Panache Development & Construction, Inc. et al v. Romspen Mortgage Limited Partnership et al

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IN THE UNITED STATES BANKRUPTCY COURT
FOR THE WESTERN DISTRICT OF TEXAS
AUSTIN DIVISION
In re:
RIC (AUSTIN), LLC,
Debtor.
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Case No. 24-10264-cgb
Chapter 11
PANACHE DEVELOPMENT &
CONSTRUCTION, INC., et al.,
Plaintiffs and Counter-Defendants,
v.
ROMSPEN MORTGAGE, LP,
ROMSPEN (REOMASTER)
HOLDINGS, INC.,
Defendants and Counter-Plaintiffs.
v.
Adam Zarafshani, an individual,
Third-Party Defendant.
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Adv. No. 24-01061-cgb
OPINION ON STANDING OF A CREDITOR TO SEEK
RECHARACTERIZATION AND EQUITABLE SUBORDINATION
Dated: September 30, 2026.
__________________________________
CHRISTOPHER G. BRADLEY
UNITED STATES BANKRUPTCY JUDGE
________________________________________________________________
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Introduction
In this opinion, the Court considers the defendants’ argument that individual
creditors generally lack standing to bring recharacterization and equitable
subordination causes of action in a bankruptcy case. The Court holds that this
argument is incorrect.
Every creditor has standing to seek recharacterization of another (purported)
creditor’s claim. Recharacterization is the court’s determination that a purported
claim should not be allowed as a claim (that is, a debt) but instead must be treated
as an equity interest. Bringing a recharacterization action is essentially a form of
claim objection. Any party in interest, including any creditor, may object to a claim
and may also seek recharacterization.
As for equitable subordination, this Court holds that any creditor may seek to
equitably subordinate another creditor’s claim. While courts divide on this issue, this
Court concludes that both text and logic lead to this conclusion. The Court also
explains why the policy concerns that have motivated some courts to hold otherwise
do not stand up to scrutiny.
In addition, at least some of what is alleged in this case involves the plaintiffs’
particularized injury. Courts appear unanimous in the conclusion that a creditor who
has a special interest that will be served, or has suffered a particularized injury that
could be remedied, has standing to seek equitable subordination. This opinion
explains the Court’s view that the particularized injury test in both a strict and a
broader form does not ultimately provide a practicable or coherent way of
determining standing. But, if either version of the test were applied here, the
plaintiffs’ alleged particularized injury would likely give them standing to seek at
least some of the relief at issue here.
Finally, the plaintiffs here would be eligible to obtain derivative standing. The
Court would grant derivative standing to the plaintiffs and accordingly hold that they
had standing to pursue equitable subordination. The estate has essentially no funding
that has not been provided by the defendants or their affiliates and is subject to a
strict budget that does not include expensive litigation. For these and other reasons
discussed below, the estate is not well-positioned to pursue this litigation.
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Procedural Background1
Plaintiffs and Counter-Defendants Panache Development & Construction,
Inc. (“Panache”), AFMN Investments, LLC (“AFMN”), and Vesta Texas, LLC
(“Vesta Texas”) (collectively the “Panache Parties” or “Plaintiffs”) filed this
adversary proceeding on November 4, 2024, seeking various forms of relief,
including recharacterization and equitable subordination of claims filed by Romspen
Mortgage Limited Partnership (“Romspen”) and Romspen (Reomaster) Holdings
Inc. (“Reomaster”) (collectively the “Romspen Parties”).2 At this time, the operative
claims between the parties are contained in the Plaintiffs’ Second Amended
Complaint for Declaratory Relief and Combined Claim Objection (the “Second
Amended Complaint”) 3 and Romspen Mortgage Limited Partnership’s First
Amended Counterclaims and Third-Party Claims (the “Counterclaims”).4
On February 20, 2026, the Romspen Parties filed their Motion for Partial
Summary Judgment (the “Motion”).5 On March 13, 2026, the Panache Parties filed
their Response and Objection to Romspen Mortgage Limited Partnership and
Romspen (Reomaster) Holdings Inc.’s Motion for Partial Summary Judgment (the
“Response”). 6 On March 20, 2026, the Romspen Parties filed their Romspen
Mortgage Limited Partnership and Romspen (Reomaster) Holdings Inc.’s Reply in
Support of Motion for Partial Summary Judgment (the “Reply”).7
In relevant part, the Motion seeks entry of a summary judgment dismissing
Counts One and Two of the Second Amended Complaint—which seek
recharacterization and equitable subordination of the Romspen Parties’ claims—
because the Plaintiffs lack standing to pursue those causes of action.8 The Court held
1 For the sake of brevity, the Court limits the procedural history and facts to those that are relevant
to the Panache Parties’ standing to seek recharacterization and equitable subordination of the
Romspen Parties’ claims.
2 Panache v. Romspen (In re RIC (Austin), LLC), Adv. No. 24-01061, ECF No. 1 (the “Adversary
Proceeding”).
3 Adversary Proceeding, ECF No. 54-1 (the Second Amended Complaint is attached as Exhibit A
to the Panache Parties’ Motion for Leave to File Second Amended Complaint).
4 Adversary Proceeding, ECF No. 30 (Romspen Counterclaims and Third-Party Claims).
5 Adversary Proceeding, ECF No. 139 (Romspen Motion for Partial Summary Judgment).
6 Adversary Proceeding, ECF No. 147 (Response and Objection to Romspen Motion for Partial
Summary Judgment).
7 Adversary Proceeding, ECF No. 150 (Reply in Support of Motion for Partial Summary
Judgment).
8 Adversary Proceeding, ECF No. 139 (during the briefing process and at the April 2, 2026, hearing,
the Panache Parties withdrew Counts Four and Five of the Second Amended Complaint).
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a hearing on the Motion on April 2, 2026.9 At the conclusion of the hearing, the
Court took the standing argument under advisement and denied all other relief
requested in the Motion. Therefore, this opinion is limited to the standing question.
As the relief requested in this adversary proceeding could affect the plan
proposed in the main bankruptcy case, the Court set a combined trial of this
proceeding and the hearing on confirmation of the debtor’s plan of reorganization.10
The Court held that hearing and trial and has provided an opinion on the underlying
merits of this adversary proceeding as well as on plan confirmation, finding in favor
of the Romspen Parties and the Debtor on most relevant issues.11
As stated in the trial opinion, the Court decided that although they were
unsuccessful on the merits, the Plaintiffs did indeed have standing to assert the
claims. But the Court wished to explain that standing ruling separately (particularly
because there was time pressure to issue an opinion on the issues determined at trial,
and this opinion was not ready). This opinion now provides the explanation.
Jurisdiction
The district court has jurisdiction over this proceeding under 28 U.S.C.
§ 1334(b). Under 28 U.S.C. § 157(a), the district court has referred the underlying
case and this proceeding to this Court.12 These claims are core matters under 28
U.S.C. § 157(b)(1) and (2)(B), (K), and (O) that the Court is statutorily authorized
to hear and determine. Because they are part of the claims allowance process, the
Court has constitutional authority to determine them.13
Further, to the extent that any of the matters described herein are instead
“related to” proceedings or would otherwise be beyond the final adjudicatory
9 At the hearing, the Court also considered a motion for partial summary judgment filed by the
Panache Parties and third-party defendant Adam Zarafshani at ECF No. 147 in the Adversary
Proceeding, which the Court denied in its entirety.
10 Adversary Proceeding, ECF No. 134 (Fourth Agreed Amended Scheduling Order, setting trial
of the adversary proceeding to begin on April 22, 2026); In re RIC (Austin), No. 24-10264 (the
“Main Case”), ECF No. 301 (Scheduling Order setting the hearing on confirmation of the Debtor’s
plan to begin on April 22, 2026).
11 Adversary Proceeding, ECF No. 207 (Combined Opinion on Plan Confirmation and Adversary
Proceeding).
12 Order #1301, Order of Reference of Bankruptcy Cases and Proceedings (W.D. Tex. Oct. 4,
2013).
13 Stern v. Marshall, 564 U.S. 462, 499 (2011).
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authority of this Court, the Panache Parties, Romspen Parties, and Third-Party
Defendant Adam Zarafshani have all consented to entry of final orders by the
Bankruptcy Court.14
Factual Background
This adversary proceeding involves the tortured history of a large commercial
redevelopment project (the “Project”) on the east side of Austin, Texas, that spanned
not one, but two chapter 11 bankruptcy cases.15 The first case, In re 3443 Zen
Garden, LP, was filed as an involuntary petition in March of 2020 and was later
converted to a voluntary case under chapter 11 (the “Zen Garden Case”).16 In that
case, Romspen, the senior lender, filed a secured claim for over $96 million.17
Panache, the general contractor for the project, filed a claim for over $11.8 million,
which included a secured claim of over $5 million.18
During the Zen Garden Case, Panache and several other creditors filed an
adversary proceeding seeking equitable subordination of Romspen’s claim and the
limitation of Romspen’s credit bid rights in an upcoming sale of the Project.19
Ultimately, Romspen and Panache settled their dispute and Romspen credit bid
$45 million of its claim to purchase the Project.20
As part of the settlement, on October 19, 2020, Panache and Romspen entered
into a binding term sheet (the “Binding Term Sheet”) that led to creation of RIC
(Austin) (the “Debtor”), the debtor in the current bankruptcy case.21 In the Binding
Term Sheet, the parties split ownership but agreed that Romspen would have
14 Adversary Proceeding, ECF No. 181, Amended Proposed Pre-Trial Order, (“[t]he Parties have
agreed to the entry of final orders and judgment by the Bankruptcy Court.”). See also Wellness
Int’l Network, Ltd. v. Sharif, 575 U.S. 665, 671 (2015) (holding that a bankruptcy court has
authority to enter orders and judgments in non-core proceedings with the consent of all parties to
the proceeding).
