Lehman Brothers Inc.

FOR PUBLICATION
UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
In re:
LEHMAN BROTHERS INC.,
Debtor.
Case No. 08-01420 (JMP)
(SIPA)
MEMORANDUM OPINION AUTHORIZING AND DIRECTING THE
SUBORDINATION OF CLAIMS OF CLAREN ROAD CREDIT MASTER FUND LTD.
AND CERTAIN UNDERWRITERS
HUGHES HUBBARD & REED LLP
Attorneys for James W. Giddens, Trustee for the SIPA Liquidation of Lehman Brothers Inc.
One Battery Park Plaza
New York, New York 10004
Michael E. Salzman, Esq.
Robert B. Funkhouser, Esq.
GIBSON, DUNN & CRUTCHER LLP
Attorneys for Claren Road Credit Master Fund Ltd.
200 Park Avenue
New York, New York 10166
Marshall R. King, Esq.
CLEARY GOTTLIEB STEEN & HAMILTON LLP
Attorneys for Certain Junior Underwriters
One Liberty Plaza
New York, New York 10006
Luke A. Barefoot, Esq.
BINGHAM MCCUTCHEN LLP
Attorneys for UBS Financial Services Inc.
399 Park Avenue
New York, New York 10022
Joshua Dorchak, Esq.
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JAMES M. PECK
UNITED STATES BANKRUPTCY JUDGE
Introduction
The two contested matters before the Court call for a determination of whether the
language of section 510(b) of the Bankruptcy Code mandates the subordination of certain claims
that have been made against Lehman Brothers Inc. (“LBI”) in this SIPA liquidation. The claims
in question arise from and are represented by securities that were issued by an affiliate of LBI, its
parent Lehman Brothers Holdings Inc. (“LBHI”). James Giddens, as LBI's trustee (the “SIPA
Trustee”), urges that two categories of claims involving certain bonds issued by LBHI should be
subordinated to other unsecured claims. These are: (i) a claim by Claren Road Credit Master
Fund, Ltd. (“Claren Road”), a prime brokerage customer of LBI, that seeks breach of contract
damages due to the failure of LBI to execute an order for the sale of LBHI bonds placed only
days before the Lehman collapse, and (ii) reimbursement and contribution claims by a number of
junior underwriters in connection with their having to defend and settle claims brought against
them by investors in relation to the public offering of LBHI bonds.
While the facts are undisputed, the questions presented nonetheless demonstrate that
510(b) subordination questions can be more difficult to resolve when dealing with the priority of
claims represented by securities of an affiliate of the debtor. Each of the claimants argues that
the language of section 510(b) is ambiguous on its face when applied to claims represented by
securities of an affiliate and that the underlying policy objectives of claim subordination are not
applicable to their claims. One reason for potential confusion is that the interpretation of the
statute is taking place here within an atypical setting for addressing 510(b) issues because LBI is
not a corporate debtor in a conventional chapter 11 case but a dealer in securities in the largest
SIPA case in history. Accordingly, LBI's ordinary course pre-liquidation business activities as a
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broker-dealer necessarily involved the execution of a multitude of securities trades and the
raising of capital through its affiliates to fund its operations.
Although claimants have been creative in their attempts to portray the language of section
510(b) as unclear and inapplicable to their claims, the statute is clear in requiring subordination.
Claren Road has made a claim for damages due to the failure of LBI to complete the purchase of
its LBHI bonds. The underwriters have made claims against LBI for reimbursement that tie
directly to their having participated in the public offering of LBHI bonds. In both of these
circumstances, the bonds were issued by an affiliate of LBI and the claims made against LBI
arise out of and are based upon transactions that relate to these bonds. Plainly, these are claims
made against LBI that are represented by securities of its affiliate, LBHI.
Thus, the claimants are not seeking recovery of amounts based upon the securities in
respect of their relative rank in the capital structure of LBI and LBHI but are pressing other
claims represented by the securities (for damages or for reimbursement). Applying the common
meaning of the statutory language, section 510(b) directs subordination of the claims in question,
and the Court so finds for the reasons stated in greater detail in this decision.
