(CN) - Junior underwriters that lost millions after the collapse of Lehman Bros. in 2008 cannot claim priority in the brokerage's bankruptcy proceedings, the Second Circuit ruled Monday.
Lehman Bros. and its parent Lehman Bros. Holdings collapsed on Sept. 15, 2008, as a result of heavy investments in residential mortgage-backed securities that were exposed as worthless in the 2008 financial crisis.
In its bankruptcy filing, Lehman Bros. declared that it owed $155 billion to its top two creditors, Citibank and Bank of New York, plus hundreds of millions to other creditors.
When the dust settled, a score of other firms found themselves holding the bag for the losses connected to the $32.4 billion worth of securities for which Lehman had been the lead underwriter.
BNY Mellon Capital Markets, BNP Paribas, Fortis Securities and other junior underwriters asserted they lost $78 million defending and settling securities fraud claims arising from Lehman's offerings.
They sought reimbursement for these losses from Lehman's liquidation estate, but a federal judge in Manhattan ruled that the underwriters' claims should be subordinated to the claims of general unsecured creditors.
The Second Circuit affirmed Monday.
"Claims arising from securities of a debtor's affiliate should be subordinated in the debtor's bankruptcy proceeding to all claims or interests senior or equal to claims in the bankruptcy proceeding that are of the same type as the underlying securities," Judge Dennis Jacobs wrote for the three-judge panel in New York.
The junior underwriters' reading of the statute makes sense only when both the debtor and its affiliate's estates are consolidated in bankruptcy, the panel said.
Quoting precedent from a 2006 In re Enron decision, the court said "Congress enacted § 510(b) to prevent disappointed shareholders from recovering their investment loss by using fraud and other securities claims to bootstrap their way to parity with general unsecured creditors in a bankruptcy proceeding."
Jacobs added: "In order to prevent such bootstrapping from being effected indirectly, the statute likewise subordinates claims for contribution and reimbursement based on payments made to disappointed investors."