in Re Merrimac Paper Company, Inc. v. Ralph Harrison

United States Court of Appeals
For the First Circuit
No. 05-1010
IN RE MERRIMAC PAPER COMPANY, INC.,
Debtor,
__________________
MERRIMAC PAPER COMPANY, INC.,
Plaintiff, Appellee,
v.
RALPH HARRISON,
Defendant, Appellant.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Nathaniel M. Gorton, U.S. District Judge]
[Hon. Joel B. Rosenthal, U.S. Bankruptcy Judge]
Before
Selya, Lynch, and Howard,
Circuit Judges.
Thomas P. Smith, with whom Caffrey & Smith, P.C. was on brief,
for appellant.
Ellen L. Beard, Senior Appellate Attorney, U.S. Department of
Labor, with whom Howard M. Radzely, Solicitor of Labor, Timothy D.
Hauser, Associate Solicitor, and Elizabeth Hopkins, Counsel, were
on brief, for Secretary of Labor, amicus curiae (in support of
reversal).
Gary R. Greenberg, Louis J. Scerra, Jr., Annapoorni R.
Sankaran, and Greenberg Traurig, LLP on brief for Peter Shapiro and

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a Certified Class of Persons and Entities Similarly Situated, amici
curiae (in support of reversal).
James F. Wallack, with whom Rafael Klotz and Goulston &
Storrs, P.C., were on brief, for appellee.
August 25, 2005

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SELYA, Circuit Judge. This case raises important
questions about the ability of bankruptcy courts to subordinate
claims arising from stock redemption installment payments that
trace their origin to ERISA-qualified retirement plans. After
reviewing recent Supreme Court precedents, we hold, as a general
matter, that bankruptcy courts may not use their powers of
equitable subordination to downgrade stock redemption claims on a
categorical basis; instead, they must evaluate the propriety of
equitable subordination case by case. Taking this general
approach, we hold, more specifically, that the stock redemption
note at issue here — a note delivered in partial liquidation of the
retirement benefits of a retiring employee under an employee stock
ownership plan — may not be equitably subordinated because the
debtor has not made a particularized showing of special
circumstances (such as misconduct on the part of the note holder).
Consequently, we reverse the contrary rulings of the courts below,
vacate the order appealed from, and remand for further proceedings
consistent with this opinion.
I. BACKGROUND
The material facts are not in dispute. The debtor,
Merrimac Paper Company, Inc., is a Delaware corporation that
maintains its principal place of business in Massachusetts. The
appellant, Ralph Harrison, worked for the debtor in an executive
capacity from 1963 to 1999. When the debtor adopted an employee

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stock ownership plan (ESOP) in 1985, the appellant became a
participant.
The ESOP was qualified under the Employee Retirement
Income Security Act of 1974 (ERISA). See 29 U.S.C. § 1107(d)(6);
see also 26 U.S.C. § 4975(e)(7). Pursuant to its terms, the debtor
established a trust and proceeded to make variable annual
contributions to it (in amounts designated from time to time by its
board of directors). The trust invested the funds on behalf of
participating employees, primarily in the debtor's stock. The
trust maintained an individual account for each participant,
specifying his or her share of the investments held in trust. Over
time, the ESOP (and through it, the debtor's employees as a class)
came to own the majority of the debtor's issued and outstanding
common stock.
The ESOP provided that upon a participating employee's
separation from service, the vested portion of that employee's
individual account would be distributed to him or her in the form
of the debtor's stock. Because the stock was not publicly traded,
a retiring employee had the option either to retain the stock
received or, at any time within fifteen months of the distribution
date, to compel the debtor to redeem it at fair market value (a
step known as the "put option"). Upon an employee's exercise of
the put option, the debtor could elect to pay for the redeemed
stock in substantially equal annual payments over a period not to

