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Merrimac Amicus Brief Supporting Appellant for Reversal No. 05-1010
IN THE UNITED STATES COURT OF APPEALS FOR THE FIRST CIRCUIT
IN RE MERRIMAC PAPER COMPANY, INC., Debtor
RALPH HARRISON, Defendant-Appellant v.
MERRIMAC PAPER COMPANY, INC., Plaintiff-Appellee
On Appeal from the United States District Court for the District of Massachusetts
BRIEF FOR THE SECRETARY OF LABOR AS AMICUS CURIAE SUPPORTING APPELLANT FOR REVERSAL
HOWARD M. RADZELY Solicitor of Labor
TIMOTHY D. HAUSER Associate Solicitor for Plan Benefits Security
ELIZABETH HOPKINS Counsel for Appellate and Special Litigation
ELLEN L. BEARD Senior Appellate Attorney U.S. Department of Labor Room N-4611 Washington, D.C. 20210 (202) 693-5767 240005218162 TABLE OF CONTENTS A. Statement of the facts B. The bankruptcy court decision C. The district court decision. I. Harrison's ERISA claims are not subject to mandatory subordination under the Bankruptcy Code
A. Even if some ERISA claims fall within section 510(b) of the Bankruptcy Code, Harrison's claims do not.
B. ERISA claims are not claims arising from the purchase or sale of a security within the meaning of section 510(b) of the Bankruptcy Code.
C. ERISA claims are not claims for damages within the meaning of section 510(b) of the Bankruptcy Code
II. Harrison's claims are not subject to equitable subordination under the Bankruptcy Code
Addendum A: Eggert v. Merrimac Paper Co., No. 03-cv-10048-MLW, Third Amended Complaint (filed Sept. 1, 2004 D. Mass.)
Addendum B: Eggert v. Merrimac Paper Co., No. 03-cv-10048-MLW, Memorandum and Order (filed Mar. 31, 2004 D. Mass.)
TABLE OF AUTHORITIES Cases: Abraham v. Norcal Waste Sys., Inc., 265 F.3d 811 (9th Cir. 2001)
Aetna Health Inc. v. Davila, 124 S. Ct. 2488 (2004)
Berry v. Ciba-Geigy Corp., 761 F.2d 1003 (4th Cir. 1985)
Bona v. Barasch, No. 01 Civ. 2289, 2003 WL 1395932 (S.D.N.Y. Mar. 20, 2003)
Borst v. Chevron Corp., 36 F.3d 1308 (5th Cir. 1994)
Broadnax Mills, Inc. v. Blue Cross & Blue Shield, 876 F. Supp. 809 (E.D. Va. 1995)
Calamia v. Spivey, 632 F.2d 1235 (5th Cir. 1980)
Donovan v. Bierwirth, 680 F.2d 263 (2d Cir. 1982)
Dudley Supermarket, Inc. v. Transamerica Life Ins. & Annuity Co., 302 F.3d 1 (1st Cir. 2002)
FCC v. NextWave Personal Communications, Inc., 537 U.S. 293 (2003)
Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101 (1989)
Great-West Life & Annuity Ins. Co. v. Knudson, 534 U.S. 204 (2002)
Guidry v. Sheet Metal Workers Nat'l Pension Fund, 493 U.S. 365 (1990)
Horn v. McQueen, 215 F. Supp. 2d 867 (W.D. Ky. 2002)
In re 604 Columbus Ave. Realty Trust, 968 F.2d 1332 (1st Cir. 1992)
In re Betacom of Phoenix, Inc., 240 F.3d 823 (9th Cir. 2001)
In re Blondheim Real Estate, Inc., 91 B.R. 639 (Bankr. D.N.H. 1988)
In re Cambridge Biotech Corp., 186 F.3d 1356 (Fed. Cir. 1999)
In re Drexel Burnham Lambert Group, Inc., 138 B.R. 717 (Bankr. S.D.N.Y. 1992)
In re Enron Corp. Sec., Derivative & "ERISA" Litig., 284 F. Supp. 2d 511 (S.D. Tex. 2003)
In re Evangelist, 760 F.2d 27 (1st Cir. 1985)
In re Geneva Steel Co., 281 F.3d 1173 (10th Cir. 2002)
In re Giorgio, 862 F.2d 933 (1st Cir. 1988)
In re Granite Partners, L.P., 208 B.R. 332 (Bankr. S.D.N.Y. 1997)
In re Hechinger Inv. Co., 298 F.3d 219 (3d Cir. 2002)
In re Lenco, Inc., 116 B.R. 141 (Bankr. E.D. Mo. 1990)
In re Lifschultz Fast Freight, 132 F.3d 339 (7th Cir. 1997)
In re Main Street Brewing Co., 210 B.R. 662 (Bankr. D. Mass. 1997)
In re Mobile Steel Co., 563 F.2d 692 (5th Cir. 1977)
In re Telegroup, Inc., 281 F.3d 133 (3d Cir. 2002)
In re WorldCom, Inc., 263 F. Supp. 2d 745 (S.D.N.Y. 2003)6
Keith v. Kilmer, 261 F. 733 (1st Cir. 1920)
Massachusetts Mut. Life Ins. Co. v. Russell, 473 U.S. 134 (1985)
Matthews Bros. v. Pullen, 268 F. 827 (1st Cir. 1920)
Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995)
New York State Conference of Blue Cross & Blue Shield Plans v. Travelers Ins. Co. 514 U.S. 645 (1995)
OceanSpray Cranberries, Inc. v. PepsiCo, Inc., 160 F.3d 58 (1st Cir. 1998)
Patterson v. Shumate, 504 U.S. 753 (1992)
Rankin v. Rots, 278 F. Supp. 2d 853 (E.D. Mich. 2003)
Recupero v. New England Tel. & Tel. Co., 118 F.3d 820 (1st Cir. 1997)
Reich v. Hall Holding Co., 990 F. Supp. 955 (N.D. Ohio 1998), aff'd, 285 F.3d 415 (6th Cir. 2002)
Reich v. Valley Nat'l Bank, 837 F. Supp. 1259 (S.D.N.Y. 1993)
Sommers Drug Stores Co. Employee Profit Sharing Trust v. Corrigan Enters., Inc., 793 F.2d 1456 (5th Cir. 1986)
Stein v. Smith, 270 F. Supp. 2d 157 (D. Mass. 2003)
Turner v. CF&I Steel Corp., 770 F.2d 43 (3d Cir. 1985)
Turner v. Fallon Cmty. Health Plan, Inc., 127 F.3d 196 (1st Cir. 1997)
United States v. Noland, 517 U.S. 535 (1996)
United States v. Reorganized CF&I Fabricators of Utah, Inc., 518 U.S. 213 (1996)
Varity Corp. v. Howe, 516 U.S. 489 (1996)
Wardle v. Central States, Southeast & Southwest Areas Pension Fund, 627 F.2d 820 (7th Cir. 1980)
Wharf (Holdings) Ltd. v. United Int’l Holdings, Inc., 532 U.S. 588 (2001)
Statutes and regulations:
Bankruptcy Code:
11 U.S.C. § 507(a) (3)
11 U.S.C. § 507(a) (4)
11 U.S.C. § 510(b)
11 U.S.C. § 510(c)
11 U.S.C. § 510(c)(1)
11 U.S.C. § 510(c)(2)
Employee Retirement Income Security Act of 1974, Title I, 29 U.S.C. §§ 1001 et seq.:
Section 2(b), 29 U.S.C. § 1001(b)
Section 404(a)(1)(A), 29 U.S.C. § 1104(a)(1)(A)
Section 404(a)(1)(A)-(D), 29 U.S.C. § 1104(a)(1)(A)-(D)
Section 404(a)(1)(B), 29 U.S.C. § 1104(a)(1)(B)
Section 404(a)(1)(D), 29 U.S.C. § 1104(a)(1)(D)
Section 406, 29 U.S.C. § 1106
Section 409(a), 29 U.S.C. § 1109(a)
Section 502(a)(1)(B), 29 U.S.C. § 1132(a)(1)(B)
Section 502(a)(2), 29 U.S.C. § 1132(a)(2)
Section 502(a)(3), 29 U.S.C. § 1132(a)(3)
Section 514(a), 29 U.S.C. § 1144(a)
Section 514(d), 29 U.S.C. § 1144(d)
Internal Revenue Code:
26 U.S.C. § 409(h)(1)(B)
29 C.F.R. § 2550.408(b)-3(1)(4) Miscellaneous: Collier on Bankruptcy app. B, pt. 4(c) (Alan N. Resnick et al. eds., 15th ed. rev. 2004)
Dan B. Dobbs, Law of Remedies (2d ed. 1993)
H.R. Doc. No. 93-137, pts. I & II (1973), reprinted in Collier on Bankruptcy app. B, pt. 4(c) (Alan N. Resnick et al. eds., 15th ed. rev. 2004)
H.R. Rep. No. 95-595 (1977), reprinted in 1978 U.S.C.C.A.N. 5963
S. Rep. No. 95-989 (1978), reprinted in 1978 U.S.C.C.A.N. 5787
