Summary
holding that warrants containing a redemption feature that did not mature before the bankruptcy petition were properly characterized as equity interests
Summary of this case from Carrieri v. Jobs.com Inc.Opinion
Bankruptcy Case No. 398-32129-RCM-11. Civil Action No. 3:99-CV-0421-G.
March 7, 2000.
MEMORANDUM ORDER
This case is before the court on the appeal of Duel Glass ("Glass") from the bankruptcy court's decision to deny class certification and to sustain the appellees' objections to Glass's claims. The appeal presents two issues: (1) whether the bankruptcy court erred in denying class certification and (2) whether warrants — required to be redeemed for cash after their expiration — should be treated as equity interests or as liabilities. For the reasons discussed below, the bankruptcy court's order is affirmed.
I. BACKGROUND
On March 6, 1998, Search Financial Services, Inc. ("SFSI"), Search Financial Services Acceptance Corporation, Search Funding Corporation, and MS Financial, Inc. (collectively, the "Debtors") filed Chapter 11 bankruptcy petitions. Appellees' Brief ¶ 1. Four months later, Glass filed a proof of claim ("Glass's Claim") as an unsecured creditor on his own behalf and on behalf of others who together owned approximately 7,500,000 warrants to purchase shares of SFSI stock. Id. at 5-6. The warrants also provided that if they were not exercised by March 15, 2001, SFSI would redeem them for 25 cents per share. Principal Brief of Appellant, Duel Glass ("Appellant's Brief") at 8. The Debtors objected to Glass's Claim, arguing that the warrants should be treated not as unsecured claims, but as equity interests in SFSI. Appellee's Brief ¶ 7.
About two weeks after the Debtors filed their objections, Glass filed a motion seeking class certification of all of the SFSI warrant holders and the appointment of himself as class representative. Appellant's Brief at 5. A hearing on both the objection to Glass's Claim and the motion for certification was held on October 30, 1998, after which the bankruptcy court concluded: (1) that the warrants were equity interests and (2) that Glass had made "no showing of proper authority to file a class proof of claim. . . ." Id. at 5-6; Transcript of Hearing on October 30, 1998 at 214. In accordance with those conclusions, the court entered findings of fact and conclusions of law sustaining the Debtors' objections to Glass's Claim and denying Glass's motion for certification. Id. at 6; Order Denying Motion for Class Certification and Order Granting Objections to Claim Nos. 396, 397, 398, 401, 402, 403, 404, 405 and 95 (entered November 10, 1998).
On November 16, 1998, the court confirmed the Debtors' Joint Plan of Reorganization ("Joint Plan"). Appellees' Brief ¶ 3. Under the Joint Plan, the liabilities of the Debtors were to be treated differently than equity interests. Id. ¶ 8. Obligations classified as liabilities were assigned to Class 5 or 6 and considered unsecured claims. These unsecured claims were required to be paid in full before any payment was made to holders of equity interests, which were assigned to Class 9. Id. ¶¶ 8-9. Moreover, the plan itself warned that "[h]olders of Class 9 Claims are not anticipated to receive any distribution. . . ." Id. ¶ 8. Thus, by holding that the warrants were equity interests, the bankruptcy court virtually precluded any recovery by Glass and the class he seeks to represent. Glass now appeals the bankruptcy court's rulings.
II. STANDARD OF REVIEW
In reviewing a decision of the bankruptcy court, this court functions as an appellate court and applies the standards of review generally applied in federal court appeals. See Matter of Webb, 954 F.2d 1102, 1003-04 (5th Cir. 1992); Matter of Coston, 991 F.2d 257, 261 n. 3 (5th Cir. 1993) (en banc) (citing Matter of Hipp, Inc., 895 F.2d 1503, 1517 (5th Cir. 1990). Conclusions of law are reviewed de novo. See Matter of Herby's Foods, Inc., 2 F.3d 128, 131 (5th Cir. 1993). Findings of fact, on the other hand, whether based on oral or documentary evidence, are not to be set aside unless clearly erroneous, and due regard must be given to the opportunity of the bankruptcy court to judge the credibility of the witnesses. See Bankruptcy Rule 8013; see also Herby's Foods, Inc., 2 F.3d at 130-31. A finding is clearly erroneous "when although there is evidence to support it, the reviewing court on the entire evidence is left with a firm and definite conviction that a mistake has been committed." Matter of Missionary Baptist Foundation of America, 712 F.2d 206, 209 (5th Cir. 1983) (quoting United States v. United States Gypsum Co., 333 U.S. 364, 395 (1948)).
III. ANALYSIS A. Classification of the Warrants
The Bankruptcy Code is clear — and indeed both parties agree — that warrants are generally treated as equity securities. Glass, however, argues that the redemption feature of the warrants at issue in this case places them outside the general definition found in the Bankruptcy Code and into the broad catch-all definition of a "claim." The court, however, finds Glass's arguments unpersuasive.
See 11 U.S.C. § 101(16)(C) ("`equity security' means . . . warrant or right, other than a right to convert, to purchase, sell, or subscribe to a share, security, or interest. . . ."); In re America West Airlines, Inc., 179 B.R. 893, 897 (Bankr. D. Ariz. 1995); see also Appellee's Brief ¶ 14; Reply Brief of Appellant, Duel Glass ("Appellant's Reply") at 7-8.