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The ESOP's stock redemption provisions conformed precisely to 1
the applicable federal statutes and regulations. See 29 U.S.C. §
1107(d)(6)(A); see also 26 U.S.C. §§ 401(a)(23), 409(h); 26 C.F.R.
§ 54.4975-7(b)(12)(iv).
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exceed five years. If the debtor chose to make installment
payments, it was required to pay interest on the deferred balance
and to furnish adequate security.1
At the time of the appellant's retirement in 1999, his
ESOP account held approximately 6% of the debtor's common stock.
He indicated an intention to exercise the put option. Following an
appraisal, the appellant's shares were valued at $1,116,200.
On July 19, 2000, the appellant formally exercised the
put option. In simultaneous transactions, he constructively
received the shares and sold them back to the debtor, which gave
him a promissory note for $916,300 (the Note). This amount equaled
the appraised value of the shares less a cash advance paid earlier
to the appellant. The Note bore interest at a rate of 8.5% per
annum and called for the principal balance to be amortized in three
equal annual installments.
The appellant received the first installment payment on
January 4, 2001. The debtor thereafter encountered financial
difficulties and failed to make the next annual payment. On
September 6, 2002, the appellant accelerated the Note and brought
suit in a Massachusetts state court for breach of contract based on
the failure to pay. A few days later, the appellant attached the

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debtor's real estate (the Attachment) to secure payment of the
balance owed on the Note.
The appellant's state court complaint did not mention
ERISA. He remedied this omission in January of 2003, when he
instituted a second suit in the federal district court. His
federal court complaint named the debtor, the ESOP, and the ESOP's
trustees as defendants and averred, inter alia, that these
defendants had denied him ERISA benefits (specifically, the unpaid
balance due on the Note) and, in the bargain, had failed to fulfill
their fiduciary duties under ERISA. The debtor countered by
removing the state court action to the federal court on the ground
that it constituted part and parcel of the same case or controversy
as the newly filed federal action. See 28 U.S.C. §§ 1367, 1441.
Two months later, the debtor filed for bankruptcy
protection under Chapter 11 of the Bankruptcy Code. See 11 U.S.C.
§§ 1101-1174. The docketing of the bankruptcy petition
automatically stayed the appellant's two pending actions. See id.
§ 362(a)(1). The appellant filed a timely claim in the bankruptcy
proceedings and noted on the claim form that he sought "ERISA
benefits." He attached to the claim copies of both the Note and
the state court complaint.
On June 20, 2003, the debtor commenced an adversary
proceeding against the appellant in an effort to subordinate his
claim. See 11 U.S.C. § 510(b), (c)(1). It also sought to have the

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Attachment transferred to the bankruptcy estate for the benefit of
creditors generally. See id. § 510(c)(2). The debtor's ensuing
motion for summary judgment characterized the appellant's claim as
a "stock redemption claim" but did specify that it had its genesis
in an ESOP retirement distribution. While its summary judgment
motion was pending, the debtor filed its proposed plan of
reorganization. That plan contemplated that the claims of general
unsecured creditors would have priority over stock redemption
claims (whether secured or unsecured), regardless of their origin.
As the debtor could only pay a fraction of the value of the general
unsecured claims, this meant that the Note would be extinguished
and the appellant would receive nothing on it.
The appellant opposed both the summary judgment motion
and the reorganization plan, arguing among other things that
payment of ERISA-protected employee benefits pursuant to an ESOP is
qualitatively different than a garden-variety stock redemption and
that, even if the court treated his claim as a stock redemption
claim notwithstanding its ERISA-connected roots, equitable
subordination was not available in the absence of any inequitable
conduct on his part. The appellant also launched a
counteroffensive; he asked the district court to withdraw the
adversary proceeding, challenging the bankruptcy court's
jurisdiction on the ground that the adversary proceeding required
the resolution of ERISA issues. See 28 U.S.C. § 157(d) (stating

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that a district court shall withdraw such a proceeding if it
requires consideration of both bankruptcy law and other federal
law). Concomitantly, the appellant asked the bankruptcy court to
lift the automatic stay insofar as it pertained to his pending
actions.
This counteroffensive bore no fruit. The district court
denied the motion to withdraw the adversary proceeding on July 8,
2003, holding that the proceeding did not involve a substantial
question of ERISA law. The bankruptcy court denied without
prejudice the appellant's motion to lift the automatic stay. The
court explained that, in its view, "many if not all of the issues"
presented in the original litigation would be rendered moot by its
resolution of the matters pending in the bankruptcy court.
On November 7, 2003, the bankruptcy court granted the
debtor's summary judgment motion and subordinated the appellant's
claim. In re Merrimac Paper Co., 303 B.R. 710, 722-23 (Bankr. D.
Mass. 2003) (Merrimac I). The court considered the appellant to
have made two claims, namely, a straightforward claim for payment
of the Note and an ERISA claim unrelated to the Note. See id. at
718. With respect to the latter claim, the court remarked that it
had looked to the complaint in the original federal court action
and considered the claim to be for "damages that arise from [the
appellant's] sale of stock to Merrimac." Id. at 719.

