## Facts

- Barry B. Kreisler and Marsha D. Erenberg, real-estate developers, filed separate Chapter 7 cases that were jointly administered, with a trustee appointed.
- Each debtor held interests in two Chicago properties encumbered by multiple mortgages, including a junior mortgage held by Community Bank of Ravenswood.
- Community Bank filed secured claims of nearly $900,000 in each case and sought to exit the bankruptcy proceedings.
- While the trustee and Community Bank discussed a potential compromise involving foreclosure and a reduced claim, no agreement was reached.
- The debtors formed Garlin Mortgage Corporation to purchase Community Bank’s junior secured claim for $16,500, with Kreisler negotiating the purchase.
- Garlin’s purported owners/directors were a relative and a friend who contributed no capital and did not manage the company; the purchase was financed through a loan from another entity controlled by the debtors.
- Kreisler arranged for Garlin to pay him a $35,000 fee upon settlement with the estate.
- Garlin did not file the notice of assignment required by Bankruptcy Rule 3001(e)(2), and the debtors did not disclose their control of Garlin to the trustee or the bank.
- The bankruptcy court equitably subordinated Garlin’s claim behind all other claims under 11 U.S.C. § 510(c), leaving Garlin unpaid due to insufficient estate funds; the district court affirmed.

## Issues

1. Whether equitable subordination under 11 U.S.C. § 510(c) may be imposed based on misconduct in arranging and concealing a claim purchase when the conduct did not injure other creditors or give the claimant an unfair advantage.

## Decision

- The Seventh Circuit reversed the district court (and the bankruptcy court’s subordination order).
- The court held that equitable subordination was not warranted because the alleged misconduct did not cause injury to other creditors and did not confer an unfair advantage affecting distributions.
- The court concluded that the other creditors’ economic position was unchanged whether Community Bank or Garlin held the junior secured claim.

## Legal Principles

- Equitable subordination under 11 U.S.C. § 510(c) generally requires: (1) creditor misconduct, (2) resulting injury to other creditors or an unfair advantage to the claimant, and (3) consistency with the Bankruptcy Code’s priority scheme.
- A bankruptcy court may not use equitable subordination as a stand-alone punitive sanction absent proof of creditor harm or unfair advantage.
- Claims trading is contemplated by the Bankruptcy Rules; an unusual claim purchase structure is not, by itself, a basis for subordination without a demonstrated adverse effect on other creditors.

## Conclusion

The Seventh Circuit held that § 510(c) equitable subordination is remedial and requires proof that misconduct harmed other creditors or produced an unfair advantage; concealment and insider control, without demonstrated injury, did not justify subordinating the purchased secured claim.


In re Kreisler, 546 F.3d 863 (7th Cir. 2008)