Securities Regulation Daily ICA voidable contracts provision provides private right of action
Monday, August 5, 2019

ICA voidable contracts provision provides private right of action

By Amy Leisinger, J.D.

Although the intervening noteholders did have the right to move for rescission, they failed to establish a violation of the Investment Company Act in connection with the indenture so as to void it.

A Second Circuit panel has affirmed a district court’s decision to order distribution of the assets of a trust according to the terms of the trust’s governing indenture. According to the panel, however, the district court erred in finding that Investment Company Act Section 47(b) does not provide a private right of action. Nevertheless, the panel concurred that the junior noteholders (the intervenors) failed to demonstrate that the trust or the indenture violated the Act in such a manner as to void the indenture and its provisions providing preferential payment for the senior noteholders. The panel affirmed summary judgment in favor of the trust and dismissed the intervenors’ cross-claims (Oxford University Bank v. Lansuppe Feeder, Inc., August 5, 2019, Leval, P.).

Notes and the indenture. Soloso, a special purpose investment vehicle that issued notes to investors pursuant to the terms of an indenture, used proceeds from its sale of notes to purchase trust preferred securities that generated interest used to pay noteholders. Lansuppe Feeder LLC held senior notes, entitled to priority of payment in liquidation, and other entities held junior notes with a higher rate of return but lower payment priority under the distribution scheme detailed in the indenture.

In April 2013, Soloso failed to pay the interest due on senior notes, which, under the indenture, constituted an "Event of Default" entitling the holders of two-thirds of the senior notes (in this case, Lansuppe) to direct liquidation of the trust’s assets. The junior noteholders intervened in the liquidation trust instruction, objecting to the planned liquidation on the ground that Soloso had violated the Investment Company Act by issuing notes to a purchaser who was not a "qualified purchaser" and failing to register with the SEC. The indenture contained provisions meant to ensure that Soloso remained exempt from registration by selling notes only to qualified purchasers, but Soloso failed to do so, and, thus, the intervenors contended, their investments may be rescinded under Section 47(b). The district court granted summary judgment in favor of Lansuppe, finding that Section 47(b) does not create a private right of action and that, in any event, the intervenors’ cross claims fail on the merits.

Private right of action. The district court concluded that the intervenors have no private right of action under Section 47(b) because the Act provides a different enforcement mechanism through the SEC and "there is ‘no implication of an intent to confer rights’ on the [i]ntervenors as a protected ‘particular class of persons.’" However, the panel found, the district court overlooked "clear evidence" of congressional intent to provide a right of action in the text of Section 47(b). The text states that "a court may not deny rescission at the instance of any party," which indicates that "any party" may seek rescission in court by filing suit, according to the panel. Such language is "effectively equivalent" to an express right of action, the panel stated.

Failure to state a claim. Although Section 47(b) entitles the intervenors to seek rescission of a contract that violates the Act, the panel found that their claim must fail because the contract they seek to rescind does not violate the Act. The indenture’s terms and related performance (the precise contract at issue in this case) do not violate the Act, the panel stated. The indenture obligates the trustee to distribute the trust assets first to senior noteholders, and the intervenors do not claim that this provision violates the Act, according to the panel. The sale of unregistered notes to non-qualified purchasers could have violated the Act as the intervenors allege, the panel explained, but these are not the contracts the intervenors seek to rescind.

As the intervenors failed to identify any provision of the indenture whose performance would violate the Act and thus support rescission, the panel affirmed the district court’s decision to grant summary judgment in favor of Lansuppe and dismiss the intervenors’ cross-claims.

The case is No. 16-4061.

Attorneys: Jonathan Edward Pickhardt (Quinn Emanuel Urquhart & Sullivan, LLP) for Lansuppe Feeder, LLC.

Companies: Lansuppe Feeder, LLC; Wells Fargo Bank, National Association, as trustee for Soloso CDO 2005-1 Ltd

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