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In evaluating these claims, the bankruptcy court first
considered section 510(b) of the Bankruptcy Code, which requires
subordination of any and all claims arising from "rescission of a
purchase or sale of a security of the debtor." The court found
that the claim under the Note arose from the enforcement of a debt,
not the sale of a security. Id. at 718-19. Accordingly, the claim
could not be subordinated under section 510(b). Id. at 719.
Conversely, the court characterized what it described as the
"unrelated" ERISA claim as one arising out of the sale of stock
and, thus, found it to be within the purview of section 510(b).
Id. at 719-20. Consequently, that claim was subordinated. Id. at
720.
The court then turned to the question of equitable
subordination. See 11 U.S.C. § 510(c) (authorizing a bankruptcy
court to subordinate any and all claims for equitable reasons).
The court ruled that, under traditional principles of equitable
subordination, all claims based on stock redemption notes must be
subordinated. Id. at 720-22. Hence, insofar as the appellant's
claim was based on the Note, it had to be equitably subordinated.
Id. at 722. Consistent with these holdings, the court transferred
the appellant's interest in the Attachment to the bankruptcy

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The plan of reorganization provides that if the appellant 2
successfully appeals the subordination ruling(s), he will have a
secured claim (subject to further challenge) to the extent of the
Attachment and an unsecured claim for the balance. Funds have been
escrowed to assure the implementation of this arrangement. See
Merrimac I, 303 B.R. at 712 & n.2.
We acknowledge with appreciation the helpful amicus brief and 3
oral argument proffered by the United States Department of Labor.
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estate, see 11 U.S.C. § 510(c)(2), and confirmed the debtor's plan
of reorganization.2
The appellant unsuccessfully appealed the subordination
order to the district court. See In re Merrimac Paper Co., 317
B.R. 215, 223 (D. Mass. 2004) (Merrimac II); see also 28 U.S.C. §
158(c). This timely appeal followed.3
II. ANALYSIS
Although we serve as a second tier of appellate review,
we "cede no special deference to the district court's initial
review." In re Bank of New Engl. Corp., 364 F.3d 355, 361 (1st
Cir. 2004). Rather, we review directly the bankruptcy court's
determination, scrutinizing its findings of fact for clear error
and its conclusions of law de novo. In re Carp, 340 F.3d 15, 21
(1st Cir. 2003). The application of the Bankruptcy Code to the
facts as found (or, as here, to undisputed facts) presents a mixed
question of law and fact, reviewable for clear error "unless the
bankruptcy court's analysis was based on a mistaken view of the
legal principles involved." Id. at 22; see also In re Indep. Eng'g
Co., 197 F.3d 13, 16 (1st Cir. 1999).

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The threshold question here involves the precise nature
of the claims that are subject to review. The debtor argues that
we should review only the propriety vel non of equitable
subordination of the Note claim, as any ERISA claim distinct from
the Note claim was never properly pleaded (or, if properly pleaded,
was waived). The appellant disputes this characterization of the
record, but insists that, in all events, such issues are
superfluous. He submits that were we to reverse the bankruptcy
court's ukase equitably subordinating the Note claim, he will
obtain complete relief whether or not his ERISA claim was properly
pleaded or punctiliously preserved.
We agree with the appellant. And because we hold that
equitable subordination of the Note claim was unwarranted here, see
text infra, we need not decide independently the propriety of the
bankruptcy court's subordination of what it viewed as the
appellant's separate ERISA claim under section 510(b).
A. Equitable Subordination.
Section 510(c) of the Bankruptcy Code provides in
pertinent part that a bankruptcy court may, "under principles of
equitable subordination, subordinate for purposes of distribution
all or part of an allowed claim to all or part of another allowed
claim." 11 U.S.C. § 510(c)(1). The Code does not elaborate upon
the nature of these principles, but the Supreme Court has made
clear that in administering this section, the starting point should