15 Main Case (filed on March 12, 2024, by Panache as an involuntary chapter 7 case and later
converted to a voluntary chapter 11 case); In re 3443 Zen Garden, LP, No. 20-10410 (plan
confirmed on January 27, 2021, and closed on August 23, 2022).
16 In re 3443 Zen Garden, LP, No. 20-10410, Notice of Consent, ECF No. 10.
17 Id., Claim No. 14-1.
18 Id., Claim No. 22-1.
19 Austin Glass & Mirror, Inc. v. Romspen Mortg. Ltd. P’ship (In re 3443 Zen Garden, LP), No.
20-01048, ECF No. 1.
20 In re 3443 Zen Garden, LP, No. 20-10410, ECF No. 278 (order authorizing sale of the Project
to Romspen).
21 Adversary Proceeding, ECF No. 139, Ex. I (Romspen Motion for Summary Judgment).
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ultimate control and decision-making authority for the Debtor.22 In keeping with this
structure, the Debtor was formed and took ownership of the Project.23 Around the
same time, Romspen formed Reomaster to hold its 75% equity interest and Panache
formed Vesta Texas to hold its 25% equity interest in the Debtor.24
A few months after execution of the Binding Term Sheet, Romspen agreed to
provide the Debtor with up to $125 million in financing, and AFMN (another
affiliate of Zarafshani) entered into a promissory note with the Debtor for about
$11.05 million.25 The promissory note memorialized the Debtor’s assumption of the
Panache deficiency claim from the Zen Garden Case.26 Several years later, AFMN
signed a subordination agreement wherein AFMN agreed to subordinate its claim to
Romspen’s claims, among many other things (the “Subordination Agreement”).27
Unfortunately, after the truce reached in the prior bankruptcy case, disputes
between the parties re-emerged, culminating in Panache filing an involuntary
petition against RIC (Austin) and commencing this bankruptcy case28 and adversary
proceeding. 29 After the RIC (Austin) involuntary petition was converted to a
voluntary petition under chapter 11, Peter Oelbaum, acting as Manager for
Reomaster, engaged Gregory S. Milligan with Harney Partners to serve as Chief
Restructuring Officer for the Debtor.30
In this adversary proceeding, the Plaintiffs contend that Romspen
intentionally destabilized the Debtor in an effort to eliminate the Panache Parties’
minority interests.31 They ask the Court to recharacterize Romspen’s claims from
22 Adversary Proceeding, ECF No. 139, Ex. I ¶ 6 (Romspen Motion for Summary Judgment).
23 Id., pg. 7 (Romspen Motion for Summary Judgment).
24 Id., pg. 7 (Romspen Motion for Summary Judgment).
25 Id., Ex. K (Romspen proof of claim attaching Loan Agreement with RIC (Austin) dated
12/2/20); Ex. L (promissory note between AFMN and the Debtor); Main Case, ECF No. 331 ¶ 12
(Brief in Support of Confirmation).
26 Adversary Proceeding, ECF No. 139, Ex. K; Ex. L; Main Case, ECF No. 331 ¶ 12 (Brief in
Support of Confirmation).
27 Adversary Proceeding, ECF No. 139, Ex. N (Romspen Motion for Summary Judgment). In
many respects, the Subordination Agreement appears merely to memorialize agreements already
made, including in the Binding Term Sheet, and the sentence in the text above is not intended to
suggest otherwise.
28 Main Case, ECF 1 (Involuntary Petition, filed March 12, 2024).
29 Adversary Proceeding, ECF No. 1 (Complaint, filed Nov. 4, 2024).
30 Main Case, ECF 59-3 (Engagement Letter).
31 Adversary Proceeding, ECF No. 54-1 ¶ 1 (Second Amended Complaint).
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secured claims to equity.32 Alternatively, the Plaintiffs ask the Court to equitably
subordinate the Romspen claims to those of all other holders of allowed claims (of
which they are the largest).33 In the Second Amended Complaint and in the Response
to the Motion, the Plaintiffs allege, among other things, that Romspen deliberately
undermined the Project to gain control and improve its repayment position, which
directly injured other stakeholders, including the Panache Parties.34
In its plan of reorganization, the Debtor proposes to sell new membership
interests in the Debtor to the winner of an equity action and to use the proceeds to
fund the plan and one year of operating expenses for the reorganized debtor.35
Reomaster subsequently won the equity auction with a $5.4 million stalking horse
bid.36 The plan also provides that, subject to this adversary proceeding, Romspen’s
first lien claim will be allowed in the total amount of approximately $114 million.37
Of that amount, $34.5 million (the current value of the collateral) would be allowed
as secured claim, junior only to Romspen’s approximately $4.9 million
administrative expense claim for debtor-in-possession financing and a partially
allowed secured claim for county taxes.38 The remaining claims against the Debtor
are treated as unsecured because the current value of its property ($34.5 million) is
insufficient to pay more senior secured claims in full. Thus, Romspen’s $99.7
million second lien claim would be allowed as unsecured, subject to this adversary
proceeding.39 And AFMN’s claim, as well as Panache’s claim for its work on the
32 Id., ¶¶ 119-124 (Second Amended Complaint).
33 Id., ¶¶ 119-124 (Second Amended Complaint).
34 Adversary Proceeding, ECF No. 54-1 ¶¶ 58, 77, 122, 132, 142 (Second Amended Complaint);
Adversary Proceeding, ECF No. 147, p. 14 (Response and Objection to Romspen Motion for
Summary Judgment) (“Plaintiffs allege that Romspen manipulated the capital structure and
priority scheme to enhance its own recovery position while subordinating or eliminating the
economic interests of junior creditors and equity holders. (Doc. 54-1, ¶¶ 58, 77). That alleged harm
is not merely a decline in enterprise value. Counts One and Two seek recharacterization and
equitable subordination of Romspen’s claims relative to Plaintiffs’ own recovery positions. If
Romspen’s claims are recharacterized or subordinated, Plaintiffs’ recoveries increase. That is a
direct economic injury—not a derivative injury belonging to the estate.”).
35 Main Case, ECF No. 288 (Debtor’s Combined Disclosure Statement and Second Amended Plan
of Reorganization).
36 Main Case, ECF No. 288 (Debtor’s Combined Disclosure Statement and Second Amended Plan
of Reorganization); ECF No. 331 ¶ 25 (Brief/Memorandum of Law in Support of Confirmation).
37 Main Case, ECF No. 288, p. 8 (Plan treatment of Class 1).
38 Id., p. 8 (Plan treatment of Class 1). Notably, because Romspen made the election as was its
right under § 1111(b) of the Bankruptcy Code, ECF No. 122, the entirety of this claim will be
treated as secured and Romspen retains its lien until this claim is paid in full.
39 Main Case, ECF 288, the Combined Disclosure Statement and Second Amended Chapter 11
Plan, p. 8 (Plan treatment of Class 2).
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project and for attorney’s fees, both of which were filed as secured claims, would be
treated (so far as they are ultimately allowed) as unsecured claims.40
Summary Judgment Standard
This opinion resolves an issue of law. Summary judgment is to be granted “if
the movant shows that there is no genuine dispute as to any material fact and the
movant is entitled to judgment as a matter of law.”30 A fact is material if it “might
affect the outcome of the suit under the governing law.”31 This standard of review
does not merely ask the court to determine “whether there is a sufficient factual
dispute to permit the case to go forward, but whether a rational trier of fact could
find for the non-moving party based upon the record evidence before the
court.”32 To defeat a motion for summary judgment, “the non-movant must go
beyond the pleadings and come forward with specific facts indicating a genuine issue
for trial.”33 In determining a summary judgment motion, all facts and evidence must
be taken in the light most favorable to the non-movant.34
Analysis
Recharacterization and equitable subordination are powerful and
extraordinary equitable remedies that adjust the status of allowed claims.
Recharacterization allows a court to recharacterize a claim as equity, instead
of debt. 41 The power to recharacterize debt as equity is not expressly in the
Bankruptcy Code, but the Fifth Circuit recognizes the power to recharacterize as
deriving from the Bankruptcy Code’s requirement that a court evaluate and allow
40 Main Case, ECF 288, the Combined Disclosure Statement and Second Amended Chapter 11
Plan, p. 9 (Plan treatment of Class 3 and 4); Claim Nos. 4-1, 5-1.
41 Grossman v. Lothian Oil Inc. (In re Lothian Oil Inc.), 650 F.3d 539, 544 (5th Cir. 2011). Some
factors courts apply to determine whether debt should be recharacterized as equity include: “(1)
the names given to the instruments, if any, evidencing the indebtedness; (2) the presence or absence
of a fixed maturity date and schedule of payments; (3) the presence or absence of a fixed rate of
interest and interest payments; (4) the source of repayments; (5) the adequacy or inadequacy of
capitalization; (6) the identity of interest between the creditor and the stockholder; (7) the security,
if any, for the advances; (8) the corporation’s ability to obtain financing from outside lending
institutions; (9) the extent to which the advances were subordinated to the claims of outside
creditors; (10) the extent to which the advances were used to acquire capital assets; and (11) the
presence or absence of a sinking fund to provide repayments.” Seidel v. Neugebauer (In re With
Purpose, Inc.), No. 24-03038, 2025 WL 1698694, at *80-81 (Bankr. N.D. Tex. Jun. 16, 2025)
(quoting Bayer Corp. v. MascoTech, Inc. (In re AutoStyle Plastics, Inc.), 269 F.3d 726, 750 (6th
Cir. 2001)).
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claims and interests in the estate under applicable law. 42 In other words,
recharacterization is almost always a consideration of whether a particular purported
claim would be treated as debt or equity under state law. Under this view, while not
expressly mentioned in the Bankruptcy Code itself, the power to recharacterize is
inherent in the power to consider whether to deny or allow claims against the estate.43
The Bankruptcy Code provides for subordination of one claim to another on
both contractual44 and equitable grounds.45 Equitable subordination is at issue in this
adversary proceeding. The bankruptcy court may subordinate, “under principles of
equitable subordination . . . all or part of an allowed claim to all or part of another
allowed claim.”46 The “principles of equitable subordination” have been worked out
in a lengthy history of case law and can be distilled as follows: “[E]quitable
subordination is appropriate when (1) the claimant engaged in inequitable conduct;
(2) the misconduct resulted in harm to the debtor’s other creditors or conferred an
unfair advantage on the claimant; and (3) equitable subordination is not inconsistent
with the Bankruptcy Code.” 47
The question here is whether the Panache Parties, as creditors, have standing
to seek either the recharacterization of Romspen’s claims or the equitable
subordination of those claims.
To be clear, the question turns on what is sometimes termed “statutory” or
“prudential” standing and not what is termed “constitutional” (or “Article III” or
“injury-in-fact”) standing.48 Constitutional standing is not challenged here and is
present. There is a live controversy between the parties, and the Panache Parties
42 In re Lothian Oil Inc., 650 F.3d at 543.
43 In re Lothian Oil Inc., 650 F.3d at542 (“We conclude that recharacterization extends beyond
insiders and is part of the bankruptcy courts’ authority to allow and disallow claims under 11 U.S.C.
§ 502.”).
44 11 U.S.C. § 510(a).
45 11 U.S.C. § 510(c).
46 Id.
47 Life Partners Creditor’s Trust v. Cowley (In re Life Partners Holdings, Inc.), 926 F.3d 103, 122
(5th Cir. 2019) (citing [SI Restructuring, Inc.] v. Faulkner (In re SI Restructuring, Inc.), 532 F.3d
355, 360 (5th Cir. 2008)).
48 See generally Cibolo Waste, Inc. v. City of San Antonio, 718 F.3d 469, 473 (5th Cir. 2013)
(distinguishing between Article III standing, enforcing the constitutional requirement that courts
determine cases and controversies, and prudential standing, the “judicially self-imposed limits on
the exercise of federal jurisdiction.” (quoting Elk Grove Unified Sch. Dist. v. Newdow, 542 U.S.
1, 11 (2004))).
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would benefit from the successful prosecution of their claims against Romspen.49
Successful prosecution would give them greater rights in, and/or money payouts
from, this bankruptcy estate.50
The issue, then, before the Court is a question of statutory standing, which
embodies “judicially self-imposed limits on the exercise of federal jurisdiction.”51
Prudential standing encompasses, “the general prohibition on a litigant’s raising
another person’s legal rights, the rule barring adjudication of generalized grievances
more appropriately addressed in the representative branches, and the requirement
that a plaintiff’s complaint fall within the zone of interests protected by the law
invoked.” 52 The prong of prudential standing most relevant here is that which
“encompasses ‘the general prohibition on a litigant’s raising another person’s legal
rights.’”53
The Court will first analyze the Panache Parties’ prudential standing to bring
this recharacterization action and then turn to equitable subordination.
A. Creditors have statutory or prudential standing to bring
recharacterization actions because they are a form of claim objection.
Recharacterization can be sought by any creditor because it is a form of claim
objection. Claim objections can be brought by any party in interest. Creditors are
parties in interest, therefore any creditor can seek recharacterization. Fifth Circuit
law supports this straightforward syllogism.
Fifth Circuit law supports the first step in the syllogism, grounding the
recharacterization power in the power to deny or allow claims.54 In its seminal case,
Lothian Oil, the Fifth Circuit provides a short but lucid opinion explaining that
recharacterization is merely another way in which our bankruptcy law honors our
federalist constitutional structure by giving power to state law entitlements.55 The
49 Elk Grove Unified Sch. Dist., 542 U.S. at 11.
50 See, e.g., Elswick Co., LLC v. Comm2013 CCRE12 Crossing Mall Rd. LLC (In re Tara Retail
Grp., LLC), 595 B.R. 215, 221 (Bankr. N.D.W. Va. 2018) (explaining why constitutional standing
is present under similar circumstances).
51 Cibolo Waste, Inc., 718 F.3d at 474 (quoting Elk Grove Unified Sch. Dist., 542 U.S. at 11).
52 Elk Grove Unified Sch. Dist., 542 U.S. at 12 (2004) (quoting Allen v. Wright, 468 U.S. 737, 751
(1984)).
53 Elk Grove Unified Sch. Dist., 542 U.S. at 12 (quoting Allen v. Wright, 468 at 751 (1984)).
54 Grossman v. Lothian Oil Inc. (In re Lothian Oil Inc.), 650 F.3d 539, 543 (5th Cir. 2011).
55 In re Lothian Oil Inc., 650 F.3d at 543.
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Supreme Court’s Butner opinion recognized this principle most prominently,56 but
this structure underlies the entirety of bankruptcy law. Recharacterization is an
important tool in the claims allowance process to ensure that the bankruptcy court is
properly prioritizing claims and recognizing rights under state law. If a party has
invested in the debtor in such a way that the investment, despite being cloaked or
claimed as debt, would in fact be legally characterized as an equity interest under
governing state law, it would offend the Butner principle for a bankruptcy court to
treat it as a valid debt claim. Thus, a bankruptcy court should recharacterize it as
equity—in essence, denying it as a “claim” and recognizing it as merely the
“interest” that it would be outside of bankruptcy.57
The second and third steps of the syllogism are even more straightforward.
The Code expressly permits any party in interest to object to a claim.58 Creditors
such as the Panache Parties are defined as parties in interest in Chapter 11 cases.59
Thus, creditors such as the Panache Parties have statutory standing to assert
recharacterization claims.60
56 Butner v. United States, 440 U.S. 48, 54 (1979) (“Congress has generally left the determination
of property rights in the assets of a bankrupt’s estate to state law.”).
57 Elswick Co., LLC v. Comm2013 CCRE12 Crossing Mall Rd. LLC (In re Tara Retail Grp., LLC),
595 B.R. 215, 222 (Bankr. N.D.W. Va. 2018) (“[R]echaracterization . . . is essentially an objection
to a claim on the basis that it is an equity interest.”); Official Comm. of Unsecured Creditors of
Russell Cave Co. v. Gen. Elec. Cap. Corp. (In re Russell Cave. Co.), 107 F. App’x 449, 451 (6th
Cir. 2004) (recharacterization is “a request for the bankruptcy court to hold a debt, and hence any
claim, is non-existent”).
58 11 U.S.C. § 502(a). See also Fed. R. Bankr. P. 3007 advisory committee’s note to 1983
amendment (noting that while a trustee often has a duty to do so, “any party in interest may object
to a claim”).
59 11 U.S.C. § 1109(b).
60 It does not change the analysis whether the claim allegedly subject to recharacterization is a
secured claim, as is the case here. Main Case, Claim No. 6-3. It may arguably mean that the
recharacterization claim must be brought as an adversary proceeding. Fed. R. Bankr. P. 7001(h).
If so, that requirement of course was met here. The better answer, though, is that it is permissible
but not necessary to seek recharacterization of a claim through an adversary proceeding. The Court
may order similar procedural protections in a contested matter under Fed. R. Bankr. P. 3007(b)
and 9014(c), when the point of the proceeding is merely to disallow the claim and not seek any
affirmative relief). See In re McCowan, No. 09-10347, 2018 WL 4056991 at *5 (Bankr. E.D.N.C.
Aug. 24, 2018) (“An adversary proceeding is not required to contest secured status asserted in a
proof of claim.”).
However, even if 7001 is applicable and an adversary proceeding is required, any creditor
has the right to bring the proceeding. Creditors regularly object to claims. They have standing to
do that, including if the objection will de facto mean the creditor receives nothing on account of
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Some courts differ from the approach explained by the Fifth Circuit and
applied here. In the Fourth and Sixth Circuits, for example, courts look to the
Bankruptcy Code’s general § 105(a) power to authorize recharacterization.61 Under
that approach, recharacterization is held to be part of the bankruptcy court’s
equitable power to implement the Bankruptcy Code’s priority scheme. 62 This
approach to recharacterization might well lead to the same answer; but because it is
not applicable here in the Fifth Circuit or in jurisdictions that adopt the same
analysis,63 this Court will not consider it further.
B. Creditors generally have standing to bring equitable subordination
actions.
In bankruptcies, courts often struggle with whether a particular action, such
as a veil-piercing action or breach of fiduciary duty claim, can be brought against a
third party by an individual creditor or whether it falls within the exclusive control
of the trustee in bankruptcy.64 Largely in accord with other circuits,65 the Fifth
Circuit has provided a series of nuanced analyses of this sometimes-difficult
distinction (although none directly about equitable subordination).66 The case law
has emphasized three points:
its alleged lien. Creditors also regularly bring actions to determine lien status or priority. The Court
does not here opine on whether all creditors always have standing to do so; the Court will merely
observe that where they would directly benefit from the successful prosecution of such an action,
they likely have a right to challenge lien status or priority. This result is both analytically sound
for the reasons set forth in section C below, as well as confirmed by this Court’s observation of
common practice.
61 Bayer Corp. v. MascoTech, Inc. (In re AutoStyle Plastics, Inc.), 269 F.3d 726, 47–53 (6th Cir.
2001); Fairchild Dornier GMBH v. Official Comm. of Unsecured Creditors (In re Dornier
Aviation (N. Am.), Inc.), 453 F.3d 225, 233–34 (4th Cir. 2006).
62 In re Dornier Aviation (N. Am.), Inc., 453 F.3d at 233.
63 See, e.g., Official Comm. of Unsecured Creditors v. Hancock Park Cap. II, L.P. (In re Fitness
Holdings Int’l, Inc.), 714 F.3d 1141, 1149 (9th Cir. 2013).
64 Schimmelpenninck v. Byrne (In re Schimmelpenninck), 183 F.3d 347, 350 (5th Cir. 1999)
(holding that veil-piercing causes of action belonged to the debtor and were property of the estate);
SI Restructuring, Inc. v. Faulkner (In re SI Restructuring, Inc.), 532 F.3d 355, 360 (5th Cir. 2008)
(requiring a showing of actual harm to equitably subordinate a claim for breach of fiduciary duty).
65 See, e.g., Matter of Vitreous Steel Prods. Co., 911 F.2d 1223, 1231 (7th Cir. 1990).
66 In re SI Restructuring, Inc., 532 F.3d at 360; Meridian Cap. CIS Fund v. Burton (In re Buccaneer
Res., LLC), 912 F.3d 291, 296 (5th Cir. 2019) (holding that a tortious interference “claim” that did
not derive from harm to the debtor belonged to the debtor’s former CEO asserting the claim);
Highland Cap. Mgmt. LP v. Chesapeake Energy Corp. (In re Seven Seas Petroleum, Inc.), 522
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(1) the automatic stay applies to a cause of action that
under state (or federal) law belongs to the debtor, or
(2) the automatic stay applies to a cause of action that
seeks to recover property of the estate when the property
is held or controlled by a person or entity other than the
debtor, and
(3) in applying the above rules, a court must keep in mind
the general bankruptcy policies of securing and preserving
the debtor’s property and ensuring equal distribution of the
debtor’s assets to similarly-situated creditors.67
All three of these points are helpful in illustrating why, in this Court’s view, and
despite the division in the case law,68 the automatic stay should not apply to bar an
F.3d 575, 587 (5th Cir. 2008) (holding that conspiracy and fraud claims were not derivative of
harm to the debtor and so did not belong to the bankruptcy estate); Packer v. Athol Packer (In re
Athol Packer), 816 F.3d 87, 91-92 (5th Cir. 2016) (holding that alter ego and reverse veil-piercing
claims belonged to the estate); Segerstrom v. Segerstrom (In re Segerstrom), 247 F.3d 218, 224
(5th Cir. 2001) (holding that malpractice cause of action was property of the bankruptcy estate);
In re Schimmelpenninck, 183 F.3d at 358 (holding that corporate veil-piercing causes of action
belonged to the debtor); Educators Grp. Health Trust v. Wright (In re Educators Grp. Health
Trust), 25 F.3d 1281, 1285-86 (5th Cir. 1994) (holding that claims relating to mismanagement of
the debtor were property of the bankruptcy estate but that other claims for fraud, conspiracy to
commit fraud, and misrepresentation, belonged to the school districts who obtained health benefits
from the debtor).
67 In re Schimmelpenninck, 183 F.3d at 355.
68 In accord with this Court’s view in favor of creditor standing, the best authority is Bunch v. J.M.
Cap. Fin., Ltd. (In re Hoffinger Indus., Inc.), 327 B.R. 389, 394 (Bankr. E.D. Ark. 2005). A major
authority against creditor standing is Miller v. Elway (In re Elrod Holdings Corp.), 392 B.R. 110,
115 (Bankr. D. Del. 2008) (Shannon, J.) (holding a cause of action to equitably subordinate another
creditor’s claim is property of the estate and may only be brought by the trustee unless the creditor
seeking to bring such claim demonstrates that they suffered a particularized injury due to the
allegedly inequitable conduct). Judge Shannon, and other courts holding that a cause of action
seeking equitable subordination is property of the estate, look to whether the “injury,” that is the
alleged inequity, was “general,” in the sense that it was suffered by the estate, or whether it was
“particularized” to the creditor. This opinion elsewhere challenges the particularized injury test,
suggesting that it is not analytically coherent. See section C below. See also In re Seven Seas
Petroleum, Inc., 522 F.3d at 588 (5th Cir. 2008) (explaining that the labels of a general or
particularized injury are not very helpful in determining who has the right to bring the cause of
action, but rather serve as useful descriptors after the court has already completed the analysis to
determine who may assert the claim).
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equitable subordination action nor should the debtor or trustee have the exclusive
right to bring such action.
First, because equitable subordination claims in bankruptcy are creatures of
federal law, we look there for any indication that such claims “belong” to the
bankruptcy estate. The Code provides no such indication. Instead, like various other
actions such as objections to claim, lien challenges, and a wide variety of other issues
that can be raised by any party in interest to a bankruptcy, equitable subordination
does not appear limited to the debtor or trustee but can generally be sought by any
creditor.69
Second, equitable subordination does not seek to “recover” anything,
including any property of the estate, because at most, all it does is change the order
of distribution among the different claimants to estate property. Third, relatedly,
allowing a wide variety of parties to bring equitable subordination claims does not
unsettle the Code’s distributive priorities by allowing one creditor to arrogate more
to itself. To the contrary, it is a method, blessed by the Bankruptcy Code itself, of
vindicating appropriate priorities in the distributions from the estate.
The following sections elaborate why neither the text, the logic, nor the
policies underlying the Bankruptcy Code support restricting individual creditors
from seeking equitable subordination. Section 1 argues neither the text nor the logic
of the Code support restricting individual creditors from seeking equitable
subordination. Section 2 shows that the policy concerns animating cases that deny
individual creditors standing to bring certain actions do not present compelling
reasons with respect to equitable subordination.
1. The text and logic of the Bankruptcy Code fail to support the argument
that equitable subordination actions “belong” to the estate or that
restricting standing to bring such claims is warranted.
69 An equity holder may also bring a cause of action for equitable subordination. Because this issue
arises most commonly with creditors, for convenience and clarity, the Court will write out the
analysis for creditors only. The Court notes, however, that the analysis applies equally to individual
equity holders.
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This Court begins with the text. Relying on the tools of statutory
interpretation, we look to the text of the statute as “the alpha and the omega of the
interpretive process.”70
The text of the statute provides no indication that equitable subordination
actions belong to the bankruptcy estate nor does it prescribe any limitation on who
can seek equitable subordination. The Bankruptcy Code simply states that all or part
of an allowed claim may be subordinated to another allowed claim under principles
of equitable subordination:
[T]he court may—
(1) under principles of equitable subordination,
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; or
(2) order that any lien securing such a subordinated
claim be transferred to the estate.71
Several points are worth highlighting about this text.
First, the text contains no express statement that the right to seek equitable
subordination belongs to any particular party. This notably contrasts with various
other sections that expressly give the trustee the right to bring various causes of
actions:
• Section 108(a) provides that if the limitations period within which the
debtor could have brought a claim had not expired at the time of the
bankruptcy filing, “the trustee may commence such action” within a
prescribed extended time period. Section 108(b) provides similar relief
to “the trustee.”72
• Section 544(a) states that “[t]he trustee shall have . . . the rights and
powers of, and may avoid any transfer . . . that is voidable by” certain
70 Reed v. Taylor, 923 F.3d 411, 415 (5th Cir. 2019) (quoting United States v. Maturino, 887 F.3d
716, 723 (5th Cir. 2018). See also United States v. Lauderdale County, 914 F.3d 960, 964 (5th Cir.
2019) (“The task of statutory interpretation begins and, if possible, ends with the language of the
statute.” (quoting Trout Point Lodge, Ltd. v. Handshoe, 729 F.3d 481, 486 (5th Cir. 2013))).
71 11 U.S.C. § 510(c).
72 11 U.S.C. § 108(a).
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(real or hypothetical) creditors or purchasers of real property, and
§ 544(b) provides that “the trustee may avoid” certain other transfers.73
• Section 547(b) and (d) says “[t]he trustee may . . . avoid” certain
transfers.74
• Section 548(a) provides that “[t]he trustee may avoid” certain
transfers.75
• Section 549(a) provides that “the trustee may avoid” certain post-
petition transfers.76
• Section 550(a) provides that “the trustee may recover, for the benefit of
the estate,” the property or the value of the property from an avoided
transfer.77
Numerous other examples could be produced.78 Not to belabor the point, Congress
knew how to say that it wanted the trustee to be the party to seek various forms of
relief.79 That it did not do so here seems telling. Judge Taylor articulated this
observation in his excellent and convincing Hoffinger Industries opinion:
There is no specific provision in the statute that states that an equitable
subordination claim must be brought by the trustee. In fact, the statute
is silent in this regard. Utilizing the contextual features recognized by
the Supreme Court, it is apparent that Congress intended for § 510(c)
to be broadly available. Had the trustee been the only party with
authority to use this section, Congress could have so stated, as it has in
many instances.80
73 11 U.S.C. § 544(a) and (b).
74 11 U.S.C. § 547(b) and (d).
75 11 U.S.C. § 548(a).
76 11 U.S.C. § 549(a).
77 11 U.S.C. § 550(a).
78 See, e.g., 11 U.S.C. § 545 (authorizing the trustee to avoid the fixing of a statutory lien on
property of the debtor under certain circumstances).
79 Cadleway Props. v. Andrews (In re Andrews), No. 02-0001, 2009 WL 1076831, at *5 (Bankr.
S.D. Tex. Apr. 2, 2009) (noting that the language in § 510(c) stands in contrast to other Bankruptcy
Code based actions that may only be brought by the trustee). Sometimes, too, the statute expressly
provides for the debtor to have the ability to do certain things, like avoiding certain exemption-
impairing liens. See 11 U.S.C. § 522(f) (authorizing the debtor to avoid the fixing of a lien on an
interest of the debtor in property under certain circumstances).
80 Bunch v. J.M. Cap. Fin., Ltd. (In re Hoffinger Indus., Inc.), 327 B.R. 389, 394 (Bankr. E.D. Ark.
2005).
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In addition, equitable subordination claims are functionally very similar to
claim objections as well as recharacterization actions, which can be brought by any
party in interest.81 A claim objection requests that the court hold a debt simply not
owing; recharacterization says the claimant may have some entitlement from the
debtor, but it is an equity interest and not debt; and equitable subordination argues
that there may be a debt owing, but due to the malfeasance of the claimant, it should
be paid after other claimants. All three have the ultimate effect of putting one claim
below some or all other claims.
In practice, due to this family resemblance, claim objections are often brought
alongside requests for recharacterization and/or equitable subordination—as
happened in this very case—often relying on overlapping facts to support both the
request for recharacterization and equitable subordination.82 The Court is unable to
imagine a rationale for why an individual creditor could bring a claim objection and
request for recharacterization but be restricted from requesting equitable
subordination.
Second, the relief provided for in the text of § 510(c) seems to contemplate
subordination of a specific claim sought by an individual creditor. The statute
permits the court to “subordinate . . . all or part of an allowed claim to all or part of
another allowed claim.”83 True, the fact that “claim” is singular does not mean that
the only one claim may be subordinated to only one other claim; the Bankruptcy
81 One could object that in § 502(a), as already discussed above in section A, Congress indicated
its view that any “party in interest” could bring a claim objection. The fact that it did not do so in
§ 510(c)(1) may suggest that it wished to exclude some parties from seeking equitable
subordination. But this Court thinks not. The specific reference to “party in interest” is necessary
in the context of § 502(a) because the Bankruptcy Code specifically authorizes the trustee to object
to claims elsewhere. There seems to be a distinction, then, between instances where the statute is
expressly empowering the estate to bring a claim, as in the sections referenced above, and where
it is simply clarifying that the estate is not the only holder of the claim. This is particularly true in
the context of § 502(a), because elsewhere the statute requires a trustee to investigate and if
appropriate object to claims. 11 U.S.C. §§ 704(a)(5), 1106(a)(1), and 1107(a). One could easily
see that provision being read too broadly, to restrict the ability of others to object. Thus, the
clarification was necessary in § 502(a); not so in § 510(c).
82 E.g., Hartford Holdings, LLC v. Mladen (In re Eternal Enters., Inc.), 557 B.R. 277, 281 (Bankr.
D. Conn. 2016) (creditor permitted to bring claim objection and seek equitable subordination and
recharacterization). This is not to say that these actions are all the same. As the Fourth Circuit has
noted, “although recharacterization and equitable subordination lead to a similar result, they
address distinct concerns and require a bankruptcy court to conduct different inquiries.” Fairchild
Dornier GMBH v. Official Comm. of Unsecured Creditors (In re Dornier Aviation (N. Am.), Inc.),
453 F.3d 225, 232 (4th Cir. 2006) (internal quotation marks omitted).
83 11 U.S.C. § 510(c).
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Code’s rules of interpretation provide that “the singular includes the plural.”84 Still,
the Code seems to contemplate first and foremost a claim-versus-claim battle; and
thus one that would naturally be brought by individual creditors and not by the
representative of the estate as a whole. Based on this reading of the text, it would be
bizarre indeed to say a creditor seeking this remedy lacks the standing to urge it.85
In fact, generally speaking, equitable subordination claims often belong more
naturally to affected creditor(s) than to the bankruptcy estate. Granted, in some
instances it might make sense for the trustee to pursue equitable subordination in the
interests of the majority of the body of creditors, but the bankruptcy estate usually
does not suffer a direct impact merely from the priority of payments to its various
creditors. It seems that a court can order relief to “all unsecured creditors” or to “all
creditors except the one who behaved inequitably.”86 But certainly the statute itself
does not posit that as the norm. In many common instances, it might make more
sense for one or more creditors to pursue the action, rather than the estate as a whole
incur expenses that might not accrue to sufficient numbers of holders of claims to
84 11 U.S.C. § 102(7).
85 In re Vitreous Steel Prods. Co., 911 F.2d 1223, 1231 (7th Cir. 1990). It bears emphasizing that
the square holding of Vitreous Steel strongly supports this Court’s holding today. That said, the
Court has a few minor quibbles with Vitreous Steel. First, the trustee may usually be, in some sense,
the representative of unsecured creditors, as the opinion states. But it is more accurate to
characterize a trustee as the representative of the estate as a whole; for instance, equity holders’
interests are important when an estate may be solvent. See 11 U.S.C. §§ 323(a) (“trustee . . . is the
representative of the estate”), 11 U.S.C. § 1102 (authorizing the U.S. Trustee to appoint a
committee to represent equity security interests). Second, the Vitreous Steel court withholds
judgment on whether an unsecured creditor could bring a claim against a wholly secured creditor
(noting that an unsecured creditor may have standing to seek equitable subordination under §
510(c) “at least where the creditor whose claim is objected to is at least partially unsecured”). Id.
But the court’s reasoning in Vitreous Steel firmly supports an unsecured creditor’s standing in such
an instance. After all, an unsecured creditor would only have constitutional (injury-in-fact)
standing if it were going to see a greater distribution if equitable subordination succeeds. This
implies that at least some portion of the “target” secured creditor’s claim will be subordinated to
unsecured claims—which requires that the secured creditor will both lose its security interest and
see its now-unsecured claim brought even lower. This in turn means that not all unsecured claims
will be benefitted by the action, and thus an individual unsecured creditor has standing to bring it.
86 See Cadleway Props. v. Andrews (In re Andrews), No. 02-0001 2009 WL 1076831 at *7 (Bankr.
S.D. Tex. Apr. 2, 2009) (collecting cases on how courts “have routinely read a general remedy into
§ 510(c), subordinating a claim to all claims or an entire class of claims”). The Court agrees with
the thrust of Judge Isgur’s characterization of this law. However, “general” appears to be an
imprecise description of the relief. The text supports broad relief applying the principles of
statutory interpretation together with the requirements in § 102(7) that the singular includes the
plural. That is to say, the broad remedy need not be read into the text of § 510(c) as Judge Isgur
suggests. See id.
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make such an investment (often a risky and expensive one) worthwhile. Again, as
the Hoffinger Industries court observed: “It would be absurd to permit the estate
alone to seek to reorder priorities among specific creditors on all or part of their
debt.”87
Third, the statute, read closely, prevents a claim from being subordinated to
an equity interest, thus arguably preventing equitable subordination under § 510(c)
from providing a benefit to the entire estate. The text permits the court 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.”88 This seems to prevent the subordination of a “claim” 89 (in
common parlance, a debt) to an “interest” 90 (in common parlance, an equity or
ownership stake in the enterprise).91 This appears to cabin the relief that equitable
subordination can provide: it can move a claim down to the very bottom of the entire
waterfall of claims, but no further.92 In other words, subordination of a claim cannot
truly benefit the estate as a whole, which can include holders of equity interests as
well. Also, as several courts have pointed out and as this opinion discusses further
below (B.2.a), equitable subordination can never provide a truly “general” benefit
because it will always exclude at least the subordinated creditor.93
The textual and logical distinction between relief to the estate and relief only
to a set of claimants—even if that set might be broad—is important to maintain.
There is no obvious (and certainly no textual) reason to bar any one of a set of
87 Bunch v. J.M. Cap. Fin., Ltd. (In re Hoffinger Indus., Inc.), 327 B.R. 389, 394 (Bankr. E.D. Ark.
2005).
88 11 U.S.C. § 510(c).
89 11 U.S.C. § 101(5).
90 While the Bankruptcy Code does not specifically define “interest,” it does define “equity
security” as a “share in a corporation, whether or not transferable or denominated “stock,” or
similar security” or as an “interest of a limited partner in a limited partnership,” 11 U.S.C. §
101(16)(A) and (B), which is the type of interest apparently referred to in § 510(c). See Shubert v.
Lucent Techs. Inc. (In re Winstar Commc’ns, Inc.), 554 F.3d 382, 414 (3rd Cir. 2009)
(distinguishing between “claims” and “equity interests” in the context of equitable subordination).
91 In re Winstar Commc’ns, Inc., 554 F.3dat 414 (3rd Cir. 2009).
92 In re Winstar Commc’ns, Inc., 554 F.3d at 414 (“[A] creditor’s claim can be subordinated only
to the claims of other creditors, not equity interests.”).
93 In re Vitreous Steel Prods. Co., 911 F.2d 1223, 1231 (7th Cir. 1990); In re Hoffinger Indus.,
Inc., 327 B.R. at 413; Algonquin Powe Income Fund v. Ridgewood Heights, Inc. (In re Franklin
Indus. Complex, Inc.), No. 06–80254, 2007 WL 2509709, at *8-9 (Bankr. N.D.N.Y. Aug. 30,
2007).
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affected parties, even if that set might be broad, from defending the broader group’s
interest by seeking to equitably subordinate another claim to those of the group.
Fourth, the statute provides for subordination only for purposes of
“distribution,” which again emphasizes the fact that it is a remedy pitting creditor
versus creditor for purposes of distribution of the estate’s property only. The estate
sees no increase in the property it will be entitled to distribute; merely a
rearrangement of the folks standing in line for a piece of the distribution.
A final textual note is one that might seem to speak in favor of restricting
standing. Under the Federal Rules of Bankruptcy Procedure (though not the statute
itself), equitable subordination actions must be brought as a separate “adversary
proceeding” rather than merely being raised as a “contested matter.”
As background, in a bankruptcy case, most issues are raised as contested
matters in the main case, but some must be brought as separate, more formal,
adversary proceedings. 94 Technically speaking, because equitable subordination
must be sought in the form of an adversary proceeding, it is a valid cause of action
in a bankruptcy.95 Thus, perhaps it should ipso facto be considered “property of the
estate” (despite having no value for the estate nor promising to augment the estate
as a whole).96
But the mere fact that equitable subordination must be brought as an adversary
proceeding is by no means enough to conclude that it “belongs” to the estate. This
argument would prove far too much. Two examples show why. First, some causes
of action are clearly not “estate property.” For example, an objection to a creditor’s
claim can be brought as an adversary proceeding and therefore becomes a “cause of
action” (or more properly a “claim for relief” or “demand for . . . relief”) under the
federal rules. 97 But it does not also thereby become property of the estate in
contravention of the statute (a good example of a tail trying to wag a dog).98 As a
second example, contested lien rights have to be adjudicated in adversary
proceedings, but may still be brought by creditors.99 In fact, they are sometimes
94 FED. R. BANKR. P. 9014, 7001.
95 FED. R. BANKR. P. 7001(h).
96 See Cadle Co. v. Mims (In re Moore), 608 F.3d 253, 257-58 (5th Cir. 2010) (holding that
property of the estate broadly includes all rights of action bestowed by either federal or state law).
97 FED. R. BANKR. P. 3007(b); FED. R. BANKR. P. 7008(a).
98 See Section A; 11 U.S.C. § 502 (allowing parties in interest, not just the debtor, to object to
claims).
99 FED. R. BANKR. P. 7001(b).
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creditor-on-creditor battles in which the estate may not have, or chooses not to take,
a position (even though the estate itself also has the right to bring such actions).
In sum, the distinction of whether under the bankruptcy rules a dispute can or
must be brought as an adversary proceeding cannot bear much weight. Rather the
Court must, as it has above, engage in a substantive determination of whether the
law provides for the action to “belong” to the debtor.
2. The policy concerns animating cases that deny standing to individual
creditors do not present compelling reasons to refuse individual creditors
the right to pursue equitable subordination.
As demonstrated in the previous section, the text § 510(c) and logic of
equitable subordination support individual creditors being able to seek this remedy
as a matter of right. This section addresses the largely policy-motivated reasoning of
the cases that have held otherwise. First, it seems very clear that the policy concerns
raised by claims for affirmative relief are inapplicable when the relief sought by an
individual creditor is equitable subordination. Second, the policy concerns expressed
in cases involving standing of creditor’s committees are inapplicable to cases
involving individual creditors.
a. The policy concerns presented when individual creditors bring claims for
affirmative relief based on harm to the bankruptcy estate are not
applicable when individual creditors merely seek the distributive
rearrangement that is equitable subordination.
An individual creditor seeking equitable subordination does not raise the same
policy concerns as are present when an individual creditor brings a claim for
affirmative relief. As noted, a recharacterization action is essentially a part of the
claims allowance process that allows a party to challenge the character of a purported
creditor’s claim by arguing that it should be treated as equity, rather than debt.
Similarly, equitable subordination does not provide grounds for affirmative recovery
but is rather a fairly narrow remedy that adjusts the order that allowed claims are
paid based on principles of equity.100
100 11 U.S.C. § 510(c) (“[T]he court may . . . under principles of equitable subordination,
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.”); SI
Restructuring, Inc. v. Faulkner (In re SI Restructuring, Inc.), 532 F.3d 355, 360 (5th Cir. 2008)
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While the Bankruptcy Code directs courts to look to the “principles of
equitable subordination” that may exist outside of bankruptcy law,101 the cause of
action pursued here does not exist before or outside of the bankruptcy proceeding,
and it is very narrow. The Bankruptcy Code expressly permits a court to only change
the order in which creditors are entitled to “distribution” within the bankruptcy. It
does not augment the estate. It is thus unlike the sorts of causes of action that are
property of the estate, such as breach of contract, breach of fiduciary duty, fraud,
and so on.102 As noted,103 courts have differed over whether avoidance actions are
property of the estate, but even under the analysis of the courts (including the Fifth
Circuit) holding that they are, an equitable subordination action stands out as unlike
those actions in that equitable subordination action brings nothing into the estate and
merely reshuffles creditor priority in distribution.
Cases restricting creditor standing generally emphasize the need for the
trustee to have a free hand in bringing property into the estate, and to “prevent
individual creditors from annexing assets of the estate to gain an advantage.”104
These concerns are clearly, repeatedly, and compellingly articulated in the major
Fifth Circuit cases in this area.105 In Schimmelpenninck, for instance, the Fifth
Circuit stated that unless standing were preserved for the debtor alone, “any creditor
could seek remuneration from the debtor’s affiliates, and the multi-jurisdictional,
first-come/first-served, unequal distribution, which cuts against the policies of the
Bankruptcy Code, would be promoted.” 106 It expressed concern that a creditor
bringing what should be an estate claim would be “agglomerating to himself the
other creditors’ rightful pro-rata share of this asset . . . of the Debtor’s estate,” and
(“The Bankruptcy Code does not otherwise set forth the circumstances under which equitable
subordination is appropriate; however, the case law has formulated a number of requirements to
guide courts in their application of this remedy.”) (emphasis added).
101 11 U.S.C. § 510(c); Life Partners Creditor’s Trust v. Cowley (In re Life Partners Holdings,
Inc.), 926 F.3d 103, 122 (5th Cir. 2019) (citing SI Restructuring, Inc. v. Faulkner (In re SI
Restructuring, Inc.), 532 F.3d 355, 360 (5th Cir. 2008)).
102 Cadle Co. v. Mims (In re Moore), 608 F.3d 253, 257-58 (5th Cir. 2010) (holding that causes of
action to recover fraudulent transfers under § 548 were property of the estate); Schimmelpenninck
v. Byrne (In re Schimmelpenninck), 183 F.3d 347, 350 (5th Cir. 1999) (holding that veil-piercing
causes of action belonged to the debtor and were property of the estate).
