James M. Kerins

Document Type

Research Memorandum

Publication Date




One of the cornerstone principles of Chapter 11 under title 11 of the United States Code (“the Bankruptcy Code”) is section 510 (b). Under section 510 (b), a fraud claim by a purchaser of stock in a corporation that subsequently files a petition for relief under the Bankruptcy Code must be subordinated to general unsecured creditors. Although the application of section 510 (b) may seem straightforward, courts have struggled interpreting the ambiguous language of section 510 (b).

Prior to Congress enacting section 510 (b), there was significant confusion throughout the bankruptcy community regarding what claims must be subordinated. Many courts struggled in determining whether such claims should be treated pari passu with claims of general unsecured creditors or whether such claims should be subordinated. Congress sought to clarify these issues when it enacted section 510 (b).

When creating section 510 (b), Congress relied heavily on the law review article written by two prestigious law school professors, John J. Slain (“Slain”) and Homer Kripke (“Kripke”). According to Slain and Kripke, section 510 (b) was created to reflect “the different degree to which each party assumes a risk of enterprise insolvency.” Factoring in the general creditor’s need for protection, Congress’ rationale for section 510 (b) was that general creditors rely on a cushion of securities when they decide to extend credit. Furthermore, since creditors rely heavily on the protections from mandatory subordination in the event of bankruptcy, whereas security holders freely bargained for an equity interest rather than a debt interest when they decided to invest in the corporation's stock, Congress sought to fairly balance these risks. Because security holders voluntarily forgo the risk of insolvency with the hopes of making a profit, Congress designed section 510 (b) with the intent to provide creditors with more protection.



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