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be the compendium of judge-made principles of equitable
subordination that existed prior to 1978 (when Congress enacted the
Bankruptcy Code). See United States v. Noland, 517 U.S. 535, 539
(1996). This is not to say that section 510(c) froze pre-1978 law
in place. The federal courts have latitude to tweak preexisting
equitable principles and to develop new ones. See id. at 540.
The contours of equitable subordination are well
delineated in a Fifth Circuit opinion, In re Mobile Steel Co., 563
F.2d 692 (5th Cir. 1977) (an opinion that the Noland Court deemed
"influential," 517 U.S. at 538). First, equitable subordination
demands that the claimant be found to have engaged in inequitable
conduct. Mobile Steel, 563 F.2d at 700. Second, the misconduct
must have either resulted in injury to creditors or given the
claimant an unfair advantage. Id. Third, equitable subordination
of the claim must not be in conflict with the provisions of federal
bankruptcy law. Id. This court has adopted Mobile Steel as the
gold standard for section 510(c) cases. See In re 604 Columbus
Ave. Realty Trust, 968 F.2d 1332, 1353 (1st Cir. 1992).
In the case at hand, the debtor questions the
applicability of the Mobile Steel criteria. It points to an older
body of precedent in this circuit holding that stock redemption
claims, as a class, are subject to equitable subordination without
any showing of inequitable conduct on the claimant's part. See
Matthews Bros. v. Pullen, 268 F. 827 (1st Cir. 1920); Keith v.

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Kilmer (In re Nat'l Piano Co.), 261 F. 733 (1st Cir. 1919). This
line of authority derives from the general precept that
stockholders may not receive any of the assets of an insolvent
corporation until the corporation's creditors are paid in full.
See, e.g., In re Geneva Steel Co., 281 F.3d 1173, 1181 n.4 (10th
Cir. 2002) ("Under [the absolute priority rule], unsecured
creditors stand ahead of investors in the receiving line and their
claims must be satisfied before any investment loss is
compensated."). The driving force behind decisions such as
Matthews Bros. and Keith is the desire to prevent stockholders from
subverting this precept by structuring hastily engineered stock
redemption agreements as a means of substituting debt for equity
(and, thus, sharing company assets ratably with creditors). See
Keith, 261 F. at 734 (holding that "a stockholder, contracting with
the corporation . . . for the benefit of himself," may not "through
an executory contract, cease to be a stockholder, and become a
creditor, to share in competition with other creditors in the
assets of the corporation when bankrupt"); see also Matthews Bros.,
268 F. at 828 (clarifying that Keith applies even though the
parties acted in good faith and the corporation was solvent when
the stock redemption agreement was executed).
Keith and Matthews Bros. long predated both the
Bankruptcy Code and the enactment of ERISA. Nevertheless, lower
courts have taken the position that such categorical "no-fault"

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subordination remains appropriate under section 510(c) with respect
to claims emanating from stock redemption agreements. See, e.g.,
In re Main St. Brewing Co., 210 B.R. 662, 665-66 (Bankr. D. Mass.
1997); In re New Era Packaging, Inc., 186 B.R. 329, 335-36 (Bankr.
D. Mass. 1995); In re SPM Mfg. Corp., 163 B.R. 411, 416 (Bankr. D.
Mass. 1994). The primary support for the continued application of
these hoary precedents comes from statements made during floor
debates incident to passage of the 1978 bankruptcy bill, whose
sponsors noted, in joint statements, that existing case law would
help to establish the principles of equitable subordination. See
124 Cong. Rec. 32398 (1978) (statement of Rep. Edwards), reprinted
in 1978 U.S.C.C.A.N. 6436, 6452; 124 Cong. Rec. 33998 (1978)
(statement of Sen. DeConcini), reprinted in 1978 U.S.C.C.A.N. 6505,
6521; see also SPM Mfg., 163 B.R. at 414 (quoting joint floor
statement for proposition that, "under existing case law, a claim
is generally subordinated . . . [if] the claim itself is of a
status susceptible to subordination, such as a penalty"). Those
courts believed that stock redemption claims, like penalties, were
susceptible of subordination based on their essential nature. So
too the bankruptcy court in the instant case, which accepted this
reasoning in subordinating the appellant's claim. Merrimac I, 303
B.R. at 720-23.
The district court was more cautious. It recognized that
we had not reaffirmed our turn-of-the-century precedents since the

