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

On February 19, 2019, the Supreme Court of Ohio heard 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.

In June of 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 against Benchmark. The nursing home development was sold, giving bondholders in November of 2014 a final distribution of about $350,000 of the $6.5 million initial bond issue.

In May of 2015, 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. The trial court 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. The trial court 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.

In a unanimous decision authored by Judge 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.

Read the oral argument preview here.

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 Proposition of Law Accepted for Review

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.

At Oral Argument

Arguing Counsel

J.Philip Calabrese, Porter Wright Morris & Arthur LLP, Columbus, for Appellant Huntington Bank

Ronald R. Parry, Strauss Troy, Cincinnati, for Appellee Paul Cheatham IRA

Huntington’s Argument

If this Court does not reverse the judgment of the Sixth District, Ohio will be alone as the only jurisdiction in the country to interpret Section 8-302 of the U.C.C to transfer the right to sue automatically. That result is contrary to the plain language of the statute, which on its face is specifically intended to promote uniformity, and to be interpreted and applied consistently with the law of other jurisdictions. It would unsettle the expectations of those participating in the securities markets, both in Ohio and nationally. In ruling as it did, the Sixth District became the first and only court in the country to hold that Section 8-302 abrogates the longstanding common law rule that requires an assignment to transfer an accrued cause of action from the seller to the buyer of a security. This potentially affects every outstanding municipal bond issue in Ohio.

Ohio has long held that a cause of action is a separate, intangible property right, and it is a personal right which belongs to the person who owns the security at the time when the cause of action accrues. The term “all rights in the security,” in R.C. 1308.16(A) has a particular technical meaning, particularly in the U.C.C. that involves the transfer of title and the ownership rights that accompany title, such as the right to vote that security, to redeem it, sell it, and the right to payments of interest and principal.

The distinction between “rights in the security” and the personal property right to bring a cause of action is crucial. Because a chose in action is a personal property right, it is not “a right in the security” that automatically transfers when the security is sold. Although this appeal does not involve the liability determination of whether Huntington properly exercised its responsibilities and obligations under the Trust Indenture, the right to bring that cause of action belongs to whoever was a bondholder in June of 2003 when that cause of action allegedly accrued.

The proposition of law Huntington asks this Court to adopt is consistent with the longstanding common law of Ohio, as well as Ohio’s law governing assignment. It allows the parties by contract to transfer the right to file a lawsuit if they want to do so. It would correct the Sixth District’s erroneous interpretation which takes away rights from the defendant. And the common law rule would leave Mr. Cheatham with a direct cause of action for the damages he allegedly incurred during the times that he actually owned the bonds, to the extent he wanted to claim any breach of contract during those periods of time.

Cheatham’s Argument

This is a breach of contract case. The contract involved here is a Trust Indenture. A Trust Indenture comes into being with a bond issue before there are any bondholders. It’s a document that’s drafted, or at least approved unilaterally, by Huntington Bank before the bonds are ever sold to the public. When the bonds are sold, the terms of the indenture are to be relied on. Huntington is asking this Court to relieve it of some of the terms it wrote into that Trust Indenture.

The terms of the Trust Indenture define the bondholders’ rights. A person who buys a bond looks to the terms of the Trust Indenture. A person who buys a bond receives the right to payment. The seller, a past bondholder, has zero rights in anything. When Huntington foreclosed in 2009, it recovered about 3 to 5 cents on the dollar, which was for about 6 years of lost principal and interest payments. That payment, or any payment recovered, would have gone to current bondholders, because that is what the Trust Indenture says. The Bank didn’t go back and pay past bondholders. When it comes time to make a payment, the Bank doesn’t want to have to go investigate who owns this bond. Some of these bond issues go on for ten or twenty years. There may have been 50 people that transferred and owned this bond. The Bank simply goes to the bond register, looks at the name on the bond register, and that’s who gets the payment.

The right to receive payment is the right to file a lawsuit. If you have no right to receive payment under the Trust Indenture, and former bondholders clearly have no right to receive payment, then they do not have the right to file a lawsuit.

