CIT Group Inc. v. Tyco International Ltd. (In Re CIT Group Inc.)CIT Group Inc. v. Tyco International Ltd. (In Re CIT Group Inc.)
MEMORANDUM OF OPINION
Introduction
Before the Court are cross-motions for summary judgment filed, respectively, by the reorganized debtor, CIT Group Inc. (“CIT” or “Reorganized Debtor”), and by its former indirect parent company, Tyco International Ltd. (“Tyco”). CIT argues that a claim filed by Tyco should be subordinated pursuant to § 510(b) of the Bankruptcy Code as one for damages arising from the sale of CIT’s securities because the tax agreement on which it is based (the “Tax Agreement”) was entered into as an integral part of the spinoff of CIT from Tyco’s corporate group in 2002. Tyco asserts in its cross-motion that its claim is for damages for breach of contract and that subordination is not appropriate in view of the purpose and intent of the statute. For the reasons set forth below, CIT’s motion is denied, and Tyco’s cross-motion is granted.
Facts
A. Background
CIT filed a petition for relief and a prepackaged plan of reorganization under chapter 11 of the Bankruptcy Code (the “Plan”) on November 1, 2009 [Case No. 09-16565(ALG), Dkt. Nos. 1, 19]. The Court validated the vote of CIT’s impaired classes of creditors and confirmed the Plan on December 8, 2009 [Dkt. No. 193]. The Plan provided for the conversion to equity or reinstatement of seven classes of debt issued primarily in the form of notes and debentures; one class of unsecured notes was exchanged for new debt. General unsecured creditors, including holders of claims arising from the rejection of execu-tory contracts, were paid in full and deemed unimpaired. On the other hand, holders of preferred and common stock, as well as subordinated claims, received no recovery. 1
Pursuant to § 365 of the Bankruptcy Code, CIT rejected the Tax Agreement [Dkt. No. 193, ¶ 24], On January 7, 2010, Tyco filed a proof of claim (the “Tyco Claim”) for damages resulting from the rejection. On June 7, 2011, after an agreed standstill period, Tyco invoked an arbitration clause in the Tax Agreement and demanded that damages be determined by an arbitral panel. CIT responded on June 21, 2011 by commencing this adversary proceeding, moving for a temporary restraining order to halt the arbitration and seeking to subordinate the Tyco Claim [Adv. Pro. No. 11~02267(ALG), Dkt. Nos. 1, 2]. Thereafter, the parties agreed to stay any arbitration proceedings relating to the question of damages, as well as any issues of arbitrability, pending a determination of the question of subordination under § 510(b), as there is no dispute that Tyco will not be entitled to any recovery if the claim is subordinated [Adv. Pro. No. 11-02267(ALG), Dkt. No. 14].
B. Undisputed Facts
As indicated above, this controversy arises in connection with Tyco’s former ownership of CIT. On June 1, 2001, a wholly-owned Tyco subsidiary ultimately known as Tyco Capital Holding, Inc. (“TCH”) acquired all of the common stock of the predecessor of CIT, then a Nevada corporation (“CIT Nevada”).
CIT SOF
On April 25, 2002, Tyco announced that it intended to divest itself of its equity in CIT Nevada as part of a corporate restructuring. Id. ¶ 2, 4. This was effected in three steps: (i) a merger of CIT Nevada and TCH on July 2, 2002 (the “Upstream Merger”); (ii) a merger of this combined entity with a Delaware corporation (the “Delaware Merger” and, with the Upstream Merger, the “Mergers”), creating “new CIT,” which survived and succeeded to all the assets and liabilities of both CIT Nevada and TCH and was reorganized in the Plan as the Reorganized Debtor; and (iii) an initial public offering (the “IPO”) of the stock of “new CIT” completed on July 8, 2002. Id. ¶ 4-6. After the IPO, Tyco ceased to be a shareholder of CIT, a fact disclosed in the IPO prospectus. Id. ¶ 7.
The foregoing transactions were documented in a series of agreements that set forth the rights and obligations of CIT and Tyco, regarding, inter alia, indemnification, releases, director and officer liability insurance, and termination of intercompa-ny agreements. The parties’ agreements regarding tax matters were governed by the Tax Agreement, which had two principal provisions. See Declaration of John G. Hutchinson, Exh. 14 (attaching the Tax Agreement). First, Tyco indemnified CIT for any tax liability incurred during the time CIT Nevada was a member of the Tyco group or as a result of the Mergers. Second, and more important for purposes of these motions, CIT agreed to make a payment to Tyco measured by the benefits it achieved from any pre-spinoff tax attributes that it used thereafter. The latter provision was premised on the understanding that, pursuant to applicable law and as a consequence of the Mergers, CIT would emerge from the restructuring with the ability to apply the NOLs accrued during the years of Tyco’s ownership against its own future tax liability. Tyco SOF ¶ 5. The Tax Agreement contains a formula providing that CIT would pay Tyco the value of any TCH Tax Benefit it received as a result of utilizing such TCH Tax Attributes, plus interest. “TCH Tax Attribute” was defined to include the TCH NOLs, and “TCH Tax Benefit” was defined as the amount of CIT’s reduced tax as a result of the use of a TCH Tax Attribute. The Tax Agreement contains an arbitration clause, and Tyco asserted in its demand for arbitration that CIT was liable for undetermined damages of approximately $90 million in respect of the TCH Tax Benefits that it allegedly used. Tyco also asserted that CIT breached other provisions of the Tax Agreement resulting in additional damages of at least $100 million. See Hutchinson Declaration, Exh. 9 (attaching the Notice of Arbitration).
