Opinion
Case No. 07-31580 TEC, Adv. Proc. No. 07-3134 TC.
January 18, 2008
MEMORANDUM DECISION RE DEBTOR'S REQUEST FOR PRELIMINARY INJUNCTION
Debtor National Farm Financial Corporation (Debtor) is a holding company that owns all of the shares of Business Alliance Insurance Company (BAIC), an operating insurance carrier. Debtor's shares are held by the Chao Family Trust. Larry and Julie Chao are the trustees, and are also husband and wife. The trust can take action only upon the approval of both trustees. Larry Chao is president and CEO of both Debtor and BAIC.
Debtor entered a written contract to sell its BAIC shares to PSM Holding Corp. (PSM). When Debtor refused to close the sale, PSM sued Debtor, BAIC, and Larry Chao in the Central District of California. After a 15-day jury trial, the district court awarded PSM a $43 million judgment against Debtor, Larry Chao, and BAIC (the Judgment). The district court reduced the Judgment to $40 million, but otherwise denied defendants' post-trial motions.
Unable to post a bond to stay the Judgment pending appeal, Debtor filed a chapter 11 petition on December 5, 2007. Larry Chao filed a chapter 11 petition on January 7, 2008. Because it is an insurance company, BAIC is not eligible for relief under the Bankruptcy Code. § 109(b)(2). In the present proceeding, Debtor seeks to have this court enjoin PSM from enforcing the Judgment against BAIC, on the basis that such enforcement would unduly interfere with Debtor's ability to reorganize.
All statutory references are to the United State Bankruptcy Code, Title 11, United States Code, unless otherwise noted.
Prior decisions authorize a bankruptcy court to enjoin creditor action against the chapter 11 debtor's subsidiary that is itself unable to seek bankruptcy protection because it is an insurance company. See, e.g., In re Equity Funding Corp. of America, 396 F.Supp. 1266 (C.D. Cal. 1975). Whether such relief is appropriate turns upon application of the familiar four-part test for injunctive relief:
(1) a strong likelihood of success on the merits, (2) the possibility of irreparable injury to plaintiff if preliminary relief is not granted, (3) a balance of hardships favoring the plaintiff, and (4) advancement of the public interest (in certain cases). Alternatively, a court may grant the injunction if the plaintiff demonstrates either a combination of probable success on the merits and the possibility of irreparable injury or that serious questions are raised and the balance of hardships tips sharply in his favor.
Soldius Networks, Inc. v. Excel Innovations, Inc. (In re Excel Innovations, Inc.), 502 F.3d 1086, 1093 (9th Cir. 2007) (parentheses and italics in original). In this particular context, the likelihood of prevailing on the merits refers to the likelihood that Debtor will be able to confirm a plan of reorganization.
This chapter 11 is in substance a two-party case between PSM and Debtor. Debtor scheduled only two claims. The first is the $40 million Judgment. The other is a $300,000 claim by the attorneys who represented Debtor in the PSM litigation. Both are general unsecured claims. Debtor states that Julie Chao also asserts a claim for the harm to her beneficial interest in the family trust caused by the acts of the officers and directors that gave rise to the Judgment.
A. Likelihood of Confirming a Plan
Debtor has not shown a strong likelihood of confirming a plan. Debtor can confirm a plan in which its shareholders retain an interest in the BAIA shares only if general unsecured creditors accept the plan. § 1129(b)(2)(B). A plan cannot be confirmed over the objection of PSM, because it holds more than one-third of the general unsecured claims. § 1126(c). Debtor asserts that it will be able to confirm a plan by subordinating the Judgment to the claims of Julie Chao and the attorneys under section 510 of the Bankruptcy Code. As explained below, Debtor's theory is unsupported by law.
Debtor first argues that the Judgment should be subordinated under section 510(b), because it arises out of the purchase of a security of Debtor or an affiliate of Debtor. While the Judgment did arise out of Debtor's breach of contract to sell the shares of its affiliate BAIA, section 510(b) does not require subordination to the creditors of Debtor. The statute requires a claim arising from the purchase of BAIA shares to be given the same priority as the BAIA shares themselves. The BAIA shares are not subordinated to Debtor's creditors because to Debtor they represent an asset, like a vehicle or a building. Each of the cases relied upon by Debtor involves the very different circumstance in which the claimant had purchased shares of the debtor itself. In that circumstance, section 510(b) requires subordination to creditors of the debtor, to prevent parties who bargained only for an equity stake in debtor from elevating themselves to parity with creditors who justly expected to be paid in full before equity holders received any value. American Broadcasting Systems, Inc. v. Nugent (In re Betacom of Phoenix, Inc.), 240 F.3d 823, 828-31 (9th Cir. 2001); Falcon Capital Corp. Shareholders v. Osborne (In re THC Financial Corp.), 679 F.2d 784, 785-87 (9th Cir. 1982). In the present case, the language and purpose of section 510(b) relate only to whether the Judgment is subordinated to the claims of creditors of BAIA. Because BAIA is not entitled to seek bankruptcy protection, the claims of those creditors are not before this court.