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passage of section 510(c), but ultimately concluded that the
categorical rule of Keith and Matthews Bros. would survive.
Merrimac II, 317 B.R. at 221. The court based this conclusion on
our 1986 affirmance, without opinion, in Liebowitz v. Columbia
Packing Co., 56 B.R. 222 (D. Mass. 1985), aff'd, 802 F.2d 439 (1st
Cir. 1986) (table). See Merrimac II, 317 B.R. at 221.
Liebowitz, however, is a very slender reed. Our opinion
is unpublished and unpublished opinions have no precedential force.
See United States v. Meade, 110 F.3d 190, 202 n.23 (1st Cir. 1997);
see also 1st Cir. R. 32.3(a)(2). Thus, our affirmance in Liebowitz
is of no consequence. More importantly, two Supreme Court cases
decided subsequent to Liebowitz dispel any notion that a bankruptcy
court must categorically impose equitable subordination merely
because a claim arises out of a note taken in connection with a
redemption of corporate stock.
The first of these cases is Noland. There, the Internal
Revenue Service (IRS) filed a post-petition claim for a
noncompensatory tax penalty against a bankrupt corporation.
Noland, 517 U.S. at 536. Such a claim ordinarily would be entitled
to first priority in bankruptcy as an administrative expense. See
11 U.S.C. §§ 503(b)(1)(C), 507(a)(1). Although the bankruptcy
court found no misconduct on the part of the IRS, it ordered the
penalty claim equitably subordinated under section 510(c) to avoid
the perceived unfairness of allowing the IRS to take precedence

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over secured and unsecured creditors who had given value to the
business. The Sixth Circuit affirmed, looking to the legislative
history of the Bankruptcy Code and holding that a tax penalty claim
could be subordinated, even in the absence of inequitable conduct
on the claimant's part. In re First Truck Lines, Inc., 48 F.3d
210, 214-18 (6th Cir. 1995).
The Supreme Court reversed. It made clear that the
matter of equitable subordination had to be approached at a
judicial rather than legislative level. Noland, 517 U.S. at 543.
Thus, section 510(c)'s reference to "principles of equitable
subordination" would permit a court sitting in equity to "make
exceptions to a general rule when justified by particular facts."
Id. at 540. Such case-by-case adjudication is at the core of
judicial competence.
The Court made equally clear, however, that courts were
not authorized to subordinate entire classes of claims based "not
on individual equities but on the supposedly general unfairness" of
preferring that class of claims over another. Id. at 540-41. Such
categorical judgments are legislative in nature; they "are not
dictated or illuminated by principles of equity and do not fall
within the judicial power of equitable subordination." Id. at 541
(quoting In re Burden, 917 F.2d 115, 122 (3d Cir. 1990) (Alito, J.,
concurring in part and dissenting in part)). The Court emphasized
that "Congress could have, but did not, deny . . . tax penalties

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the first priority given to other administrative expenses," and
ruled that "bankruptcy courts may not take it upon themselves to
make that categorical determination under the guise of equitable
subordination." Id. at 543.
In delineating the scope of the bankruptcy court's
authority to subordinate claims under section 510(c), the Noland
Court specifically rejected any contrary intimations found in the
legislative history. In language that leaves no room for
interpretation, the Court specifically stated that, as a
fundamental matter, the legislative history of section 510(c)
"cannot be read to convert statutory leeway for judicial
development of a rule on particularized exceptions into delegated
authority to revise statutory categorization." Id. at 542.
Finally, despite its earlier endorsement of Mobile Steel as the
benchmark of equitable subordination, the Court expressly declined
to rule that equitable subordination was unavailable merely because
the IRS was not guilty of misconduct. See id. at 543 (leaving open
the question of whether "a bankruptcy court must always find
creditor misconduct before a claim may be equitably subordinated".
In the same year, the Court decided United States v.
Reorganized CF & I Fabricators of Utah, Inc., 518 U.S. 213 (1996).
There, the IRS had filed a proof of claim under 26 U.S.C. §
4971(a), a statute that imposed a 10% tax on the "accumulated
funding deficiency" of certain corporate pension plans. Id. at

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216. The IRS sought to classify its claim as one for excise taxes
in order to receive priority under what is now 11 U.S.C. §
507(a)(8)(E). The bankruptcy court held that the claim did not
qualify as such. Reorganized CF & I, 518 U.S. at 216-17. The
claim was thus classified as an unsecured claim in the
corporation's Chapter 11 reorganization plan, but the bankruptcy
court nevertheless subordinated it to the claims of general
unsecured creditors based on its status as a penalty. Id. at 227.
The Supreme Court again reversed. The Court noted that
the case was different than Noland in that "Noland passed on the
subordination from a higher priority class to the residual category
. . . whereas here the subordination was imposed upon a disfavored
subgroup within the residual category." Id. at 229. Still, the
Court read Noland as standing for the proposition that the
"categorical reordering of priorities that takes place at the
legislative level of consideration is beyond the scope of judicial
authority" with respect to equitable subordination under section
510(c). Id.
These two cases make it transparently clear that the
bankruptcy court erred in subordinating both the secured and
unsecured portions of the appellant's claim. The appellant has a
non-priority claim based on the Note, but — just as in CF & I — the
bankruptcy court's decision to subordinate the claim was not

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The debtor's reliance on other pre-Noland cases is equally 4
misplaced. Indeed, one of those cases, In re Burden, 917 F.2d 115
(3d Cir. 1990), was specifically rejected in Noland. See 517 U.S.
at 538-40.
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premised on the specific facts of the case but, rather, on the
taxonomic status of the claim. See Merrimac I, 303 B.R. at 722.
The debtor attempts to resist this conclusion by
contending that stock redemption claims, as a class, are subject to
no-fault equitable subordination under Keith and Matthews Bros. It
cites SPM Manufacturing as a "leading" bankruptcy court decision
holding that this rule survives the passage of the Bankruptcy Code.
We reject this contention, as it fails to take into account the
Noland Court's unambiguous repudiation of the legislative history
upon which the SPM Manufacturing court relied.4
To be sure, the debtor tries to distinguish Noland on the
ground that "it focuses exclusively on whether a bankruptcy court
can categorically subordinate . . . claims that Congress
specifically chose to treat as priority claims." Appellee's Br. at
20. In its view, Noland "does not take away a bankruptcy court's
ability to [equitably] subordinate . . . types of claims to which
Congress has not assigned a specific priority." Id. Conspicuously
absent from this line of argument is any acknowledgment of
Reorganized CF & I, which clearly and directly rejected the very
distinction that the debtor now strives to draw. See Reorganized
CF & I, 518 U.S. at 229. Taken together, the principles enunciated

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in Noland and Reorganized CF & I vividly demonstrate why the
bankruptcy court erred in equitably subordinating the appellant's
claim based on nothing more than its classification as a stock
redemption claim.
We do not lightly discard our prior precedents. Stare
decisis must yield, however, when a "preexisting panel opinion is
undermined by subsequently announced controlling authority, such as
a decision of the Supreme Court." Eulitt v. Me., Dep't of Educ.,
386 F.3d 344, 349 (1st Cir. 2004). Here, the decisions in Noland
and Reorganized CF & I, read together, constitute such supervening
authority. We therefore abrogate the categorical rule of Keith and
Matthews Bros. and hold that claims founded on stock redemption
notes are not to be automatically subordinated solely on the basis
of their intrinsic nature.
We do not, however, entirely reject the reasoning of
Keith and Matthews Bros. Indeed, we believe the core principle of
these decisions — that equity holders should not be able
artificially to evade the debt-over-equity paradigm — is generally
sound. But what Noland and Reorganized CF&I tell us is that even
if claims arising out of stock redemption notes generally should be
regarded as suspect, and thus subject to subordination, a court
sitting in equity must nonetheless consider whether subordinating
a particular claim would be fair based on the totality of the
circumstances in the individual case. Cf. Noland, 517 U.S. at 540

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(holding that although penalty claims cannot be categorically
subordinated, they may be subordinated on a case-by-case basis).
We add a coda. Our prior cases adopting the first prong
of Mobile Steel, see, e.g., 604 Columbus Ave. Realty Trust, 968
F.2d at 1353, did not deal with the type of situations described in
Keith and Matthews Bros.. This fact, combined with the Noland
Court's specific reservation of the question, 517 U.S. at 543,
leaves it far from clear whether the inequitable conduct
requirement would apply in such circumstances. As we have said,
however, that is a question for another day.
B. The Equities.
Our holding that stock redemption claims, as a class, may
not automatically be subjected to equitable subordination does not
end our odyssey. We therefore turn to the case-specific inquiry
that the bankruptcy court failed to undertake: do the equities of
this case support the equitable subordination of the appellant's
stock redemption note claim? In undertaking this assessment, we
begin with an explanation of the statutory mechanism underpinning
the creation and use of ESOPs. An ESOP is an oddity among ERISA
plans. It serves three discrete purposes: it functions as an
employee retirement benefit plan, as a device for increasing a
corporation's capitalization, and as a method of fostering loyalty.
See Lalonde v. Textron, Inc., 369 F.3d 1, 4 n.7 (1st Cir. 2004).
Notwithstanding the fact that its focus is on investing exclusively

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in company stock, an ESOP is considered a "stock bonus plan" and,
as such, must meet various regulatory benchmarks prescribed by
Congress and by the Secretary of the Treasury. 29 U.S.C. §
1107(d)(6)(A). The benchmarks include a mandate that an ESOP must
satisfy the cash distribution requirement of section 409(h) of the
Internal Revenue Code. See 26 U.S.C. § 401(a)(23). That section
provides that beneficiaries of such a plan may demand their share
of employer securities upon retirement, id. § 409(h)(1)(A), and "if
the employer securities are not readily tradable on an established
market," a retiring employee may "require that the employer
repurchase [the] employer securities under a fair valuation
formula," id. § 409(h)(1)(B).
This latter choice is the put option, and its exercise is
limited to a relatively brief interval following separation from
service (by retirement or otherwise). See id. § 409(h)(4). When
an employer is subject to the put option (i.e., when, and only
when, its stock is not readily tradable), the employer may elect to
pay the repurchase price over a period not to exceed five years.
Id. § 409(h)(5)(A). Once that election is made, the employer must
post adequate security. Id. § 409(h)(5)(B).
Having limned the origins of the Note, we look next to
the equities of subordinating the appellant's claim. Any case-by-
case analysis of the equities of subordinating a particular claim
that arises out of a stock redemption must begin with an

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examination of whether the underlying rationale for the Keith rule
applies. In a pre-Noland case, the Seventh Circuit described that
rationale as follows:
[Stock redemption] claims are, in substance,
based on equity interests. When [the holders
of those claims] invested in [the
corporation], they positioned themselves to
benefit if the company performed well, but
they also accepted the risk that the company
might perform poorly. Thus [they] accepted
risks and benefits that . . . unsecured
creditors did not, and as such their equity
interests were legally subordinate to possible
claims of unsecured creditors.
Matter of Envirodyne Indus., Inc., 79 F.3d 579, 583 (7th Cir.
1996). This rationale does not apply to the appellant's claim for
several reasons.
First, the stock redemption transaction in this case
occurred within the ERISA framework. That matters because a
participant in an ERISA plan does not assume the same levels of
risk as a typical equity investor. Indeed, one of ERISA's
principal purposes is to minimize risks to a participant's
retirement benefits. See 29 U.S.C. § 1001(b); see also Nachman
Corp. v. Pension Benefit Guar. Corp., 446 U.S. 359, 375 (1980)
(stating that ERISA seeks to ensure that "if a worker has been
promised a defined pension benefit upon retirement — and if he has
fulfilled whatever conditions are required to obtain a vested
benefit — he will actually receive it"). Thus, although the
employee's position entails market risk during the period of

