Update: Once a Shareholder - Always a Shareholder?

Update: Once a Shareholder - Always a Shareholder?

The Bankruptcy Court for the Southern District of Texas has placed an additional arrow in the quiver of unsecured creditors seeking to obtain enhanced recoveries through the subordination of debt received by the debtor’s former owners in exchange for their shares.

Key Takeaways

  • In In re Caprock Oil Tools, the bankruptcy court ruled that a claim held by a former shareholder for money the company owed him as a result of redeeming his shares must be subordinated to general unsecured claims - and treated as common stock - because it “arose from” the purchase or sale of common stock.
  • The court reasoned that the nature of the shareholder’s claim against the debtor is defined by his initial election to hold an equity interest in the company and share in its profits, rather than receive a fixed return as a creditor.
  • The Texas court declined to follow a line of New York and Delaware cases holding that a debtor’s debt obligation issued to repurchase its own stock is not subject to subordination because a former shareholder does not share in the debtor’s profits after it relinquished its stock.
  • In light of Caprock, owners selling their company in a leveraged buyout should consider the risk of subordination before agreeing to receive debt rather than cash in exchange for shares.  Conversely, Caprock may provide unsecured creditors with new opportunities for enhanced recoveries in bankruptcy cases involving failed leverage buyouts.  The Texas court’s divergence from Delaware and New York case law on this issue could affect parties’ choice of venue for bankruptcy cases.

Read our complete client alert.

Kasowitz’s Bankruptcy Litigation and Restructuring team is one of the leading bankruptcy groups in the country.  We have extensive experience representing parties in out-of-court workouts, restructurings, insolvency and bankruptcy litigation, and all related and attendant state and federal court litigations.

For more information, please contact partner Adam L. Shiff.