Opinion ID: 70731
Heading Depth: 2
Heading Rank: 6

Heading: Subordination of the Appellants' Counterclaims

Text: 63 In the bankruptcy court, the appellants filed counterclaims against the Limited Partnerships based upon violations of federal securities laws and the Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. Sec. 1961, et seq. (RICO). Essentially, the appellants alleged that their purchase of limited partnership interests was tainted by criminally fraudulent activity by the general partners. The appellants sought to apply the recovery on their counterclaims as a set off against their liability to contribute additional capital to the Limited Partnerships. See 11 U.S.C. Sec. 553 (under certain circumstances, allowing a creditor to offset a mutual debt owing by such creditor to the debtor). The bankruptcy court rejected the appellants' counterclaims on the merits. See In re The Securities Group 1980, 124 B.R. at 901. In the alternative, the court held that the appellants were not entitled to set off their purported damages against their liability to the creditors of the Limited Partnerships. In denying the appellants' alleged right to a set off, the court drew analogies to mandatory subordination under 11 U.S.C. Sec. 510(b) (providing that certain claims arising from the purchase of a security of the debtor shall be subordinated to all claims or interests that are senior to or equal the claim or interest represented by such security) and equitable subordination under 11 U.S.C. Sec. 510(c)(1) (authorizing the bankruptcy court under principles of equitable subordination [to] subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim). See id. at 903-07. 64 The appellants concede that the right to a set off under Sec. 553 is merely permissive and subject to the discretion of the bankruptcy court. In re Diplomat Electric, Inc., 499 F.2d 342, 346 (5th Cir.1974) (holding that the right to a set off in bankruptcy is discretionary and reviewing the denial of a set off for clear abuse). 14 In this case, had the bankruptcy court allowed the appellants' set off claims, the assets available to satisfy the Limited Partnerships' creditors would have been reduced dollar for dollar by the amount of the damages set off. In light of this situation, the bankruptcy court determined that the equities favored the Limited Partnerships' creditors, who relied on the limited partners' public promise to contribute additional capital. Under all the circumstances, including the strong policy underlying the partnership law of New York to protect creditors as compared to the capital contribution of partners, 15 we cannot say that the bankruptcy court abused its discretion in denying the appellants' set off claims. 16