Opinion ID: 73167
Heading Depth: 2
Heading Rank: 2

Heading: The Impact of Section 510(a)

Text: As part of its comprehensive 1978 revision of the bankruptcy laws, Congress enacted a Code provision that provides for the legal enforcement of subordination agreements in bankruptcy courts: A subordination agreement is enforceable in a case under this title to the same extent that such agreement is enforceable under applicable nonbankruptcy law. 11 U.S.C. § 510(a). Chase argues that the language of this provision contradicts the Rule of Explicitness and that section 510(a), therefore, overrules pre-Code practice. Chase contends that section 510(a) requires courts to enforce subordination agreements according to their terms without indulging the equitable considerations present in much of the pre-Code case law. Furthermore, Chase argues that, because the statutory language is plain and unambiguous, the legislative history of the section (particularly the fact that it contains no mention of an intent to depart from prior practice by overruling the Rule of Explicitness) is irrelevant to our inquiry. The Junior Creditors, on the other hand, argue that the Rule of Explicitness has survived the 1978 revision of the bankruptcy laws because Congress has evidenced no intent to depart from it. We begin our analysis of this problem by examining the language of the statute itself, which we presume to be conclusive. We will not stray from that principle of construction unless the literal application of the statute would  produce a result demonstrably at odds with the intentions of its drafters.'  Varsity Carpet Servs., Inc. v. Richardson (In re Colortex Indus.), 19 F.3d 1371, 1375 (11th Cir.1994) (quoting Ron Pair Enters., 489 U.S. at 242, 109 S.Ct. at 1031). The language of section 510(a) provides no such challenge; it directs courts to enforce subordination agreements to the extent that the agreements are enforceable under applicable nonbankruptcy law. 11 U.S.C. § 510(a). In another context, the Supreme Court has held that Congress's use of the phrase applicable nonbankruptcy law in the Bankruptcy Code refers to any relevant federal or state law. See Patterson v. Shumate, 504 U.S. 753, 757-759, 112 S.Ct. 2242, 2246-47, 119 L.Ed.2d 519 (1992) (noting that nonbankruptcy law is broader than state law, a term Congress also used in the Bankruptcy Code). Unlike the Patterson case, which involved a relevant provision of federal legislation, however, the parties before us have identified no independent federal statute that might guide the interpretation of subordination agreements; nor have they argued that federal common law should govern the outcome of this case.8 This absence of relevant federal authority should not be surprising because the enforcement and interpretation of private contracts is ordinarily a question of state law. Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52, 60 n. 4, 115 S.Ct. 1212, 1217 n. 4, 131 L.Ed.2d 76 (1995) (quoting Volt Info. Sciences, Inc. v. Board of Trustees of Leland Stanford Junior Univ., 489 U.S. 468, 474, 109 S.Ct. 1248, 1253, 103 L.Ed.2d 488 (1989)); see also Butner v. United States, 440 U.S. 48, 55, 99 S.Ct. 914, 918, 59 L.Ed.2d 136 (1979) (Property interests are created and defined by state law. Unless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding.). The subordination agreements in this case each contain a choice of law clause that provides that New York law governs the enforcement and interpretation of the contracts. The relevant nonbankruptcy law for the enforcement of subordination agreements in this case, therefore, appears to be New York law. See e.g., Plastino v. Eureka Fed. Sav. and Loan Ass'n (In re Sunset Bay Assocs.), 944 F.2d 1503, 1508 (9th Cir.1991) (applying California law to interpret a subordination agreement as the applicable nonbankruptcy law pursuant to section 510(a)); In re Best Prods. Co., 168 B.R. 35, 69 (Bankr.S.D.N.Y.1994) (applying New York law pursuant to section 510(a) and a 8 Although a number of courts have read Patterson's declaration that applicable nonbankruptcy law includes federal law to refer to relevant federal common law as well as statutes, see e.g., Resolution Trust Corp. v. Gibson, 829 F.Supp. 1110, 1117-19 (W.D.Mo.1993), a federal common law of contracts is justified only when required by a distinctive national policy, Fantastic Fakes, Inc. v. Pickwick Int'l, Inc., 661 F.2d 479, 483 n. 2 (5th Cir. Unit B 1981) (quoting Bartsch v. Metro-Goldwyn-Mayer, Inc., 391 F.2d 150, 153 (2d Cir.1968) (internal quotation marks omitted)). The interpretation and enforcement of a contract between private parties presents no such distinctive federal interest. choice of law provision in the subordination agreement); In re Envirodyne Indus. Inc., 161 B.R. 440, 445 (Bankr.N.D.Ill.1993) (citing section 510(a) and construing a provision in a subordination contract under New York law), aff'd 29 F.3d 301 (7th Cir.1994 ).9 The Junior Creditors argue that section 510(a) and its direction to enforce subordination agreements according to nonbankruptcy law is irrelevant to this dispute because the Rule of Explicitness is a rule of contract interpretation—not enforcement. Regardless of whether we characterize the Rule of Explicitness as interpretation or enforcement, however, section 510(a)'s instruction to enforce subordination agreements on par with other contracts under nonbankruptcy law constitutes a plain departure from the prior practice of enforcing and interpreting those agreements pursuant to the bankruptcy courts' equitable powers. Although the Junior Creditors have argued to the contrary, the Rule of Explicitness developed as a tool for the exercise of those equitable powers. See e.g., Time Sales, 491 F.2d at 844 & n. 10 (holding that the district court had not abused its discretion in the exercise of its equitable powers). Section 510(a)'s instruction to enforce subordination agreements according to nonbankruptcy law, therefore, appears to cut away the equitable mantle under which the bankruptcy courts fashioned the Rule of Explicitness.10 9 Section 510(a)'s instruction to enforce subordination agreements is roughly analogous to section 2 of the Federal Arbitration Act, which makes agreements to arbitrate enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract. 9 U.S.C. § 2. In this context, the Supreme Court has explained that, although federal law establishes the enforceability of arbitration agreements, a court must construe that agreement according to generally applicable principles of state law. See Perry v. Thomas, 482 U.S. 483, 492 n. 9, 107 S.Ct. 2520, 2527 n. 9, 96 L.Ed.2d 426 (1987); see also First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938, 944, 115 S.Ct. 1920, 1924, 131 L.Ed.2d 985 (1995) (applying ordinary state-law principles that govern the formation of contracts in interpreting an arbitration agreement). 