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

843 F.3d 876 (10th Cir. 2016)

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Nature of the Case

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Facts

Quiznos had borrowed heavily before its business sharply declined. From 2007 to 2011, Quiznos lost roughly 3,000 franchise restaurants and profitability plunged. With the restructuring of the debt, Ps gained control over Quiznos. Ps became members of a manager-managed limited-liability company that operated Quiznos. Ps acquired about 80% of the shares. Ps pumped $150 million into Quiznos. Ps obtained the power to amend the LLC agreement however they wished. The LLC agreement empowered Ps to appoint eight managers (one of whom would serve as the chairperson of the board. Ps could also remove the managers that they had appointed. The appointed managers would select the Chief Executive Officer, who would serve as the ninth manager. Ps also obtained the power to appoint five non-voting observers to attend board meetings. Management of Quiznos would be vested exclusively with the board. The day-to-day operations would be handled by the CEO and other officers. The board would appoint these officers and enjoy supervisory authority over them. The board could even dissolve the LLC. The LLC agreement allowed Ps to inspect, examine, and copy Quiznos's records. Despite all the changes Quiznos’ condition declined. Ps the sued Schaden (Ds), the managers and officers of Quiznos, for securities fraud claiming that Ds had fraudulently misrepresented Quiznos's financial condition. In court, Ps argued that the transaction involved investment contracts, triggering the 1934 Act and Rule 10b-5. The district court rejected this argument because the transaction had given Ps control over Quiznos. It dismissed the securities-fraud causes of action, concluding that Ps had failed to identify facts showing that their newly acquired interests in Quiznos constituted investment contracts. Ps appealed.