## Facts

- Lifschultz Fast Freight Corp. was a closely held, financially distressed trucking business controlled by several insiders.
- The insiders arranged financing for the business, including a secured loan from Salson Express Co., Inc. in March 1990.
- In August 1990, the debtor obtained a $1 million loan from Ambassador Factors, a non-insider lender.
- During spring and summer 1990, the debtor’s directors increased insiders’ salaries despite the company’s financial difficulties.
- Lifschultz filed a Chapter 11 petition on November 20, 1990, owing Salson about $300,000; Salson asserted a secured claim for that amount.
- The bankruptcy trustee sought equitable subordination of Salson’s secured claim, arguing the debtor was undercapitalized and that the transaction functioned as an insider equity contribution coupled with unfair conduct.

## Issues

1. Whether undercapitalization, by itself, is sufficient to equitably subordinate a secured creditor’s claim.
2. Whether the bankruptcy court clearly erred in finding the debtor adequately capitalized when the Salson loan was made.
3. Whether insider compensation increases constituted inequitable conduct supporting equitable subordination.

## Decision

- The Seventh Circuit held that undercapitalization alone is generally insufficient to equitably subordinate a secured claim.
- The court concluded the bankruptcy court’s finding of adequate capitalization was not clearly erroneous.
- The court remanded for further consideration of whether insider salary increases and related conduct were inequitable and warranted subordination.
- The court thereby rejected the district court’s broader subordination ruling and limited further proceedings to the potential misconduct issue.

## Legal Principles

- Equitable subordination is an exceptional remedy applied to prevent unfair advantage or harm to other creditors and must be consistent with the Bankruptcy Code.
- The traditional framework considers: (1) inequitable conduct by the claimant (or conduct attributable to the claim), (2) resulting injury to creditors or unfair advantage, and (3) consistency with bankruptcy law.
- Thin capitalization may be relevant evidence but, standing alone, does not justify subordinating an otherwise valid secured loan.
- Insider-related transactions receive heightened scrutiny, but insider involvement does not create automatic subordination; a demonstrated unfair element is still required.
- Appellate review of a bankruptcy court’s factual findings (including capitalization) is deferential under the clear-error standard.

## Conclusion

The Seventh Circuit limited equitable subordination of secured claims by reaffirming that undercapitalization alone is not enough, reinstated the bankruptcy court’s capitalization finding, and remanded for focused fact-finding on whether insider salary increases and related actions were inequitable and harmed other creditors.


In re Lifschultz Fast Freight Corp., 132 F.3d 339 (7th Cir. 1997)