Page 91 - Bankruptcy Volume 1

Claims may be placed in the same class only if they are substantially similar to other claims or interests
in a particular class. For example, all general unsecured claims are customarily placed in the same class.
However, a separate class may be established for small unsecured claims if the court determines that this
is reasonable and necessary for administrative convenience. In addition, many courts have held that a
deficiency claim of an undersecured creditor must be classified separately from all other unsecured
claims. The rationale for this is that undersecured creditors have the right to elect to have the claim as
fully secured under Section 1111(b)(2) of the Bankruptcy Code. Creditors making the election receive
payments equal to the amount of the claim that have a present value equal to the value of the collateral
securing the claim. Other courts have not made this distinction. In addition, each secured creditor must
be classified separately from other secured creditors to the extent that different collateral secures its
claim.

Claim Subordination

Subordination could occur by agreement or by order of the court. There are at least four types of subor-
dination that require consideration in developing a plan, as described in the following list: fn 2

1. Contractual Subordination. An agreement whereby a creditor gives another creditor superior
rights to collect the debt. This is common in Chapter 11 cases. In a leveraged buyout, junior
bonds often are issued that are subordinated to senior notes and other junior bonds. Some agree-
ments forbid the subordinated creditor from receiving any payment until the senior creditor is
paid in full. A bank may require this type, complete forbearance, under which loans from the
owner are subordinated. The more common type is inchoate forbearance, under which the sub-
ordinated creditor cannot receive payments if the debtor is in default on the senior debt.

2. Co-debtor Claims Subordination. Under Section 509 of the Bankruptcy Code, the co-debtor who
pays part of the claim of the primary creditor may have his or her claim against the debtor subor-
dinated to that of the primary creditor.

3. Securities Fraud Claims Subordination. Under Section 510(b) of the Bankruptcy Code, claims
for fraud in the purchase or sale of a security are subordinated to all claims or interests superior
or equal to the security, except that if such claim is common stock, it has the same priority as
common stock. For example, defrauded purchasers of common stock will have the same priority
as other common stockholders but will be subordinated to all preferred stockholders and to gen-
eral unsecured creditors.

4. Equitable Subordination. Section 510(c) of the Bankruptcy Code provides that the court, after
notice and a hearing, may apply principles of equitable subordination. Grounds for equitable
subordination include fraud, illegality, breach of fiduciary relationships, or other blatant wrong-
doings, as well as undercapitalization at the time credit is extended, and control over the debtor’s
operations.

fn 2 Daniel C. Cohn, "Subordinated Claims: Their Classification and Voting Under Chapter 11 of the Bankruptcy Code," American
Bankruptcy Law Journal, 56 (October 1982): 295–301.

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