.jpg)
Three leading trade associations applaud yesterday’s decision by Judge Shira A. Scheindlin of the U.S. District Court for the Southern District of New York in Springfield Associates v. Enron Corp. Her decision reverses a Bankruptcy Court decision that threatened to disrupt the robust secondary market in claims against companies in bankruptcy.
The case arose out of Springfield’s secondary market purchase of $5 million of Enron bank debt originally held by Citibank. Enron brought an adversary proceeding against Springfield seeking to equitably subordinate its claim based solely on Citibank’s alleged inequitable conduct and receipt of avoidable transfers. There is no allegation that Springfield itself engaged in any improper conduct or received any avoidable transfer.
The Enron bankruptcy court accepted Enron’s argument, issuing a decision holding that improper conduct or receipt of an avoidable transfer by a prior holder of a claim taints the claim itself, rendering it worthless in the hands of a subsequent—and a wholly innocent—purchaser.
The negative and dramatic adverse market implications of the bankruptcy court’s decision were called to Judge Scheindlin’s attention, on appeal, by a joint amicus submission by the Loan Syndications and Trading Association (“LSTA”), the Securities Industry and Financial Markets Association (“SIFMA”), and the International Swaps and Derivatives Association (“ISDA”), all leading financial industry trade associations.
Yesterday’s decision by Judge Scheindlin vacates the bankruptcy court’s decision. Judge Scheindlin’s opinion describes the bankruptcy court’s opinion as “overreaching,” and notes that it “resulted in [an] outcry from commentators and amici curiae, who have expressed great concern that [the decision] will wreak havoc in the markets for distressed debt.” Her opinion makes clear that equitable subordination and disallowance are “personal disabilities” that do not transfer with claims when they are sold. She therefore holds that the purchasers of claims “are protected from being subject to the personal disabilities of their sellers.
Judge Scheindlin’s decision does draw a distinction between sales and “pure assignments” (such as when a surety that pays a claim is subrogated by operation of law to the rights of the original obligee), finding that a transferee that acquires a claim by “pure assignment” may take it subject to the personal disabilities of the original transferor. Her opinion makes clear, however, that “sales of claims on the open markets are indisputably sales” such that “[e]quitable subordination and disallowance arising out of the conduct of the [transferor] will not be applied to good faith open market purchasers of claims.”
As Judge Scheindlin aptly put it—relying expressly on the amici submissions—“it is proper to consider the effect that the Court’s interpretation would have on the markets. The unnecessary breadth of the Bankruptcy Court’s decisions threatened to wreak havoc on the markets for distressed debt. That result has now been avoided.”
Elliot Ganz, the General Counsel of the LSTA, expressed satisfaction with that conclusion. “Judge Scheindlin’s careful opinion is a tremendous victory for the entire market. The decision lifts a horrible cloud that hung over every purchase and sale of debt in the secondary market—a cloud that threatened to choke off these otherwise vibrant markets. Her opinion rejects each and every one of Enron’s arguments. In addition, I am very pleased that the Court considered and relied upon the perspective that the amici brought to this question. While Enron will presumably appeal this decision, I am confident that if and when this question reaches a higher court, the conclusion that Judge Scheindlin reached—that a claim held by an innocent purchaser may not be equitably subordinated or disallowed based on the wrongful acts of a previous holder—will be affirmed.”
