Wu v. QTIP Trust #2 of Humphrey H. Swift Trust et a

UNITED STATES BANKRUPTCY COURT
For The Northern District Of California
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
1 The HHS Trust and the Stephen H. Swift Trust shall collectively be referred to as the
“Trusts.”
1
ORDER
UNITED STATES BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
In re:
SWIFT INSTRUMENTS, INC.,
Debtor.
Case No. 06-50896 CN
Chapter 7
CAROL WU, CHAPTER 7 TRUSTEE,
Plaintiff,
vs.
STEPHEN H. SWIFT TRUST; ANNE H.
SWIFT; STEPHEN W. SWIFT; SAMUEL
H. SWIFT; AND QTIP TRUST #2 OF
HUMPHREY H. SWIFT TRUST - 1966 U/I
DATED AUGUST 1, 1966,
Defendants.
Adversary No. 09-5335
MEMORANDUM DECISION AND
ORDER GRANTING MOTION FOR
SUMMARY JUDGMENT
On October 15, 2010 this Court heard cross motions for summary judgment filed by plaintiff
Carol Wu, Chapter 7 trustee (“Wu”) and defendants Stephen H. Swift Trust and QTIP Trust #2 of
the Humphrey H. Swift Trust - 1966 U/I Dated August 1, 1966 (the “HHS Trust”)1
. Appearances
were stated on the record. 	Wu seeks summary judgment on her first claim for relief, which seeks to
subordinate, under Bankruptcy Code § 510(b), the proof of claims filed by the Trusts and defendants
The following constitutes
the order of the court. Signed December 10, 2010
________________________________________
Charles Novack
U.S. Bankruptcy Judge	________________________________________
Entered on Docket
December 14, 2010
GLORIA L. FRANKLIN, CLERK
U.S BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
Case: 09-05335 Doc# 62 Filed: 12/10/10 Entered: 12/14/10 09:49:54 Page 1 of
11

UNITED STATES BANKRUPTCY COURT
For The Northern District Of California
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
2 Defendant Stephen Swift opposed Wu’s motion but did not file a separate motion for
summary judgment on his proof of claim. Defendant Samuel Swift neither opposed the motion nor
filed his own summary judgment motion with regard to his proof of claim. Since the issues with
regard to each claim are identical, the court will collectively refer to the defendants as the “Swifts.”
3 This memorandum decision shall constitute the court’s findings of fact and conclusions of
law.
2
ORDER
Stephen W. Swift and Samuel Swift as damages arising from the debtor’s purchase of the Swift
Instrument, Inc. stock owned by the defendants’ predecessors in interest. The Trusts contend in their
summary judgment motions that their claims cannot be subordinated under § 510(b) as a matter of
law. 2 The HHS Trust’s summary judgment motion also seeks to dismiss Wu’s second and third
claim for relief (which assert claims under Bankruptcy Code §§ 502(d) and 547 against defendants
Anne Swift, the HHS Trust, Stephen Swift and Samuel Swift). For the reasons stated below, the
court grants the Trusts’ motions for summary judgment against Wu’s first claim for relief and denies
Wu’s competing motion for summary judgment against all defendants. 	The court further grants the
HHS Trust’s motion for summary judgment against Wu’s second claim for relief on the ground that
the preference claim is time-barred under Bankruptcy Code § 546. Finally, the court denies the HHS
Trust’s motion as to Wu’s third claim for relief. 3
I. 	UNDISPUTED FACTS
Wu and the Swifts agree that there are no questions of fact regarding Wu’s § 510(b) claim for
relief, and that this court’s sole task is to interpret that code section and apply it to the undisputed
facts. The court summarizes these undisputed facts as follows:
Chapter 7 debtor Swift Instruments, Inc. (“Swift Instruments” or the “company”) was a
corporation founded by relatives of Humphrey H. Swift (“H.H. Swift”) and Samuel H. Swift. 	Both
H.H. and Samuel H. Swift owned significant shares of Swift Instruments. To ensure that their stock
remained within the control of the Swift family and/or Swift Instruments, H.H. Swift and Samuel H.
Case: 09-05335 Doc# 62 Filed: 12/10/10 Entered: 12/14/10 09:49:54 Page 2 of
11