Cheatham’s cause of action arises under the terms of the Trust Indenture. Once there is an event of default, the Trustee has an obligation under the terms of the Indenture, to act as a prudent person would to protect the interests of the bondholders. Prior to a default, the Bank is merely a paying agent. It processes the payments and sends them out to bondholders. After a default, then the Bank must spring into action and act as an ordinarily prudent person.

While not here on the liability issue, it is Cheatham’s position that he can prove liability. The point is that the lawsuit arises under the terms of the Trust Indenture, meaning it is “a right in the security.” While there are lawsuits that could arise that relate to the security, the right to receive principal and interest, the right to enforce the Trustee’s obligation to act as a prudent person and to protect the bondholders, is a right that is within security because it is within the bond documents that become part of the security.

What Was On Their Minds

Outwardly, very little. What follows is a recap of the very few questions asked, mostly from Justice DeWine.

Cheatham’s argument is largely based on kind of a contractual argument about the terms of the bond indenture, commented Justice DeWine. Can a bond indenture never give a subsequent purchaser those rights, or just not in this case? This was the only question asked in the opening part of Huntington’s argument.  When Cheatham’s turn came, DeWine said he was trying to understand how Cheatham’s theory works in practice. Might I call my broker, he said, buy a number of bonds, and have different rights in each one, depending on who owned them before and what injuries were done to that prior owner. Is that right? Even though I pay the same price for them? Presumably I could buy a bond, some of them might have been owned by one person who wasn’t injured, maybe because there was some reliance interest or other things, while another person was injured. So each one of these bonds just kind of carries with it different rights as it gets passed from person to person? Is this how this works?

Justice French asked if Mr. Parry was agreeing with the Sixth District majority, because it sounded like he was agreeing with the reasoning of Judge Mayle in her separate concurrence, which was that it’s not just that you recover as a matter of law, or that you hold those causes of action as a matter of law, but that you have to look at the specific indenture document. Is that what he was are arguing? I think those are two different things, she noted, then asking what his statutory analysis was.

Do the bondholders from whom Mr. Cheatham purchased the bonds, once they were in default, have any recourse here, asked Chief Justice O’Connor?  The original ones, that were hanging on, that turned out to be useless paper—do they have any recourse? Because presumably when they sold them, that’s their return?

How It Looks From The Bleachers

To Professor Emerita Bettman

This was a mostly entirely politely silent bench, so the outcome is hard to predict. Mr. Calabrese used only a little over eight minutes in his opening, and got only one question.  Mr. Parry was more expansive, but when he thought he had used his time he had more than five minutes left, and seemed momentarily at a loss for words. The Chief interjected that he didn’t have to use those minutes, but what lawyer wouldn’t? So he rallied and kept talking.

I don’t know much about this area, but I’m calling this for Huntington. If the decision of the Sixth District really is a total outlier, that is contrary to the point of the U.C.C. I think the Court is going to adopt the proposition of law proposed by Huntington, and hold that in order for a buyer to have a cause of action in these circumstances there must be an express assignment from the seller. Whether those who held the bonds in June of 2003 had a valid grievance with the Bank under the Trust Indenture is another matter, and doesn’t sound like it would necessarily be a walk in the park for the Bank.

To Student Contributor Carson Miller

Huntington likely gets the win here, but with the Justices offering little from the bench it is difficult to be confident either way. Justices DeWine and French both hinted that Cheatham’s argument sidestepped the issue before the Court and failed to address the Sixth District’s holding. Indeed, much of Cheatham’s argument was devoted to the terms of the Trust Indenture, rather than the statutory interpretation issue this case is purportedly about. Huntington’s final argument might be its most effective: the U.C.C is meant to be applied similarly across jurisdictions, and the Sixth District’s interpretation would make Ohio the only jurisdiction in the country to automatically transfer causes of action in bond sales.

This is difficult to predict, but I think Justices DeWine and French side with Huntington. How the other Justices vote is anyone’s guess. I think Huntington’s efforts to deal with the statutory issue will be well taken, and Huntington should win, but the final vote could be anywhere from unanimous to a slim majority.