S. Rep. No. 95-1263 (1978), reprinted in 1978 U.S.C.C.A.N. 6761
III Austin W. Scott & William W. Fratcher, The Law of Trusts (4th ed. 1988)
John J. Slain & Homer Kripke, The Interface between Securities Regulation and Bankruptcy -- Allocating the Risk of Illegal Securities Issuance between Securityholders and the Issuer's Creditors, 48 N.Y.U.
L. Rev. 261 (1973) This is a case of first impression in the courts of appeals regarding the subordination of ERISA claims in bankruptcy. The Secretary of Labor has primary authority to interpret and enforce Title I of the Employee Retirement Income Security Act of 1974 (ERISA), 29 U.S.C. § 1001 et seq., including authority to bring civil actions for breach of fiduciary duty to employee benefit plans. Corporate bankruptcies often put plan participants at heightened risk of losing funds accumulated for their retirement or health care. For instance, a corporate bankruptcy may leave plans holding large amounts of worthless company stock, sometimes acquired or held as a result of breaches of fiduciary duty. Therefore, the Secretary has a strong interest in ensuring that the subordination provisions of the Bankruptcy Code are not misapplied to subordinate ERISA claims brought by plan participants, beneficiaries, or the Secretary herself, merely because the claims have some relationship to a plan's holdings of employer stock. This case involves bankruptcy claims by a retired participant in an ERISA-covered employee stock ownership plan (ESOP), who took a distribution of his plan benefits in company stock and "put" (sold) it back to the plan sponsor in exchange for a promissory note, part of which remained unpaid when the sponsor entered Chapter 11 reorganization proceedings. The questions presented are: 1. Whether the participant's ERISA claims for benefits and fiduciary breach are subject to mandatory subordination under 11 U.S.C. § 510(b) as claims "for damages arising from the purchase or sale" of a security of the debtor. 2. Whether his ERISA claims or contract claims for non-payment of the note are subject to equitable subordination under 11 U.S.C. § 510(c) absent any inequitable conduct. A. Statement of the facts Defendant-appellant Ralph Harrison is a former employee of plaintiff-appellee Merrimac Paper Company (MPC or Merrimac), which is now the debtor in a Chapter 11 proceeding. Harrison worked for Merrimac from 1963 to 1999. MPC sponsored an ESOP, which provides that participants receive a distribution of their Merrimac stock upon separation from employment. The plan gives participants a right to sell or "put" the stock back to the company in exchange for cash. App. 162-63, 360-61. When Harrison retired, his individual account in the ESOP was credited with approximately 6% of MPC's common stock, an amount then valued at $1,116,200. After he exercised his put option, MPC made an initial payment of $200,000 on January 1, 2000. On July 19, 2000, MPC gave Harrison a promissory note for the balance of his account, $916,300, with 8.5% interest, secured by the shares of MPC common stock that Harrison previously owned through the ESOP. The note was payable in three equal annual installments. Harrison received the first installment payment of $343,203 on January 4, 2001, but received no payments thereafter. App. 163, 360. On September 6, 2002, Harrison brought a claim against MPC in state court for breach of contract in failing to pay the balance due on his promissory note. On September 12, 2002, he obtained an attachment in the amount of $610,000 on real property owned by MPC. On January 8, 2003, Harrison brought an ERISA action in federal district court against MPC, the ESOP, and four individuals alleged to be ERISA fiduciaries. App. 163-64, 360. The ERISA action included a benefit claim under 29 U.S.C. § 1132(a)(1)(B), asserting that defendants unlawfully denied plan benefits by failing to pay the balance due on the promissory note and by failing to provide "adequate security" on the note as required by the plan. Harrison also sued MPC for fiduciary breach under 29 U.S.C. §§ 1132(a)(2) and 1132(a)(3). He claimed, among other things, that MPC breached its fiduciary duties under ERISA, see 29 U.S.C. § 1104(a)(1)(A), (B), (D), by failing to provide adequate security for the note. Eggert v. MPC, No. 03-cv-10048-MLW, Third Am. Compl. 8-9 (filed Sept. 1, 2004 D. Mass.) (attached as Addendum A to this brief). The district court denied a motion to dismiss for lack of standing, holding that Harrison's rights under the put option, including the right to adequate security, could be characterized as benefits under the plan, and thus gave rise to a colorable claim for vested benefits for standing purposes under Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101 (1989). No. 03-cv-10048-MLW, Mem. & Order 31, 33-34 (filed Mar. 31, 2004) (attached as Addendum B). B. The bankruptcy court decision On March 17, 2003, MPC filed a voluntary petition under Chapter 11 of the Bankruptcy Code. On June 20, 2003, MPC commenced an adversary action against Harrison in the bankruptcy court, seeking (as relevant here): mandatory subordination of Harrison's claims under 11 U.S.C. § 510(b), equitable subordination of Harrison's claims under section 510(c)(1), and avoidance of Harrison's lien on MPC property under section 510(c)(2). App. 112, 162, 164, 172-81. The bankruptcy court addressed the ERISA claims and the contract claims separately under section 510(b). It declined to subordinate the contract claims, reasoning that claims for the balance due on a promissory note neither fall within the plain language of that provision nor bear any relationship to its purpose because the claimants are no longer shareholders. App. 173-74. However, it did subordinate the ERISA claims, explaining that "review of the ERISA Complaint supports that these claims are for damages that arise from their sale of stock to Merrimac." App. 174-75. The court also relied in part on In re Lenco, Inc., 116 B.R. 141 (Bankr. E.D. Mo. 1990), where the court subordinated an ERISA claim under section 510(b), and noted "ERISA's express language that it is not to be interpreted to supersede another federal law." App. 175-76. The bankruptcy court subordinated both the contract and ERISA claims under section 510(c), although it did not discuss the ERISA claims separately. Despite the Supreme Court's disapproval of categorical subordination under section 510(c) in United States v. Noland, 517 U.S. 535 (1996), the bankruptcy court concluded that one of the "principles of equitable subordination" codified by section 510(c) is the categorical subordination of stock redemption claims. After subordinating Harrison's claims under section 510(c)(1), the court transferred his lien on MPC real property to the bankruptcy estate under section 510(c)(2). App. 176-80. C. The district court decision The district court affirmed. Regarding the state law claims under section 510(b), it observed that "Appellee does not contest the ruling of the Bankruptcy Court that Appellants' claims arising from default under the Notes are not subject to subordination under § 510(b)." App. 374. Accordingly, it did not reach that question. As to the ERISA claims, the district court agreed with the bankruptcy court that "the only conceivable basis for Appellants' ERISA claims is their sale of stock" and that "ERISA does not override the express language of § 510(b)." Thus, the district court affirmed mandatory subordination of the ERISA claims under section 510(b). App. 374, 375. With respect to section 510(c), the district court noted that this Court has not addressed equitable subordination of claims arising from stock repurchase agreements since the Bankruptcy Code was enacted. It also acknowledged that this Court has adopted a widely-accepted test for equitable subordination that requires inequitable conduct by the claimant. App. 368. Nevertheless, it agreed with the bankruptcy court that Noland did not supersede the earlier First Circuit cases equitably subordinating stock redemption claims as a class. In its view, "stockholders of a corporation do not become debt creditors or stand on equal footing with trade or other creditors by virtue of selling their stock back to the corporation . . . because a corporation acquires nothing of value when it purchases its own stock. . . . A stockholder who accepts a promissory note in payment for his stock assumes the risk that the corporation may be insolvent when the note becomes due." App. 370. The district court gave short shrift to the ERISA claims, first stating (incorrectly) that "the only claims Appellants assert in the instant action are for non-payment of their Notes, claims which indisputably are governed by the bankruptcy laws." App. 371. The court added that "Appellants' conclusory statements about the equities of this particular case do not extend to ERISA the authority to trump the bankruptcy laws." Id. In its view, "application of the bankruptcy laws, and specifically 11 U.S.C. § 510, is not altered by the fact that Appellants may have underlying claims based on ERISA." Id. The court also affirmed the transfer of Harrison's lien to the bankruptcy estate under 11 U.S.C. § 510(c)(2). App. 372. Harrison's ERISA claims are not subject to mandatory subordination under section 510(b) of the Bankruptcy Code. His claim for benefits is simply another way of pleading his claim for the balance due on the note, and his fiduciary breach claim concerns Merrimac's failure to provide adequate security for the note. Neither claim seeks damages arising from the purchase or sale of a security. More generally, ERISA claims do not arise from the purchase or sale of a security within the meaning of section 510(b). Section 510(b) was aimed at securities law claims, not ERISA claims, and participants in ERISA plans do not assume the same risks as equity investors. Also, ERISA claims do not seek damages; they seek either plan benefits or equitable relief for breaches of fiduciary duty. Finally, Harrison's claims are not subject to equitable subordination under section 510(c) of the Bankruptcy Code. The lower courts ignored binding Supreme Court precedent by categorically subordinating his claims as stock redemption claims, and there is no suggestion of inequitable conduct on his part. I. HARRISON'S ERISA CLAIMS ARE NOT SUBJECT TO MANDATORY SUBORDINATION UNDER THE BANKRUPTCY CODE Section 510(b) of the Bankruptcy Code requires mandatory subordination of "a claim . . . for damages arising from the purchase or sale" of a security of the debtor, and specifies that, "if such security is common stock, such claim has the same priority as common stock." 11 U.S.C. § 510(b). The question before this Court is whether Harrison's ERISA claims are claims for damages arising from the purchase or sale of a security within the meaning of this provision. The Secretary submits that they are not. A. Even if some ERISA claims fall within section 510(b) of the Bankruptcy Code, Harrison's claims do not The ERISA claims in this case are limited in scope – Harrison sought benefits from the ESOP, and alleged a breach of fiduciary duty in failing to provide adequate security for his promissory note. Even assuming, arguendo, that section 510(b) applies to some ERISA claims, it does not apply to the claims in this case because they do not arise from investment decisions by a plan fiduciary, but rather from Merrimac's failure to pay benefits due under the plan, and to provide adequate collateral for Harrison's promissory note as required by ERISA. The lower courts have already held that section 510(b) does not apply to Harrison's state law claim for unpaid installments due on the note from Merrimac.