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In re CIT Group Inc.: Second Circuit Affirms Dismissal of Attempted Claim Subordination
Practical Law Legal Update 9-521-6415 (Approx. 4 pages)
In re CIT Group Inc.: Second Circuit Affirms Dismissal of Attempted Claim Subordination
by PLC Finance
| Published on 03 Oct 2012 • USA (National/Federal) |
The US Court of Appeals for the Second Circuit issued a summary order affirming an order of the US Bankruptcy Court for the Southern District of New York in an adversary proceeding relating to In re CIT Group Inc. The Second Circuit affirmed the dismissal of the debtor's attempt to subordinate its former corporate parent's breach of contract claim under section 510(b) of the Bankruptcy Code on the ground that it arose from the purchase or sale of the debtor's securities.
On September 6, 2012, the US Court of Appeals for the Second Circuit issued a summary order in an adversary proceeding filed by CIT Group Inc. (CIT) against Tyco International, Inc. (Tyco) in CIT's Chapter 11 bankruptcy case. The Second Circuit affirmed an order of the US Bankruptcy Court for the Southern District of New York dismissing the adversary proceeding brought by CIT against Tyco for subordination of Tyco's breach of contract claim under section 510(b) of the Bankruptcy Code. The Second Circuit affirmed that a mere connection between a claim and the purchase or sale of a security is not enough to deem that the claim "arises from" the purchase or sale of a security.
In 2001, a subsidiary of Tyco purchased CIT. In 2002, Tyco sought to sell all of the equity interests in CIT in an initial public offering (IPO). In connection with the IPO, Tyco entered into a tax agreement with CIT. Under the tax agreement:
- Tyco agreed to indemnify CIT against certain tax burdens arising from the Tyco subsidiary's purchase of CIT.
- CIT agreed to repay Tyco for any tax benefits resulting from the CIT's use of the Tyco subsidiary's net operating losses.
CIT filed for bankruptcy in 2009 and rejected the tax agreement. Tyco then filed a claim under section 365(g) of the Bankruptcy Code for breach of the tax agreement. In turn, CIT brought the adversary proceeding against Tyco to attempt to subordinate Tyco's claim under section 510(b) of the Bankruptcy Code, which provides for subordination of claims arising from the purchase or sale of a debtor's securities.
The Bankruptcy Court granted Tyco's motion for summary judgment, finding that the purpose of section 510(b) is to prevent equity claims from being disguised as higher-priority creditor claims. The Bankruptcy Court relied on In re Med Diversified, which held that claims should be subordinated if a claimant either:
- Took on the risk and return expectations of a shareholder rather than a creditor.
- Seeks to recover a contribution to the equity pool relied on by creditors in deciding whether to extend credit to a debtor.
The Bankruptcy Court held that:
- Although the tax agreement had a nexus to the issuance of stock in the debtor's IPO, the existence of a mere connection between a claim and the purchase or sale of a security is not enough to support a finding that a claim "arises from" the purchase or sale.
- A claim with a mere connection should not be subordinated unless subordination would satisfy the purposes of section 510(b).
It also found that the tax agreement was not an equity interest in the debtor, but rather a creditor claim, making subordination inappropriate.
The Second Circuit affirmed.
To learn more about the general distribution principles governing the payment of claims in bankruptcy and the order in which claims are paid, see Practice Note, Order of Distribution in Bankruptcy and Diagram: Order of Distribution in Bankruptcy.
Court documents: