In a decision with broad and significant implications for many investors, the Court of Appeals for the Fifth Circuit has held that claims arising under a guarantee of a security issued by an affiliate can be subject to mandatory subordination pursuant to section 510(b) of the Bankruptcy Code. While the decision may come as a surprise to some investors who assume that guarantee claims, unlike claims for securities fraud, are not subject to mandatory subordination, the decision serves as a critical reminder of the breadth of section 510(b) of the Bankruptcy Code.
The case of In re American Housing Foundation
, is significant not only for its ultimate holding regarding the subordination of guarantee claims, but also for its analysis of the Bankruptcy Code’s definition of “affiliate.” Such analysis is in tension with Bankruptcy Court decisions from the District of Delaware and elsewhere.
In American Housing
, the debtor was a nonprofit developer of low-income housing. To fund many of its developments, the debtor created various single-purpose limited partnerships (LPs). Interests in these LPs were sold to investors and guaranteed by the debtor. The debtor (or its wholly-owned subsidiaries) served as the LPs’ general partners.