Oxford University Bank v. Lansuppe Feeder, LLC, 933 F.3d 99 (2d Cir. 2019)
Holders of junior notes sued for rescission of the indenture under which the notes were issued on the grounds that they were entitled to rescission under Section 47(b) of the Investment Company Act (the “Act“) because the issuer violated the Act by failing to register as an investment company. Splitting from the Third Circuit, the U.S. Court of Appeals for the Second Circuit held that Section 47(b) of the Investment Company Act creates an implied private right of action for a party to a contract that violates the Act to seek rescission of the contract.
Soloso CDO 2005-1 Ltd., a special purpose investment vehicle (“Soloso“), issued senior notes and junior notes pursuant to a 2005 indenture. The notes were secured by Trust Preferred Securities, which Soloso purchased from the proceeds of the notes and which generated interest used to pay noteholders a return on their investment. In 2013, Soloso failed to make an interest payment due under the senior notes, triggering an event of default under the indenture. As a result, the senior noteholders were entitled to exercise remedies and, in 2015, they directed the indenture trustee to liquidate Soloso’s assets. Liquidation of the assets and application of the proceeds in accordance with the waterfall provision in the indenture would have resulted in the junior noteholders receiving none of the proceeds. The junior noteholders objected to the liquidation on the ground that Soloso had violated the Investment Company Act by issuing notes to a purchaser who was not a “qualified purchaser” under the Act.
The Investment Company Act requires investment companies to register with the Securities and Exchange Commission unless an exemption applies. Soloso had not registered as an investment company, instead relying on Section 3(c)(7) of the Act, which excepts from the definition of investment company any issuer whose outstanding securities are owned exclusively by persons who, at the time of acquisition of such securities, are qualified purchasers and that is not making and does not at that time propose to make a public offering of such securities. The indenture included provisions intended to prevent notes from being transferred to non-qualified purchasers in order to ensure that Soloso would remain exempt under Section 3(c)(7). However, certain notes were resold by original purchasers to an entity that the junior noteholders alleged was not a qualified purchaser. The junior noteholders claimed that Soloso’s failure to register under the Investment Company Act therefore violated the Act and that, pursuant to Section 47(b) of the Act, they were entitled to rescind the indenture.
Section 47(b) of the Investment Company Act states that a contract made in violation of, or whose performance involves a violation of, the Act “is unenforceable by either party,” and that, to the extent such a contract has been performed, “a court may not deny rescission at the instance of any party” unless the court finds that denial of rescission would be more equitable than granting rescission. In interpreting Section 47(b), the Court referenced the Supreme Court’s decision in Alexander v. Sandoval, 532 U.S. 275, 121 S.Ct. 1511, 149 L.Ed.2d 517 (2001), in which the Supreme Court stated that “private rights of action to enforce federal law must be created by Congress,” and that in determining whether Congress has created a private right of action “the interpretive inquiry begins with the text and structure of the statute”, with statutory intent being determinative. The Court also applied – and distinguished – its prior decision in Bellikoff v. Eaton Vance Corp., 481 F.3d 110 (2d Cir. 2007), which found that no private right of action existed under certain other provisions of the Investment Company Act in part because such provisions did not contain rights-creating language.
In the present case, the Court found that, unlike the provisions of the Investment Company Act at issue in Bellikoff, “[t]he text of § 47(b) unambiguously evinces Congressional intent to authorize a private action”, and that, as a result, Section 47(b) creates an implied private right of action for a party to a contract that violates the Act to seek rescission of the contract.
Despite the Court’s conclusion that Section 47(b) entitles a party to a contract that violates the Investment Company Act to seek rescission, it found that the junior noteholders failed to state a claim with respect to rescission of the indenture because neither the terms of the indenture nor its performance violate the Act. If anything, the sale contracts under which non-qualified purchasers acquired notes could potentially be rescinded under Section 47(b).
The Court acknowledged that its interpretation of Section 47(b) is inconsistent with the Third Circuit’s decision in Santomenno ex rel. John Hancock Trust v. John Hancock Life Ins. Co., 677 F.3d 178 (3d Cir. 2012), and with several lower court decisions. The Court stated that it disagreed with the reasoning of the other courts in those decisions. With respect to the Santomenno decision, the Court found that, instead of focusing on the text of the statute, the Third Circuit relied on canons of interpretation that are meant to help interpret ambiguous provisions. With respect to the other federal court decisions, the Court stated that those decisions incorrectly concluded that Section 47(b) provides a remedy but not a substantive right, and effectively read the rescission clause of Section 47(b) out of the Investment Company Act.
Article courtesy of Margaret G. Parker-Yavuz of Akin Gump Strauss Hauer & Feld LLP