Equitable Subordination of a Claim Depends on Insider Status, Conduct of the Claimant, and if There was Harm
Equitable subordination is a remedial doctrine pursuant to which a creditor’s claim may be subordinated to other claims. The doctrine is designed to “undo or to offset any inequality in the claim position of a creditor that will produce injustice or unfairness to other creditors in terms of the bankruptcy results.” Equitable subordination is codified in section 510(c) of Title 11 of the United States Code (the “Bankruptcy Code”). Section 510(c) of the Bankruptcy Code “authorizes a bankruptcy court to ‘subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim.’” The courts have uniformly adopted a three-part equitable subordination test.
This memorandum explores what level of inequitable conduct and harm allows a court to subordinate a claim under section 510(c). Part I describes the three-part test applied by courts when analyzing a request to equitably subordinate a claim. Part II analyzes what constitutes inequitable conduct. Part III explores when inequitable conduct actually causes an injury to another creditor or confers an unfair advantage on the claimant.