UNITED STATES BANKRUPTCY COURT
For The Northern District Of California
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
4 The HHS Trust also received a warrant to purchase 1,700 shares of the company’s
non-voting stock at $1 per share. The HHS Trust never exercised this warrant.
3
ORDER
Swift executed a Stock Restriction Agreement in June 1952 which (as amended) required H.H. and
Samuel H. Swift (and/or their executors or trustees) to sell their Swift Instruments stock to the
company upon certain events, including their demise. The Stock Restriction Agreement required the
company to purchase the stock at a value determined by “the Total Stockholders’ Equity per share of
stock outstanding as determined in accordance with generally accepted accounting principles
consistently applied and as set forth in the company’s audited balance sheet . . . .”
H.H. Swift died in January 2002, and ownership of his Swift Instruments stock passed to his
probate estate. Under the terms of the Stock Restriction Agreement, his probate estate sold his
shares to the company for $3,063,000.00, of which approximately one-third was paid immediately.
The company issued two promissory notes for the $2,012,749.89 balance, payable to H.H. Swift’s
estate. These notes, dated June 24, 2002 and March 13, 2003, specifically stated that they were
issued “as partial payment of the purchase price arising from the [company’s] repurchase” of H.H.
Swift’s company stock. Under the terms of H.H. Swift’s will, these notes were assigned to the
HHS Trust. The notes were then consolidated into a single promissory note, dated April 15, 2003.
The consolidated note required ten annual payments, which were due in June of each year.
Defendant HHS Trust did not provide any consideration for the assignment.
Swift Instruments promptly defaulted on the April 2003 note. 	To accommodate the
company, the HHS Trust and the company executed a restated note in January 2004. The January
2004 note altered the payment dates, rolled the missed June 2003 payment into the remaining
payments, and added certain “Events of Default” to the note terms. 4 The company made its restated
note payments through September 30, 2005. Some of these payments were made within a year of the
company’s May 24, 2006 bankruptcy filing.
Case: 09-05335 Doc# 62 Filed: 12/10/10 Entered: 12/14/10 09:49:54 Page 3 of
11

UNITED STATES BANKRUPTCY COURT
For The Northern District Of California
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
5 The company also issued stock warrants to the Swifts as part of the note
restructuring, which were never exercised.
4
ORDER
The HHS Trust timely filed its proof of claim in July 2006. The HHS Trust asserts a general,
unsecured non-priority claim for $2,265,095.53, which represents the unpaid balance of the restated
note.
B. 	The SHS Trust Note
Samuel H. Swift died in 1997. Pursuant to the terms of the Stock Restriction Agreement, the
company purchased his Swift Instruments stock. The company purchased 12,600 shares from his
probate estate for $1,394,190, of which $1,278,000.00 was financed through a series of promissory
notes. Pursuant to Samuel H. Swift’s testamentary wishes, his executor assigned the note to
defendant SHS Trust. The SHS Trust did not provide any consideration for this assignment. The
SHS Trust timely filed its proof of claim, in which it asserted an unsecured non-priority claim for
$80,336.63. This amount represents the unpaid balance of the company’s promissory note.
C. 	Stephen and Samuel Swift Claims.
The company’s 1997 purchase of Samuel H. Swift’s stock included shares that he had placed
in Divorce Settlement Trusts created for the benefit of defendants Stephen and Samuel Swift. To
pay for these shares, the company issued two additional promissory notes, each in the amount of
$226,407.09, payable respectively to Stephen and Samuel Swift. The notes were amended in
December 2000 and restructured in January 2004 to alter the payment schedules and to add accrued
interest to the principal note balances.5 The company made all note payments through September
30, 2005.
In September 2006 defendant Stephen Swift timely filed his proof of claim asserting an
Case: 09-05335 Doc# 62 Filed: 12/10/10 Entered: 12/14/10 09:49:54 Page 4 of
11

