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Paul Cheatham I.R.A. v. Huntington National Bank

Supreme Court of Ohio

August 22, 2019

Paul Cheatham I.R.A., Appellee,
Huntington National Bank, Appellant.

          Submitted February 19, 2019

          Appeal from the Court of Appeals for Lucas County, No. L-16-1292, 2017-Ohio-9234.

          Strauss Troy and Ronald R. Parry, for appellee.

          Porter, Wright, Morris & Arthur, L.L.P., Kathleen M. Trafford, J. Philip Calabrese, and Jay A. Yurkiw, for appellant.

          Thompson Hine, L.L.P., Scott A. King, Brian J. Lamb, and Terry W. Posey Jr., urging reversal for amicus curiae American Bankers Association.

          Dennis D. Hisch, urging reversal for amici curiae commercial-law professors.

          STEWART, J.

         {¶ 1} This case presents a question of first impression regarding the rights of a bondholder to seek redress for injuries suffered by a prior holder of the bonds. At common law, only the person who suffered the injury can, absent assignment of a chose in action, seek redress for the injury. The Sixth District Court of Appeals found a statutory exception to the common-law rule for securities under R.C. 1308.16(A) (Ohio's codification of Uniform Commercial Code ("UCC") 8-302), which states that "a purchaser of a certificated or uncertificated security acquires all rights in the security that the transferor had or had power to transfer." The court of appeals held that this statute allows a purchaser of a bond to assert a breach-of-contract claim that accrued before the bondholder's purchase because the purchaser acquired the rights of one who held the bond when the breach allegedly occurred. For the reasons explained below, we reverse the judgment of the court of appeals.

         {¶ 2} A chose in action is personal in nature and, absent assignment, cannot be asserted by another. R.C. 1308.16(A) does not automatically assign rights to a purchaser upon a transfer of title-it does nothing more than set forth the rule of securities that the purchaser takes all rights in the thing transferred that the seller had the power to give ("shelter rule"). We hold that absent a valid assignment of a right to bring a cause of action, the sale of a municipal bond does not automatically vest in the purchaser, by operation of R.C. 1308.16, all causes of action the seller had the right to bring relating to the bond.

         {¶ 3} Additionally, the language of the trust indenture in this case-the agreement in the bond contract made between a bond issuer and the indenture trustee-does not provide an independent basis for bypassing the common law rule against automatic assignment of claims. Language stating that "actual ownership of the bond is a condition precedent to the maintenance of a cause of action that arises under the Trust Indenture" does not automatically transfer a right to a cause of action that accrued to a prior bondholder-it merely limits the rights of third-party beneficiaries.


         {¶ 4} In 1998, Lucas County issued $6.59 million in revenue bonds to back construction of the Villa North Health Care and Rehabilitation Center. The parties agree that Lucas County was the lessor and, technically, the obligor on the bonds in order to make them exempt from federal taxes. The bonds, however, were not an obligation of the county: the actual obligor (and lessee) was the Foundation for the Elderly, Inc. Lucas County had to pay only those receipts that it had received from the Foundation for the Elderly. Appellant, Huntington National Bank, entered a trust indenture with Lucas County in which it agreed to collect payments on the bonds and distribute funds, whether principal or interest, to the bondholders.

         {¶ 5} The project had its difficulties. In June 2003, Huntington informed the bondholders that the obligor and lessee had defaulted on approximately $420, 000 in principal and interest payments. A new entity, Benchmark Healthcare of Toledo, Inc. ("Benchmark"), assumed the lease but defaulted in December 2003. In May 2004, Huntington informed the bondholders that Benchmark had filed for reorganization under Chapter 11 of the Bankruptcy Code. Benchmark filed an amended reorganization plan in December 2007, but by July 2009, reorganization had failed. The bankruptcy was dismissed, and Huntington filed a foreclosure action against Benchmark.

         {¶ 6} Appellee, Paul Cheatham I.R.A. ("Cheatham IRA"), alleged that beginning in 2003, it began purchasing the bonds. This was a potentially risky investment strategy: identify distressed, nontaxable bonds and buy them at a discount with the hope that any problems that had caused the value of the bonds to decline would be remedied, resulting in an increase in value. In fact, the Cheatham IRA continued to purchase the bonds after Benchmark filed for reorganization under the bankruptcy code, paying 32 cents on the dollar. However, out of an initial bond issue in the amount of $6.59 million, bondholders received a total of $339, 452.05, or five cents on the dollar.

         {¶ 7} The Cheatham IRA filed a class-action complaint, alleging that Huntington had breached the trust indenture. It alleged that the trust indenture required Huntington to exercise the rights and power vested in it by the trust indenture using the same degree of care and skill that a prudent person would exercise or use under the circumstances in the conduct of that person's own affairs. It further alleged that Huntington allowed the Villa North project to be mismanaged despite having available to it different remedies that could have protected the interests of the bondholders. Its claimed damages were the value of the bonds had Huntington acted immediately upon default to accelerate payment of interest and principal and disgorgement of Huntington's fiduciary fees to the bondholders based on their proportionate share of the bonds.

         {¶ 8} The Cheatham IRA asked the court to certify a class of more than 50 bondholders who, on November 14, 2014 (the date of final distribution), owned bonds secured by the Villa North project. The Cheatham IRA argued in support of its motion for a class action that it had satisfied Civ.R. 23(B)(3), which requires that questions of law or fact common to the class predominate over questions that affect the individual members and that a class action is the superior means of adjudicating the dispute. Huntington opposed class certification, arguing that individual members of the proposed class of bondholders purchased their bonds at different times in the life of the Villa North project, so the evidence and legal issues on the breach-of-contract claim would differ based on when the class members acquired the bonds.

         {¶ 9} The Cheatham IRA argued that it established commonality under R.C. 1308.16(A), which states that "a purchaser of a certificated or uncertificated security acquires all rights in the security that the transferor had or had power to transfer." It maintained that it made no difference whether there was commonality as to when the bondholders acquired their bonds because the right to sue for breach of trust that was held by bondholders at the time of the breach transferred to subsequent purchasers of the bonds.

         {¶ 10} The trial court held that commonality had not been established. It found that the Cheatham IRA had alleged numerous breaches of the trust indenture over a significant period of time and that the original bondholders' claims based on those breaches did not transfer to subsequent purchasers under the "rights in the security" language in R.C. 1308.16(A). Thus, the court held that the questions of law and fact common to the class members did not predominate over questions affecting each individual member, because each class member would allege a different time and purchase price as the basis for a breach and thus would have different potential damages.

         {¶ 11} On appeal, the Sixth District Court of Appeals reversed. That court noted that the Cheatham IRA had phrased the issue as" 'whether the purchaser of a bond acquires causes of action that arose, under the terms of a Trust Indenture, prior to the time that the bondholder acquired the bonds.'" 2017-Ohio-9234, 102 N.E.3d 597, ¶ 13. Acknowledging that this was an issue of first impression in Ohio, the court of appeals looked to R.C. 140.01(J) and (I), which provide that a trust indenture is part of the "bond proceedings" and therefore is a right that is passed to a current bondholder under R.C. 1308.16(A). 2017-Ohio-9234, 102 N.E.3d 597, at ¶ 19. The court of appeals held that "a contract claim for breach of the Trust Indenture, whether asserted against the trustee or the obligor, arises out of the contract with the bondholders and is thus a 'right in the security' that automatically transfers to subsequent purchasers pursuant to R.C. 1308.16(A)." Id. at ¶ 27.

         {¶ 12} A concurring judge stated her view that under R.C. 1308.16(A), a bondholder has standing to sue under a trust indenture but that the statute did not answer the ultimate question of whether a bondholder has standing to sue for prior breaches of that agreement 2017-Ohio-9234, 102 NE3d 597, at ¶ 31 (Mayle, J, concurring). The concurring opinion stated that the answer could be found in whether an accrued cause of action could be asserted independently of continued ownership of the security. Id. at ¶ 38, citing Natl. Res. Co. v. Metro. Trust Co., 17 Cal.2d 827, 833, 112 P.2d 598 (1941). The concurring opinion examined the trust indenture to determine what rights could be transferred to a subsequent bondholder under R.C. 1308.16(A). The indenture defined a "bondholder" as the person in whose name a bond was registered. In the concurring judge's view, actual ownership of a bond was a condition precedent to the maintenance of a cause of action, so the breach-of-contract claims under the trust indenture transferred with the bond to a subsequent bondholder because those claims could not be asserted apart from the contract out of which they arose and they were essential to the complete enforcement of the trust indenture. Id. at ¶ 42.

         {¶ 13} We accepted jurisdiction over an appeal filed by Huntington, agreeing to hear the following 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 [UCC 8-302], all claims and causes of action of the seller relating to the bond that ...

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