Background
The facts giving rise to the respective claims of Claren Road and the underwriters against
LBI are described below.
Claren Road
Prior to commencement of this case on September 19, 2008 (the “Commencement
Date”), LBI was a registered broker-dealer and a wholly-owned subsidiary of LBHI. Claren
Road opened a prime brokerage account with LBI in December 2005.
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On September 12, 2008, Claren Road and LBI entered into a transaction in which LBI
was to purchase two sets of LBHI bonds from Claren Road as follows: (i) 4,506,000 Euro
Medium Term Notes issued by LBHI with a maturity date of October 2011 at an individual bond
price equal to 75% of par, and (ii) 4,800,000 Euro Medium Term Notes issued by LBHI with a
maturity date of June 2013 at an individual bond price equal to 77% of par (collectively, the
“LBHI Bonds”). LBI did not perform its obligation to acquire the LBHI Bonds, and the
transactions failed on September 17, 2008 (two days after the filing of LBHI’s chapter 11 case).
Claren Road filed timely claims for this breach by LBI of its contractual obligation, including a
claim seeking compensation for the decrease in value of the LBHI Bonds during the period from
September 12, 2008 to the Commencement Date in the amount of $8,522,201.09 (the “Claren
Road Claim”).1
On October 25, 2013, the SIPA Trustee filed a motion for, among other things,
subordination of the Claren Road Claim pursuant to section 510(b) of the Bankruptcy Code. 2
According to the SIPA Trustee, the Claren Road Claim fits squarely within the ambit of
mandatory subordination as outlined in section 510(b) because it is a claim arising from the
failure by LBI to purchase securities issued by its affiliate – LBHI.
Claren Road objected to this motion, arguing that the language of section 510(b) is
ambiguous when applied to a debtor that did not issue the underlying securities as is the case
1 	Claren Road also filed claims in the LBHI chapter 11 case on account of the LBHI Bonds.
2 	See Trustee’s Mot. for an Order (1) Confirming the Trustee’s Denial of SIPA Customer Status to Claren Road
Customer Claim No. 900005056, and (2) Subordinating the Claim Pursuant to Bankruptcy Code Section
510(b), Oct. 25, 2013, ECF No. 7539.
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here.3 In its objection, Claren Road points to the legislative history of section 510(b) and asserts
that subordination of the Claren Road Claim does not further the policy objectives underlying the
statute.
Underwriters
Prior to the Commencement Date, LBI served as underwriter along with a number of
other co-underwriters (the “Co-Underwriters”) in connection with certain LBHI securities
offerings. LBI and the Co-underwriters entered into a Master Agreement Among Underwriters,
dated December 1, 2005, which governed the relationship among all underwriters.4 The
agreement required each underwriter to contribute, based on its agreed percentage participation
in an offering, toward losses or liabilities incurred by another underwriter arising from
allegations that the offering materials contained untrue statements or omissions.
After the collapse of Lehman Brothers, numerous investors brought lawsuits against the
Co-Underwriters in connection with LBHI securities offerings.5 LBI is not named as a defendant
in these suits presumably because such litigation as to LBI is barred by the automatic stay. See
11 U.S.C. § 362. These actions alleged that LBHI’s offering documents contained material
misstatements and omissions. As a result of these actions, the Co-Underwriters have incurred
millions of dollars in defense costs and settlement payments and have filed claims in this case on
3 	See Objection to Trustee’s Motion for an Order (1) Confirming the Trustee’s Denial of SIPA Customer Status
to Claren Road Customer Claim No. 900005056, and (2) Subordinating the Claim Pursuant to Bankruptcy
Code Section 510(b), Nov. 8, 2013, ECF No. 7625.
4 	Ex. 1 to Decl. of Peter Fox in Supp. of the Junior Underwriters’ Resp. to the Trustee’s One Hundred Fourth
Omnibus Objection to General Creditor Claims (No Liability Claims), Sept. 9, 2013, ECF No. 7204.
5 	These suits have been consolidated as a securities class action in the United States District Court for the
Southern District of New York, captioned In re Lehman Brother Equity/Debt Securities Litigation, Case No.
