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In re Linn Energy, L.L.C.

United States Court of Appeals, Fifth Circuit

September 3, 2019

In the Matter of: LINN ENERGY, L.L.C.; BERRY PETROLEUM COMPANY, L.L.C.; LINNCO, L.L.C.; LINN ACQUISITION COMPANY, L.L.C.; LINN ENERGY FINANCE CORPORATION; LINN EXPLORATION; PRODUCTION MICHIGAN, L.L.C.; LINN EXPLORATION MIDCONTINENT, L.L.C.; LINN MIDSTREAM, L.L.C.; LINN MIDWEST ENERGY, L.L.C.; LINN OPERATING, INCORPORATED; MID-CONTINENT I, L.L.C.; MID-CONTINENT II, L.L.C.; MID-CONTINENT HOLDINGS II, L.L.C., Debtors
v.
LINN ENERGY, L.L.C.; BERRY PETROLEUM COMPANY, L.L.C.; LINNCO, L.L.C., Appellees DANA FRENCH, personal representative of the Estate of Clarence J. "Peter" Bennett, Appellant In the Matter of: LINN ENERGY, L.L.C.; BERRY PETROLEUM COMPANY, L.L.C.; LINNCO, L.L.C.; LINN ACQUISITION COMPANY, L.L.C.; LINN ENERGY FINANCES CORPORATION; LINN EXPLORATION; PRODUCTION MICHIGAN, L.L.C.; LINN EXPLORATION MIDCONTINENT, L.L.C.; LINN MIDSTREAM, L.L.C.; LINN MIDWEST ENERGY, L.L.C.; LINN OPERATING INCORPORATED; MID-CONTINENT I, L.L.C.; MID-CONTINENT II, L.L.C.; MID-CONTINENT HOLDINGS II, L.L.C., Debtors BRUCE D. BICKEL, personal representative of the Estate of Clarence J. “Peter” Bennett, Appellant
v.
LINN ENERGY, L.L.C.; BERRY PETROLEUM COMPANY, L.L.C.; LINNCO, L.L.C., Appellees

          Appeals from the United States District Court for the Southern District of Texas

          Before CLEMENT, HAYNES, and WILLETT, Circuit Judges.

          EDITH BROWN CLEMENT, Circuit Judge.

         In this case we decide that payments owed to a shareholder by a bankrupt debtor, which are not quite dividends but which certainly look a lot like dividends, should be treated like the equity interests of a shareholder and subordinated to claims by creditors of the debtor. We therefore affirm.

         I.

         Clarence Bennett had a wealthy uncle. In 1930, that uncle died. His will created a trust for the benefit of certain relatives, including Bennett. The will placed 250 shares of the uncle's company, Berry Holding Company ("BHC"), into the trust and divided the trust beneficiaries into classes. The first class was "A Group." Its members would share 37.5% of the income earned on the 250 shares for so long as any of them were alive. The second class, which included Bennett, was "B Group." Just like A Group, its members would share 37.5% of the income earned on the trust for so long as any B Group members were alive. The trust provided that upon the death of any member of A Group or B Group, his share would be divided equally among the surviving members of his group.

         The remaining 25% of trust income was to be held in trust until the third class, "C Group," of which Bennett was also a member, came of age. The C Group members were children at the time. The trust provided that when the youngest of them turned 21, the C Group members would receive the income on the 25% which had been held in trust up to that point, and the trust corpus would be distributed amongst the C Group members.

         In 1949, the youngest member of C Group came of age. In a court-approved agreement, the 250 shares of BHC were divided among the eight C Group members so that each received 31.5 shares. Further, to facilitate the continuing distributions of income to A Group and B Group members, the agreement provided that BHC would place all the income on the 250 shares of BHC stock into the C.J. Berry Trust Beneficiaries Distribution Account. BHC would then distribute the income to the classes from the account as required by the trust. In other words, 37.5% of the income in the account would go to A Group, 37.5% would go to B Group, and the C Group members would each receive the remaining income earned on their 31.5 shares. Because the BHC shares were now owned by the eight C Group members, an equitable charge was placed on the shares for the value of the distributions to the A Group and B Group members. An "equitable charge" is a type of security interest which allows a creditor to sue for recovery of the property on which the charge is placed if the debtor defaults. Equitable Charge, Black's Law Dictionary (11th ed. 2019). By virtue of his B Group membership, Bennett maintained an interest in 37.5% of the income paid as dividends on the 250 shares. And by virtue of his C Group membership, Bennett owned 31.5 shares of BHC stock outright.

         From 1949 to 1986, Bennett received regular income payments on BHC stock dividends. Then, in 1986, BHC underwent a merger and became Berry Petroleum Company ("BPC"), a publicly traded company. An unrelated dispute arose between BPC and a third party, Victory Holding Company ("VHC"). To settle the dispute, BPC agreed to retire VHC's shares-i.e., buy VHC out. But there was a problem: the proposed retirement would injure B Group. VHC owned approximately 950, 000 shares of BPC stock that were subject to B Group's 37.5% equitable charge. If the VHC shares were retired, it would mean that no dividends would be paid on those shares. Since B Group's then-living members were entitled to 37.5% of any dividends issued to VHC, they would be harmed by the retirement.

         To appease the B Group members (only three were still alive at this point), BPC created the "Victory Trust." BPC would act as the trustee of the Victory Trust. The trust provided that the VHC shares would be retired by BPC; however, BPC would continue to pay B Group members in an amount equal to 37.5% of the dividends that VHC would have received if its shares had not been retired. Those payments were not actually dividends (since no dividends were issued to VHC anymore), but rather "deemed dividends," akin to settlement payments whose amount was tethered to the value of BPC distributions. Each time BPC paid dividends to its shareholders, BPC calculated the dividends that VHC would have received and then paid Bennett and the other two survivors 37.5% of that amount from the money BPC kept in the Victory Trust.

         The system worked. From 1986 to 2013, BPC paid B Group members as required by the Victory Trust. Note that the trust only required BPC to pay the B Group members income when dividends were issued; the trust did not require BPC to issue dividends in the first place. So while B Group members had a right to 37.5% of the income which would have been paid as dividends to VHC, they had no right to any income if dividends were not paid.

         By 2013, Bennett was the only surviving member of B Group. He alone received 37.5% of the income paid as dividends on VHC's "shares" of BPC stock. He also received dividends through his own stock ownership in BPC. Then, in 2013, BPC entered into a share-for-share exchange with Linn Energy LLC and LinnCo LLC (collectively, "Linn"). Through the transaction, BPC became Berry Petroleum Company, LLC ("Berry"). To help obtain Bennett's approval of the deal as a stockholder in BPC, Linn purportedly promised to undertake and continue BPC's obligation to pay Bennett, as the last surviving beneficiary of B Group, the deemed dividends. But once the deal was done, the payments stopped coming. For purposes of this appeal, it does not matter whether Linn and BPC acted appropriately in terminating the payments. This appeal assumes the claims against Linn and BPC are valid.

         In late 2014, Linn filed suit in the Eastern District of California seeking a declaration that it owed Bennett nothing. Bennett filed a counterclaim in January 2015, then died in June 2015. His estate filed an amended counterclaim against Linn and added Berry as a defendant in December 2015, asserting six causes of action. In addition to breach of contract claims, the Estate advanced tort claims including misrepresentation, elder abuse, and breach of fiduciary duty.

         In May 2016, Linn, Berry, and various associated entities filed for bankruptcy in Texas. The Estate filed claims for almost $10 million in unpaid deemed dividends. Linn and Berry (collectively, the "Debtors") filed an objection, arguing that the claims should either be expunged or subordinated under Section 510(b) of the Bankruptcy Code because Bennett had been an investor. The bankruptcy court sustained the Debtors' objections in part and subordinated half of the Estate's claims. Because of the Debtors' limited assets, the subordination order effectively gutted the Estate's chances to receive any money. The bankruptcy court allowed the Estate to amend its complaint to clarify the basis for the misrepresentation and breach of fiduciary duty claims. The Estate amended its remaining claims before the bankruptcy court, and in the meantime appealed the first subordination order. In April 2018, the district court affirmed that order. The Estate immediately appealed to this court. Following a hearing, the bankruptcy court ...


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