Under the law of the Ninth Circuit, the subordination of claims based on equitable considerations generally requires three findings: (1) that the claimant engaged in some type of inequitable conduct; (2) that the misconduct injured creditors or conferred unfair advantage on the claimant; and (3) that subordination would not be inconsistent with the Bankruptcy Code. When the remedy of equitable subordination involves a non-insider, non-fiduciary, the level of pleading and proof is elevated: gross and egregious conduct will be required before a court can equitably subordinate a claim.
The debtors, a resort development and its principal owner, were in the process of completing and selling off units in a real estate development near Yellowstone National Park. The secured creditor made a massive loan of $ 375 million less fees, administrative costs, and a $ 24,241,910.98 takeout to payoff preexisting debt. The principal owner then took a loan of $ 209 million from the development out of those proceeds, for which he used a backdated note. He used those funds for his own personal benefit.
Should the rights of the principal secured creditor and its secured claim of $232 million equitably subordinated, pursuant to 11 U.S.C.S. § 510(c)?
The court found that equitable subordination to the detriment of the secured creditor was an appropriate remedy, even though the secured creditor did not qualify as an insider of the debtor. The secured creditor had ignored the debtors' financial statements, and performed minimal due diligence, and the only equitable remedy for its overreaching and predatory lending practices was to subordinate its first lien position to that of creditors that had provided debtor-in-possession financing and to that of the allowed claims of unsecured creditors. The secured creditor could still submit a credit bid for the amount of its allowed secured claim, but subject to the equitable subordination.