In re Lehman Bros., 503 B.R. 778

Background

Lehman Brothers Inc. (LBI), a SIPA broker-dealer, is a wholly-owned subsidiary of Lehman Brothers Holdings Inc. (LBHI); certain LBHI bonds were involved in prepetition transactions.
Claren Road, a prime brokerage customer, contracted with LBI on Sept. 12, 2008 for LBI to purchase specified LBHI bonds; LBI failed to close and Claren Road asserted ~ $8.5 million breach-of-contract damages.
A group of junior co-underwriters incurred defense and settlement costs in litigation over LBHI securities offerings and filed reimbursement/contribution claims against LBI under their underwriting agreement.
The SIPA Trustee moved to subordinate both the Claren Road claim and the Co-Underwriters’ claims under 11 U.S.C. § 510(b) as claims “arising from” the purchase or sale of affiliate securities.
Claimants argued § 510(b) is ambiguous or inapplicable because the relevant securities were issued by LBI’s affiliate (LBHI) and not LBI, and thus there is no corresponding claim within LBI’s capital structure to subordinate.
The Bankruptcy Court held § 510(b) unambiguous as applied: claims against LBI that arise from purchase/sale of affiliate securities (including damages, reimbursement, contribution) are subordinated to general unsecured claims of LBI.

Issues

Issue	Plaintiff's Argument	Defendant's Argument	Held
Whether § 510(b) mandates subordination of Claren Road’s breach-of-contract claim arising from LBI’s failure to buy LBHI bonds	Claren Road: § 510(b) is ambiguous when securities are issued by an affiliate; the LBHI bonds don’t create a claim in LBI’s capital structure, so subordination shouldn’t apply	Trustee: The claim is “for damages arising from the purchase or sale” of an affiliate’s security and thus fits § 510(b) mandatory subordination	Subordinated: Court applied plain language; Claren Road’s damages claim is represented by affiliate securities and must be subordinated to LBI’s general unsecured claims
Whether § 510(b) mandates subordination of underwriters’ reimbursement/contribution claims tied to LBHI offerings	Underwriters: § 510(b) inapplicable because LBHI securities do not constitute claims in the LBI estate; no securities class in LBI to subordinate to	Trustee: Contribution/reimbursement claims arise from sale of affiliate securities and are expressly covered by § 510(b)	Subordinated: Court held reimbursement/contribution claims arise from sale of affiliate securities and are subordinated to LBI general unsecured claims
Whether legislative purpose or policy should override plain statutory text here	Claimants: Legislative history shows § 510(b) aims at equity-holder-like claims and protecting creditors’ reliance on equity—policy counsels limiting subordination	Trustee: Plain statutory text controls; no need to consult legislative history where statute is clear	Plain text controls: Court declined to rely on policy where § 510(b) is unambiguous as applied; statutory mandate governs
Whether § 510(b) requires a hypothetical consolidated capital-structure claimant to exist for affiliate securities	Claimants: Subordination nonsensical absent a claim against the issuer (affiliate); reading should require an intra-capital-structure reference	Trustee: “Claim represented by such security” refers to the claim against debtor that arises from the affiliate security (e.g., damages, reimbursement)	Court rejected the hyper-technical reading; held claims arising from affiliate securities represent general unsecured claims of the debtor and are subordinated

Key Cases Cited

Rombro v. Dufrayne (In re Med Diversified, Inc.), 461 F.3d 251 (2d Cir.) (discussing § 510(b) interpretation and when legislative history is consulted)
Lamie v. U.S. Trustee, 540 U.S. 526 (statutory text must be applied when unambiguous)
Williams v. Taylor, 529 U.S. 362 (courts must give effect to every clause and word of a statute)
In re Enron Corp., 341 B.R. 141 (Bankr. S.D.N.Y.) (broad interpretation of § 510(b) in Second Circuit decisions)
In re Jacom Computer Servs., Inc., 280 B.R. 570 (Bankr. S.D.N.Y.) (underwriter contribution/reimbursement claims subordinated under § 510(b))
In re VF Brands, Inc., 275 B.R. 725 (Bankr. D. Del.) (claims based on purchase of affiliate stock subordinated to debtor’s unsecured creditors)
In re PT-1 Commc’ns, Inc., 304 B.R. 601 (Bankr. E.D.N.Y.) (Second Circuit and district courts in the Circuit adopt broad § 510(b) interpretation)
In re Mid-Am. Waste Sys., Inc., 228 B.R. 816 (Bankr. D. Del.) (contribution claims can be subordinated under § 510(b))
RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065 (statutory text controls even if result is beyond legislative history)