Subordinating A Punitive Damages Claim In A Chapter 11 Case? (Camera v. Matheson)

Subordinating? (Photo by Marilyn Swanson)

Issue: Can claims for “punitive damages” be subordinated in Chapter 11 cases under § 726(a)(4)?

Here are operative statutes:

Sec. 510 authorizes subordination, and § 103(a) makes § 510 applicable in all chapters of the Bankruptcy Code;
Sec. 726(a)(4) places “punitive damages” at a lower distribution level from other unsecured claims, but § 103(b) says that § 726 applies only in Chapter 7 cases; and
Sec. 1129(a)(a)(7) requires that unsecured claims receive at least as much value under a Chapter 11 plan as they would receive in Chapter 7.

An opinion that sorts through the issue is Camara v. Matheson Flight Extenders, Inc., Case No. EC-25-1142 (9th Cir. BAP, decided 5/11/2026; Ordered Published).

Facts

In a discrimination lawsuit against Debtor, Creditors obtain a federal court judgment for, (i) $968,100 compensatory damages, (ii) $14 million punitive damages, and (iii) interest and attorney fees.

Debtor promptly files a voluntary Chapter 11 bankruptcy, in which Creditor and Debtor reach a settlement that provides for payments from Debtor to Creditors over time totaling $7,299,999. The settlement is incorporated into a plan that is confirmed.

After a decade of making plan payments to Creditors, Debtor defaults and proposes a liquidating plan that treats Creditor’s jury award as a general unsecured claim. The Bankruptcy Court confirms the liquidating plan. Thereafter, Debtor moves to subordinate Creditors’ claim, under § 726(a)(4) and § 1129(a)(7), as an award of punitive damages.

The Bankruptcy Court agrees with Debtor and subordinates Creditor’s claim.

Appeal

On appeal, the Ninth Circuit Bankruptcy Appellate Panel reverses because:

the Bankruptcy Code does NOT allow for application of § 1129(a) outside the context of plan confirmation.

What follows is a summary of the Ninth Circuit BAP’s rationale on two issues:

Does Creditors’ claim qualify as a punitive damages claim? (the answer is, “Yes”); and
Can the punitive damages claim be subordinated in this context? (the answer is, “No, but Debtor still has options”).

Punitive Damages

Sec. § 726(a)(4) of the Bankruptcy Code gives “punitive damages” claims a lower distribution priority than other unsecured claims.

And the Bankruptcy Court properly characterized Creditors’ claim in this case as consisting of “punitive damages.”

Creditors argue that the bankruptcy settlement and first confirmed plan converted their punitive damages claim into a contract claim that holds a higher distribution priority (under § 726(a)(2)), as a matter of claims preclusion.

However, the Bankruptcy Court properly rejected such argument and correctly held that:

claims preclusion does not bar bankruptcy courts from inquiring into the true nature of a debt, even where the debt was liquidated in a settlement agreement;
a prepetition settlement agreement, for example, does not interfere with a bankruptcy court’s ability to parse whether a debt is dischargeable under the Bankruptcy Code; and
even a novation that transforms a tort liability to a contract liability does not prevent a bankruptcy court from analyzing the true nature of a claim for various Bankruptcy Code purposes.

Subordination

But reversal and remand is still required.

Here’s why.

One path for subordinating Creditors’ punitive damages claim is § 510. But this path does not apply here, even though § 103(a) makes § 510 applicable in all chapters, because:

the U.S. Supreme Court has declared that “bankruptcy courts lack the power to categorically subordinate claims under § 510(c)”; and
the Bankruptcy Court refused in this case to make any findings or conclusions under § 510(c), resting its decision instead on § 726(a)(4) and § 1129(a)(7).

An alternative path for subordinating Creditors’ punitive damages claim is § 726(a)(4), which:

provides the priority distribution scheme in Chapter 7 liquidations; and
places claims of punitive damages in lower priority than the general unsecured claims priority in § 726(a)(2).

This alternative path is not available here, however, because § 726(a) does not apply in Chapter 11 cases outside the plan confirmation process:

§ 103(b) provides that § 726(a) applies only in Chapter 7 cases;
the U.S. Supreme Court held (in Czyzewski v. Jevic Holding Corp., 580 U.S. 451, 457 (2017)) that courts may not violate the priority scheme in § 726 outside the plan confirmation context; and
§ 1129(a)(7) makes the § 726(a) distribution scheme applicable in a Chapter 11 plan confirmation contexts by requiring that an unsecured creditor must receive, under a Chapter 11 plan, a value that is “not less than the amount” such creditor would receive in a Chapter 7 liquidation.

Here, Debtor did not move for modification of the liquidating plan under § 1127(b). And absent such a context, the Bankruptcy Court lacked authority to apply § 1129(a) to subordinate a claim post-confirmation.

Options Available to Debtor on Remand

On remand, Debtor is not foreclosed from:

seeking post-confirmation modifications of the confirmed plans under § 1127; or
requesting subordination of a claim under other applicable authorities, such as § 510.

Our conclusion is simply that such post-confirmation actions must comply with the terms and provisions of the Bankruptcy Code.

Conclusion

Very interesting!

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