08-Civ-5523 (LAK).
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account of alleged contribution and indemnity obligations of LBI (the “Co-Underwriters
Claims”).
On July 12, 2013, the SIPA Trustee filed an objection6 to the Co-Underwriters Claims
arguing that such claims should be subordinated under section 510(b) of the Bankruptcy Code.7
Similar to the argument for subordination of the Claren Road Claim, the SIPA Trustee asserts
that the Co-Underwriters Claims are covered by the plain language of section 510(b) because
they are contribution claims arising from the sale of affiliate securities.
Certain of the Co-Underwriters8 jointly opposed the SIPA Trustee’s claim objection on
September 9, 20139 contending, among other things, that the Co-Underwriters Claims fall
outside of the reach of section 510(b) subordination because the securities of LBHI are not
represented in the SIPA proceeding. The essence of their argument is that there is no applicable
6 	See The Trustee’s One Hundred Fourth Omnibus Objection to General Creditor Claims (No Liability
Claims), July 12, 2013, ECF No. 6768.
7 	The SIPA Trustee also argued in its claim objection that the Co-Underwriters Claims should be disallowed
under section 502(e)(1)(B) of the Bankruptcy Code. The Court need not address this issue because it finds
that the Co-Underwriters Claims are subordinated under section 510(b) of the Bankruptcy Code to the claims
of general unsecured creditors. Although subordination and disallowance are different concepts, both have
the same practical result in this case as general unsecured creditors will receive less than par on account of
their claims.
8 	The objecting Co-Underwriters include: ANZ Securities, Inc.; BMO Capital Markets Corp. (f/k/a Harris
Nesbitt Corp.); BNY Mellon Capital Markets, LLC; Cabrera Capital Markets, LLC; DnB Nor Markets, Inc.;
BNP Paribas FS, LLC (as successor in interest to Fortis Securities, LLC, f/k/a Fortis Investment Services,
LLC); nabSecurities, LLC (f/k/a nabCapital Securities, LLC); National Australia Bank Ltd.; National
Financial Services, LLC; SunTrust Robinson Humphrey, Inc.; and The Williams Capital Group, L.P..
9 	See Resp. of Underwriter Claimants to the Trustee’s One Hundred Fourth Omnibus Objection to General
Creditor Claims (No Liability Claims), Sept. 9, 2013, ECF No. 7205.
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class of securities to which the Co-Underwriters Claims (represented by LBHI securities) can be
subordinated.10
Joint Hearing Regarding 510(b) Issues
Although the underlying facts differ, the legal issue raised by the parties is the same. The
SIPA Trustee and the claimants presented oral argument on January 8, 2014 with respect to
subordination of the Claren Road Claim and the Co-Underwriters Claims. The Court took both
matters under advisement and considers them together in this decision.
Discussion
Although the Claren Road Claim and the Co-Underwriters Claims arise from differing
fact patterns, the SIPA Trustee seeks subordination of both claims under section 510(b) of the
Bankruptcy Code. Analysis necessarily starts with the language of the statute. Section 510(b)
states as follows:
For the purpose of distribution under this title, a claim arising from
rescission of a purchase or sale of a security of the debtor or of an
affiliate of the debtor, for damages arising from the purchase or
sale of such a security, or for reimbursement or contribution
allowed under section 502 on account of such a claim, shall be
subordinated to all claims or interests that are senior to or equal
the claim or interest represented by such security except that if
such security is common stock, such claim has the same priority as
common stock.
11 U.S.C. § 510(b) (emphasis added). The Court of Appeals for the Second Circuit along with
the bankruptcy courts within the Second Circuit have uniformly applied a “broad interpretation
of section 510(b).” Rombro v. Dufrayne (In re Med Diversified, Inc.), 461 F.3d 251, 255 (2d Cir.