Debtor next argues that the Judgment should be subordinated to Julie Chao's claim, pursuant to section 510(c) of the Bankruptcy Code. This argument is predicated on the assumption that the Judgment is subject to rescission, because the contract upon which it is based was not approved by Debtor's shareholders, as required by California Corporations Code section 1001.
From this premise, Debtor first contends that the Judgment should be subordinated, because payment of the claim would violate a statute. La Grand Steel Products Co. v. Goldberg (In re Poole, McGonigle Dick, Inc.), 796 F.2d 318, 322-24 (9th Cir.), amended by 804 F.2d 576 (9th Cir. 1986). That decision does not support subordination in the present case. The statute in question in Poole prohibited the repurchase of shares by an insolvent corporation. Subordination in that circumstance served the same purpose cited by the cases interpreting section 510(b): to prevent a party that bargained only for an equity position from elevating itself to parity with creditors. Id. at 323. Debtor cites no authority for the proposition that failure to secure the shareholders' approval of a contract vitiates a money judgment for breach of that contract. The Solorza decision holds only that a sale not approved by shareholders is not void, because the shareholders may later decide to ratify it. Solorza v. Park Water Co., 86 Cal.App.2d 653 (1948). Section 208(b) of the Corporations Code suggests that lack of required shareholder approval does not relieve the corporation from monetary liability under a contract. That section provides that a contract made by an officer with actual or apparent authority binds the corporation, "except as the board's authority is limited by law other than this division. . . ." Sections 208 and 1001 are both in Division 1 of the Corporations Code. Thus, any failure to comply with section 1001 is not a limitation imposed by law "other than this division." Furthermore, subsection (a) of section 208 suggests that the shareholder's remedies are to sue to enjoin closing of the sale, or to sue the responsible officers and directors for breach of duty.
Debtor contends that subordination is also appropriate under section 510(c), because PSM engaged in improper litigation tactics by not joining Julie Chao as a party in the district court action. Debtor cites no authority for this contention. Furthermore, to the extent that Debtor has any standing to raise this issue, Debtor has not explained why it did not do so in the district court. It is also worthy of note that the district court permitted PSM to argue that "NFFC was not handled by the Chaos in such a way as to be considered a separate legal entity from BAIC" and stated "it is up to the jury to determine whether Mr. Chao's signature on the [contract] is sufficient to bind BAIC and NFFC and himself." Fineman Decl., Exh. E at 9:18-20; 8:21-23.
The one claim that would appear to be subject to subordination is that of Julie Chao. Because she holds (indirectly) only an equity interest in Debtor, any claim for damage to that equity interest must be subordinated to the claims of Debtor's creditors. See Betacom, supra, 240 F.3d at 828-31.
It is clear from the above that PSM holds more than one-third in amount (indeed virtually all) of the general unsecured claims against Debtor, and that PSM can therefore block confirmation of any plan that provides for Debtor's shareholders to retain any interest in the shares of BAIC. § 1129(b)(2)(B). Thus, Debtor has not shown a strong likelihood of confirming a plan.
B. Balance of Hardships
Nor has Debtor shown that the balance of hardships tips sharply in its favor. Debtor's most legitimate interest is in having some effective remedy if the Judgment is reversed. Debtor seeks to do so by staying all enforcement of the Judgment during what may be a protracted appeal. There are alternate remedies that would not deny PSM all benefits of its Judgment, and at the same time would preserve for Debtor an effective remedy should it prevail on appeal. This court, for instance, could condition relief from stay permitting PSM to hold and vote the shares of BAIA on PSM's not transferring those shares, or seizing or transferring assets of BAIC out of the ordinary course of business, pending the outcome of the appeal. It is unlikely that BAIA itself would be dismembered in such a setting. The duty of the Insurance Commissioner to protect BAIA's policyholders to a large extent requires the protection of BAIA itself. If there arises some specific threat to the continued viability of BAIA, this court can always revisit whether the broad injunctive relief presently sought is appropriate. Debtor's desire to keep control of BAIA during the appeal does not outweigh PSM's interest in enjoying the profits of BAIA during that period.
C. Irreparable Harm and Public Interrest
This court assumes without deciding that Debtor has no adequate legal remedy and may suffer irreparable harm if injunctive relief is not granted. It appears that public policy considerations are neutral. The relevant public interest to be protected is that of the policy holders of BAIC, and they will be protected by the Insurance Commissioner.
CONCLUSION
Because Debtor has not shown a likelihood of prevailing on the merits, or that the balance of hardships justifies the long-term imposition of the broad relief presently sought, such relief will be granted only on a temporary basis. Thus, the temporary restraining order entered on December 6, 2007 will remain in effect through February 8, 2008 or until a further order is entered, whichever comes first. The court will hold a status conference regarding this action on January 28, 2008 at 10:30 a.m. The court respectfully requests counsel for the Insurance Commissioner to attend and participate.