Discussion
A. Legal Standard
Summary judgment under Rule 56, made applicable by Bankruptcy Rule 7056, is proper where “the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law.” Fed.R.Civ.P. 56(a);
see also Celotex Corp. v. Catrett,
The fact that both parties have moved for summary judgment does not establish that there are no material facts in dispute.
See Morales v. Quintet Entm’t, Inc.,
B. Subordination under 11 U.S.C. § 510(b)
The sole issue before the Court is whether the Tyco Claim comes within the ambit of § 510(b) of the Bankruptcy Code, which provides:
For the purpose of distribution under this title, 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) (2006). Neither party argues that the Tyco Claim is one arising directly from fraud in connection with the purchase or sale of a security, or is a claim for rescission or reimbursement or contribution on account of such a claim. On the other hand, neither party disputes that there was a sale of CIT’s common stock in connection with the spinoff, that such stock is a “security” as defined in Bankruptcy Code § 101(49), and that the Tax Agreement has some connection with the stock issuance. The issue is whether the Tyco Claim, based on the rejection of a tax agreement executed by an affiliated seller in a corporate restructuring that included a stock issuance, is one for damages “arising from” the sale of a security and is therefore subject to subordination under § 510(b).
1. The Construction of § 510(b)
The leading case and only published decision of the Second Circuit on § 510(b) is
Rombro v. Dufrayne (In re Med Diversified),
As the Second Circuit noted in
In re Med Diversified,
other Court of Appeals decisions use the same principles to construe § 510(b). For example, the Third Circuit, in
Baroda Hill Investments, Inc. v. Telegroup, Inc. (In re Telegroup, Inc.),
CIT relies heavily on
In re Telegroup
for the proposition that a causal connection between the claim and a securities transac
Similarly, the Tenth Circuit, in
Allen v. Geneva Steel Co. (In re Geneva Steel Co.),
CIT urges that “the Tyco Claim arises directly from the sale of CIT’s shares through the IPO because it asserts damages for the purported breach of one of the principal contracts executed in connection with the sale of the shares” and, therefore, comes within the scope of § 510(b). CIT’s Memorandum of Law 19 (“CIT Memo”). There is no question that the Tax Agreement has a nexus to the issuance of the stock in the IPO in that both were agreed to in connection with the spinoff of CIT from Tyco. As the foregoing cases demonstrate, however, the existence of a mere “connection” between the claim and the purchase or sale of a security is not enough to support a finding that the claim “arises from” the purchase or sale and should be subordinated unless the purposes of the statute would be served thereby. As the Second Circuit held in In re Med Diversified, the real question is whether the claimant bargained for the risks and rewards of a holder of equity rather than a holder of debt. Based on the present record, and as further discussed below, it is clear that Tyco contracted for the status of a creditor and not a holder of equity.
CIT also relies on
In re International Wireless Communications Holdings, Inc.,
2. Equity’s Expected Risks and Returns
As did the Second Circuit in
In re Med Diversified,
“we must look outside the text of the statute to determine its intended meaning.”
On its face, the Tax Agreement provides Tyco with a contractual recovery that is not an unlimited interest in CIT’s residual profits. CIT argues that Tyco assumed (or retained) the risk profile of a shareholder in the Tax Agreement because (1) the potential upside to Tyco was undefined and (2) any payments to Tyco were dependent on CIT’s future revenues.
CIT Memo
25-27. As to the first point, Tyco admits that payments from CIT under the Tax Agreement were variable.
4
It is clear, however, that a fixed or variable rate of return and the manner in which payments are measured are not dispositive on the question of the class of risks and rewards assumed by the claimant. For example, in
Racusin v. American Wagering, Inc. (In re American Wagering, Inc.),
Similarly, in
In re NationsRent, Inc.,
not [for] “damages” arising from or caused by fraud, a securities violation or as an obligation which Debtors undertook in connection with the issuance of stock. The Court is persuaded that the Make-Whole Amounts are simply that, namely, claims to recover payment due under agreements of sale of businesses. The Make-Whole Claimants were not investors, nor were they speculating on the success of the Debtors. Instead, the Make-Whole Amounts exist to provide the Seller Claimants with their bargained for sales price. The Make-Whole Amounts are deferred compensation with a formula which serves as a damage buffer.
