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Avenue Capital Management II, L.P. v. Schaden

United States Court of Appeals, Tenth Circuit

December 13, 2016

AVENUE CAPITAL MANAGEMENT II, L.P., a Delaware limited partnership; AVENUE INTERNATIONAL MASTER, L.P., a Cayman Islands exempted limited partnership; AVENUE INVESTMENTS, L.P., a Delaware limited partnership; AVENUE SPECIAL SITUATIONS FUND VI (MASTER), L.P., a Delaware limited partnership; MANAGED ACCOUNTS MASTER FUND SERVICES-MAP10, a sub-trust of an umbrella unit trust constituted by a trust deed governed by the laws of Ireland; AVENUE-CDP GLOBAL OPPORTUNITIES FUND, L.P., a Cayman Islands exempted limited liability partnership; AVENUE SPECIAL OPPORTUNITIES CO-INVESTMENT FUND I, L.P., a Delaware limited partnership; AVENUE SPECIAL OPPORTUNITIES FUND I, L.P., a Delaware limited partnership; DRAWBRIDGE SPECIAL OPPORTUNITIES FUND L.P., a Delaware limited partnership; DRAWBRIDGE SPECIAL OPPORTUNITIES FUND LTD, a Cayman Islands company; FCI HOLDINGS I LTD, a Cayman Islands company; FCI HOLDINGS II LTD, a Cayman Islands company; FCOF II UB SECURITIES LLC, a Delaware limited liability company; FCOF UB INVESTMENTS LLC, a Delaware limited liability company; FTS SIP L.P., a Jersey limited partnership; PANGAEA CLO 2007-1 LTD, a Cayman Islands company; SARGAS CLO I LTD, a Cayman Islands company, WORDEN MASTER FUND II L.P., a Cayman Islands exempted limited partnership; WORDEN MASTER FUND L.P., a Cayman Islands exempted limited partnership, Plaintiffs-Appellants,
v.
RICHARD F. SCHADEN, an individual; RICHARD E. SCHADEN, an individual; FREDERICK H. SCHADEN, an individual; GREG MACDONALD, an individual; DENNIS SMYTHE, an individual; ANDREW R. LEE, an individual; PATRICK E. MEYERS, an individual; JOHN M. MOORE, an individual; THOMAS RYAN, an individual; CONSUMER CAPITAL PARTNERS LLC, a Delaware limited liability company a/k/a Cervantes Capital LLC, Defendants-Appellees.

         Appeal from the United States District Court for the District of Colorado (D.C. No. 1:14-CV-02031-PAB-KLM)

          Rex S. Heinke, Akin Gump Strauss Hauer & Feld LLP, Los Angeles, California (Jeffery A. Dailey, Akin Gump Strauss Hauer & Feld LLP, Philadelphia, Pennsylvania, Jessica M. Weisel, Akin Gump Strauss Hauer & Feld LLP, Los Angeles, California, Stephen M. Baldini, Akin Gump Strauss Hauer & Feld, LLP, New York, NY, and Allen L. Lanstra, Skadden, Arps, Slate, Meagher & Flom, Los Angeles, California, with him on the briefs) for Plaintiffs-Appellants.

          Nathaniel P. Garrett, Jones Day, San Francisco, California (Amanda K. Rice, Jones Day, San Francisco, California, Timothy R. Beyer, Bryan Cave, Denver, Colorado, Bruce S. Bennett and Christopher Lovrien, Jones Day, Los Angeles, California, with him on the brief) for Defendants-Appellees.

          Before LUCERO, BALDOCK, and BACHARACH, Circuit Judges.

          BACHARACH, Circuit Judge.

         This securities-fraud case arises out of a transaction to restructure Quiznos's debt.[1] In this transaction, multiple investment funds ("Avenue" and "Fortress")[2] purchased equity in Quiznos. After Quiznos's financial condition plummeted, Avenue and Fortress sued former Quiznos managers and officers, claiming that they had fraudulently misrepresented Quiznos's financial condition and invoking § 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5.[3]

         1. The district court dismissed the causes of action for securities fraud based on failure to state a valid claim.

         The 1934 Act's definition of "security" includes an investment contract, stock, or instrument commonly known as a "security." 15 U.S.C. § 78c(a)(10). In district court, Avenue and Fortress argued that the transaction involved investment contracts, triggering the 1934 Act and Rule 10b-5. The district court rejected this argument, reasoning in part that the transaction had given Avenue and Fortress control over Quiznos. Ultimately, the district court dismissed the securities-fraud causes of action, concluding that Avenue and Fortress had failed to identify facts showing that their newly acquired interests in Quiznos constituted investment contracts.

         2. Issues and Conclusions

         Avenue and Fortress challenge the district court's conclusion on three grounds, arguing that the transaction involved (1) investment contracts, (2) stock, and (3) instruments commonly known as securities. We reject each argument: The transaction did not involve investment contracts, and Avenue and Fortress failed to properly preserve their current arguments characterizing the interests as stock or instruments commonly known as securities.

         3. We engage in de novo review.

         The district court ruled that the causes of action for securities fraud had failed to state a valid claim. In addressing this ruling, we engage in de novo review. Slater v. A.G. Edwards & Sons, Inc., 719 F.3d 1190, 1196 (10th Cir. 2013).

         To survive the motion to dismiss, Avenue and Fortress had to plead enough facts to create a facially plausible claim. Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). In applying this standard, we accept the truth of the complaint's well-pleaded factual allegations. Cty. of Santa Fe v. Pub. Serv. Co. of N.M., 311 F.3d 1031, 1034 (10th Cir. 2002). These factual allegations include not only the statements in the complaint but also the documents referenced in the complaint that are central to the claims. GFF Corp. v. Associated Wholesale Grocers, Inc., 130 F.3d 1381, 1384 (10th Cir. 1997). Thus, we rely on (1) the facts alleged in the complaint and (2) the central documents referenced in the complaint.

         4. Quiznos restructured its debt after experiencing a sharp downturn.

         The complaint and referenced documents show that Quiznos had borrowed heavily before its business sharply declined. From 2007 to 2011, Quiznos lost roughly 3, 000 franchise restaurants and profitability plunged.

         With this plunge, Quiznos could no longer satisfy its loan covenants. As a result, Avenue, Fortress, and others could foreclose on collateral, call in debt, or accelerate payments. To avoid a calamity, Quiznos restructured its debt.

         5. With the restructuring of the debt, Avenue and Fortress gained control over Quiznos.

         The restructuring took place through a transaction involving Quiznos, Avenue, Fortress, and others. This transaction made Avenue and Fortress members of a manager-managed limited-liability company that operated Quiznos. Avenue acquired about 70% of the LLC's shares, and Fortress acquired about 10% of the shares. In exchange, Avenue pumped $150 million into Quiznos and Avenue and Fortress reduced Quiznos's debt.

         With roughly 80% of the LLC's shares, Avenue and Fortress collectively obtained the power to amend the LLC agreement however they wished. In addition, the LLC agreement empowered Avenue to appoint seven managers (one of whom would serve as the chairperson of the board) and Fortress to appoint one manager. Avenue and Fortress could also remove the managers that they had appointed. The appointed managers would select the Chief Executive Officer, who would serve ...


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