103 See Official Comm. of Unsecured Creditors v. Hancock Park Cap. II, L.P. (In re Fitness
Holdings Int’l, Inc.), 714 F.3d 1141, 1149 (9th Cir. 2013).
104 Highland Cap. Mgmt. LP v. Chesapeake Energy Corp. (In re Seven Seas Petroleum, Inc.), 522
F.3d 575, 589 (5th Cir. 2008) (quoting In re Schimmelpenninck, 183 F.3d at 360 (5th Cir. 1999)).
105 In re Schimmelpenninck, 183 F.3d at 356; In re Seven Seas Petroleum, Inc., 522 F.3d at 589.
106In re Schimmelpenninck, 183 F.3d at 356.
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would thereby “obtain indirectly a very preferential status that he cannot obtain
directly.”107 The Fifth Circuit also discussed this concern in Seven Seas.108 There,
the Fifth Circuit expressed concern that a creditor empowered to bring an action
could “ultimately seek to recover assets of the estate that are not under the debtor’s
control,” such as fraudulent transfers.109
The principles and concerns that animate these cases are simply not present
in equitable subordination cases. There is no risk of individual creditors
appropriating money that would otherwise flow to the estate. Equitable
subordination actions rearrange the order of creditors’ claims to distribution from
the debtor’s estate; they do not bring any money into the estate. A plaintiff creditor
can at most subordinate a wrongdoing creditor’s claim to one or more of the other
claims in the case.110
A trustee usually has exclusive standing to assert the estate’s right to
payment—which, again, would directly affect the assets in the estate and thus all
creditors. But it is the various creditors, on their own and as classes, that have the
real interest in the order that the debtor pays their various claims, because the higher
a creditor’s claim falls in the priority waterfall, the more likely it is that the claim
actually gets paid (and sometimes even paid in full). Fights between and among
creditors within this waterfall simply are often of little to no interest to, or impact
on, the estate, even if the inequitable actions of the subordinated creditor were
against the debtor.
This important distinction between claims for affirmative recovery and those
merely rearranging the rights of creditors amongst themselves is present in the case
law (even if its crucial importance has not been uniformly recognized). For instance,
the Seventh Circuit in Vitreous Steel denied an individual unsecured creditor
standing to bring actions for recovery for preferential transfer, fraudulent
conveyance, conversion of estate property, and enforcement of the trustee’s “strong-
arm” powers, while at the same time holding that the creditor had standing to pursue
the remedy of equitable subordination.111
107 In re Schimmelpenninck, 183 F.3d at 358.
108 In re Seven Seas Petroleum, Inc., 522 F.3d at 589.
109 In re Seven Seas Petroleum, Inc., 522 F.3d at 589.
110 Bunch v. J.M. Cap. Fin., Ltd. (In re Hoffinger Indus., Inc.), 327 B.R. 389, 413 (Bankr. E.D.
Ark. 2005.
111 In re Vitreous Steel Prods. Co., 911 F.2d 1223, 12331 (7th Cir. 1990). See also Algonquin Powe
Income Fund v. Ridgewood Heights, Inc. (In re Franklin Indus. Complex, Inc.), No. 06-80254,
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Nevertheless, despite the lack of support for such restrictions in either the text
of the Bankruptcy Code or its general policy underpinnings, some courts have
concluded that equitable subordination actions cannot generally be brought by
creditors. An early and prominent discussion of these policy concerns was In re
Morpheus Lights, Inc.112 There, a California bankruptcy court denied standing to a
general unsecured creditor who sought equitable subordination, fiduciary duty, and
unfair competition claims against an officer and a lender of the debtor.113 There, the
court held that not only were the fiduciary duty and unfair competition claims
property of the estate (which is uncontroversial) but that the right to seek equitable
subordination was as well, and that an individual creditor did not have standing to
pursue such a claim without court approval.114
In determining that the equitable subordination action was property of the
estate, the Morpheus court relied on two cases that analogized claims seeking
equitable subordination and claims seeking affirmative relief. First, the Morpheus
court discussed a Second Circuit case in which that court determined that a creditor
could not assert alter ego claims that the debtor and creditor’s committee were also
asserting in a separate action,115 as well as on a Ninth Circuit Bankruptcy Appellate
Panel decision holding that only trustees and not creditors generally have standing
to pursue avoidance actions.116 For reasons exhaustively discussed directly above,
this Court finds any reliance on such an analogy between claims for affirmative relief
and claims seeking equitable subordination to be unconvincing. Equitable
subordination claims do not risk the “non-pro-rata distribution” concerns as claims
leading to affirmative relief.
2007 Bankr. LEXIS 3004, at *23 (Bankr. N.D.N.Y. Aug. 30, 2007) (emphasizing that both
Vitreous Steel and the cases upon which it relies provide that court permission is required for
unsecured creditors to pursue claims such as fraudulent conveyance and preference actions but not
equitable subordination and noting the lack of any citations to cases in which court permission
“was required to bring a claim for equitable subordination”).
112 Variable-Parameter Fixture Dev. Corp. v. Comerica Bank-California (In re Morpheus Lights,
Inc.), 228 B.R. 449, 454 (Bankr. N.D. Cal. 1998).
113 In re Morpheus Lights, Inc., 228 B.R. at 454.
114 In re Morpheus Lights, Inc., 228 B.R. at 454.
115 In re Morpheus Lights, Inc., 228 B.R. at 453 (citing St. Paul Fire & Marine Ins. Co. v. PepsiCo.,
Inc., 884 F.2d 688, 700-01 (2d Cir. 1989)).
116 In re Morpheus Lights, Inc., 228 B.R. at 453-54 (citing Hansen v. Finn (In re Curry & Sorensen,
Inc.), 57 B.R. 824, 828 (9th Cir. BAP 1986)). The Morpheus court goes on to cite other cases in
support of this analysis. Id. These cases are equally inapplicable as they all also deal with claims
for affirmative relief such as fraudulent transfers. Id.
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Nonetheless, the Morpheus court urged its view that “requiring a creditor-
plaintiff to seek the court’s permission before bringing a claim on behalf of the estate
is supported by sound policy reasons.”117 Its entire discussion of those “sound policy
reasons” is as follows: “The requirement promotes the orderly and equitable
administration of the bankruptcy estate. If individual creditors were permitted to
pursue separate actions to the detriment of other creditors and of the estate, the
administration of the bankruptcy estate would be chaotic.”118
This Court respectfully observes that the “policy concerns” expressed in
Morpheus are inapplicable in equitable subordination actions. These concerns are
reasonable with respect to claims that could bring funds into the estate and that, if
brought by individual creditors, risk depriving the estate of such funds in favor of
the individual creditor. In these instances, permitting the individual creditor to
pursue its claim without first requiring court approval conflicts with the Bankruptcy
Code’s core principles of pro rata distribution to similarly situated creditors.119 As
noted above, the Fifth Circuit has also acknowledged such concerns in the context
of an individual creditor bringing a suit against the debtor companies on a theory of
piercing the corporate veil.120
But the policy concerns that justify denying standing to creditors seeking to
bring affirmative claims such as corporate veil piercing are not relevant here.
Equitable subordination claims are simply not analogous to such claims with respect
to their impact on the estate. This Court is at a loss to understand how individual
creditors seeking equitable subordination bring any “detriment” to the estate or other
creditors (aside from, of course, the target of the action).121 Nor is it clear how such
standing would be disorderly, inequitable, or “chaotic.”
117 In re Morpheus Lights, Inc., 228 B.R. at 454.
118 In re Morpheus Lights, Inc., 228 B.R. at 454.
119 Schimmelpenninck v. Byrne (In re Schimmelpenninck), 183 F.3d 347, 356 (5th Cir. 1999).
120 In re Schimmelpenninck, 183 F.3d at 356 (noting that, if individual creditor had standing to
bring veil-piercing action against debtor’s subsidiary or affiliates, “any creditor could seek
remuneration from the debtor’s affiliates, and the multi-jurisdictional, first-come/first-served,
unequal distribution, which cuts against the policies of the Bankruptcy Code, would be
promoted”). See also id. at 358 (noting that, if granted standing to pursue recovery from debtor’s
subsidiary, an individual creditor would be “agglomerating to himself the other creditors’ rightful
pro-rata share of this asset . . . of the Debtor’s estate,” and would thereby “obtain indirectly a very
preferential status that he cannot obtain directly”).
121 Bunch v. J.M. Cap. Fin, Ltd. (In re Hoffinger Indus., Inc.), 327 B.R. 389, 413-14 (Bankr. E.D.
Ark. 2005).
