Segal v. Ledyard ( 1998 )

F I L E D
United States Court of Appeals
Tenth Circuit
UNITED STATES COURT OF APPEALS NOV 25 1998
TENTH CIRCUIT PATRICK FISHER
Clerk
IN RE: RUFF FINANCIAL SERVICES, INC.,
doing business as Ruffco, Inc.,
Debtor.
_________________________
ROGER G. SEGAL, Trustee,
Plaintiff-Appellant,
No. 97-4094
v. (D.C. No. 96-CV-798-B)
(D. Utah)
MARYJANE B. LEDYARD, H.L. WIGGINS,
SUE WIGGINS, ROBERT HALL, JIM
GREESON, COLUMBIA PAINT
CORPORATION, DULUTH ENTERPRISES,
COLIN C. WONG, THE EAR, NOSE AND
THROAT DEFINE BENEFIT TRUST,
MICHAEL FANNON and SUSAN FANNON,
Defendants-Appellees.
ORDER AND JUDGMENT *
Before SEYMOUR, Chief Judge, EBEL and KELLY, Circuit Judges.
Roger G. Segal, the trustee of Ruff Financial Services, Inc. (Ruffco), filed
*
This order and judgment is not binding precedent, except under the
doctrines of law of the case, res judicata, and collateral estoppel. The court
generally disfavors the citation of orders and judgments; nevertheless, an order
and judgment may be cited under the terms and conditions of 10th Cir. R. 36.3.
suit against noteholders of the corporation. He claimed defendants’ promissory
notes actually constituted shares in the corporation which Ruffco had redeemed
while it was insolvent, in violation of Utah law. On cross motions for summary
judgment, the bankruptcy court found in favor of the trustee. On appeal, the
district court reversed, holding that the notes were loans, not shares, and that the
trustee therefore was not entitled to recover payments made under the notes. We
review the grant of summary judgment de novo. See Hollytex Carpet Mills, Inc.
v. Oklahoma Employment Sec. Comm’n (In re Hollytex Carpet Mills), 73 F.3d
1516, 1518 (10th Cir. 1996). Because we agree with the district court that the
promissory notes constituted debt, we affirm.
Ruff Financial Services, Inc. (Ruffco) was a Utah corporation that engaged
in business as a precious metals dealer from 1985 until 1991. In 1986, Ruffco
offered for sale sixty “units,” each of which consisted of 50,000 shares of
convertible preferred stock in Ruffco plus a $25,000 promissory note. The notes
could not be bought separately from the shares. Their terms provided for 7.5%
interest per annum, payable quarterly. The maturity date was June 1, 1989, but
noteholders could demand immediate repayment after January 1, 1988, and prior
to the maturity date at a 6% interest rate. Payment on the notes was subordinated
to loans from financial institutions, but not to claims from general creditors.
In May 1989, Ruffco sent a “roll over” letter to the noteholders inviting
-2-
them to defer payment on their notes for greater returns later. No noteholder
chose deferment, and by June 1989 Ruffco had paid the balance on all of the
notes. In May 1991, Ruffco filed a Chapter 11 petition for relief in bankruptcy
court, which was later converted into a Chapter 7 petition. Mr. Segal was
appointed as the Chapter 7 trustee. He filed suit against the noteholders, claiming
that Ruffco’s redemption of the notes violated Utah law.
Utah law provided at the time that “[n]o purchase of or payment for its own
shares may be made at a time when the corporation is insolvent or when the
purchase or payment would make it insolvent.” U TAH C ODE A NN . § 16-10-5 (5)
(repealed 1992). It defined “shares” as “the units into which the proprietary
interests in a corporation are divided.” U TAH C ODE A NN . § 16-10-2 (14)
(repealed 1992 and re-enacted as U TAH C ODE A NN . § 16-10a-102 (32) (1992)).
The trustee claims Ruffco violated this statute when it redeemed the promissory
notes. He argues that because the notes could only be purchased in a “unit” with
stock shares, they are merely disguised shares which Ruffco redeemed while
insolvent.
The Utah statute requires a “proprietary interest” for the notes to be shares.
While it is clear that the stock portion of the unit conveyed such an interest, there
is no evidence that the note portion did the same. Simply because defendants
obtained both instruments through one transaction does not make the two
-3-
instruments the same. On the contrary, the stock certificates and the promissory
notes conveyed different types of interests carrying different amounts of risk.
Various tests exist to determine whether a note constitutes a loan or equity.
The bankruptcy court applied the “family resemblance test” articulated by the
Supreme Court in Reves v. Ernst & Young, 494 U.S. 56 (1990), as the appropriate
way to determine whether promissory notes are securities under the Securities
Exchange Act of 1934. The district court declined to apply that test, instead
analyzing the notes under a multi-factored test used by circuit courts to decide
whether an advance of money constitutes a loan for tax purposes.
We agree with the district court that the tax cases are more relevant to this
case. The purpose of the statute at issue is to protect creditors, see Owyhee, Inc.
v. Robbins Marco Polo, 407 P.2d 565, 567-68 (Utah 1965), whereas the purpose
of the Securities Exchange Act is to protect investors, see Reves, 494 U.S. at 60-
61. While the tax cases are not precisely on point, they deal with interests
similar to those at issue here and, as such, guide our analysis. See Cenex, Inc. v.
United States, 156 F.3d 1377, 1381-82 (Fed. Cir. 1998); Roth Steel Tube Co. v.
C.I.R., 800 F.2d 625, 630 (6th Cir.1986); Bauer v. C.I.R., 748 F.2d 1365, 1368
(9th Cir. 1984); Stinnett’s Pontiac Serv., Inc. v. C.I.R., 730 F.2d 634 (11th Cir.
1984).
While each tax case delineates a similar test, Stinnett’s Pontiac sets forth
-4-
the most comprehensive list of elements to consider in determining whether the
notes constitute debt or equity:
(1) the names given to the certificates evidencing the indebtedness;
(2) the presence or absence of a fixed maturity date; (3) the source of
payments; (4) the right to enforce payment of principal and interest;
(5) participation in management flowing as a result; (6) the status of
the contribution in relation to regular corporate creditors; (7) the
intent of the parties; (8) “thin” or adequate capitalization; (9) identity
of interest between the creditor and stockholder; (10) source of
interest payments; (11) the ability of the corporation to obtain loans
from outside lending institutions; (12) the extent to which the
advance was used to acquire capital assets; and (13) the failure of the
debtor to repay on the due date or to seek a postponement.
730 F.2d at 638. Under this test, the promissory notes appear to constitute debt.
For example, the notes were entitled “subordinated promissory notes,” there was a
fixed maturity date and fixed interest rate, the noteholders had a right to enforce
payment, the notes were not subordinated to general creditors, the parties intended
for the notes to be loans, Ruffco repaid the notes on time, and the notes conferred
no voting rights.
In sum, we agree with the district court’s characterization of the notes as
loans, and AFFIRM. 1
ENTERED FOR THE COURT
Stephanie K. Seymour
Chief Judge
1
Because we conclude the notes are loans, not shares, it is not necessary to
address the other findings by the bankruptcy court.
-5-