See 11 U.S.C. § 101(5) ("`claim' means . . . (A) right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured; or (B) right to an equitable remedy for breach of performance if such brief gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured.").
1. Debt or Equity
First, Glass relies on two court decisions that he contends "classified a redemption feature of warrants as a `claim' under the Bankruptcy Code." Appellant's Reply at 8. Both cases, however, actually rebut Glass's conclusions that the warrants in this case should be treated as liabilities. The first case on which Glass relies analyzed a warrant agreement in which an individual invested $200,000 with two companies starting a microbrewery. See In re Main Street Brewing Co., Ltd., 210 B.R. 662 (Bankr. D. Mass. 1997). In exchange for the $200,000, the companies were required to use their best efforts to: (1) obtain a liquor license; (2) close on $1,000,000 in governmental guaranteed loans; and (3) obtain certain government approvals to issue stock to the warrant holder. If the companies completed these tasks by a certain date, the warrant holder was required to exercise his right to receive 20% of each company's stock. If, however, the companies failed to accomplish these goals by April 15, 1996, they were required to return the warrant holder's $200,000 plus interest at the rate of 11% per annum. Neither company obtained the government approvals to issue stock to the warrant holder, and the warrant holder demanded the return of his $200,000 plus accrued interest. Id. at 663.
While Glass is correct that Main Street Brewing held that the debtor entities had breached their obligation to return the warrant holder's investment plus interest and that the warrant holder held a liability, he mistakenly concludes that implicit in the court's decision is a holding that warrants with a redemption provision are, at all times, treated as liabilities. In fact, the court's language supports another conclusion. The bankruptcy court held that the warrant holder's "equity interests expired at the end of the required period for the exercise of these warrants." Id. at 666. By implication, then, the court concluded that the warrant holder owned an equity interest up to the point his ability to exercise the warrant expired and the debtors' obligation to make the cash payment accrued. Thus, the court essentially held that a warrant providing for mandatory redemption becomes a liability only after it expires.
The second case cited by Glass evaluated stock options that allowed their holder either (1) to exercise the option and purchase stock at a set price or (2) to redeem them for a cash payment within 60 days before the option expired. See Matter of Baldwin-United Corporation, 52 B.R. 549, 550 (Bankr. S.D. Ohio 1985). The court held that "[a]s these rights [to cash payment] mature and are exercised, the option holders become unsecured creditors. . . ." Id. at 552. In other words, the option holders became unsecured creditors only after their right to receive a cash payment matured. Before that time, then, the option holders were something other than unsecured creditors; they were holders of equity interests.
In this case, the Debtors filed for bankruptcy on March 6, 1998 — more than three years before the warrants were to mature. And as discussed above, Main Street Brewing and Baldwin-United clearly concluded — and this court agrees — that warrants with redemption provisions are equity interests until their expiration. Therefore, because Glass's warrants had not expired at the time the Debtors filed for bankruptcy, the bankruptcy court properly treated them as equity interests and placed them into Class 9 under the Joint Plan.
2. The Warrants Treatment in SFSI Disclosures
Glass also looks to SFSI's financial statements in support of his contention that the warrants should be considered a liability and assigned to Class 5. Appellant's Brief at 24-28. As a publicly traded company subject to the reporting requirements of the SEC, SFSI published its financial condition quarterly and disclosed audited financial statements annually. SFSI, in accordance with the Generally Accepted Accounting Principles ("GAAP"), consistently carried its obligation to make the 25-cent payment to warrant holders as a liability in the financial statements of its public disclosures. See, e.g., SEC Form 10Q Quarter ended 12/31/96, Amendment 1, filed June 10, 1997 (R. 15(6)). With this in mind, Glass argues that the bankruptcy court should have treated the warrants as SFSI and GAAP treated them — as liabilities. Appellant's Brief at 24-29.
However, neither GAAP's nor SFSI's treatment of the warrants is relevant to their classification under the Bankruptcy Code. Indeed, a debtor cannot choose the manner in which a claim is classified by adjusting the way in which it accounts for it in public disclosures. To so hold would allow a company's accountant to trump the Bankruptcy Code. Here, the Code and the (admittedly limited) case law discussed above provide that the warrants are equity interests until they expire. And because they had not expired by the time the Debtors filed for bankruptcy, Glass's warrants make him an equity holder and not an unsecured creditor, regardless of the warrants' treatment in SFSI's disclosures.
B. Class Certification
Given the conclusion that the warrants are equity interests rather than debt, it is unnecessary to reach Glass's argument that the bankruptcy court erred in denying certification of a class of warrant holders. The most that Glass could gain from such a decision is the creation of a class consisting of those with equity interests. And under the Joint Plan, any distribution to equity holders is extremely unlikely. See Appellee's Brief ¶ 8. Thus, in light of the fact that the warrants at issue in this case are equity and that under the Joint Plan equity holders will likely not be entitled to any distribution, further inquiry into the appropriateness of class certification would be pointless.
III. CONCLUSION
Because the bankruptcy court correctly classified the warrants at issue in this case as equity interests, and because that classification renders the question of class certification moot, the decision of the bankruptcy court is AFFIRMED.
SO ORDERED.
March 7, 2000.