In Kurtin v. Ehrenberg (In re Elieff), BAP No. CC-21-1081-SFL (March 21, 2022), the Bankruptcy Appellate Panel of the Ninth Circuit (“BAP”) held that when a claim is subordinated under 11 U.S.C. § 510(b), any judgment and other liens and encumbrances securing that claim are subordinated as well.
In Kurtin, Kurtin and Elieff were equal partners engaged in a series of real estate investment and development projects. Each project was owned and run through a separate business entity or collection of entities. In 2003, Kurtin sued Elieff and his separately owned development entities alleging claims for breach of contract, breach of fiduciary duty, conversion, embezzlement, and constructive fraud. Elieff then sued Kurtin and his separately owned development entities alleging similar causes of action. After some litigation, Kurtin and Elieff entered into a settlement agreement that provided for Kurtin to transfer all his interests in the ventures and other consideration in exchange for four payments, secured by a lien on the interests in the ventures. Elieff only made two of the payments. Kurtin obtained a judgment for breach of the settlement agreement. Elieff then filed a voluntary petition under Chapter 11 (the case was later converted to a Chapter 7). Within weeks of the bankruptcy filing, Elieff commenced an adversary proceeding against Kurtin, which, among other claims for relief, included subordination claims under 11 U.S.C. § 510(b) (“Adversary Proceeding”).
The bankruptcy court granted summary judgment in favor of the Chapter 7 trustee (who became the plaintiff in the Adversary Proceeding when the case was converted), subordinating Kurtin’s claim under 11 U.S.C. § 510(b). 11 U.S.C. § 510(b) provides that a claim “for damages from the purchase or sale of [a security of the debtor or an affiliate 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.” Based on this language, the bankruptcy court reasoned that 11 U.S.C. § 510(b) relief is triggered whenever there is some nexus of causal relationship between the claim and the purchase or sale of securities of the debtor or the debtor’s affiliates. Thus, even though some aspects of the settlement agreement did not directly relate to the purchase or sale of securities, since Kurtin transferred all of his interests in the ventures in exchange for settlement payments, there is a causal nexus and Section 510(b) applies. Additionally, upon request by the parties, the bankruptcy court also issued a clarifying order concluding that Kurin’s judgment liens were also subordinated for the same reasons and to the same extent that his claim had been subordinated by the court. Kurtin appealed the bankruptcy court’s decision.
Ultimately, the BAP held that the bankruptcy court correctly determined that Kurtin’s claim for damages arose from the purchase or sale of a security, and 11 U.S.C. § 510(b) thus required subordination of his claim and the associated lien rights. The BAP reasoned that the bankruptcy court correctly determined that Kurtin’s entire claim for breach of contract arose from the sale of his interest in the ventures for purposes of Section 510(b) because all the settlement payments were integral and indivisible consideration for the securities sale. To hold otherwise would impermissibly read into the mandatory language of Section 510(b) a requirement that the claim “solely” arise from the purchase or sale of securities and Section 510(b) contains no such requirement. Additionally, the BAP also reasoned that even though 11 U.S.C. § 510(b) addresses only claims, it permits the court to subordinate judgment liens as well. The term “claim” encompasses the right to payment, whether personal or in rem. Failure to subordinate the judgment lien would defeat the purpose of 11 U.S.C. § 510(b). Therefore, the BAP determined that Kurtin’s claim may receive a distribution only after all general unsecured claims are paid in full.
Thus, according to the BAP, when a claim is subordinated under 11 U.S.C. § 510(b), any judgment and other liens and encumbrances securing that claim are subordinated as well. Bankruptcy practitioners should be aware of this decision as it may have a direct impact on the priority of creditors in a bankruptcy case.