## Facts

- American Lumber Co. (American) was a wholesale lumber business that sold lumber to builders.
- First National Bank of St. Paul (Bank) loaned American $100,000 and took a security interest in American’s accounts receivable.
- As American’s financial condition worsened, the Bank took additional security interests in American’s inventory and equipment.
- The Bank later assumed extensive control over American’s operations, including dominion over accounts receivable, inventory, and equipment.
- The Bank directed American’s cash and collection practices and made key financial decisions with the primary goal of protecting and paying down the Bank’s own debt.
- While exerting this control, the Bank refused to allow payment of American’s unsecured creditors and made misleading statements about American’s financial prospects to those creditors.
- The Bank began liquidating American’s inventory and equipment and applied the proceeds to American’s indebtedness to the Bank.
- An involuntary bankruptcy petition was filed against American, and a trustee was appointed to administer the estate.
- The Bank filed a secured claim in the bankruptcy case.
- American and the trustee brought an adversary proceeding against the Bank seeking to avoid the Bank’s liens/transfers as preferential and fraudulent under the Bankruptcy Act and to subordinate the Bank’s claim based on inequitable conduct as a controlling creditor.

## Issues

1. Whether the Bank’s obtaining and enforcing additional security interests in American’s inventory and equipment, while American was insolvent and within the statutory period, constituted avoidable preferences under § 60 of the Bankruptcy Act.
2. Whether the liens and related transfers were fraudulent under § 67(d)(2) and/or § 67(d)(3) of the Bankruptcy Act because they were taken without fair consideration while American was insolvent and/or because they operated to hinder, delay, or defraud other creditors.
3. Whether, given the Bank’s control over American and its conduct toward other creditors, the Bank’s claim should be equitably subordinated to the claims of general unsecured creditors.

## Decision

- Judgment was entered for the trustee (and American’s estate).
- The court held that the Bank’s additional security interests in American’s inventory and equipment, and the resulting benefit to the Bank relative to other creditors, were avoidable preferences under Bankruptcy Act § 60.
- The court also held that the transfers were fraudulent under Bankruptcy Act § 67(d)(2) and/or § 67(d)(3).
- The court awarded the trustee a money judgment of $488,744.65 against the Bank.
- The court equitably subordinated the Bank’s claim to the claims of American’s general unsecured creditors due to the Bank’s inequitable conduct as a controlling lender.

## Legal Principles

- A lien granted to secure an antecedent debt can be an avoidable preference under Bankruptcy Act § 60 when made while the debtor is insolvent, within the preference period, and when it allows the creditor to receive more than it would receive in a bankruptcy distribution.
- Under Bankruptcy Act § 67(d)(2), a transfer may be set aside as fraudulent when made without fair consideration while the debtor is insolvent or rendered insolvent.
- Under Bankruptcy Act § 67(d)(3), a transfer may be set aside when made with actual intent to hinder, delay, or defraud creditors, or when its practical effect and surrounding circumstances support that conclusion.
- Equitable subordination permits a bankruptcy court to subordinate a creditor’s claim when (i) the creditor engaged in inequitable conduct, (ii) the conduct injured other creditors or gave the creditor an unfair advantage, and (iii) subordination is consistent with the Bankruptcy Act’s distribution scheme.
- A lender’s domination of a debtor’s business affairs, combined with self-interested liquidation tactics and misleading communications that harm unsecured creditors, can justify equitable subordination and monetary relief to restore a fair distribution.

## Conclusion

In *In re American Lumber Co.*, the bankruptcy court found that First National Bank of St. Paul moved beyond ordinary secured lending by taking control of American’s receivables and liquidation process, cutting off unsecured creditors, and steering decisions to pay itself first. The court avoided the Bank’s additional inventory and equipment liens as preferential and fraudulent transfers under the Bankruptcy Act, entered a $488,744.65 money judgment for the trustee, and subordinated the Bank’s claim to the claims of general unsecured creditors to remedy the harm caused by the Bank’s inequitable conduct.


In re American Lumber Co., 7 B.R. 519 (1979)