Three U.S. financial industry trade associations are applauding a U.S. court decision, reversing a bankruptcy court decision, that they say threatened to disrupt the secondary market in claims against companies in bankruptcy.

The case, Springfield Associates v. Enron Corp, arose out of Springfield’s secondary market purchase of US$5 million of Enron bank debt originally held by Citibank. Enron brought a proceeding against Springfield seeking to equitably subordinate its claim based solely on Citibank’s alleged inequitable conduct and receipt of avoidable transfers, the trade associations said. There is no allegation that Springfield itself engaged in any improper conduct or received any avoidable transfer.

“The Enron bankruptcy court accepted Enron’s argument, issuing a decision holding that improper conduct or receipt of an avoidable transfer by a prior holder of a claim taints the claim itself, rendering it worthless in the hands of a subsequent — and a wholly innocent — purchaser,” they note.

On appeal, a joint amicus submission by the Loan Syndications and Trading Association, the Securities Industry and Financial Markets Association, and the International Swaps and Derivatives Association, all financial industry trade associations, drew attention to the negative and dramatic adverse market implications of the bankruptcy court’s decision.

Now, a decision by Judge Shira Scheindlin of the U.S. District Court for the Southern District of New York vacates the bankruptcy court’s decision. Her opinion describes the bankruptcy court’s opinion as “overreaching,” and notes that it “resulted in [an] outcry from commentators and amici curiae, who have expressed great concern that [the decision] will wreak havoc in the markets for distressed debt.”

Her opinion makes clear that equitable subordination and disallowance are “personal disabilities” that do not transfer with claims when they are sold, the associations note. She therefore holds that the purchasers of claims “are protected from being subject to the personal disabilities of their sellers.

The decision said, “it is proper to consider the effect that the court’s interpretation would have on the markets. The unnecessary breadth of the bankruptcy court’s decisions threatened to wreak havoc on the markets for distressed debt. That result has now been avoided.”

Elliot Ganz, general counsel of the LSTA, expressed satisfaction with that conclusion. “Judge Scheindlin’s careful opinion is a tremendous victory for the entire market. The decision lifts a horrible cloud that hung over every purchase and sale of debt in the secondary market — a cloud that threatened to choke off these otherwise vibrant markets.”

“Her opinion rejects each and every one of Enron’s arguments,” Ganz added. “In addition, I am very pleased that the court considered and relied upon the perspective that the amici brought to this question. While Enron will presumably appeal this decision, I am confident that if and when this question reaches a higher court, the conclusion that Judge Scheindlin reached — that a claim held by an innocent purchaser may not be equitably subordinated or disallowed based on the wrongful acts of a previous holder — will be affirmed.”