[1] His ERISA benefit claim seems to be just another way of pleading his claim on the note, as the only relief he seeks in the benefit claim is the value of the unpaid installments and "adequate security" for those payments under the terms of the plan. This claim is pleaded in the alternative because it can be conceptualized in two ways. That is, if Harrison received a complete distribution of his plan benefits in the form of company stock, and then sold the stock back to the company under the put option in his plan, his claim can be treated as a state law contract claim for nonpayment of the note. On the other hand, if the installment payments under the note are themselves viewed as a cash distribution of his benefits in the ESOP, his claim is one for ERISA benefits due and unpaid. In neither case, however, can the claim be viewed as a claim for damages arising from any act or omission affecting his investment in company stock. Nor do Harrison's fiduciary breach claims seek "damages arising from the purchase or sale of . . . a security" of the debtor within the meaning of section 510(b). Harrison seeks adequate security for his note ((as required by the Internal Revenue Code, ERISA regulations, see infra p. 28 n.8, and the plan), and resulting priority over other creditors in the bankruptcy proceeding. In effect, he argues that, if MPC had followed the terms of the plan's put option, his note would have been secured by MPC real property or other adequate security in the first place, as it was after he obtained the attachment in state court. Thus, Harrison's fiduciary breach claim in the bankruptcy proceeding is not a claim for "damages," but rather an equitable claim – he asks the court, sitting in equity, to honor the maxim that "equity treats as done that which in good conscience should be done." In re Cambridge Biotech Corp., 186 F.3d 1356, 1366 (Fed. Cir. 1999). The ERISA claim can also be viewed as an equitable defense in the bankruptcy proceeding, defending against subordination of his benefit claim and associated lien in bankruptcy. Moreover, because the claim seeks to retain an identifiable res as relief for fiduciary breach (Harrison's state court lien on MPC real property), the remedy sought fits within the Supreme Court's description of equitable restitution in Great-West Life & Annuity Insurance Co. v. Knudson, 534 U.S. 204 (2002). That is, it seeks "not to impose personal liability on the defendant [MPC], but to restore to the plaintiff particular funds or property in the defendant's possession [Harrison's attachment of MPC's real property, which is otherwise part of the bankruptcy estate]." Id. at 214. B. ERISA claims are not claims arising from the purchase or sale of a security within the meaning of section 510(b) of the Bankruptcy Code More generally, we believe that ERISA claims for fiduciary breaches related to a plan's holdings in company stock are not claims "arising from the purchase or sale of . . . a security" under section 510(b). Such an action does not fall within the ambit of section 510(b) for two related reasons. First, an ERISA plan participant is not similarly situated to an ordinary shareholder. An ERISA participant does not assume the same risks as ordinary equity investors, the class of claimants section 510(b) was designed to subordinate. Second, ERISA claims are not based on the company's status as an issuer of securities, or on the participant's status as an investor in company stock, but rather on the company's distinct status as a plan fiduciary charged with a unique obligation to safeguard the interests of the pension plan and its participants. Merrimac owed a fiduciary duty to the Plan and its participants not because it was the issuer of securities or because the Plan was an investor in Merrimac stock, but because it was a Plan fiduciary obligated to safeguard the Plan's interests with prudence and loyalty in conformity with ERISA. Similarly, the Plan and its participants were not ordinary equity investors that share the risk of their company's failure. Rather, the Plan and its participants are entities uniquely protected by the special duties imposed upon all plan fiduciaries by ERISA. Section 510(b) of the Bankruptcy Code does not, by its terms or intent, subordinate these ERISA-based claims to the claims of other unsecured creditors. Indeed, most courts recognize that the text of section 510(b) – particularly the phrase "arising from" – is ambiguous. See, e.g., In re Geneva Steel Co., 281 F.3d 1173, 1179 (10th Cir. 2002); In re Telegroup, Inc., 281 F.3d 133, 138 (3d Cir. 2002). As the Third Circuit has explained: "For a claim to 'arise from the purchase or sale of a security,' there must obviously be some nexus or causal relationship between the claim and the sale of the security, but § 510(b)'s language alone provides little guidance in delineating the precise scope of the required nexus." Id. at 138.[2] Given the textual ambiguity just described, courts have generally sought guidance from the legislative history in delineating the scope of the statutory provision. See, e.g., In re Telegroup, 281 F.3d at 138-41; In re Granite Partners, L.P., 208 B.R. 332, 336-37 (Bankr. S.D.N.Y. 1997). One revealing piece of legislative history is the Report of the Commission on Bankruptcy Laws of the United States, H.R. Doc. No. 93-137, pts. I & II (1973) (Commission Report), reprinted in Collier on Bankruptcy app. B, pt. 4(c) (Alan N. Resnick et al. eds., 15th ed. rev. 2004), which contained proposed language very similar to section 510(b)'s final language. See Granite Partners, 208 B.R. at 336 n.8. According to the accompanying explanation, the proposed provision was "intended to reach claims by holders of the debtor's securities that were based on 'federal and state securities legislation, rules pursuant thereto, and similar laws,' but would not affect any other claim (e.g., a wage claim) which the investor also held." Id. (quoting Commission Report, pt. II, at 116, reprinted in Collier, supra, app. B, pt. 4(c) at 4-684). If the same intent is attributed to the Congress that later adopted the same statutory language, it is strong evidence that section 510(b) was not designed to apply to ERISA claims, particularly benefit claims, which are similar to wage claims. See Horn v. McQueen, 215 F. Supp. 2d 867, 879 (W.D. Ky. 2002); Reich v. Valley Nat'l Bank, 837 F. Supp. 1259, 1286-87 (S.D.N.Y. 1993); see also 11 U.S.C. § 507(a)(3), (4) (giving wages and employee benefits similar priority in bankruptcy). The key report that accompanies the enacted provision reveals the same intent – to ensure that shareholders with securities law claims would not be treated in the same manner in bankruptcy as general unsecured creditors. See H.R. Rep. No. 95-595, at 194 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6154. In determining that such claims should be subordinated, Congress relied heavily on a law