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Enron Redux

By Mark G. Douglas

Featured prominently in business and financial headlines in late 2005 and early 2006 were a pair of highly controversial rulings handed down by the New York bankruptcy court overseeing the Chapter 11 cases of embattled energy broker Enron Corporation and its affiliates. In the first, Bankruptcy Judge Arthur J. Gonzalez held that a claim is subject to equitable subordination under section 510(c) of the Bankruptcy Code even if it is assigned to a third-party transferee who was not involved in any misconduct committed by the original holder of the debt. See The Bankruptcy Strategist Vol. 23, Number 2 (December, 2005) www.lawjournalnewsletters.com/issues/ljn_bankruptcy/23_2/news/145627-1.html. In the second, Judge Gonzalez broadened the scope of his cautionary tale, ruling that a transferred claim should be disallowed under section 502(d) of the Bankruptcy Code unless and until the transferor returns payments to the estate that are allegedly preferential. See The Bankruptcy Strategist Vol. 23, Number 3 (January, 2006) www.lawjournalnewsletters.com/issues/ljn_bankruptcy/23_3/news/145795-1.html.

Although immediately appealed, the rulings had players in the distressed-securities market scrambling to devise better ways to limit their exposure by building stronger indemnification clauses into claims-transfer agreements. Their 'buyer beware' approach, moreover, was greeted by a storm of criticism from lenders and traders alike, including the Loan Syndications and Trading Association, the Securities Industry Association, the International Swaps and Derivatives Association, Inc. and the Bond Market Association. According to these groups, if caveat emptor is the prevailing rule of law, claims held by a bona fide purchaser can be equitably subordinated even though it may be impossible for the acquiror to know, even after conducting rigorous due diligence, that it was buying loans from a 'bad actor.'

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