Id.
at 92. Again, in
Raven Media Investments, LLC v. DirecTV Latin America, LLC (In re DirecTV Latin Am., LLC),
The Tyco Claim is similar to the claims in these cases: it arises from a Tax Agreement that provides for payments in the future based on a variable metric, but it does not include an interest in the firm’s future equity value or management. When the Tax Agreement is viewed as a whole, with both the tax indemnification rights for CIT and the TCH NOL reimbursement rights for Tyco, it resembles an exchange as part of a corporate sale with consideration being paid over time and in to-be-determined amounts. Although the amount owed to Tyco under the Tax Agreement was based on CIT’s future revenues and thus on financial metrics that might correlate with share price, Tyco could not have expected a return similar to that of shareholders, who as the residual owners of a corporate enterprise are entitled to share in profits with no limitation. The expectations of shareholders are not tied to taxable income, a technical concept, but to overall profits generating dividends or causing a rise in share price. Neither the availability of profits for dividends nor an increase in share price would necessarily result in increased payments to Tyco, and it is equally accurate to describe Tyco’s rights in the TCH NOLs as a participation in the tax consequences of past losses rather than in future gains.
It is also worth noting that there is nothing inherent in an interaffiliate tax agreement that would justify treating Tyco’s interest like equity. In general, tax sharing agreements are enforced in bankruptcy and create contractual debtor-creditor relationships.
See, e.g., Resolution Trust Corp. v. Franklin Savs. Corp. (In re Franklin Savs. Corp.),
It is recognized, as CIT argues, that “nothing in § 510(b)’s text requires a subordinated claimant to be a shareholder.”
In re Betacom,
CIT cites no authority that subordinates a claim under § 510(b) merely because it was derived from an equity interest that was exchanged for a debt interest in the distant past. In fact, there is substantial authority that a former shareholder can divest itself of a debtor’s shares in exchange for a contractual payment obligation without being subject to subordination under § 510(b). Courts are concerned with “the temptation to lay aside the garb of a stockholder, on one pretense
It is therefore not determinative that the Tax Agreement may have been part of Tyco’s effort to recoup losses generated during the time Tyco was the ultimate owner of CIT in the form of the TCH NOLs, or to “monetize” Tyco’s equity interest in CIT, as CIT puts it.
3. Equity Cushion
The second policy rationale for subordination of claims under § 510(b) is to prevent a claimant from recovering as a creditor where it made a “contribution to the equity pool presumably relied upon by creditors in deciding whether to extend credit to the debtor.”
In re Med Diversified,
CIT’s argument that Tyco made a contribution to the CIT equity pool does not withstand analysis. First, an equity cushion matters most when creditors need to resort to it to satisfy their claims. The TCH NOLs, however, have no value except under the reverse situation, i.e., if CIT is flush with taxable income. Creditors would have little reason to rely on or expect recourse to any asset that would be worthless if the company has no taxable income.
Second, if creditors are to rely on an equity contribution, there must be some investment in the company on which to rely. CIT characterizes Tyco’s investment post-IPO by reference to its holdings pre-IPO, essentially arguing that any value derived from an IPO is necessarily a return on investment to a former sole shareholder. However, CIT never identifies Tyco’s alleged investment after the IPO in favor of CIT. It is clear that it did not consist of an interest in equity because Tyco ceased to be a shareholder. The closest analogue to a purchase price for
Based on the foregoing, the equity-cushion rationale justifying subordination of claims arising from securities transactions does not assist CIT.
Conclusion
For the reasons set forth above, CIT’s motion for summary judgment is denied, and Tyco’s cross-motion for summary judgment is granted. Tyco’s counsel shall settle an order on five days’ notice.
Notes
. A portion of the preferred stock represented a $2.3 billion U.S. Government investment in CIT through the Troubled Asset Relief Program (TARP).
. References are to the CIT and Tyco Statements of Undisputed Facts, respectively. The facts relied on herein are substantially uncontested by the opposing party.
. The only other reported Second Circuit decision construing § 510(b) is its summary order affirming a District Court oral opinion that in turn affirmed a decision of this Court.
See Waltzer v. Nisselson (In re MarketXT Holdings Corp.),
. Tyco calculates that the total return could range from zero to approximately $278 million, assuming a corporate tax rate of 35% and the use by CIT of approximately $794 million of TCH NOLs, with the product of the two being the maximum potential tax benefit to CIT, which would then be payable to Tyco under the Tax Agreement.