The Supreme Court held arguments Monday in the only banking case on its agenda this term, probing whether senior creditors or shareholders of insolvent companies have an upper hand in bankruptcies.
The case, Bank of America v. 203 N. LaSalle Street Partnership, resulted from the failure of the real estate partnership to repay a $93 million loan on a commercial property. The loan was secured by the property - 15 floors of a downtown Chicago office building - which covered only $54.5 million of the loan.
Despite the bank's objections, a bankruptcy court judge let the owners keep the building because the partnership had invested $6.1 million in new capital under a Chapter 11 reorganization. A divided federal appeals court upheld that decision. Bank of America appealed to the Supreme Court.
The case will turn on the justices' interpretation of the so-called absolute priority rule in federal bankruptcy law, which prevents equity holders from retaining ownership if major unsecured creditors have not been fully repaid.
Richard M. Bendix Jr., a lawyer who represented the partnership, told the justices that lower court decisions were properly based on the so- called new value exception. Employed by an increasing number of courts, that exception lets equity holders retain a business if they add money to a venture to sustain it.
But Roy T. Englert Jr., an attorney representing Bank of America, and a Justice Department lawyer contended that the bankruptcy judge had violated the law by giving the partnership an exclusive crack at keeping the building. The bank should have been permitted to make a competing bid, they argued, because the absolute priority rule says that equity holders cannot be given preferred treatment to retain their interest.
Mr. Bendix responded that the partnership had complied with the rule because it bought the building with funds separate from its equity interest.
Reaction from the justices was mixed.
Justice John Paul Stevens seemed to side with the partnership, emphasizing that only those shareholders who put in the extra money benefited from the bankruptcy court ruling. "I don't see that it was because they were partners (that) they got the interest," he said. "It was because they put in cash."
But Chief Justice William H. Rehnquist and others said the investors had been given a special advantage. "Because of their prior status, they and they alone were allowed to make this purchase," he said.
Justice Stephen G. Breyer said that bankruptcy courts sometimes have a legitimate public interest in keeping a company going rather than letting a creditor liquidate it, as Bank of America planned to do in this case. He suggested that a judge could confine bidding to the highest bidder who plans to keep the company running.
Yet Justice Ruth Bader Ginsburg questioned the motives of the partnership, which would have been liable for $20 million of income taxes if the bank had foreclosed. "Here we have nothing at stake for anybody except to preserve this leaky tax shelter," she said.