Zafar Khan v. Kenneth Barton
846 F.3d 1058
| 9th Cir. | 2017Background
- In 2013, Kenneth Barton obtained a California Superior Court judgment against Zafar Khan and Terrance Tomkow (the Debtors) for fraud and conversion, restoring or valuing 6,016,500 RPost International, Ltd. shares and awarding roughly $3.84 million for converted shares.
- Each debtor filed Chapter 13 petitions a few days before the Superior Court set stock valuation; their schedules undervalued RIL stock at $0 and listed Barton's claim as $100,000 (unliquidated).
- Barton filed proofs of claim and moved to convert the Chapter 13 cases to Chapter 7, alleging Debtors filed in bad faith; Debtors objected and sought mandatory subordination of Barton’s claim under 11 U.S.C. § 510(b).
- The bankruptcy court held § 510(b) did not apply because Barton’s claims arose from post-purchase torts (fraud/conversion), not from purchase/sale of a security, and granted Barton’s conversion motions for bad-faith filing and concealment.
- The BAP affirmed conversion and refusal to disallow the claim, but (incorrectly, per this panel) had held § 510(b) did not apply to individual debtors; the Ninth Circuit rejected that reasoning, held § 510(b) applies to individuals but affirmed on the alternative ground that Barton’s claims did not "arise from" a purchase or sale.
Issues
| Issue | Plaintiff's Argument (Barton) | Defendant's Argument (Debtors) | Held |
|---|---|---|---|
| Whether § 510(b) applies to individual debtors | § 510(b) does apply to individuals; Barton relied on BAP reasoning below | Debtors argued § 510(b) inapplicable to individuals (BAP had held so) | Court: § 510(b) does apply to individuals, rejecting BAP’s contrary rationale |
| Whether Barton’s claim must be subordinated under § 510(b) because it "arises from" purchase or sale of a security | Barton argued his remedy flowed from ownership of shares and thus is tied to his purchase; claim should be subordinated | Debtors argued the claim arose from later torts (fraud/conversion in 2009), not from the purchase, so § 510(b) does not apply | Court: Claim did not "arise from" purchase/sale — it arose from later conversion/fraud; § 510(b) subordination denied |
| Whether conversion from Chapter 13 to Chapter 7 was appropriate for bad faith | Barton argued Debtors filed in bad faith to defeat state-court judgment and concealed assets, supporting conversion | Debtors argued no bad faith; Leavitt factors not met (esp. that motive "only" to defeat litigation) | Court: Considering totality of circumstances, bankruptcy court’s finding of bad faith was not clearly erroneous and conversion was proper |
Key Cases Cited
- Del Biaggio Liquidating Tr. v. Freeman, 834 F.3d 1003 (9th Cir. 2016) (§ 510(b) applies broadly and can reach damage claims tied to securities; § 510(b) applies to individual debtors)
- Pensco Tr. Co. v. Tristar Esperanza Props., LLC, 782 F.3d 492 (9th Cir. 2015) (claims can arise from failed equity transactions even if no consummated sale)
- Am. Broad. Sys., Inc. v. Nugent (In re Betacom of Phoenix, Inc.), 240 F.3d 823 (9th Cir. 2001) (broad reading of "arising from" for § 510(b) in some transactional contexts)
- Racusin v. Am. Wagering, Inc. (In re Am. Wagering, Inc.), 493 F.3d 1067 (9th Cir. 2007) (distinguishes claims where stock value merely measures damages for non-investor claims from claims that stem from the purchase/sale of securities)
- Leavitt v. Soto (In re Leavitt), 171 F.3d 1219 (9th Cir. 1999) (factors and "totality of circumstances" test for bad-faith conversion from Chapter 13 to Chapter 7)