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employment (the ESOP holds the stock in trust for its participants,
and so the employee is, functionally, a stockholder), ERISA seeks
to eliminate that risk once retirement occurs. The ordinary
repurchase by a company of its stock carries with it the implied
condition that payment is contingent on the fulfillment of
obligations to other creditors. Cf. Robinson v. Wangemann, 75 F.2d
756, 757-58 (5th Cir. 1935) (implying the existence of such a
condition). The mandates of ERISA, however — particularly its
requirement that the holders of ESOP-spawned stock redemption notes
be given adequate security — argue persuasively against the
implication of any such condition where an ERISA-qualified ESOP is
involved.
We add, moreover, that this Note is not (and should not
be treated as) an ordinary stock redemption note because
classifying it as such would elevate form over substance. ERISA's
statutory scheme, taken as a whole, ensures that even though an
ESOP is denominated as a "stock ownership plan," it offers retirees
a choice between continued stock ownership and a pecuniary
retirement benefit. It gives that choice to the employee by giving
him, in the first instance, an unqualified right to demand stock.
If there is a ready market for the stock, the employee can convert
it into cash quite easily. If, however, the employer's shares are
not readily tradeable, ERISA makes certain that the ESOP provides
him an equivalent mechanism for converting the stock into cash.

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So it was here. When the appellant's ESOP benefits came
due, he elected not to take stock ownership in the debtor,
preferring instead to convert shares that were not readily tradable
into cash. The debtor honored that election. It chose, however,
to defer a portion of its payment obligations. By structuring the
transaction to play out over time, the debtor placed the appellant
in his present predicament as a noteholder.
This chronology helps to explain why the appellant's
claim for payment due on the Note should not be viewed in the same
light as claims arising from stock redemption notes that have a
more conventional genesis. The appellant's election made manifest
his intention to refrain from becoming an equity investor (with all
the risks attendant thereto). Under these circumstances, there is
a strong policy argument that the Note should be viewed for what it
is: a note received in partial payment of retirement plan
benefits.
To sum up, it is readily evident that the Note on which
the appellant's claim is based did not arise from a conventional
stock redemption. Thus, the underlying rationale for no-fault
equitable subordination is so severely undercut as to be worthless.
Here, moreover, the lower courts gave no other reason, cognizable
in equity, for subordinating the appellant's claim.
In other circumstances, we might remand for further
proceedings; after all, an individualized assessment of what a

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We do not answer the broader question, left open in Noland, 5
of whether the lack of creditor misconduct is itself dispositive.
-26-
creditor did or failed to do in relation to his claim ordinarily
entails questions of fact. This case, however, is one in which the
nature of the appellant's conduct is undisputed. Under such
circumstances, a remand would serve no useful purpose. There is no
evidence of any misconduct attributable to the appellant nor does
anything about his behavior offer the slightest reason for
equitable subordination. We hold, therefore, that there is no
equitable basis for subordinating the appellant's claim under 11
U.S.C. § 510(c)(1). This holding necessarily results in the 5
reversal of the bankruptcy court's transfer of the Attachment based
on section 510(c)(2), as a lien can only be transferred under that
section when the underlying claim has been equitably subordinated.
See id. 510(c)(2).
III. CONCLUSION
We need go no further. Consistent with the Supreme
Court's recent case law, we hold that bankruptcy courts may not
categorically subordinate classes of claims based on generalized
policy considerations. Instead, they must exercise their equitable
discretion to decide whether or not to subordinate particular
claims on a case-by-case basis. Given the facts of this case, we
hold as a matter of law that it was improper for the bankruptcy
court, in the absence of misconduct on the part of the note holder

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or any other special circumstance, to impose equitable
subordination on a claim that arises from a promissory note
received in connection with the deferred payment of retirement
benefits under an ERISA-qualified ESOP. Accordingly, the decisions
below must be reversed.
We reverse the order of the district court equitably
subordinating the appellant's claim and transferring the
Attachment, remand the case to the district court, and direct that
court to remand the case to the bankruptcy court with such
instructions as may be necessary to carry out our holding. Costs
shall be taxed in favor of the appellant.

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