Friesen v. Seacoast Capital Partners II, L.P. (In re QuVIS, Inc.)

469 B.R. 353

In re QuVIS, INC., Debtor,Douglas A. Friesen, M.D.; Marilyn R. Friesen Greenbush, Ph.D.; Douglas C. Cusick; JFM Limited Partnership I; and Unsecured Creditors' Committee, Plaintiffs,

v.Seacoast Capital Partners II, L.P., Defendant.

No. 11–1072–EFM.

United States District Court, D. Kansas.

March 13, 2012.

Ryan M. Peck, William B. Sorensen, Jr., Morris, Laing, Evans, Brock & Kennedy, Chtd., Wichita, KS, for Plaintiffs.

Thomas J. Lasater, Fleeson, Gooing, Coulson & Kitch, LLC, Wichita, KS, for Defendant.

MEMORANDUM AND ORDER

ERIC F. MELGREN, District Judge.

Plaintiffs appeal from the bankruptcy court's decision to grant Defendant summary judgment on Plaintiffs' adversary action requesting equitable subordination of Defendant's secured interest in the debtor's assets. The Bankruptcy Code gives courts the discretion to equitably subordinate creditors' claims if the creditor engaged in inequitable conduct that injured other creditors and if subordination is not inconsistent with other provisions of the Bankruptcy Code. Plaintiffs claim that Defendant—whose Managing Director sat on the debtor's board of directors—committed misconduct when it filed its own UCC–1 financing statement after the debtor's financing statement lapsed, thereby giving Defendant's security interest priority over the Plaintiffs' unsecured interest. Because there is no genuine issue of material fact as to whether Defendant engaged in inequitable conduct, the Court affirms the bankruptcy court's decision to grant Defendant summary judgment.

I. Factual and Procedural Background¹

The debtor, QuVIS Inc., was a Topeka technology company offering digital motion imaging technology. Plaintiffs are unsecured creditors of the debtor who purchased promissory notes from QuVIS prior to 2005. Defendant Seacoast Capital Partners II, L.P., is a licensed Small Business Investment Company (“SBIC”) as defined in the Small Business Investment Act of 1958.² On June 1, 2005, after conducting due diligence, Seacoast purchased a promissory note after loaning QuVIS the sum of $3,160,066.40 (the “June 2005 Note”). The note was issued in accordance with a security agreement QuVIS entered with all Noteholders—including Plaintiffs—that was dated June 30, 2003 (“2003 Note Agreement” or “Note Agreement”).³

QuVIS also executed a Joinder Agreement that outlined the terms of the sale of Seacoast's June 2005 Note.⁴ The Joinder Agreement named Seacoast as a Lender subject to the provisions of the 2003 Note Agreement. It also permitted Seacoast to place a representative on QuVIS's board of directors and to designate a person to observe all board meetings.⁵ The QuVIS board of directors approved the Joinder Agreement after “full discussion and careful [ ] consider[ation].” ⁶ Neither Seacoast nor its Managing Director, Eben Moulton—who later sat on QuVIS's board of directors—were involved in the negotiation of the 2003 Note Agreement or 2005 Joinder Agreement. Both Seacoast and Moulton understood that the Note Agreement set forth collateral sharing terms such that no lien was subordinate to any other interest held by QuVIS's Lenders.⁷ The parties agree that Seacoast would not have accepted the promissory notes if Seacoast's interest was subordinate to existing lienholders.⁸

On May 3, 2006, Eben Moulton was elected to serve on QuVIS's board as an outside director. Moulton previously served as an outside director on the boards of many small business companies to which Seacoast provided venture capital, as well as boards of public companies. Moulton's service on QuVIS's board of directors is consistent with Moulton's understanding that the Small Business Investment Act encourages SBICs to support the management of the small business ventures in which the SBIC invests.

The parties' agreement also stated that QuVIS was responsible for perfecting Seacoast's interest in the promissory notes.⁹ The parties agree that QuVIS generally filed UCC filing statements on behalf of the Lenders. QuVIS filed the original financing statement with the Kansas Secretary of State on March 14, 2002, and filed UCC–2 Financing Statement Amendments to subsequently add the names of new secured parties. Plaintiffs's security interests were all secured under QuVIS's 2002 financing statement. But unbeknownst to the parties, QuVIS never filed a UCC–2 amendment naming Seacoast as a secured party under the original 2002 financing statement. In fact, after Seacoast loaned QuVIS an additional $719,933.60 on November 2, 2005, QuVIS again neglected to file a UCC–2 amendment. As a result, Seacoast's security interests were never perfected.¹⁰

On March 14, 2007, the UCC–1 financing statement that QuVIS filed in 2002 lapsed by operation of state law.¹¹ On that same day, by coincidence, Seacoast loaned QuVIS an additional $350,000 and received another promissory note. Neither Seacoast nor QuVIS filed any UCC financing statements for this loan. Moulton believed that the March 2007 note was perfected, but did not verify the status of the lien. If Moulton had known that QuVIS's 2002 UCC–1 financing statement had lapsed, Moulton would have acted to ensure the proper legal documentation was filed to secure Seacoast's lien.

According to the 2003 Note Agreement, as well as Moulton's understanding, when QuVIS's loans matured on June 30, 2007, each Lender would have the option of either (1) exchanging the note for QuVIS stock pursuant to a detailed formula, or (2) receiving cash payment on the note. In the spring of 2007, Moulton and the other QuVIS board members searched for a new funding source to retire the obligations of Lenders who might elect cash payment. Moulton believed the investment banking firm Pacific Crest Securities was a potential source of funding. In April 2007, Moulton and other QuVIS board members met with Pacific Crest and negotiated an engagement letter. When the QuVIS board members realized that they could not close the deal with Pacific Crest before the June 30, 2007, maturity date of the Notes, the board decided to request that the Lenders extend the maturity date. On May 31, 2007, board member Owen Leonard circulated a draft letter for the board's consideration. The letter requested that the Lenders extend the June 30, 2007, maturity date to September 30, 2007. After receiving feedback from the other directors, including Moulton, QuVIS sent the letter to the Lenders on June 7, 2007. The letter did not mention that the 2002 financing statement had lapsed, and the board's minutes from 2007 do not reference the lapse.

After receiving the letter from the QuVIS board of directors, Seacoast asked its outside counsel to review the letter and offer advice. Seacoast's attorneys obtained a UCC search report, which did not show any financing statement or amendment securing Seacoast's loans, nor did the report list QuVIS's lapsed 2002 financing statement. On June 14, 2007, Seacoast filed a UCC–1 financing statement to perfect its security interest in QuVIS.¹² Two other Lenders, Greg Kite and The Christine Baugher Trust, filed UCC–1 financing statements on June 7, 2007. Directors Leonard and Nelson did not file UCC–1 statements until January 2009, and Plaintiffs filed financing statements in 2008.

Plaintiffs brought an involuntary Chapter 11 bankruptcy suit against QuVIS on March 20, 2009.¹³ QuVIS consented to an order for relief that was entered on May 18, 2009. In its Disclosure Statement and Plan, QuVIS proposed to treat all Lenders under the 2003 Note Agreement equally as secured creditors with equal priority such that all Lenders would receive a pro rata share of QuVIS's assets. Seacoast filed a document in support of QuVIS's proposal, arguing that all of the original Lenders' liens could be perfected upon the filing of a UCC–1 financing statement by any one of the Lenders. In its order determining the secured status of QuVIS's noteholders (“Secured Status Order”),¹⁴ the bankruptcy court denied QuVIS's request to classify all of the Lenders as equals. The bankruptcy court found that “the Loan Agreement did not abrogate the first to file rule under the circumstances here and that payments to the Noteholders who filed new UCC–1s should be made in the order in which each Noteholder filed a financing statement.” ¹⁵ Applying the first-to-file rule, the bankruptcy court found that Seacoast's interest was subordinate to liens held by J. Greg Kite and the M. Christine Baugher Revocable Living Trust, but superior to Plaintiffs' secured claims. Kite claimed $133,933 of QuVIS's assets, the Trust claimed $133,363, and Seacoast claimed $5.3 million. Because QuVIS's assets amount to only $1.3 million, none of the Plaintiffs have security for their claims.

In response to the bankruptcy court's ruling, Plaintiffs filed an adversary suit against Seacoast, arguing that Seacoast's lien should be equitably subordinated to an unsecured claim under section 510(c) of the Bankruptcy Code.¹⁶ Plaintiffs alleged that Seacoast, through Moulton's position on QuVIS's board of directors, had actual or constructive knowledge of the lapse of QuVIS's 2002 financing statement, and that Seacoast had a fiduciary duty to notify the other Noteholders of the lapse. Plaintiffs argued that Seacoast acted unfairly when it filed its own UCC–1 financing statement, and that Seacoast's actions were a result of its alleged insider status. Seacoast moved for summary judgment on Plaintiffs' claims. The bankruptcy court granted the motion for summary judgment, holding that Seacoast was not an insider and did not engage in gross misconduct by filing its UCC–1. Plaintiffs subsequently filed this appeal. Plaintiffs' claim for equitable subordination presents no genuine issue of material fact. Because Seacoast is not an insider of QuVIS's and its conduct in filing a UCC–1 financing statement does not rise to the level of gross misconduct, the Court affirms the bankruptcy court's decision to grant Seacoast summary judgment.

II. Analysis

A. Pl...