Opinion ID: 490185
Heading Depth: 3
Heading Rank: 3

Heading: 11 U.S.C. Sec. 510(c)--Equitable Subordination

Text: 23 The Creditors alternatively argue that the district court properly subordinated the contingent indemnity claims under 11 U.S.C. Sec. 510(c)(1) which grants the bankruptcy court discretion under principles of equitable subordination, [to] subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim or all or part of an allowed interest to all or part of another allowed interest. Section 510(c)(1) codifies existing case law. H.R.Rep. No. 595, 95th Cong., 1st Sess. 359, reprinted in 1978 U.S.Code Cong. & Admin.News 5963, 6315. The bankruptcy court may subordinate a claim if it finds the claimant engaged in fraud, unfairness or inequity, In re Poole, 796 F.2d at 322, and the claimant's conduct harmed the debtor or its other creditors, Trone v. Smith (In re Westgate-California Corp.), 642 F.2d 1174, 1177-78 (9th Cir.1981). As the court exercises broad equitable power to subordinate claims, we review for an abuse of discretion. In re Poole, 796 F.2d at 321. 24 The district court subordinated all the officers' indemnity claims, even though the officers may ultimately prevail in their defense in the adversary litigation. It is beyond cavil that the court could subordinate indemnity claims of officers found liable of securities violations or fraud. Bankruptcy policy prohibits the debtor from indemnifying unsuccessful securities defendants to the prejudice of innocent creditors, at least when liability is predicated on fraud or negligence. In re Investors Funding Corp., 8 B.R. 260, 262, 264 (S.D.N.Y.1980); In re Baldwin-United Corp., 55 B.R. 885, 902-03 (Bankr.S.D.Ohio 1985) (no indemnity from debtor for securities violations based on fraud or negligence); In re Equity Funding Corp., 416 F.Supp. 132, 156 (C.D.Cal.1975) (same). Here, the officers have been sued for fraud and for violations of a California securities law, which requires that the defendant knew or should have known of the failure to register the security, Cal.Corp.Code Sec. 25504; see Christian Life, 45 B.R. at 910-11; Tomei v. Fairline Feeding Corp., 67 Cal.App.3d 394, 400-01, 137 Cal.Rptr. 656, 659 (1977). If the officers are ultimately found liable for negligence or fraud under either of these theories, innocent creditors should not have to reimburse them for liability or defense expenses. 25 The more difficult question is whether the district court properly subordinated indemnity claims for defense expenses of officers who ultimately may prevail in their defense. The Creditors contend that the court properly exercised its discretion to subordinate all claims of indemnity of former officers of the church, even of those who ultimately may prevail, in light of the officers' inequitable conduct in establishing and maintaining the trust fund. The court, however, failed to make any findings of improper or wrongful conduct by the officers and cited no equitable reasons to justify the subordination order. The court did not find that Argue or the remaining officers knew or should have known that the trust fund was required to be registered or that the trust fund had insufficient assets to cover liabilities. When a creditor seeks equitable subordination of a claim, the record must objectively disclose a threshold demonstration that the claimant has behaved inequitably and to the detriment of the debtor or its other creditors. Westgate-California Corp. v. First Nat. Finance Corp., 650 F.2d 1040, 1044 n. 1 (9th Cir.1981). Absent findings of the requisite inequitable and harmful conduct by the officers or of a sufficiently developed record, subordination of all indemnity claims of officers based on equitable subordination is premature. See id. at 1044 (premature to subordinate claim absent findings or a sufficient record).