2006) (citing In re Enron Corp., 341 B.R. 141, 162–63 (Bankr. S.D.N.Y. 2006) and In re PT-1
10 	UBS Financial Services Inc., another Co-Underwriter, separately objected to the SIPA Trustee’s claim
objection. See Resp. of UBS Financial Services Inc. to the Trustee’s One Hundred Fourth Omnibus
Objection to General Creditor Claims (No Liability Claims), Sept. 9, 2013, ECF No. 7206.
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Commc’ns, Inc., 304 B.R. 601, 610 (Bankr. E.D.N.Y. 2004)); KIT Digital, Inc. v. Invigor Group
Ltd. (In re KIT Digital, Inc.), 497 B.R. 170, 181 (Bankr. S.D.N.Y. 2013) (“While I certainly
agree that other Circuits have construed section 510(b) broadly, so has the Second Circuit, along
with bankruptcy and district court judges in the Second Circuit.”). 	The inclusion of the word
“shall” in the statute mandates subordination for claims meeting the criteria set forth in the
statute.
“It is well established that when the statute’s language is plain, the sole function of the
courts . . . is to enforce it according to its terms.” Lamie v. U.S. Trustee, 540 U.S. 526, 534
(2004) (internal citations and quotation marks omitted). If possible, a Court reviewing a statute
must give effect to every clause and word of a statute. Williams v. Taylor, 529 U.S. 362, 404
(2000) (citations omitted).
In the sections that follow, the Court separately discusses whether the Claren Road Claim
and the Co-Underwriters Claims should be subordinated to the claims of general unsecured
creditors.
Claren Road
Claren Road characterizes the Claren Road Claim as a breach of contract claim based on
LBI’s failure to acquire the LBHI Bonds. The SIPA Trustee argues that the Claren Road Claim
must be subordinated under section 510(b) because it is a claim “for damages arising from the
purchase or sale of” “a security of the debtor or of an affiliate.” 11 U.S.C. § 510(b).
The LBHI Bonds are securities as defined in section 101(49) of the Bankruptcy Code.
This definition expressly includes a “bond.” 11 U.S.C. § 101(49).11 Moreover, LBHI is an
11 	The term “security” is also defined within SIPA and similarly includes bonds. SIPA § 78lll(14).
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affiliate of LBI as defined in section 101(2)(A) of the Bankruptcy Code because it is “entity that
directly or indirectly owns, controls, or holds with power to vote, 20 percent or more of the
outstanding voting securities of the debtor. . . .” 11 U.S.C. § 101(2)(A). Thus, the LBHI Bonds
are securities of a debtor affiliate.
Also, the Claren Road Claim unmistakably is a claim “for damages arising from the
purchase or sale” of the LBHI Bonds. Indeed, Claren Road points directly to LBI’s failure to
purchase LBHI Bonds from Claren Road. See, e.g., KIT Digital, 497 B.R. at 178 (“In particular,
the extent to which “arising from the purchase or sale” is ambiguous depends on how divorced
from the underlying sale the underlying claim is. The clause “arising from the purchase or sale”
is not ambiguous at all when it’s applied to an alleged breach of the agreement of purchase or
sale itself, or to a fraud that induced such an agreement.”).
The SIPA Trustee submits that this is where the analysis should end, contending that
section 510(b) provides for subordination of the Claren Road Claim to the claims of other
general unsecured creditors. Claren Road disagrees and finds ambiguity within section 510(b)
that should lead to further inquiry as to whether subordination is appropriate for its claim.
Claren Road’s arguments are addressed below.
Section 510(b) is Not Ambiguous When Applied to the Claren Road Claim
Claren Road asserts that section 510(b) is ambiguous when applied to a claim arising
from the purchase or sale of a security of a debtor affiliate and identifies a number of cases that
have found section 510(b) to be ambiguous in different contexts. See, e.g., Med Diversified, 461
F.3d at 254-56 (internal quotation marks and citation omitted) (finding the phrase “arising from”
in section 510(b) to be ambiguous when determining whether a claim of a former debtor
executive based on debtor’s failure to issue common stock pursuant to a termination agreement
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should be subordinated – “Because the phrase “arising from” is ambiguous as applied to the
claims in this case, we must look outside the text of the statute to determine its intended
meaning.”).
