## Facts

- O’Day Corporation, a fiberglass sailboat manufacturer, became the subject of an involuntary Chapter 7 case after ceasing operations.
- Harold B. Murphy was appointed Chapter 7 trustee and filed an adversary proceeding against Meritor Savings Bank, the lender that financed an LBO involving O’Day.
- The LBO was structured so that new loan proceeds were used largely to pay out the controlling shareholder, while O’Day granted Meritor security interests in substantially all assets.
- After the transaction, O’Day retained only a nominal amount of value (reported as $1,344), leaving little working capital.
- The trustee sought to avoid Meritor’s liens and security interests as fraudulent conveyances under Massachusetts fraudulent conveyance law via 11 U.S.C. § 544(b), arguing lack of fair consideration and that the LBO left O’Day insolvent or with unreasonably small capital.
- The trustee also sought equitable subordination of Meritor’s unsecured claim under 11 U.S.C. § 510(c), alleging overreaching conduct in the transaction’s structuring and aftermath.

## Issues

1. Whether O’Day’s grant of liens and security interests to the LBO lender was avoidable as a fraudulent conveyance due to lack of fair consideration and because the transaction left O’Day insolvent or with unreasonably small capital.
2. Whether the LBO’s multiple steps should be treated as a single integrated transaction when assessing consideration and capital adequacy.
3. Whether the lender’s conduct justified equitable subordination of its unsecured claim under 11 U.S.C. § 510(c).

## Decision

- The court avoided substantial portions of Meritor’s LBO-related liens and security interests as fraudulent conveyances.
- The court treated the LBO steps as one integrated transaction, emphasizing substance over form where parties understood and implemented the overall structure.
- The court denied equitable subordination of Meritor’s remaining unsecured claim, finding the showing of inequitable conduct insufficient to reorder unsecured priority.

## Legal Principles

- Under Massachusetts fraudulent conveyance law (as invoked through 11 U.S.C. § 544(b)), transfers and obligations may be avoided when the debtor does not receive fair consideration and is left insolvent or with unreasonably small capital.
- In assessing an LBO, a court may “collapse” formally separate steps and evaluate the economic substance as a single transaction when the participants knowingly structured and executed the integrated deal.
- “Unreasonably small capital” is a forward-looking financial condition that can exist short of inability to pay debts as they mature or balance-sheet insolvency, and it focuses on whether the capital structure was likely to lead to insolvency.
- Capital adequacy analysis examines the prudence of projections and other contemporaneous indicators of working-capital sufficiency, without relying on hindsight from later failure.
- Equitable subordination under 11 U.S.C. § 510(c) requires inequitable conduct causing creditor injury or unfair advantage, and must be consistent with bankruptcy distribution policy; avoidance of liens as fraudulent transfers does not, by itself, establish grounds to subordinate an unsecured claim.

## Conclusion

The court set aside significant LBO-related security interests because O’Day received inadequate value and was left with unreasonably small capital when the transaction was analyzed as an integrated whole, but it refused to subordinate the lender’s unsecured claim absent the level of inequitable conduct required by § 510(c).


Murphy v. Meritor Sav. Bank (In re O'Day Corp.), 126 B.R. 370 (Bankr. D. Mass. 1991)