Fifth Circuit Subordinates Claim for Deemed Dividends

"… [P]ayments owed to a shareholder by a bankrupt debtor, which are not quite dividends but which certainly look a lot like dividends, should be treated like the equity interests of a shareholder and subordinated to claims by creditors of the debtor," held the U.S. Court of Appeals for the Fifth Circuit on Sept. 3, 2019. In re Linn Energy, LLC, 2019 WL 4149481 (5th Cir. Sept. 3, 2019). According to the court, subordination of a purported creditor's claims "was appropriate" when "deemed dividends gave the [creditor] benefits normally reserved for equity investors." Affirming the lower courts, the Fifth Circuit found the creditor-shareholder's claim to be for "damages" involving "securities," "aris[ing] from" a "purchase or sale," and having a "nexus with those securities." Because the estate had "limited assets," the "subordination order effectively gutted the [creditor-shareholder's] chances to receive any money." Id. at 2.

Relevance

Courts have broadly interpreted the nature and scope of claims arising from the purchase or sale of a security under Bankruptcy Code (Code) §510(b). That section provides in relevant part as follows: "a claim arising from the rescission of a purchase or sale of a security of a debtor or of an affiliate of a debtor, [or] for damages arising from the purchase or sale of such security … shall be subordinated to all claims or interests that are senior or equal to the claim or interest represented by such a security, except that if such security is common stock, such claim has the same priority as common stock." Code §510(b) thus "mandates subordination of 'a claim … for damages arising from the purchase or sale of … a security [of the debtor].'" In re Med. Diversified, Inc., 461 F.3d 251, 253 (2d Cir. 2006).