## Facts

- Kham & Nate’s Shoes No. 2, Inc. operated retail shoe stores and filed for Chapter 11 in January 1984, continuing as debtor in possession.
- First Bank of Whiting was a secured lender and issuer of letters of credit supporting transactions with the debtor’s customers.
- Prepetition, the debtor experienced sustained losses and substantial tax arrears, and the parties considered financing options to protect the Bank’s priority.
- The bankruptcy court entered an order authorizing postpetition financing with superpriority status under 11 U.S.C. § 364(c)(1).
- The debtor and the Bank executed a postpetition financing agreement providing a $300,000 line of credit; the note was payable on demand and the agreement allowed termination on five days’ notice, expressly reserving the Bank’s right to terminate financing at any time.
- The debtor drew approximately $75,000 shortly after execution; draws also occurred under letters of credit.
- The Bank notified the debtor on February 29, 1984 that it would make no further advances after March 7; it did not then demand repayment.
- The bankruptcy court treated the Bank’s termination of further advances as inequitable conduct and subordinated the Bank’s claims under 11 U.S.C. § 510(c), effectively stripping secured status under the plan.
- The confirmed plan also permitted the debtor’s principals to retain equity interests even though unsecured creditors would not be paid in full, based on the principals’ guarantees of new post-confirmation loans as asserted “new value.”
- The district court affirmed; the Bank appealed.

## Issues

1. Whether a lender’s exercise of an express contractual right to terminate future advances under a postpetition credit facility constitutes “inequitable conduct” warranting equitable subordination under 11 U.S.C. § 510(c).
2. Whether a Chapter 11 plan may allow existing equity owners to retain their interests when unsecured creditors are not paid in full, based on the owners’ personal guarantees as “new value” consistent with the absolute priority rule.

## Decision

- The Seventh Circuit held that equitable subordination was improper because the Bank acted within its contractual rights and the record did not show misconduct of the type required for § 510(c) relief.
- The court rejected the plan’s equity-retention feature because personal guarantees are not a contribution of “money or money’s worth” that can satisfy any “new value” requirement.
- The court vacated the confirmation order and remanded for further proceedings.

## Legal Principles

- Equitable subordination under 11 U.S.C. § 510(c) requires creditor misconduct that is wrongful in a bankruptcy-relevant sense (e.g., fraud, misrepresentation, overreaching, or conduct conferring an unfair advantage), not merely the creditor’s insistence on bargained-for contract terms.
- Bankruptcy courts generally may not penalize a creditor for enforcing an express termination or demand right in a financing agreement absent additional wrongful conduct.
- The absolute priority rule bars equity holders from retaining interests under a plan that does not pay senior classes (including unsecured creditors) in full unless a valid exception applies.
- A claimed “new value” contribution must be a real, quantifiable contribution to the estate—typically “money or money’s worth”; a guarantee, standing alone, does not supply such value at confirmation.

## Conclusion

The Seventh Circuit ruled that a secured lender’s termination of further advances pursuant to an explicit postpetition financing agreement was not inequitable conduct supporting equitable subordination, and that equity holders could not keep their interests over unpaid unsecured creditors based solely on personal guarantees; the plan confirmation was vacated and the case remanded.


Kham & Nate's Shoes No. 2, Inc. v. First Bank of Whiting, 908 F.2d 1351 (7th Cir. 1990)