The recent equitable subordination cases of In re Kreisler and Erenberg, 546 F.3d 863 (7th Cir. 2008) and Credit Suisse v. Official Committee of Unsecured Creditors (In re Yellowstone Mountain Club, LLC), Bankr. D. Mont., No. 09-00014 show a possible deviation in the courts regarding the proper application of the doctrine of equitable subordination. Accordingly, secured lenders should stay abreast of these different interpretations and possibly consider adjusting their lending practices.

On August 11, the Honorable Allan L. Gropper issued an opinion of the U.S. Bankruptcy Court for the Southern District of New York denying five motions to dismiss certain Chapter 11 bankruptcy cases of several property-specific special purpose subsidiaries (SPE Debtors), including a number of issuers of commercial mortgage-backed securities (CMBS), that are owned by mall operator General Growth Properties, Inc.

In Greene v. Mullarkey, Case No. 07-30561-HJB, Adversary Proceeding No. 08-03009, 2009 Bankr. LEXIS 2191 (Bankr. D. Mass. Aug. 13, 2009), Christine Greene, her brother Matthew Mullarkey, and his wife Nicole Mullarkey were entangled in what the Bankruptcy Court described as an intra-family feud. The feud related to ownership of a two-family residential property and "played out on or in the property's porch, attic, basement, garage, yard and in-ground pool," prompting the Court to pay its "respect and admiration for the work done by the Massachusetts Probate and Family Court."

Although courts are generally reluctant to equitably subordinate claims of non-insiders, the United States Bankruptcy Court for the District of Montana recently did just that to the claims of a non-insider lender based on overreaching and self-serving conduct in Credit Suisse v. Official Committee of Unsecured Creditors (In Re Yellowstone Mt. Club, LLC), Case No. 08-61570-11, Adv. No. 09-00014 (Bankr. D. Mont. May 13, 2009).

During the bankruptcy cycle following the recession of 2001, numerous debtors – notably airlines such as US Airways and United Air Lines, Inc. – undertook “distress terminations” of their ERISA-qualified defined benefit pension plans, which are insured by the Pension Benefit Guaranty Corporation (PBGC). The PBGC found itself holding large general unsecured claims arising from significant underfunding of pension plans insured by the PBGC as a result of these terminations. Efforts by the PBGC to obtain either administrative priority or secured status for these claims invariably failed.1

On May 31, 2009, approximately 30 days after Chrysler Group LLC and affiliated debtors filed for bankruptcy relief, the United States Bankruptcy Court for the Southern District of New York authorized the sale of substantially all of Chrysler’s assets to “New Chrysler” – an entity formed by Chrysler and Fiat Automobiles SpA and initially majority-owned by Chrysler’s Voluntary Employees’ Beneficiary Association (VEBA) – free and clear of liens, claims and encumbrances under section 363 of the United States Bankruptcy Code (the Fiat Transaction).

In the fourth quarter of 2008, global credit markets were virtually frozen, leading many distressed businesses and their constituents to take measures to avoid bankruptcy filings at almost all costs. Without access to debtor-in-possession (DIP) financing, bankruptcy most often results in liquidation – and with lenders reluctant to provide new money, even in exchange for superpriority and/or priming liens, total collapse became an increasingly common result.

Deadlines for the Filing of Proofs of Claims In the Chrysler and Lear Bankruptcies Have Been Set

1. Deadline Relating to Chrysler Bankruptcy:

An opinion issued earlier this year by the Delaware Bankruptcy Court in In re SemCrude, L.P., et al. (Bankr. Del., No. 08-11525; January 9, 2009) may end much of the practice of so-called “triangular setoffs” by creditors in bankruptcy cases. The Court in SemCrude found that creditors violate section 553 of the Bankruptcy Code by setting off amounts among multiple debtors, even when exercising contractual assignment rights. This ruling is likely to have far-reaching impact given the dearth of case law on this fairly common contractual provision.

In the recent heyday of real estate and structured finance, the use of “bankruptcy–remote” special purpose entities (SPEs) as borrowers was a fundamental underwriting requirement by lenders in many loans, and a critical factor considered by ratings agencies, to shield lenders and their collateral from the potentially adverse impact of bankruptcy filings by their borrowers’ parents and siblings.