Update: On August 22, 2019, the Supreme Court of Ohio handed down a merit decision in this case.  Read the analysis here.

Read the analysis of the argument here.

On February 19, 2019, the Supreme Court of Ohio will hear oral argument in Paul Cheatham IRA v. The Huntington National Bank, 2018-0184. At issue in the case is whether a sale of municipal bonds vests in the buyer all causes of action of the seller relating to the bond that arose before the transaction.

Case Background

In 1998, Lucas County, Ohio, issued municipal bonds in support of a nursing home development, to be run by Foundation for the Elderly, Inc. Foundation for the Elderly was the obligor for the bonds, and Huntington served as Trustee for the bondholders of the project. As Trustee, it was Huntington’s obligation to collect payments from the obligor and distribute them to the bondholders. In the event of default, Huntington was to act in the best interests of the bondholders.

Sometime before June 2003, Foundation for the Elderly defaulted on the bonds, and by December 2003, Benchmark Healthcare became a substitute obligor and also defaulted. Huntington notified bondholders of both defaults and obligor substitutions. The Cheatham IRA (“Cheatham”) began purchasing the bonds in November 2003, after the default by the Foundation for the Elderly, and continued purchasing the bonds through 2007 at a fraction of their face value, even after Benchmark filed for bankruptcy.  After Benchmark failed to restructure under Chapter 11, Huntington foreclosed on the bonds, giving bondholders a final distribution of about $350,000 of the $6.5 million initial bond issue.

In May of 2015, twelve years after the initial obligor’s default, Cheatham filed a class action lawsuit against Huntington on behalf of itself and other similarly-situated bondholders. Among several claims, Cheatham alleged under a breach of contract claim that Huntington did not do enough to protect bondholder interests, leading to a low final distribution. Lucas County Common Pleas Court Judge James Bates dismissed all claims except the breach of contract claim as being barred by the statute of limitations.

Cheatham then sought class certification of all current bondholders on the breach of contract claim. Cheatham took the position that under R.C. 1308.16(A) (Ohio’s version of U.C.C. 8-302) a purchaser of a security acquires all rights in the security the transferor had. Thus, when the previous bondholders sold their bonds, their right to sue for breach of contract against Huntington transferred automatically to the current bondholders. Judge Bates disagreed with this interpretation of R.C. 1308.16(A),and denied class certification for failure to satisfy  Civ.R. 23(B)(3)’s predominance requirement. Cheatham’s individual breach of contract claim was not dismissed, but Cheatham appealed the denial of class certification.

The Appeal

In a unanimous decision  authored by Judge James P. Jensen, in which Judge Osowick concurred and Judge Mayle concurred and wrote separately, the Sixth District Court of Appeals reversed the trial court’s finding that Cheatham did not satisfy Civ. R. 23(B)(3)’s predominance requirement, and held that subsequent purchasers of bonds do acquire causes of action under R.C. 1308.16, including third-party claims for breach of contract. The appeals court noted the distinction between claims against separate companies and claims against the trustee for the bonds themselves; as a part of a bond proceeding, the transferable rights of bondholders include the right to bring claims against that trustee. Because the basis of the claim is grounded in the same instrument that is part of the contract with the bondholders, the claim is a right in the security that transfers automatically to subsequent purchasers.

Judge Mayle wrote separately to assert that the right to sue for claims that accrued prior to the transfer depends upon the specific security at issue. If the accrued claim cannot arise separately from the enforcement of the original security contract, then it should transfer with the assignment of the security. Since the Trust Indenture here is so central to the bonds at issue, and the contract itself limits legal action to the parties and bondholders, the bondholders have standing to sue for breaches of the trust agreement even if purchased after the cause of action accrued.

Votes to Accept the Case

Yes: Chief Justice O’Connor, and Justices Fischer, Kennedy, and O’Donnell.

No: Justices French, DeWine, and DeGenaro.

Key Statutes and Precedent

R.C. 1308.16(A) (UCC 8-302) (“a purchaser of a certificated or uncertificated security acquires all rights in the security that the transferor had or had power to transfer.”)

R.C. 140.01(J) (“‘Bond proceedings’ means one or more ordinances, resolutions, trust agreements, indentures, and other agreements or documents, and amendments and supplements to the foregoing, or any combination thereof, authorizing or providing for the terms, including any variable interest rates, and conditions applicable to, or providing for the security of, obligations and the provisions contained in such obligations.”)

R.C. 140.06(I) (a trust agreement may provide, in the event of default, for “foreclosure, or any other legal remedy.”)

Bowman v. Parma Bd. of Education, 44 Ohio App. 3d 169 (8th Dist. 1988) (“[a]s a general rule contract claims survive the death of the plaintiff.”)

Leverso v. Southtrust Bank, 18 F.3d 1527 (11th Cir. 1994) (“the terms of the [trust agreement] govern the parties’ contractual rights . . . .”)

Bluebird Partners, L.P. v. First Fid. Bank, N.A., 85 F.3d 970 (2d Cir. 1996) (Under federal law, claims are not automatically assigned to the subsequent purchaser of a security because the law “protect[s] those who are injured . . . not those who subsequently purchase securities at the reduced price.”)

R.A. Mackie & Co. v. PetroCorp Inc., 329 F.Supp.2d 477 (S.D.N.Y. 2004) (Security holders’ rights in the security must be judged against the language in the contract between the parties; the rights “thus include the rights against the issuer under the contract embodied in the security.”)

Consolidated Edison, Inc. v. Northeast Utilities, 318 F.Supp.2d 181 (S.D.N.Y. 2004) (Section 8-302 “applies primarily to disputes over the quality of title and the competing ownership rights passed from transferor to transferee.”)

In re Activision Blizzard, Inc. Stockholder Litig., 124 A.3d 1025 (Del. Ch. 2015) (“When a share of stock is sold, the property rights associated with the shares, including any claim for breach of those rights and the ability to benefit from any recovery or other remedy, travel with the shares.”)

Huntington’s Argument

Cheatham  conceded that if his interpretation of R.C. 1308.16 is incorrect, then class certification would be inappropriate. His interpretation is incorrect, and the trial court properly denied class certification.

Common law and Ohio law treat causes of action as personal property rights separate from the property itself. Absent a valid assignment of the cause of action, the right to sue cannot be included in the bond sale. The law treats the transfer of a security as a separate matter from the transfer of an accrued cause of action relating to that security. The Trust Indenture for the bonds at issue does not alter these background principles of Ohio law and the common law that accrued claims do not automatically transfer without an express assignment. No provision of the Trust Indenture assigns any accrued cause of action from a seller to a buyer, and it disavows any implied rights. Thus, Cheatham cannot pursue any claims that accrued before he first acquired any bonds, in November of 2003, nor may he pursue claims on behalf of a class dating from Foundation for the Elderly’s initial default in June 2003.

R.C. 1308.16, on its face, does not transfer all ownership rights in the seller’s possession. The statute does not say that a purchaser acquires all rights of the seller or all rights related to the security. Instead, it provides the purchaser acquires all rights in the security itself.

UCC Section 8-302’s history and construction do not support automatic transfer of causes of action. Originally, Section 8-302 was treated as a means to determine the transferor’s title, or ownership interest, in the security itself in the event another claimed ownership of the security. This history contradicts Cheatham’s interpretation that Section 8-302 causes the automatic transfer of accrued causes of action when a security is sold.

Looking to other states’ treatment of UCC 8-302 shows the meaning of the provision. New York specifically chose to change the common-law rule that accrued causes of action do not transfer unless expressly provided by the parties. This statute would have been superfluous if the UCC provided for automatic transfer of causes of action.  And case law interpreting federal securities law is consistent with the common law requirement that there must be an express assignment in order to transfer accrued causes of action to a purchaser.

The Sixth District is the only court to have ever concluded that R.C. 1308.16(A) automatically transfers accrued causes of action, and the statutes it relied on do not support that position. Instead of analyzing the common law, the Sixth District applied statutes that allow, but do not require, a bondholder to maintain a cause of action based on alleged pre-purchase breaches. This decision ignores longstanding Ohio law that requires evidence of a seller’s intent to transfer a cause of action to the buyer.

