The recent equitable subordination cases of In re Kreisler and Erenberg, 546 F.3d 863 (7th Cir. 2008) and Credit Suisse v. Official Committee of Unsecured Creditors (In re Yellowstone Mountain Club, LLC), Bankr. D. Mont., No. 09-00014 show a possible deviation in the courts regarding the proper application of the doctrine of equitable subordination. Accordingly, secured lenders should stay abreast of these different interpretations and possibly consider adjusting their lending practices. Those who fail to do so could see their claims in bankruptcy move further down the chain of priority.
The doctrine of equitable subordination allows a bankruptcy court, using principles of equity, to subordinate all or part of one creditor’s claim to all or part of another creditor’s claim where the inequitable conduct of one creditor has caused injury to the interests of another creditor. Codified at 11 U.S.C. § 510(c), the doctrine is simple to state and yet, at least it would appear, is rather difficult to apply.
Courts have adopted the Mobile Steel Test as a method to decide when it is appropriate to invoke the doctrine of equitable subordination. The Mobile Steel Test, as its name suggests, originates in the case of In re Mobile Steel Co., 563 F.2d 692 (5th Cir. 1977). The Mobile Steel Test lays out three conditions that must be satisfied before exercising the power of equitable subordination. They are as follows: