Bankruptcy Law
Rejection Did Not Vitiate Subordination of Contractual Rights
By Michael Enright
U.S. District Court Judge Analisa Torres, in the Southern District of New York, recently upheld the bankruptcy court’s ruling that a subordination provision in an executory contract was enforceable notwithstanding the debtor’s rejection of the contract. 344 Individuals v. Giddens (In re Lehman Brothers, Inc.), Case No. 17-6246 (September 26, 2018). The decision involved an appeal from proceedings in the Lehman Bros. cases, and involved claims brought by former Shearson employees who entered into deferred compensation agreements in the 1980s. The agreements contained provisions stating that the employees’ rights to receive benefits were unsecured, subordinated obligations. The employees claimed that the agreements had been breached and that the breach vitiated the subordination provisions, putting them on an equal footing with general unsecured creditors. The court first concluded that the employees’ position was contrary to applicable New York contract law. The court then turned to the employees’ further assertion that because the contracts were rejected in the course of the bankruptcy case, the contracts were deemed breached, and the trustee could not cherry pick particular provisions to enforce against the employees as counterparties to a rejected executory contract. The court held, however, that the subordination provisions still bound the employees with regard to their claims. Rejection of the contracts did not completely terminate the contracts, nor did it revoke or void contractual obligations. Rather, rejection simply freed the estate from the obligation to perform the contracts. The employees could pursue claims for damages upon such a breach of their contracts, but their ability to collect damages would still be subordinated as they had agreed. Rejection did not elevate the priority of the employees’ claims based on breach of contract. The decision is a good reminder that rejection of an executory contract “does not make the contract disappear,” and does not involve “contract-vaporizing properties.”