review article written by Professors John J. Slain and Homer Kripke, The Interface between Securities Regulation and Bankruptcy – Allocating the Risk of Illegal Securities Issuance between Securityholders and the Issuer's Creditors, 48 N.Y.U. L. Rev. 261 (1973) (Slain & Kripke). See H.R. Rep. No. 95-595, at 194-96, reprinted in 1978 U.S.C.C.A.N. at 6154-56; In re Betacom of Phoenix, Inc., 240 F.3d 823, 829 (9th Cir. 2001). As the title of their article indicates, the law professors focused their attention on allocating losses arising from the illegal issuance of securities, and argued that shareholders, rather than general creditors, should bear the risk of illegal issuance of securities as well as the risk of enterprise insolvency. Slain & Kripke, supra, at 286-88. In their view, both risks are voluntarily assumed by shareholders, who hope to obtain profits through an equity investment, and neither is assumed by creditors, who assert a fixed dollar claim and rely on the equity cushion provided by the shareholders in case of bankruptcy. Id. The bill enacted by Congress "generally adopt[ed] the Slain/Kripke position." H.R. Rep. No. 95-595, at 196, reprinted in 1978 U.S.C.C.A.N. at 6156; see also Geneva Steel, 281 F.3d at 1176 (describing Slain & Kripke argument and legislative history); Telegroup, 281 F.3d at 140-41 (same). The Slain & Kripke rationale for subordinating shareholder claims does not apply to ERISA claims. Under the strict legal regime of fiduciary duties imposed by ERISA, a participant or beneficiary in an ERISA plan does not assume the type or degree of risk borne by a typical equity investor in the securities market. ERISA is designed to minimize the risk to retirement savings by interposing fiduciaries subject to strict duties of prudence and loyalty between plan participants and the market. See 29 U.S.C. § 1001(b) (ERISA purposes); 29 U.S.C. 1104(a)(1)(A)-(D), 1106 (ERISA fiduciary duties); Donovan v. Bierwirth, 680 F.2d 263, 272 n.8 (2d Cir. 1982) (ERISA imposes upon plan fiduciaries duties of prudence and loyalty that are the "highest known to the law"). The interests of ERISA participants in their plans, including ESOPs, are thus protected by a detailed legal regime that has no equivalent in the laws protecting ordinary shareholders. See Moench v. Robertson, 62 F.3d 553, 568-70 (3d Cir. 1995) (discussing fiduciary duties of ESOP fiduciaries). Consequently, the underlying rationale for section 510(b) – to make equity investors bear the risks of corporate insolvency – does not apply when ERISA participants challenge investment decisions made by their fiduciaries. Nor do ERISA claims themselves resemble the type of securities law claims that Congress addressed in section 510(b). ERISA claims do not "arise from" any breach of a company's duties under the securities laws, such as securities fraud or violation of insider trading rules. The Secretary and plan participants do not bring ERISA claims to vindicate their interests as shareholders, but rather to vindicate the plan's rights to stringent standards of fiduciary conduct. And the injuries they allege stem from the misconduct of the company in its capacity as a plan fiduciary, not in its capacity as a corporate issuer or market participant.[3] Thus, courts recognize that the duties corporations owe to all their shareholders, including plans or plan participants, are distinct from the ERISA duties that corporations owe to plans and plan participants when they act as fiduciaries. "The state law and ERISA duties are parallel but independent: as director, the individual owes a duty, defined by state law, to the corporation's shareholders, including the plan; as fiduciary, the individual owes a duty, defined by ERISA, to the plan and its beneficiaries." Sommers Drug Stores Co. Employee Profit Sharing Trust v. Corrigan Enters., Inc., 793 F.2d 1456, 1468 (5th Cir. 1986); accord Abraham v. Norcal Waste Sys., Inc., 265 F.3d 811, 822 (9th Cir. 2001); In re WorldCom, Inc., 263 F. Supp. 2d 745, 765 (S.D.N.Y. 2003) (recognizing the existence of separate but "overlapping duties" under ERISA and the securities laws); In re Enron Corp. Sec., Derivative & "ERISA" Litig., 284 F. Supp. 2d 511, 565-66 (S.D. Tex. 2003) (similar); Rankin v. Rots, 278 F. Supp. 2d 853, 877-78 (E.D. Mich. 2003) (similar); see also Stein v. Smith, 270 F. Supp. 2d 157, 167 (D. Mass. 2003) (similar). Both the decisions below noted that, under the "federal savings clause" to ERISA preemption, 29 U.S.C. § 1144(d), ERISA does not trump other federal laws, such as the Bankruptcy Code. App. 176, 374. But those comments fail to address the underlying question, which is whether section 510(b) applies to ERISA claims at all.[4] They also ignore the fundamental canon of statutory interpretation that, "[w]hen two statutes are capable of co-existence, it is the duty of the courts, absent a clearly expressed congressional intention to the contrary, to regard each as effective." FCC v. NextWave Personal Communications, Inc., 537 U.S. 293, 304 (2003) (Bankruptcy Code and Communications Act of 1934); see also Patterson v. Shumate, 504 U.S. 753 (1992) (ERISA and Bankruptcy Code); Guidry v. Sheet Metal Workers Nat'l Pension Fund, 493 U.S. 365 (1990) (ERISA and Labor Management Reporting and Disclosure Act). Here, as in Patterson, there is no conflict between ERISA and the Bankruptcy Code. Section 510(b) is ambiguous in the context of ERISA claims involving company stock. Analysis of the legislative history and purposes of both statutes makes clear that fiduciary breach and benefit claims involving employee benefit plans are not the type of claims that section 510(b) was designed to encompass. Thus, this Court should preserve the effectiveness and intent of both section 510(b) and ERISA by holding that mandatory subordination does not apply to ERISA claims. C. ERISA claims are not claims for damages within the meaning of section 510(b) of the Bankruptcy Code Harrison's ERISA claims also fall outside the scope of section 510(b) of the Bankruptcy Code because they do not seek "damages" as that term is commonly understood. 11 U.S.C. § 510(b).[5] "The damages remedy was historically a legal remedy," which provides a jury trial as a matter of right under the Seventh Amendment. Dan B. Dobbs, Law of Remedies § 1.2, at 9 (2d ed. 1993). See also Aetna Health Inc. v. Davila, 124 S. Ct. 2488, 2499 (2004); OceanSpray Cranberries, Inc. v. PepsiCo, Inc., 160 F.3d 58, 61 (1st Cir. 1998) (describing damages as a legal remedy). Unlike claims for securities fraud, which seek damages and are tried to a jury, see, e.g., Wharf (Holdings) Ltd. v. United Int'l Holdings, Inc., 532 U.S. 588 (2001), ERISA claims are equitable in nature, are not tried to a jury, and do not seek damages as that term is used in section 510(b). In his complaint, Harrison makes a claim for plan benefits under ERISA section 502(a)(1)(B), 29 U.S.C. § 1132(a)(1)(B), and claims for relief under ERISA sections 502(a)(2) and 502(a)(3), 29 U.S.C. § 1132(a)(2), (3), to remedy breaches of fiduciary duty. This Court has held that damages are not a permissible remedy in an ERISA benefit claim; the claimant may seek only the benefits provided by the plan. Turner v. Fallon Cmty. Health Plan, Inc., 127 F.3d 196, 198-99 (1st Cir. 1997); see also Massachusetts Mut. Life Ins. Co. v. Russell, 473 U.S. 134 (1985) (ERISA plan participant may not seek extracontractual damages for improper processing of benefit claim under 29 U.S.C. § 1109(a)). Moreover, most courts have held that ERISA benefit claims are equitable in nature and do not entitle parties to a jury trial. See, e.g., Turner v. CF&I Steel Corp., 770 F.2d 43, 46-47 (3d Cir. 1985); Berry v. Ciba-Geigy Corp., 761 F.2d 1003, 1006-07 (4th Cir. 1985); Calamia v. Spivey, 632 F.2d 1235, 1237 (5th Cir. 1980); Wardle v. Central States, Southeast & Southwest Areas Pension Fund, 627 F.2d 820, 829-30 (7th Cir. 1980); see also Recupero v. New England Tel. & Tel. Co., 118 F.3d 820, 831-32 (1st Cir. 1997) (noting, in ERISA benefit case, that "historically, juries have had no part in judicial review of out-of-court decisions" such as typical benefit claims). Accordingly, Harrison's claim for benefits is not a claim for "damages." Nor does he seek damages to remedy the alleged fiduciary breaches. As an initial matter, we question whether Harrison's claim under section 502(a)(2), 29 U.S.C. 1132(a)(2), is viable because it seeks no identifiable relief on behalf of the Plan, as that provision requires. Russell , 473 U.S. at 140. However, by claiming that MPC failed to provide adequate security for his note, Harrison does state a claim for breach of fiduciary duty under section 502(a)(3), 29 U.S.C. 1132(a)(3), which allows an individual participant to recover "appropriate equitable relief" to remedy a fiduciary breach even when the plan has not been harmed. Varity Corp. v. Howe, 516 U.S. 489, 507-15 (1996). Because section 502(a)(3) by its terms authorizes only "equitable relief," which was historically distinct from damages, Harrison's fiduciary breach claim cannot possibly be said to seek "damages" within the meaning of section 510(b) of the Bankruptcy Code.[6] Most courts have recognized the inherently equitable nature of ERISA claims for breach of fiduciary duty by denying requests for jury trials. See, e.g., Borst v. Chevron Corp., 36 F.3d 1308, 1323-24 (5th Cir. 1994) (no jury trial on fiduciary breach claim); Broadnax Mills, Inc. v. Blue Cross & Blue Shield, 876 F. Supp. 809, 816 (E.D. Va. 1995) (collecting cases); but see Bona v. Barasch, No. 01 Civ. 2289, 2003 WL 1395932, at *35 (S.D.N.Y. Mar. 20, 2003) (under Great-West, relief that plaintiffs sought under section 502(a)(2), losses to the plan, was legal relief that entitled them to jury trial). Indeed, the equitable character of ERISA remedies is now so well established that most litigants do not even pursue jury trials. See Dudley Supermarket, Inc. v. Transamerica Life Ins. & Annuity Co., 302 F.3d 1, 2-3 & n. 3 (1st Cir. 2002) (noting that appellants had not appealed "the district court's ruling that there is no right to trial by jury for actions alleging breach of fiduciary duty under ERISA"). This Court has also denied a request for jury trial in a corporate fiduciary breach case, explaining that "[a]ctions for breach of fiduciary duty, historically speaking, are almost uniformly actions 'in equity' – carrying with them no right to trial by jury." In re Evangelist, 760 F.2d 27, 29 (1st Cir. 1985) (Breyer, J.). The same principle applies to actions for breach of fiduciary duty under ERISA. Such actions do not seek legal relief, do not carry a right to a jury trial, and thus do not seek "damages" within the meaning of section 510(b) of the Bankruptcy Code. II. HARRISON'S CLAIMS ARE NOT SUBJECT TO EQUITABLE SUBORDINATION UNDER THE BANKRUPTCY CODE Section 510(c) (1) of the Bankruptcy Code provides that a bankruptcy court "may . . . under principles of equitable subordination, subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim or all or part of an allowed interest to all or part of another allowed interest." 11 U.S.C. § 510(c)(1). Unlike section 510(b), which requires subordination of a narrow class of claims, section 510(c) permits a bankruptcy court, sitting as a court of equity, to subordinate virtually any claim when it is equitable to do so based on the facts of a particular case. Section 510(c), however, does not permit subordination of any general category of claims. Therefore, the courts below erred by subordinating Harrison's claims on a categorical basis without any inequitable conduct on his part. The Supreme Court has held that the Bankruptcy Code does not permit the categorical subordination of any class of claims under section 510(c), because to do so would be "in derogation of Congress's scheme of priorities." United States v. Noland, 517 U.S. 535, 536 (1996). As the Court explained, "the adoption in § 510(c) of 'principles of equitable subordination' permits a court to make exceptions to a general rule when justified by particular facts." Id. at 540. It does not permit bankruptcy courts to make decisions "at the level of policy choice at which Congress itself operated in drafting the Code." Id. at 543. In a companion case, United States v. Reorganized CF&I Fabricators of Utah, Inc., 518 U.S. 213 (1996), the Court made clear that the principles articulated in Noland were not limited to "subordination from a higher priority class to the residual category of general unsecured creditors at the end of the line." Id. at 229. The same principles bar the subordination of "a disfavored subgroup within the residual category" – as occurred in CF&I and this case – because "categorical reordering of priorities that takes place at the legislative level of consideration is beyond the scope of judicial authority to order equitable subordination under § 510(c)." Id.