United States Court Of Appeals For The Second Circuit Holds That Claims Arising From Securities Of A Debtor's Affiliate Must Be Subordinated To Senior Or Equal Claims Of The Same Type As The Underlying Securities

On December 14, 2015, the United States Court of Appeals for the Second Circuit held that claims arising from securities of a debtor's affiliate must be subordinated to all claims or interests senior or equal to claims of the same type as the underlying securities in the bankruptcy proceeding. As a result, appellants' claims for contribution and reimbursement for losses incurred in the course of defending and settling securities fraud lawsuits brought by investors in securities issued by Lehman Brothers Inc.'s ("LBI") affiliate were subordinated to the claims of LBI's general unsecured creditors pursuant to Section 510(b) of the Bankruptcy Code. This decision, which the Court of Appeals based on precedent, textual support and legislative history, provides clarity with respect to the appropriate classification of claims in the affiliate securities context.

Background

LBI was lead underwriter for unsecured notes issued by Lehman Brothers Holdings Inc. ("Lehman Holdings"), its affiliate and parent. Between 2004 and 2008, LBI and the appellants in these cases (the "Junior Underwriters") launched 22 offerings of Lehman Holdings securities, totaling $32.4 billion. A Master Agreement Among Underwriters (the "Agreement") governed the relationship between LBI and the Junior Underwriters. The Agreement created a right of indemnification and contribution among co-underwriters for losses or liabilities resulting from securities fraud claims arising out of the offerings.

Following the bankruptcy of Lehman Holdings and the Securities Investor Protection Act ("SIPA") liquidation proceeding of LBI, investors in Lehman Holdings notes filed securities fraud lawsuits against the Junior Underwriters, alleging material misstatement and omissions in the offering documents. The Junior Underwriters stated that they incurred $78 million in the defense and settlement of those claims, and asserted claims for contribution or reimbursement against LBI, as lead underwriter of the notes. The SIPA trustee objected, arguing1 that the claims were subject to mandatory subordination pursuant to Section 510(b) of the Bankruptcy Code. The Junior Underwriters argued that Section 510(b) could not be used to subordinate the claims in LBI's SIPA proceeding because the securities were issued by Lehman Holdings, not LBI; therefore, because the securities were not part of LBI's waterfall, Section 510(b) did not apply to the Junior Underwriters' claims.

The United States Bankruptcy...