## Facts

- In 1978, the Shaine Foundation (a charitable trust) received shares of SPM Manufacturing Corporation (SPM), a Massachusetts corporation.
- The Foundation was controlled by members of the Shaine family, who were also SPM’s stockholders, directors, and officers.
- On May 27, 1982, SPM redeemed the Foundation’s stock by issuing a promissory note for $662,925, reflecting the full purchase price.
- The redemption involved 3,240 shares of preferred stock (priced at $30 per share) and 1,500 shares of Class B common stock (priced at $377.15 per share).
- SPM kept the redeemed shares as treasury stock.
- The note bore interest at 12% per year and called for payment over 15 years in equal monthly installments of $7,956.26; it contained no contractual subordination provision.
- At the time of the redemption, SPM was in good financial health; its certified financial statements for December 31, 1982 showed a net worth of $2,988,916 after deducting amounts for redeemed shares.
- Years later, SPM became insolvent and entered Chapter 7 liquidation.
- The Foundation filed a proof of claim as a general unsecured creditor for $542,246.96, representing the unpaid balance of the note after default.
- The Official Unsecured Creditors’ Committee objected to the claim and sought equitable subordination under 11 U.S.C. § 510(c), arguing the redemption-note claim should not share equally with trade and other unsecured creditor claims.
- Although equitable subordination is typically brought by adversary proceeding under Bankruptcy Rule 7001, the Foundation did not object to the procedural posture, and there were no material factual disputes.

## Issues

1. In a Chapter 7 case, may the unpaid balance of a promissory note issued by a solvent corporation to redeem its own stock be equitably subordinated to other unsecured claims under 11 U.S.C. § 510(c) based on the claim’s origin, even absent inequitable conduct by the claimant?
2. Does Massachusetts corporate law validating the redemption obligation prevent a bankruptcy court from subordinating the redemption-note claim in bankruptcy distributions?

## Decision

- The bankruptcy court held that the Foundation’s claim should be equitably subordinated to the claims of other general unsecured creditors under 11 U.S.C. § 510(c).
- The court rejected the Foundation’s argument that equitable subordination requires creditor misconduct in all cases; it concluded that subordination may rest on the nature and origin of the claim when equal treatment would be unfair in bankruptcy distribution.
- The court treated the redemption-note obligation as economically akin to an equity cash-out rather than value provided to the debtor as a true loan, supporting subordination behind general unsecured creditors.
- The court determined that state corporate law enforceability did not control priority in bankruptcy; federal bankruptcy distribution rules govern and can displace contrary state-law results.
- The Committee’s objection was sustained to the extent it sought subordination; the claim was allowed only in subordinated status.

## Legal Principles

- Under 11 U.S.C. § 510(c), a bankruptcy court may subordinate all or part of an allowed claim when equity requires adjustment of distribution priority.
- Equitable subordination is not confined to cases of creditor wrongdoing; depending on the circumstances, the character and source of a claim may justify subordination.
- Debt arising from a corporation’s redemption of its own stock can be treated as equity-like for distribution purposes because it functions as a payment to remove an ownership interest rather than an extension of credit that adds assets to the estate.
- Bankruptcy distribution policy generally places the residual risk of business failure on equity holders (and those claiming through an equity redemption) rather than on outside creditors.
- Federal bankruptcy law controls claim priority and distribution in bankruptcy and may override inconsistent state corporate-law treatment of redemption obligations.
- Procedural defects (such as proceeding by claim objection rather than adversary proceeding) may be disregarded when not raised by the affected party and when no factual disputes require adversary litigation.

## Conclusion

In re SPM Manufacturing Corp. holds that a claim based on a promissory note issued to redeem a corporation’s own stock may be equitably subordinated under § 510(c) to other unsecured claims, even without claimant misconduct, because the obligation functions like an equity distribution; state-law validity of the redemption note does not prevent federal bankruptcy subordination of the claim in distribution.


In re SPM Manufacturing Corp., 163 B.R. 411 (1994)