Opinion ID: 490185
Heading Depth: 3
Heading Rank: 2

Heading: 11 U.S.C. Sec. 510(b)--Mandatory Subordination

Text: 17 The Creditors argue that all of the officers' indemnity claims must be subordinated under 11 U.S.C. Sec. 510(b). We review de novo the interpretation of the statute. In re Global W. Dev. Corp., 759 F.2d at 726. Section 510(b) provided at the time of the filing of the bankruptcy petition as follows: 18 Any claim for recission [sic] of a purchase or sale of a security of the debtor ... or for damages arising from the purchase or sale of such a security shall be subordinated for purposes of distribution to all claims and interests that are senior or equal to the claim or interest represented by such security. 19 Bankruptcy Act of 1978, Pub.L. No. 95-598, Sec. 510(b), 92 Stat. 2549, 2586 (amended 1984). 6 The law in effect at the time of filing of the petition governs the case. Marxen, 307 U.S. at 207, 59 S.Ct. at 815. Section 510(b) prevents equity stockholders or holders of other subordinated securities from converting their interests into higher priority general creditors' claims by asserting damages or rescission claims. H.R.Rep. No. 595, 95th Cong., 1st Sess. 194-96, reprinted in 1978 U.S.Code Cong. & Admin.News 5963, 6154-57. Congress requires subordination of such claims because failure to subordinate the interests of shareholders to those of unsecured creditors would defeat the reasonable expectations of both. Id. General creditors rely on the equity cushion created by the investment of shareholders and expect priority in bankruptcy. Id. Shareholders in turn bargain for potential profit in exchange for expected subordination of their interests in bankruptcy. Id.; Kira v. Holiday Mart, Inc. (In re Holiday Mart, Inc.), 715 F.2d 430, 433-34 (9th Cir.1983) (proper to subordinate rescission claims of holders of subordinated debentures). 20 The Creditors argue that the same considerations require subordination of indemnity claims arising out of securities rescission or fraud litigation. Section 510(b) bars shareholders from elevating their interests to the level of unsecured creditors. The Creditors maintain that if shareholders recover damages from an officer of the debtor for securities violations, and the officer in turn recovers indemnity from the estate of the debtor as an unsecured claimant, the shareholders will achieve indirectly that which section 510(b) bars them from obtaining directly. By this circuitous means, the Creditors contend, shareholders could avoid the subordination of their equity interests and defeat the expectations of unsecured creditors. 21 Even were we to accept this argument, section 510(b) would not apply here. The officers' indemnity claims are for litigation costs, not for reimbursement of liability owed to the holders of the securities. The argument that the security holder may circuitously elevate his claim to a general unsecured claim through indemnity is relevant only to indemnity of liability. The security holder recovers nothing from the officers when the latter are merely indemnified for defense costs. Thus section 510(b)--at least prior to the 1984 amendment--does not require subordination of indemnity claims for defense costs. The blanket order subordinating all indemnity claims to general unsecured claims, even those for defense costs, is not proper under that section. 22