10 Regardless of whether the Rule of Explicitness was a creation of law or equity, the source of the rule was undeniably federal and not state law. Our conclusion that Congress, by designating state law as the appropriate vehicle by which to enforce subordination contracts, removed the rule's authoritative foundation, therefore, applies regardless of whether pre-Code practice depended upon equity or federal law. Indeed, under prior bankruptcy law, the bankruptcy courts enjoyed extensive equitable powers and exercised those powers broadly.11 The Supreme Court, however, has read the 1978 Bankruptcy Code to curtail those powers in significant ways and has explained that whatever equitable powers remain in the bankruptcy courts must and can only be exercised within the confines of the Bankruptcy Code. Norwest Bank Worthington, v. Ahlers, 485 U.S. 197, 206, 108 S.Ct. 963, 969, 99 L.Ed.2d 169 (1988).12 In certain contexts, the Code includes express provisions for the continued exercise of equitable power in the bankruptcy courts. On the topic of subordination, for example, section 510(c) authorizes the bankruptcy courts to continue the practice of equitable We note that one of the major treatises on bankruptcy law disagrees with our reading of Time Sales and its progeny on this point; it assumes that those cases rely on state law. See 4 Marcia L. Goldstein et al., Collier on Bankruptcy ¶ 510.03[3] at 510-8 & n. 11 (Lawrence P. King ed., 15th ed. rev., Matthew Bender 1998). Our own reading of the cases, which contain no reference to state authority, however, is sharply at odds with the treatise on this point. Nevertheless, regardless of our academic disagreement with the treatise over the rule's pedigree, the treatise's view of the Rule of Explicitness is consistent with our ultimate conclusion that the rule must now find its source of authority in state, not federal, law or equity. 11 As one commentator has explained: Under the Bankruptcy Act, courts used their equitable powers quite broadly. This tradition of equitable interpretation of the Act grew out of bankruptcy judges' efforts to address many important issues the Act left unresolved ... and out of their attempts to make the bankruptcy laws function in spite of Congress' failure to update the Act.... Adam J. Wiensch, Note, The Supreme Court, Textualism, and the Treatment of PreBankruptcy Code Law, 79 Geo. L.J. 1831, 1860 (1991). 12 See generally, Wiensch, The Supreme Court, 79 Geo. L.J. at 1860-61 (explaining that the lack of uniform results, attributable to the bankruptcy courts' exercise of their equitable powers under the Bankruptcy Act, was a driving force behind the enaction of the Bankruptcy Code, and that the Supreme Court has taken a much narrower view of the bankruptcy courts' powers to do equity under the Code). subordination.13 The language of section 510(c) expressly invokes the bankruptcy courts' historical exercise of their equitable powers to subordinate the claims of creditors who engaged in inequitable conduct in favor of the claims of those creditors who came to court with clean hands.14 Section 510(c), therefore, powerfully demonstrates that Congress was aware of the bankruptcy courts' exercise of their equitable powers in the context of subordination, and that Congress knew how to preserve those powers to the extent it chose to do so. In sharp contrast to section 510(c), however, section 510(a) includes no such express grant of authority that would permit the bankruptcy courts to continue enforcing and interpreting subordination agreements in equity. When compared with 13 Section 510(c) provides: Notwithstanding subsections (a) and (b) of this section, after notice and a hearing, the court may— (1) under the principles of equitable subordination, subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim or all or part of an allowed interest to all or part of another allowed interest; or (2) order that any lien securing such a subordinated claim be transferred to the estate. 11 U.S.C. § 510(c) (emphasis added). 14 The legislative statement accompanying section 510(c) states in pertinent part: It is intended that the term principles of equitable subordination follow existing case law and leave to the courts development of this principle. To date, under existing law, a claim is generally subordinated only if [the] holder of such claim is guilty of inequitable conduct, or the claim itself is of a status susceptible to subordination, such as a penalty or a claim for damages arising from the purchase or sale of a security of the debtor. 11 U.S.C. § 510 Legislative Statement; see also H.R. Rep. 95-595 at 359, reprinted in 1978 U.S.C.A.A.N. 5963, 6315 (noting the legislative intent to codify prior case law concerning the courts' power of equitable subordination and explaining that this Code provision is not intended to limit the court's power in any way. The bankruptcy court will remain a court of equity....) Congress's decision to permit the bankruptcy courts to retain their powers of equitable subordination in section 510(c), section 510(a)'s command to enforce subordination agreements according to the applicable nonbankruptcy law can only be read as a clear and contemplated break with prior practice.15 Accordingly, the plain language of the text, as well as the provision's structure, supports our conclusion that Congress, by designating state law to govern the interpretation and enforcement of subordination agreements, withdrew the foundation of equitable authority under which the bankruptcy courts had developed the Rule of Explicitness. Finally, the Junior Creditors argue that Congress could not have intended such a radical departure from pre-Code practice because the Bankruptcy Code's legislative history is devoid of any reference to the Rule of Explicitness and indicates no intent to change the law as it had developed