Opinion ID: 3029501
Heading Depth: 3
Heading Rank: 3

Heading: The Equitable Subordination Claim

Text: Equitable subordination here is slightly more complicated. An action for equitable subordination does not challenge the existence or validity of the underlying debt. Rather, it challenges granting the debt the priority to which it is entitled under applicable law because of the creditor’s inequitable conduct. In re SubMicron Sys., 432 F.3d at 454 (“Equitable subordination is apt when equity demands that the payment priority of claims of an otherwise legitimate creditor be changed to fall behind those of other claimants.”). Thus, it is an action in equity to modify the legal treatment of the claim. Because equitable subordination does not affect the allowance of a claim,11 the action is not barred by section 1 of the Settlement Agreement. Turning, then, to section 4C, we must determine what sorts of actions are “in respect of” the Term C Loans, and neither party provides a particularly compelling interpretation. 11 Indeed, there would be no point in equitably subordinating anything but an allowed claim, as only allowed claims are entitled to distribution from an insolvent debtor’s estate in the first place. See Citicorp Real Estate, Inc. v. PWA, Inc. (In re Georgetown Bldg. Assocs. Ltd. P’ship), 240 B.R. 124, 137 (Bankr. D.D.C. 1999). 15 According to the Trustee, the release provision merely means that the Trust cannot challenge the allowance of the Term C Lenders’ claims. The problem with this argument is that section 1 of the Settlement Agreement provides for the allowance of the Term C Lenders’ claims; thus, the Trustee’s reading renders paragraph 4C superfluous, which is disfavored under New York law.12 LaSalle Bank Nat’l Ass’n v. Nomura Asset Capital Corp., 424 F.3d 195, 206 (2d Cir. 2005). The Term C Lenders, on the other hand, are far more coy in explaining the meaning of paragraph 4C. They contend that a claim to subordinate equitably the debts to the Term C Lenders is clearly “in respect of” the Term C Loans, and so the release applies. Moreover, they note that any claim unrelated to the Term C Loans would not be released—though they do not elaborate as to what such a claim might be. We believe the best reading of section 4C is that the section 4A release applies to all actions that relate to the Term C Loans, as “in respect of” means “as relates to.” Oxford English Dictionary 534 (1st ed. 1971). The question, then, is whether the equitable subordination action relates to the Term C Loans. It does, as it seeks to modify the treatment of the allowed claims that arise from the Term C Loans. The Trustee argues that the objections do not relate to the loans themselves 12 The Settlement Agreement and Plan contain choice-of-law provisions selecting New York law. 16 but focus on the allegedly inequitable conduct of the Term C Lenders. This is unhelpful, as the Bankruptcy Court is not empowered to punish inequitable conduct in the abstract; rather, it allows equitable concerns to modify its treatment of claims. See 11 U.S.C. § 510(c)(1) (“[U]nder principles of equitable subordination, [a bankruptcy court may] subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim . . . .”). Without an underlying claim, equitable subordination is a non-starter. The argument that the Bankruptcy Court should apply equitable subordination necessarily relates to the underlying claims on the Term C Loans and is subject to the 4C release. The Trustee claims that this reading renders the Term C release limitless (because it releases all claims that might actually exist), and thus cannot be correct given that the section heading specifically indicates that the Term C release is limited. Contrary to his assertions, we can imagine claims against the Term C Lenders that are not related to the Term C Loans. The Term C Lenders were, after all, the Debtors’ controlling shareholders. Their conduct in controlling and managing the Debtors—quite apart from the Term C Loans themselves—could give rise to liability to the Debtors.13 This 13 We note that the debtors here are Delaware corporations. Without getting into the details, the controlling shareholders of a Delaware corporation can owe the entity fiduciary duties—thus giving rise to claims for breaches of those duties. See Weinstein Enter., Inc. v. Orloff, 870 A.2d 499, 507 (Del. 17 liability would presumably inure to the benefit of either the creditors or any minority equity stakeholders. Thus, the Trustee’s argument that the Term C Lenders’ liability could only reasonably arise from the Term C Loans is incorrect, as the Term C Lenders’ primary relationship to Insilco was as equity holders and controlling shareholders, not as lenders. The Trustee next argues that the Bankruptcy Court should have avoided a conflict between the Settlement Agreement and the Plan by construing 4C so that it does not prevent the subordination and reclassification claims that the Plan clearly contemplates. See Kass v. Kass, 696 N.E.2d 174, 180–81 (N.Y. 1998) (noting that contracts should be read and construed as a whole). While it is true that the most natural reading of the Plan and Settlement Agreement creates a conflict between the two, the parties anticipated that conflicts might exist and provided for them through a subordination clause in the Plan; the Plan defers to the Settlement Agreement in the event of conflict. Moreover, the Trustee overstates the conflict. While the Plan contemplates the Debtors or Creditors’ Committee attempting to reclassify or subordinate the Term C 2005). We express no opinion as to the potential validity of any such claims in this case, but merely note that a natural reading of the contract—precluding actions on the Term C Loans but allowing actions against the Term C Lenders in their capacity as controlling shareholders—is not absurd, nor does it render the “limitation” on the release of the Term C Lenders meaningless. 18 Loans claims, it does not explicitly authorize those attempts; rather, it merely assumes that the attempts are permissible (and, indeed, they are for interested parties not bound by the Settlement Agreement). While that assumption conflicts with the Settlement Agreement, it is not as severe a conflict as we would have if the Settlement Agreement barred the claims while the Plan explicitly allowed them. In any event, while we recognize that the Plan and Settlement Agreement are not entirely in synch, because the agreed-upon prevailing document—the Settlement Agreement—is clear, we follow it. John Hancock Life Ins. Co. v. Wilson, 254 F.3d 48, 58 (2d Cir. 2001) (noting that courts applying New York law must “give effect to the parties’ intent as expressed by the plain language of the provision”). In the alternative, the Trustee suggests that, because the language of section 4C is ambiguous, we should remand for discovery or an evidentiary hearing to determine its meaning. This is probably his best argument, but it cannot succeed because the language of section 4C is clear: it bars any actions related to the Term C Loans, and equitable subordination is necessarily related to the loans. No reasonable construction of the phrase “in respect of” would render a different result. None of this is to say that the Trustee is left without recourse against the Term C Lenders. The 4C release is limited: it does not prevent him from bringing any claims against the Term C Lenders that do not relate to the Term C Loans. 19