In re: Palmdale Hills Property

In chapter 11 bankruptcies, equitable subordination violates an automatic stay when it “has the effect of taking a valid, enforceable claim and its accompanying lien from the debtor’s estate.”

Palmdale Hills Property, LLC (“Palmdale”) owed Lehman Commercial Paper, Inc. (“Lehman”) about $649 million plus interest, when Palmdale filed for chapter 11 bankruptcy in 2008. Lehman unsuccessfully moved “for relief from Palmdale’s stay to foreclose on the collateral securing the loans that were in default,” claiming the defense of equitable subordination. Lehman appealed to the Bankruptcy Appellate Panel (“BAP”), which held that as the equitable subordination sought to minimize an otherwise allowable claim, it was an affirmative action to take control of Lehman’s property and therefore prohibited Lehman’s stay. Palmdale appealed, and the Ninth Circuit affirmed, holding that “the BAP correctly determined that Lehman’s automatic stay prevented Lehman’s claims from being subordinated.” The Court reasoned that equitable subordination would violate Lehman’s stay because it “has the effect of taking a valid, enforceable claim and its accompanying lien from the debtor’s estate.” The Court explained that the decision “does not bar Palmdale from equitably subordinating Lehman’s claims. It merely requires Palmdale to bring an adversary proceeding in Lehman’s bankruptcy court or file for relief from stay.” AFFIRMED.