[7] Therefore, the decision of the lower courts in this case to subordinate Harrison's claims because they fall in the disfavored category of "stock redemption claims" is directly contrary to the interpretation of section 510(c) contained in Noland and CF&I. The older First Circuit cases on which the lower courts and appellee rely to support categorical subordination of stock redemption claims, Keith v. Kilmer, 261 F. 733 (1st Cir. 1920), and Matthews Bros. v. Pullen, 268 F. 827 (1st Cir. 1920), cannot be binding precedent now (MPC Br. 12), because they were decided long before the enactment of section 510(c) in 1978 and its authoritative construction in Noland and CF&I. Similarly, most of the other case law that arguably supports the result below (see MPC Br. 12-18) also predates Noland and CF&I, and later decisions of the lower courts, such as In re Main Street Brewing Co., 210 B.R. 662 (Bankr. D. Mass. 1997), do not adequately address the rationale of Noland. Nor was the district court correct in stating that "a corporation acquires nothing of value when it purchases its own stock" from a former employee who participated in an ESOP. App. 370. ERISA benefits, like all fringe benefits, are part of an employee's total compensation package, and are paid in exchange for the employee's labor on behalf of his employer over the course of his career. See Horn v. McQueen, 215 F. Supp. 2d at 879; Reich v. Hall Holding Co., 990 F. Supp. 955, 960-61 (N.D. Ohio 1998), aff'd, 285 F.3d 415 (6th Cir. 2002); Reich v. Valley Nat'l Bank, 837 F. Supp. at 1286-87. Thus, Harrison had already earned his benefits when he exercised his put option to convert his stock to retirement income. Accordingly, even if this Court continues to subordinate some stock redemption claims under section 510(c), claims based on put options mandated by the Internal Revenue Code and ERISA regulations (see infra, p. 26 n.8) should not be among them. Although the Supreme Court did not decide in Noland "whether a bankruptcy court must always find creditor misconduct before a claim may be equitably subordinated," 517 U.S. at 543, there is considerable support for that position in the legislative history and case law, including decisions of this Court. The Senate Report describing the provision that became section 510(c) explains that "any subordination ordered under this provision must be based on principles of equitable subordination. These principles are defined by case law, and have generally indicated that a claim may normally be subordinated only if its holder is guilty of misconduct." S. Rep. No. 95-989, at 74 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5860 (emphasis added). In Noland itself, the Supreme Court cited with approval an "influential opinion" of the Fifth Circuit, In re Mobile Steel Co., 563 F.2d 692 (1977), which listed three conditions for equitable subordination: (1) the claimant must have engaged in "some type of inequitable conduct," (2) the misconduct must have "resulted in injury to the creditors of the bankrupt or conferred an unfair advantage on the claimant," and (3) subordination must "not be inconsistent with the provisions of the Bankruptcy Act." Noland, 517 U.S. at 538-39 (quoting Mobile Steel, 563 F.2d at 700). This Court has adopted the Mobile Steel test for equitable subordination. In re 604 Columbus Ave. Realty Trust, 968 F.2d 1332, 1353 (1st Cir. 1992); In re Giorgio, 862 F.2d 933, 938-39 (1st Cir. 1988) (Breyer, J.). Indeed, even before Noland, this Court had adopted the principles that equitable subordination requires a case-by-case determination, Giorgio, 862 F.2d at 938, and a showing of wrongdoing by the subordinated creditor. Columbus Ave., 968 F.2d at 1353. Under these principles, the decision to subordinate Harrison's claims under section 510(c) must be reversed. The courts below did not "examine the equities of [his] particular claim," Giorgio, 862 F.2d at 938, or find any "wrongdo[ing]" on his part. Columbus Ave., 968 F.2d at 1353. Instead, they applied an obsolete doctrine of categorical subordination of stock redemption claims, which this Court should now reject.[8] The judgment of the district court subordinating Harrison's ERISA claims under sections 510(b) and 510(c) of the Bankruptcy Code should be reversed. HOWARD M. RADZELY Solicitor of Labor
TIMOTHY D. HAUSER Associate Solicitor for Plan Benefits Security
ELIZABETH HOPKINS Counsel for Special and Appellate Litigation
_______________________ ELLEN L. BEARD Senior Appellate Attorney U.S. Department of Labor Room N-4611 200 Constitution Avenue, N.W. Washington, D.C. 20210 (202) 693-5767 MAY 2005 I hereby certify that on May 11, 2005, two paper copies of the amicus brief for the Secretary of Labor, Elaine L. Chao, were served using Federal Express, postage prepaid, upon the following counsel of record:
Thomas P. Smith Caffrey & Smith, P.C. 300 Essex Street Lawrence, MA 01840
James F. Wallack Rafael Klotz Goulston & Storrs, P.C. 400 Atlantic Avenue Boston, MA 02110-3333
Gary R. Greenberg Louis J. Scerra, Jr. A.R. Sankaran Greenberg Traurig One International Place 3rd Floor Boston, MA 02110
_________________________ ELLEN L. BEARD Senior Appellate Attorney
Form 6. Certificate of Compliance With Rule 32(a)
Certificate of Compliance With Type-Volume Limitation, Typeface Requirements, and Type Style Requirements
1. This brief complies with the type-volume limitation of Fed. R. App. P.32(a)(7)(B) because:
X this brief contains 6,615 words, excluding the parts of the brief exempted by Fed. R. App. P. 32(a)(7)(B)(iii), or
__ this brief uses a monospaced typeface and contains [state the number of] lines of text, excluding the parts of the brief exempted by Fed. R. App.P.32(a)(7)(B)(iii).
2. This brief complies with the typeface requirements of Fed. R. App. P. 32(a)(5) and the type style requirements of Fed. R. App. P. 32(a)(6) because:
X this brief has been prepared in a proportionally spaced typeface using Microsoft Office Word 2003 in 14 point Times New Roman font, or
__ this brief has been prepared in a monospaced typeface using [state name and version of word processing program] with [state number of characters per inch and name of type style].
(s)______________________________
Attorney for Secretary of Labor, Elaine L. Chao, as amicus curiae
Dated: May 11, 2005
Footnotes: [1] Because MPC has not appealed that determination, Harrison suggests that this Court may not need to reach the question of the subordination of his ERISA claims under section 510(b) in order to decide this appeal, but may instead merely consider whether the bankruptcy court acted within its discretion in subordinating the ERISA and state law claims under section 510(c). Harrison Br. 23-24 n.6. In addition, MPC argues (Br. 26-28) that Harrison never adequately asserted or preserved any ERISA claims in the bankruptcy proceedings. The Department expresses no opinion on that question. [2] In construing the term "relate to" in ERISA's preemption provision, 29 U.S.C. 1144(a), the Supreme Court has recognized that, despite its breadth, that term must be construed in light of ERISA's statutory purposes. New York State Conference of Blue Cross & Blue Shield Plans v. Travelers Ins. Co., 514 U.S. 645, 656 (1995) ("We simply must go beyond the unhelpful text and the frustrating difficulty of defining its key term, and look instead to the objectives of the ERISA statute as a guide to the scope of the state law that Congress understood would survive."). So too here: the phrase "arising from the purchase or sale of . . . a security" in section 510(b) of the Bankruptcy Code must be read, not in the broadest possible sense to encompass every claim that touches on securities, but in the sense that best gives effect to the more limited statutory purpose to subordinate claims arising from a claimant's status as a shareholder, given the assumption of risk attendant to that status. [3] This is not to say that a plan or its participants may never bring securities law claims in their capacity as investors. Those claims – like other shareholder claims but unlike ERISA claims – could be subject to mandatory subordination under section 510(b). [4] The bankruptcy court also relied in part on In re Lenco, Inc., 116 B.R. 141 (Bankr. E.D. Mo. 1990), in which a bankruptcy court subordinated an ERISA fiduciary breach claim under section 510(b). For the reasons already explained, we think that Lenco was wrongly decided. It is also distinguishable from this case on its facts, as the fiduciary breach at issue concerned the actual sale and purchase of securities by an ESOP. But see In re Drexel Burnham Lambert Group, Inc., 138 B.R. 717, 718 (Bankr. S.D.N.Y. 1992) (questioning whether section 510(b) overrides the provisions of ERISA that protect employee benefit plans from fiduciary misconduct). [5] Neither the Bankruptcy Code nor its legislative history contains a definition or explanation of the term "damages." In re Blondheim Real Estate, Inc., 91 B.R. 639, 640 (Bankr. D.N.H. 1988). [6] ERISA was based in large part on the law of trusts, Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 110 (1989), and trust relationships "are, and have been since they were first enforced, within the peculiar province of courts of equity." III Austin W. Scott & William W. Fratcher, The Law of Trusts § 197, at 188 (4th ed. 1988). [7] In this appeal, Merrimac makes the same argument that the Supreme Court rejected in CF&I – that Noland prohibits only subordination of "claims that Congress specifically chose to treat as priority claims." MPC Br. 20-21. But even if that were true – and it is not – the Bankruptcy Code does give statutory priority to some employee benefit claims. For example, fringe benefits earned by employees for postpetition services are entitled to administrative expense priority. In re Hechinger Inv. Co., 298 F.3d 219 (3d Cir. 2002). And a certain amount of fringe benefits earned within 180 days prepetition is entitled to priority under 11 U.S.C. § 507(a)(4). [8] There is no suggestion that Harrison engaged in any inequitable conduct that would justify subordination of his claims under section 510(c). Courts generally define "inequitable conduct" within the meaning of section 510(c) to include "(1) fraud, illegality, breach of fiduciary duties; (2) undercapitalization; and (3) claimant's use of the debtor as a mere instrumentality or alter ego." In re Lifschultz Fast Freight, 132 F.3d 339, 344-45 (7th Cir. 1997) (citations omitted). In this case, all Harrison did was to exercise a put option included in his plan as required by the Internal Revenue Code, 26 U.S.C. § 409(h)(1)(B), and Labor Department regulations, 29 C.F.R. § 2550.408b-3(l)(4), to enable him to cash out his stock upon retirement. See generally S. Rep. No. 95-1263, at 79, 83 (1978), reprinted in 1978 U.S.C.C.A.N. 6761, 6842, 6846. Thus, while there may be some cases in which equitable subordination of ERISA claims is appropriate, that determination would have to be made on a case-by-case basis, and no one contends that it is appropriate here.
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