLC, No. 20-12456, 2021 WL 3409802 (Bankr. D. Del. August 4, 2021).


Ruby Tuesday Operations LLC (“RTO“), a successor in the interests of Ruby Tuesday, Inc. (“RTI”) – a foodservice retailer and reorganized Chapter 11 debtor – objected to claims filed by former RTI shareholders. The claims were based on the appreciation rights of former shareholders, who disagreed with a 2017 merger of RTI with one of its subsidiaries. As the shareholders rejected consideration of the proposed merger, valuation action was initiated under applicable Georgian law with a view to obtaining a judgment on the value of the shares as assessed by the tribunal. The merger was closed and, as required by Georgian law, the actions of the dissidents were canceled on the closing date.

In October 2020, while the evaluation action was still ongoing, RTI filed for Chapter 11 bankruptcy and the evaluation action was automatically suspended. The former dissident shareholders have filed proof of claim for their valuation rights, asserting general unsecured non-priority claims for the amount they claim to be the “real” value of their shares as asserted in the action devaluation. As part of the debtor’s recovery plan, however, the dissidents’ claims were classified as subordinate under Section 510 (b) of the Bankruptcy Code and were not entitled to any distribution. This section provides in the relevant part that “[f]or for distribution purposes …, a claim resulting from the cancellation of a purchase or sale of a security of the debtor or an affiliate of the debtor, for damages resulting from the purchase or of the sale of such a security … is subordinated to all claims or interests which are greater than or equal to the claim or to the interest represented by such security, except that if such security is ordinary shares, this claim has the same priority as ordinary shares.

As a result, RTO objected to the proofs of claim from the former shareholders, arguing that they are subordinate under Section 510 (b) and are not entitled to any distribution. The plaintiffs, in turn, argued that since their shares were canceled, they were no longer shareholders and instead were entitled to the statutory right under the Valuation Act, a right which is not affected by the section 510 (b).

Causation, the “But for” Test and the Policy Considerations Underlying Section 510 (b)

Based on the opinion of the Third Circuit in Regarding Telegroup, Inc., 281 F.3d 133 (3d Cir. 2002), the Court upheld RTO’s objections based on the link between the plaintiffs’ assessment rights and their status as former shareholders. The Court explained that, under Third Circuit jurisprudence, for a claim to “arise” from the purchase or sale of a title under Section 510 (b), there must be a clear link or causal relationship between the claimed claim and the sale of the Security. In order to determine whether the necessary casual connection exists, the Court explained, an “in the absence of” test must be applied. This test examines whether the debt would not exist “without” the plaintiff’s purchase of the debtor’s shares.

Applying this test here, the Court concluded that the necessary causal link was present. He explained that the claims stem from a provision in the Georgia Companies Code that grants relief to dissenting shareholders and that the right of claimants to assert a claim under that law is only granted to those who have bought shares. Therefore, the Court concluded that the claims would not exist without the status of the plaintiffs as shareholders.

The Court recognized, however, that the statutory text of section 510 (b) is ambiguous and provides little guidance to delimit the precise scope of the required link. Therefore, in determining whether the subordination is justified, the court must also ensure that the subordination promotes the policy objectives of the law. Citing legislative history, the Court explained that section 510 (b) is intended to prevent shareholders from recouping their investment in shares by neutralizing or minimizing the risk of company bankruptcy.

The court rejected the argument that the dissidents ceased to be shareholders altogether when the merger closed. While they no longer owned the stock, the valuation status is clear that the amount to be awarded in a valuation action represents the value of the stock.

The Court also explained that deciding that the receivables are unsubordinated would effectively eliminate the risk of business default associated with holding shares and allow claimants to recoup their investment at par with general unsecured creditors. When the dissenters opted for the appraisal share, they hoped to reap the benefits of equity if the court found the fair value of the share to be greater than the price of the merger; but they also took a downside risk because the court could have decided that the fair value was less than the merger consideration. Thus, a ruling that dissidents are unsecured creditors would skew the risks and incentives inherent in investing in stocks, allowing shareholders to profit from the rise associated with their stocks without absorbing the fall.

On the basis of this analysis, the Court concluded that the subordination of the claims relating to the valuation rights in this case was both (1) justified because of the connection between the claims and the status of the claimants as shareholders. ; and (2) appropriate under the policy considerations underlying Section 510 (b). Since the applicable class under the Plan did not and will not receive any distribution, the claimants were not entitled to any refund on their claims.

Take away food

Although we are not necessarily convinced by the reasoning of the rise / fall of opinion, the RTI Holding The Court’s analysis that shareholders assume the risk of corporate bankruptcy by investing in equity rather than debt and therefore are subordinate, is sound. Congress enacted Section 510 (b) to prevent disappointed shareholders from recouping the value of their investment by filing bankruptcy claims that would neutralize or minimize this supposed risk. Holders of valuation rights that arise from a participation should be aware of the risk of subordination under Article 510 (b) in the event of bankruptcy, even if they are no longer shareholders at the time they file their claim. in the bankruptcy case. Presumably the RTI Holding the analysis also applies to a judgment obtained in the context of an expert assessment. Therefore, dissenting shareholders of a distressed company should weigh the potential benefit of a valuation judgment against the risk of subordination of bankruptcy.

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