Cheatham’s Argument

Even if accrued causes of action do not automatically transfer upon sale of a bond under the common law, the terms of the Trust Indenture should resolve the issue. Since the trust contract here provides a cause of action to all present and future bondholders, it does not matter when or how bondholders bought the bonds. The terms of the contract make clear that actual ownership of the bond is a requirement to bring a claim for breach of the contract. It is ownership of the bonds, not the date of acquisition, that is dispositive. Therefore, the breach of contract claim is a “right in the security” under R.C. 1308.16(A). R.C. 1308.16(A) provides for the transfer of all rights in the security, not just some of those rights. The right to bring a breach of contract claim arising out of the bond’s trust contract is one of those rights.

Huntington had long term obligations to the bondholders, and the breach of contract claim is a direct claim that adheres to the bonds themselves and is transferrable. It runs with the bonds. Cheatham is not asserting a fraud claim, or another type of claim that requires personal detrimental reliance on Huntington’s actions. Instead, this is a breach of contract claim for a breach of the terms of the trust agreement, which is a property right associated with the bonds themselves.

Even if the claims do not automatically transfer with the bonds, Cheatham has suffered an injury and alone still has standing to pursue the breach of contract claim against Huntington.

Huntington’s Proposed Proposition of Law

Absent a valid assignment of claims, the mere sale of a municipal bond does not automatically vest in the buyer, by operation of R.C. 1308.16 (Section 8-302 of the Uniform Commercial Code), all claims and causes of action of the seller relating to the bond that arose before the transaction.

Cheatham’s Proposed Counter Proposition of Law

The present Holder of a bond issued under a contract containing provisions that it is executed solely for the benefit of all present and future Bondholders and only permits Bondholders to institute a lawsuit to enforce the Indenture, acquires a breach of contract claim arising not only from conduct that occurred gradually, over time, and after the Bondholder’s purchase, but also acquires a breach of contract claim arising from similar conduct that occurred prior to the Bondholder’s purchase of the bonds.

Where such provisions are contained in the governing contract, the breach of contract claim is a “right in the security” under R.C. 1308.16(A) that adheres to and travels with the bond.

Amici in Support of Huntington

The American Bankers Association (“ABA”) filed a brief in support of Huntington. The ABA is the country’s largest banking trade association, and represents banks and holding companies across the country. Ohio common law requires an express assignment of a cause of action; there must be clear evidence of the intent to transfer such a right. This common law is consistent with other states, which generally do not recognize an assignment of a litigation claim when the underlying property is transferred unless there is a clear intent to transfer the right to bring the claim.

Additionally, R.C. 1308.16 governs claims to ownership of a security, not the transferability of causes of action arising from ownership of that security. Section 8-302 of the UCC (R.C. 1308.16’s model statute) is generally held to determine only who owns the security, not what rights may transfer to a buyer after the security is sold. This is how other states have interpreted Section 8-302, and the intent of the UCC includes uniform interpretation across state lines. The ABA adopts Huntington’s proposed proposition of law.

A number of commercial law professors also filed a brief in support of Huntington. The principal drafter, Professor Larry Garvin, is Lawrence D. Stanley Professor of Law at the Ohio State University, where he teaches and writes in the fields of contracts and commercial law. Professor Garvin is a member of the American Law Institute, where he serves as an advisor to the reporters of the Restatement of Consumer Contracts.

The professors note that the UCC drafters did not intend for Section 8-302 to apply to transfers of causes of action. The UCC codified the “shelter principle,” or the rule that a buyer receives everything a seller was able to convey. Historically, this has not included causes of action, and such a transfer requires the parties to agree to transfer more than just ownership of the security.

Therefore, the Court should hold that causes of action related to a security are not automatically assigned upon transfer, but may be transferred by express agreement. This is the case in most jurisdictions, as well as federal securities law. A default rule of automatic assignment may create redundant litigation, as sellers may be forced to sue just to retain their rights, and buyers may inherit a windfall if they acquire securities with liabilities in excess of any actual harm to the buyers.

Amicus law professors offer two proposed propositions of law: (1) Revised Code Section 1308.16(A) [U.C.C. Section 8-302] does not require that claims held by the transferor of a security automatically be assigned to the transferee; and (2) as a matter of both precedent and principle, this Court should rule that choses in action related to a security are not automatically assigned to a transferee upon transfer, but may be transferred by express agreement.

Student Contributor: Carson Miller