However, interpreting section 510(b) is “ambiguous or unambiguous when juxtaposed
against particular factual situations” and “is not ambiguous at all when . . . applied to an alleged
breach of the agreement of purchase or sale itself . . . .” KIT Digital, 497 B.R. at 178. Here, it is
undisputed that the Claren Road Claim is based on a breach by LBI of the agreement to purchase
LBHI securities. In the absence of ambiguity, the Court looks to the plain language of section
510(b) in order to determine the priority of the Claren Road Claim.
Here, the Claren Road Claim fits comfortably within that portion of section 510(b) which
mandates subordination because it is a claim “for damages arising from the purchase or sale” “of
a security of the debtor or of an affiliate. . . .” 11 U.S.C. § 510(b). The Claren Road Claim
satisfies the first part of the test for subordination. The question that remains is whether the
statutory mechanism for subordination is stated with sufficient clarity to direct subordination
without reference to legislative history.
The Claren Road Claim Should be Subordinated to General Unsecured Claims of LBI
Claren Road argues that the subordination of claims based on the securities “of an
affiliate of the debtor” is ambiguous and impractical. 11 U.S.C. § 510(b). According to Claren
Road, claims represented by the LBHI Bonds may not be subordinated because the LBHI Bonds
have no claim against the LBI estate. This argument calls for a closer examination of section
510(b).
After the portion of the statute that identifies the types of claims that qualify to be
subordinated, section 510(b) goes on to explain how subordination is to occur. Specifically, the
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section states that the claim “shall be subordinated to all claims or interests that are senior to or
equal the claim or interest represented by such security . . . .” 11 U.S.C. § 510(b) (emphasis
added). The crux of Claren Road’s argument is that the claim “represented by such security”
must mean a claim based on the LBHI Bonds themselves. In effect, Claren Road submits that
the subordination must relate to a capital structure that includes the LBHI Bonds.
Claren Road’s approach is too narrow and fails to recognize the common meaning of the
words used in the statute. A more reasonable interpretation of the statutory language is that the
“claim . . . represented by [the LBHI Bonds]” is not directed to a recovery from LBI on account
of the LBHI Bonds but extends to the breach of contract claim asserted by Claren Road against
LBI with respect to these bonds. Such a claim is a general unsecured claim that is connected to
the subject matter of the securities in question. The essence of the claim is the failure to
purchase the LBHI Bonds. This reading of the plain language of the statute leads to the
conclusion that the Claren Road Claim “shall be subordinated to all claims . . . that are senior to
or equal” the general unsecured claims against LBI.
Interpreting the phrase “claim or interest represented by such security” in this fashion is a
common sense interpretation of section 510(b) that infuses the words of section 510(b) with
meaning. If a claim “represented by such security” were to be restricted to a recovery from the
issuer for amounts outstanding under the security, then no claim arising from the purchase or sale
of affiliate securities would ever fit within the regime for subordination. Such a result would
contradict express provisions of the statute which direct that such claims shall be subordinated.
See Williams, 529 U.S. at 404 (citation omitted) (explaining that courts should give effect to
every word in a statute).
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The Bankruptcy Court for the District of Delaware faced a similar argument in In re VF
Brands, Inc., 275 B.R. 725 (Bankr. D. Del. 2002). In VF Brands, the claim in question arose
from an alleged breach of a stock purchase agreement pursuant to which the claimant purchased
from the debtor the stock of a non-debtor affiliate, Vlasic Farms. Id. at 726. The claimant
argued that, as a shareholder of Vlasic Farms, its claim would properly be subordinated to the
unsecured creditors of Vlasic Farms but not the unsecured creditors of the debtor. Id. at 727.
Judge Walrath disagreed. She noted that it “is generally true that shareholders of a subsidiary
have no claim against the parent and thus are not part of any priority scheme of claims against
the parent.” Id. However, when a shareholder of a subsidiary files a claim for breach of contract
against the parent, such claim would participate in distribution pari passu with general unsecured
creditors absent section 510(b). Id. Ultimately, she concluded that “[a]pplying section 510(b)
requires that the [claimant’s claim] (which is based on damages from the purchase of stock of an
affiliate of the [debtors]) must be subordinated to the claims of the general unsecured creditors of
the [debtors] which in the absence of that section would be equal in priority to its claim.” Id.
Recently, in Liquidating Trust Comm. of the Del Biaggio Liquidating Trust v. Freeman
(In re Del Biaggio), No. 12-CV-6447, 2013 WL 6073367 (N.D. Cal. Nov. 18, 2013) the district
court in the Northern District of California affirmed a decision of the bankruptcy court in San
Francisco that subordinated claims brought in relation to securities of an affiliate of the debtor.
There, a creditor alleged that the debtor fraudulently induced him to invest in a National Hockey
League franchise, the Predators. Id. at *2-3. The debtor and the Predators were affiliates as
defined in the Bankruptcy Code. Id. at *4. In Del Biaggio the claimant argued that his fraud
claim against the debtor and his interest in the Predators “are not senior or junior to each other
because they simply do not compete for the same assets and distributions.” Id. at *7. Citing VF
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Brands with approval, the district court disagreed with the claimant and subordinated the fraud
claim to those of debtor’s unsecured creditors.
Here, as in VF Brands and Del Biaggio, Claren Road asserts the right to receive
distributions pari passu with a debtor’s unsecured creditors in relation to a claim arising from the
purchase or sale of affiliate securities. Such claims are represented by the LBHI securities and
properly are subordinated to general unsecured claims against LBI.
Claren Road’s Other Arguments Do Nothing to Change the Outcome
Claren Road urges the Court to pay attention to the congressional intent reflected in
section 510(b) and relies heavily on the Second Circuit’s decision in In re Med Diversified where
the Court of Appeals noted that the two rationales supporting subordination were “1) the
dissimilar risk and return expectations of shareholders and creditors; and 2) the reliance of
creditors on the equity cushion provided by shareholder investment.” Med Diversified, 461 F.3d
at 256 (citations omitted).
But legislative history is not needed when language of the statute is clear. Importantly, in
Med Diversified, the Second Circuit looked to legislative history because of ambiguity as to the
application of section 510(b) to the particular facts. Id. at 255-56 (internal quotation marks and
citation omitted) (“Because the phrase “arising from” is ambiguous as applied to the claims in
this case, we must look outside the text of the statute to determine its intended meaning. . . .
Because there are only two rationales for mandatory subordination expressly or implicitly
adopted by the Congress that enacted section 510(b), we conform our interpretation of the statute
to require subordination here only if [claimant] (1) took on the risk and return expectations of a
shareholder, rather than a creditor, or (2) seeks to recover a contribution to the equity pool
presumably relied upon by creditors in deciding whether to extend credit to the debtor.”).
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These references to congressional policy are unpersuasive in the current setting where the
statute can be understood without resorting to background sources. Section 510(b) is
unambiguous when applied to the Claren Road Claim. Where there is no ambiguity, the Court
must apply the plain language of the statute even if the holding is beyond the Congressional
intent set forth in legislative history. See RadLAX Gateway Hotel, LLC v. Amalgamated Bank,
132 S.Ct. 2065, 2073 (2012).
The Court does recognize that there is a level of added difficulty in applying
subordination under section 510(b) when the debtor is a broker-dealer, especially one as large
and active as LBI was prior to the Commencement Date. LBI undoubtedly was involved in
countless transactions involving securities of all sorts of entities,12 including affiliated entities
within its integrated corporate structure. A strict application of section 510(b) requires a
differentiation between those claims arising from the purchase or sale of LBI affiliated securities
and those that arise from the purchase or sale of securities issued by unaffiliated third parties.
The Claren Road Claim relates to LBHI Bonds and as a consequence should be subordinated
under section 510(b).