UNITED STATES BANKRUPTCY COURT
For The Northern District Of California
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
5
ORDER
unsecured non-priority claim of $234,746.90. The claim represents the unpaid note balance. Samuel
Swift also timely filed a proof of claim in which he asserted an unsecured non-priority claim of
$226,407.09. This amount represented his unpaid note balance.
All parties agree that defendants HHS Trust, SSH Trust, Samuel Swift and Steven Swift were
never shareholders, officers or directors of the company.
Wu filed the underlying adversary proceeding on December 16, 2009 against the Swifts. Wu
filed her complaint more than two years after the company filed its Chapter 11 case, and more than
one year after the case was converted to Chapter 7.
II. 	LEGAL ANALYSIS
Federal Rule of Bankruptcy Procedure 7026(c) provides that parties are entitled to summary
judgment when there is “no genuine issue of material fact and that the moving party is entitled to
judgment as a matter of law.” 	Since there are no factual issues, this court may resolve these
motions for summary judgment on Wu’s first claim for relief as a matter of law. There are also no
genuine issues of material fact regarding Wu’s second claim for relief.
Bankruptcy Code § 510(b) provides for mandatory subordination of all damages claims
arising from the purchase or sale of a debtor’s security.
For purposes of distribution under this title, a claim arising from rescission of a
purchase or sale of a security of the debtor or an affiliate of the debtor, for damages
arising from the purchase or sale of such a security . . . shall be subordinated to all
claims or interest that are senior to or equal to the claim or interest represented by
such security, except that if such security is common stock, such claim has the same
priority of common stock.
There is no dispute that the company’s purchases under the Stock Repurchase Agreement
were purchases of the company’s securities. Moreover, defendants’ breach of contract claims are
potentially subject to § 510(b) subordination. See In re Betacom of Phoenix, 240 F.3d 823, 929 (9th
Case: 09-05335 Doc# 62 Filed: 12/10/10 Entered: 12/14/10 09:49:54 Page 5 of
11

UNITED STATES BANKRUPTCY COURT
For The Northern District Of California
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
6 See In re Telegroup, 281 F.3d 133, 138 (3rd Cir. 2002).
7 No one contests that the Swifts’ notes result from the Stock Restriction Agreement
purchases.
6
ORDER
Cir. 2001) (mandatory subordination not limited to securities fraud claims). Nor is § 510(b)
subordination limited to claims asserted by those who are or were shareholders. Ibid. Rather, the
critical question before this court is whether the Swifts’ breach of contract damages “arise” from the
company’s stock purchase for purposes of § 510(b).
The Ninth Circuit has stated that § 510(b) is to be interpreted broadly to give effect to the
statute’s remedial goals. See, e.g., In re American Wagering, Inc., 493 F.3d 1067, 1072 (9th Cir.
2007). 	“Section 510(b) serves to effectuate one of the general principles of corporate and
bankruptcy law: that creditors are entitled to be paid ahead of shareholders in the distribution of
corporate assets. The principles behind corporate and bankruptcy laws generally do not favor
shifting the risk of loss from shareholders to creditors, even if the shareholders are blameless. One
of the primary purposes of § 510(b), therefore, is to prevent disappointed shareholders, sometimes
the victims of corporate fraud, from recouping their investment in parity with unsecured creditors.”
In re American Wagering, Inc., 493 F.3d at 1071-72. The Ninth Circuit has identified the two main
reasons for § 510(b) claim subordination: the dissimilar risk and return expectations of creditors and
shareholders, and the reliance of creditors on the equity cushion provided by shareholder investment.
Id. at 1072. 	Promissory note claims sufficiently “linked” to securities transactions may be subject
to § 510(b) subordination. See In re Betacon of Phoenix, Inc., 240 F.3d 823, 832 (9th Cir. 2001).
While many courts have generically stated that the phrase “arising from” implies that “there
must be some nexus or causal relationship between the claim and the [purchase/sale] of the
security,” 6 this language does not, as Wu suggests, require this court to apply a “but for” analysis
and subordinate the Swift promissory note claims.7 Instead, this court must determine whether
subordinating the Swifts’ claims satisfies the purposes of the code section. See, e.g., In re JTS
Case: 09-05335 Doc# 62 Filed: 12/10/10 Entered: 12/14/10 09:49:54 Page 6 of
11

UNITED STATES BANKRUPTCY COURT
For The Northern District Of California
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
7
ORDER
Corporation, 305 B.R. 529, 545 (Bankr. N.D. Cal. 2003) (The case law within the Ninth Circuit
“does not clearly define the outer reaches of mandatory subordination. Instead, the courts must
assess whether the policies and goals underlying the statute support subordination in the given
circumstances before them.”). The fundamental purpose of § 510(b) is to prevent disappointed
shareholders or would-be shareholders from recovering their investment loss by using fraud and
other claims to bootstrap their way to parity with general unsecured creditors in a bankruptcy
proceeding. See In re Telgroup 281 F.3d at 142. This court refers the parties to the Southern
District of New York’s thorough analysis of § 510(b) in In re Enron Corp, 341 B.R. 141 (Bankr.
S.D.N.Y. 2006). 	The Enron court rejected Wu’s argument that a breach of contract claim, which is
directly related to a securities sale, therefore “arises from” that sale. Instead, the Enron court noted
that the policy considerations at issue in § 510(b) are “aimed at equity interests attempting to elevate
their claim. . . .” Id. at 156, fn. 12. The Enron court noted that while “the statutory language refers
only to ‘damages,’ the courts reasonably read this to mean ‘damages flowing from changes in the
debtor’s share price.’ Where the damages are connected to the declining value of the debtor’s stock,
the courts are inclined to read section 510(b) broadly. . . . Conversely . . . where the claim is for a
fixed amount and does not arise in parallel with the fortunes of the share price, the courts are
inclined to read section 510(b) narrowly.” Id. at 157.
While the Enron court noted that the typical, subordinated claim is between securities issuer
and holder, it acknowledged that breach of contract claims may be subordinated under § 510(b).
See, e.g., In re Betacom of Phoenix, Inc., 240 F.3d 823 (9th Cir. 2001). Significantly, however, those
courts that have held that contract claims may be subordinated under §510(b) state that they “were
concerned with claims that tried to recharacterize or restate what would otherwise be subordinated
securities claims.” In re American Wagering, Inc., 493 F.3d at 1067, 1072.
This court has not found any decision within the Ninth Circuit which has held that a
bankruptcy court may subordinate a promissory note claim under § 510(b) because the debt was
generated by a stock sale. All of the analogous case law outside of the Ninth Circuit has held to the
Case: 09-05335 Doc# 62 Filed: 12/10/10 Entered: 12/14/10 09:49:54 Page 7 of
11

UNITED STATES BANKRUPTCY COURT
For The Northern District Of California
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
8 The court acknowledges that its application of § 510(b) may be inconsistent with the
bankruptcy appellate panel decision in In re American Wagering. See the BAP’s analysis of In re
Mobile Tool Int’l, Inc., 306 B.R. 778 (Bankr. D.Del. 2004) at In re American Wagering, Inc.,326
B.R. 449, 456 (Bankr. 9th Cir. 2005). The Ninth Circuit’s decision in In re American Wagering, Inc.,
however, did not include the BAP’s analysis of Mobile Tool.
9 The Enron court questioned “the utility of the equity cushion concept as a rationale
for section 510(b) subordination. The concept is clearly useful in understanding the absolute
priority rule and the distinction between classes of claim, but it is less useful when applied to any
particular claim for the simple reason that it is difficult in a mature and liquid market to link any
8
ORDER
contrary. See In re Marketxt Holdings Corp., 361 B.R. 369, 389 (Bankr. S.D.N.Y. 2007) (collecting
cases).
The court finds that the undisputed facts demonstrate that the Swifts are seeking to enforce
their debt instruments, and are not asserting claims which rely on or are tied to the value of the
company’s stock. The Swifts (and their predecessors in interest) removed themselves as equity
holders when the company issued the promissory notes (which were executed several years before
the company filed its bankruptcy petition). These purchases, in turn, were mandated by the Stock
Restriction Agreement, which itself was signed in its original form more than 50 years earlier. While
this court recognizes that the promissory notes reflect the Swift brothers’ recoupment of their
investment in the company, the Swifts’ risks and returns under the promissory notes are defined by
their payment terms: fixed payments with a fixed rate of return. Moreover, during the various
negotiations to restate the promissory notes the company and the Swifts treated these claims as
creditor claims, and not failed equity investments. 	Simply, the Swifts’ claims are not seeking to
recharacterize a securities or equity claim.8
In addition, no evidence has been presented that the equity created by H.H.S. Swift and S.H.
Swift’s stock holdings were relied upon by creditors in deciding whether to extend credit to the
company(indeed, given the terms of the Stock Restriction Agreement, the court questions whether
any creditor could reasonably rely on the equity “removed” by any of the promissory note
payments).9 Accordingly, the Trusts’ motions for summary judgment on Wu’s first claim for relief
Case: 09-05335 Doc# 62 Filed: 12/10/10 Entered: 12/14/10 09:49:54 Page 8 of
11

UNITED STATES BANKRUPTCY COURT
For The Northern District Of California
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
particular equity investment to any particular credit extended in reliance thereon.” In re Enron, at
341 B.R. at 165-66, fn. 20.
9
ORDER
is granted, and Wu’s motion for summary judgment against the Trusts, Stephen Swift and Samuel
Swift is denied.
Wu’s second claim for relief asserts preference claims against the HHS Trust, Stephen Swift,
Anne Swift and Samuel Swift. The parties agree, however, that Wu did not timely assert these
claims under Bankruptcy Code § 546, and Wu has stated her intent to dismiss these claims. Since
these claims are time-barred, the Court dismisses Wu’s second claim for relief against all parties.
Finally, the court finds that the record is insufficient to grant the HHS Trust’s motion for
summary judgment on Wu’s third claim for relief under Bankruptcy Code § 502(d). Wu may object
to the Swifts’ proof of claims under § 502(d) despite her inability to seek affirmative relief under §§
547 and 550, and a material question of fact exists regarding Wu’s right to avoid these payments
under § 547. The allegedly preferential payments received by the HHS Trust were made beyond
ninety days and within a year of the company’s bankruptcy filing. Accordingly, Wu must establish
that the HHS Trust is an insider under Bankruptcy Code § 101(31). The HHS Trust is not a “per se”
insider under this code section, and thus qualifies as an insider only if Wu can establish that it could
exercise some control over the company. See In re Enterprise Acquisition Partners, Inc., 319 B.R.
626, 633 (Bankr. 9 th Cir. 2004) (Qualification as a non-statutory insider turns on the closeness of the
parties and the degree to which the transferee is able to exert control or influence over the debtor so
as to make the transfer not an arms-length transaction).
While the evidence indicates that the HHS Trust and the company extensively negotiated the
terms of the restated promissory note, the court notes that the company’s president was both the
daughter of the primary beneficiary of the HHS Trust, and a contingent beneficiary of the HHS Trust
(and thus had a significant interest in the note). Accordingly, the court concludes that material
Case: 09-05335 Doc# 62 Filed: 12/10/10 Entered: 12/14/10 09:49:54 Page 9 of
11

UNITED STATES BANKRUPTCY COURT
For The Northern District Of California
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
10
ORDER
questions of fact existed regarding whether the HHS Trust was an insider under Bankruptcy Code
§ 101(31), and thus whether Wu may avoid the allegedly preferential payments to the HHS Trust.
*** END OF ORDER***
Case: 09-05335 Doc# 62 Filed: 12/10/10 Entered: 12/14/10 09:49:54 Page 10 of
11

UNITED STATES BANKRUPTCY COURT
For The Northern District Of California
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
11
ORDER
Adversary No. 09-5335
COURT SERVICE LIST
Office of the U.S. Trustee / SJ
U.S. Federal Bldg.
280 S 1st St. #268
San Jose, CA 95113-3004
Melissa Lor
Michael M. Carlson
Schnader, Harrison, Segal and Lewis
One Montgomery St., #2200
San Francisco, Ca 94104
Dennis Gallaudet
67 Range Road
Cumberland, ME 04021-3432
Marcia E. Gerston
McGrane Greenfield LLP
55 S. Market Street, Suite 1500
San Jose, CA 95113
Stephen H. Swift
733 East Costilla Street, Suite A & B
Colorado Springs, CO 90903
Samuel H. Swift
128 East 400 South
Provo, UT 84606
Case: 09-05335 Doc# 62 Filed: 12/10/10 Entered: 12/14/10 09:49:54 Page 11 of
11