Co-Underwriters
The Co-Underwriters Claims are for reimbursement and contribution on account of
claims arising from the offering of LBHI securities. A review of the plain language of 510(b)
makes clear that claims of this type are expressly subordinated under the statute as it is a “a claim
. . . for reimbursement or contribution . . . on account of a claim” arising from the purchase or
sale of a security of the debtor or an affiliate of the debtor. 11 U.S.C. § 510(b). It has been held
12 	The argument made by Claren Road regarding Apple stock is a red herring. See Objection of Claren Road,
Nov. 8 2013, ECF No. 7625, at ¶ 20. If Claren Road had a breach of contract claim against LBI for failing to
close a trade relating to securities of any unaffiliated issuer, 510(b) would not apply.
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that comparable claims for contribution made by underwriters are subordinated under section
510(b). See In re Jacom Computer Servs., Inc., 280 B.R. 570, 572 (Bankr. S.D.N.Y. 2002)
(citing In re Mid-Am. Waste Sys., Inc., 228 B.R. 816, 824-26 (Bankr. D. Del. 1999)).
Like Claren Road, the Co-Underwriters argue that their claims cannot be subordinated
because the LBHI securities do not represent a claim that can be made in the LBI case. This is a
hyper-technical and improper reading of the language of section 510(b). The “claims . . .
represented by such security” are the claims of the Co-Underwriters for reimbursement and
contribution (and not for recovery on account of LBHI securities themselves). The resulting
claim would be a general unsecured claim against LBI were it not for the subordination mandate
of section 510(b).
The Co-Underwriters make a strained argument that focuses myopically on what it means
for claims to be represented by the securities of an affiliate of the debtor. The approach taken
assumes that the claims must be based on securities within the capital structure of an enterprise
that includes a debtor and affiliated entities. The false premise is that the claims represented by
the securities of an affiliate of the debtor must be the same kinds of claims that could be made by
a holder of those securities against that affiliate. Such a reading of section 510(b) does not make
logical sense nor does it fit the language of the section.
Consistent with comments made earlier in this decision with respect to the Claren Road
Claim, a claim made by the Co-Underwriters for reimbursement or contribution is a claim
represented by LBHI securities and not necessarily a claim to recover amounts invested in these
securities. The meaning of the statute is quite clear in this instance: the Co-Underwriters Claims
against LBI arise out of their sale of affiliate securities and those claims, consistent with the
hierarchy established by section 510(b), should be subordinated to other unsecured claims.
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There is no need for contorted reasoning that assumes the existence of a hypothetically
consolidated capital structure. The claims are simply claims for reimbursement and contribution
based on the sale of securities of LBHI, an affiliate of the debtor, and such claims do not rank
equally with other unsecured claims against LBI.
Conclusion
The phrase “a claim represented by a security” is subject to interpretation within the text
of section 510(b). The words may have different meanings depending on whether a claim relates
to a security of the debtor or a security issued by an affiliate of the debtor. When the claims
being made against the debtor arise out of the purchase or sale of the debtor’s own securities, the
relative priority of such claims may be subordinated to claims that are within that same capital
structure. In contrast with this example, affiliate securities ordinarily will be the source of claims
that are external to the debtor's capital structure and that become the basis for making a claim
against the debtor for damages associated with the purchase or sale of securities of its affiliate.
Accordingly, claims represented by affiliate securities rarely would seek to recover
amounts claimed by investors (exceptions would be when the debtor has guaranteed payment or
the estates are consolidated). Instead, as in the situations described in this decision, the claim
represented by the securities of LBHI is an unsecured claim for damages or for reimbursement
relating to the purchase or sale of such securities. Claims such as this fit within the statutory
framework and are properly subject to subordination under 510(b).
For the reasons stated, the Court agrees with the interpretation of section 510(b) that has
been advanced by the SIPA Trustee. The Claren Road Claim and the Co-Underwriters Claims
should be subordinated to the claims of general unsecured creditors of LBI pursuant to section
510(b) of the Bankruptcy Code. There is no need to refer to the theory of claim subordination or
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the public policy that may have led to enactment of this provision of the Bankruptcy Code. The
language is clear on its face and applies to these claims. The parties are directed to settle an
order consistent with this decision.
SO ORDERED:
Dated: New York, New York
January 27, 2014
/s/ James M. Peck
___________________________
Honorable James M. Peck
United States Bankruptcy Judge
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