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It is possible that more than one equitable subordination action based on
related facts or parties could be initiated by different creditors as well as by the
debtor. But this can just as easily happen with a claim objection or a
recharacterization proceeding, both of which, as discussed above, can be initiated by
any creditor as well as by the debtor. A court can easily exercise its tools of case
management to prevent this descending into “chaos,” for instance by consolidating
or reordering the cases as needed.122
Nor would an individual creditor’s standing to bring equitable subordination
hinder the estate’s ability to settle such a claim with court approval.123 Claims
objections (which are the best analogy to equitable subordination actions) are
regularly settled despite creditors’ standing to urge such objections themselves; if
they wish to preserve their objection, they must object to the settlement and persuade
the court not to approve it.124
In sum, the crucial distinction is that equitable subordination does not
undermine the pro rata distribution of estate assets or run the risk of a certain creditor
obtaining some strategic advantage. The Court feels like it must continue to
emphasize this point, at the risk of repetition, because it seems to have been lost in
much of the case law. Equitable subordination cases can only move wrongdoing
creditors down the claims waterfall, so there is no risk of one creditor taking
advantage of its status as plaintiff to arrogate funds for themselves that should belong
to the estate.125 In fact, even where the estate is the party that suffered a direct injury,
it may make little sense for the trustee (or even a creditor’s committee) to bring an
action for equitable subordination which may only benefit a few creditors at the top
of the claims waterfall, rather than increase the overall pool of assets for distribution.
122 The court in Elswick Co., LLC v. Comm2013 CCREI2 Crossing Mall Rd. LLC (In re Tara Retail
Grp., LLC), 595 B.R 215, 224-25 (N.D.W. Va. 2018), alluded to the potential need for such case
management when both a creditor and the debtor were seeking equitable subordination. While this
Court does not agree with the Tara Retail Group requirement of permission or its application of
the particularized injury test, this part of the opinion seems on point in terms of how a court should
practically deal with competing cases.
123 FED. R. BANKR. P. 9019.
124 See, e.g., In re Heritage Org., 375 B.R. 230, 285 (Bankr. N.D. Tex. 2007) (citing Law
Debenture Trust Co. v. Kaiser Aluminum Corp. (In re Kaiser Aluminum Corp., 339 B.R. 91, 94-
95 (D. Del. 2006)); Roberts v. Sender (In re Roberts), No. 25-1103, 2026 WL 885070 at *5-6 (10th
Cir. 2026) (citing Hamon v. DVR, LLC (In re DVR, LLC), 606 B.R. 80, 84-86 (D. Colo. 2019)).
125 See Shubert v. Lucent Techs. Inc. (In re Winstar Commc’ns, Inc.), 554 F.3d 382, 414 (3d Cir.
2009).
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b. The statutory and policy concerns presented by creditors’ committees
seeking to bring actions are not applicable to individual creditors
bringing equitable subordination actions.
Much of what has led—or in this Court’s view, misled—other courts to hold
that an individual creditor lacks standing to seek equitable subordination, seems to
be the unique statutory provisions and practical dynamics at play when a creditor’s
committee seeks equitable subordination. Many cases stating that individual
creditors lack standing are actually cases holding that creditor’s committees lack the
right to seek equitable subordination.126 Most prominently, courts have looked to the
Second Circuit’s AppliedTheory case, in which the lower court declined to grant
derivative standing to allow the official committee of unsecured creditors to seek
equitable subordination. 127
The Second Circuit’s AppliedTheory decision articulates several serious
concerns with permitting committees to bring claims including the court’s lack of
control over the reorganization process and potential loss to the estate:
Reorganizations would routinely spin out of control if decisions that
would commit the time and limited resources of the estate could be
taken without the consent of the bankruptcy court, the entity charged
by law with controlling and regulating such matters. Requiring
bankruptcy court approval conditioned upon the litigation’s effect on
the estate helps prevent committees and individual creditors from
pursuing adversary proceedings that may provide them with private
benefits but result in a net loss to the entire estate.128
Admittedly, AppliedTheory does mention “individual creditors” as part of its
concern, but its actual facts only presented a creditors’ committee bringing the
126 Official Comm. of Unsecured Creditors v. Halifax Fund, L.P. (In re AppliedTheory), 493 F.3d
82, 85 (2nd Cir. 2007).
127 In re AppliedTheory, 493 F.3d at, 85. See also Cadleway Props. v. Andrews (In re Andrews),
No. 02-0001, 2009 WL 1076831, at *6 (Bankr. S.D. Tex. Apr. 2, 2009) (distinguishing its facts
from those before the Second Circuit in AppliedTheory because there, a creditors’ committee rather
than an individual creditor sought equitable subordination as a general claim which could only be
asserted by the trustee).
128 In re AppliedTheory, 493 F.3d at 86.
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action. 129 In any case, AppliedTheory and other cases primarily dealing with
committees have perhaps—without much apparent consideration for whether
individual creditor standing raises the same concerns as does committee standing—
placed some weight on the side of the scale suggesting that individual creditors, too,
should lack standing to seek equitable subordination. Such creditors would either be
left to convince the estate to pursue such claims or convince the court that derivative
standing to seek equitable subordination is warranted.130
Courts, including the Fifth Circuit, have permitted committees to seek
equitable subordination on a derivative basis on behalf of a bankruptcy estate but not
as of right. 131 These courts have held that committees can do so only when a court
has either given permission or it is relatively plain that the estate itself suffers from
some sort of conflict or other inability to seek this remedy.132 Committees also have
been barred from seeking other forms of relief when it is deemed that a non-
conflicted trustee or debtor in possession has properly evaluated and decided not to
pursue an action.133
129 See Algonquin Powe Income Fund v. Ridgewood Heights, Inc. (In re Franklin Indus. Complex,
Inc.), 2007 WL 2509709, at *31-2 (Bankr. N.D.N.Y. Aug. 30, 2007) (noting that while
AppliedTheory mentioned individual creditors, its facts “dealt exclusively with a creditors’
committee commencing the adversary proceeding”).
130 See, e.g., Lyme Regis Partners, LLC v. Icahn (In re Blockbuster Inc.), No. 10-05524, 2011 WL
1042767, at *2 (Bankr. S.D.N.Y. Mar. 17, 2011) (Lifland, J.) (holding that individual creditor
lacked standing to bring equitable subordination claim; stating that “[b]ecause the remedy of
equitable subordination is designed to vindicate the rights of the estate as a whole, that remedy,
with limited exception, can only be brought by the debtor” and that “[t]his is precisely what the
Second Circuit concluded in [AppliedTheory]”).
131 See, e.g. Summit Coffee Co. v. Herby’s Foods, Inc. (In re Herby’s Foods, Inc.), 2 F.3d 128, 135
(5th Cir. 1993) (affirming the bankruptcy court’s equitable subordination of certain claims to that
of equity as sought by the creditors’ committee); In re AppliedTheory, 493 F.3d at85-86 (affirming
the lower court’s denial of a creditor committee’s request to equitably subordinate another claim
and holding that it was required to obtain court approval to seek equitable subordination); Official
Comm. of Unsecured Creditors of Toy King Distributors, Inc. v. Liberty Savings Bank, FSB (In re
Toy King Distributors, Inc.), 256 B.R. 1, 29 (Bankr. M.D. Fla. 2000) (holding that a creditors’
committee had standing to seek equitable subordination because it had obtained court approval);
Tenn. Valley Steel Corp. v. B.T. Com. Corp. (In re Tenn. Valley Steel Corp.), 183 B.R. 795, 800
(Bankr. E.D. Tenn. 1995) (citing Louisiana World Exposition, Inc. v. Fed. Ins. Co. (In re Louisiana
Exposition, Inc.), 832 F.2d 1391, 1397 (5th Cir. 1987)) (applying the test from Louisiana World
to determine whether a creditors’ committee should have standing to seek equitable subordination).
132 In re AppliedTheory, 493 F.3d at 85-6.
133 See, e.g., In re Sabine Oil & Gas Corp., 547 B.R. 503, 574 (barring creditors’ committee from
bringing claims where a debtor met its burden to show that bringing the claims would not be in the
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These restrictions on committees have numerous bases that are sound as to
committees. But the analogy to individual creditors does not hold.
One major distinction is that a committee’s fees are generally paid by the
estate.134 Thus, when a committee pursues a claim, every creditor is made worse off
by every dollar of fees expended, subject only to a court’s later determination of
reasonableness and benefit to the estate. 135 This is presumably what the
AppliedTheory Second Circuit opinion means when it refers to “commit[ting] the
time and limited resources of the estate” to be dissipated without court approval.136
However, as a bankruptcy court within the Second Circuit noted shortly after
AppliedTheory was decided, an individual creditor’s “commencing litigation in
bankruptcy court seldom commits resources of the estate, and has rarely, if ever,
caused ‘reorganizations [to] routinely spin out of control.’”137
AppliedTheory also cites the need to prevent “committees and individual
creditors from pursuing adversary proceedings that may provide them with private
benefits but result in a net loss to the entire estate.”138 This statement too might refer,
in part, to committee fees, although the addition of “and individual creditors” (whose
fees are not paid by the estate except in very extraordinary circumstances) 139
suggests that it has some other meaning as well. This statement in dicta is not entirely
clear, but may mean that, with respect to some claims for affirmative relief, an
individual creditor may recover private benefits that would otherwise go to the estate
and thus are in that sense a “loss” to the estate. If so, again the Court emphasizes that
best interest of the estate). See also Commodore Int’l Ltd. v. Gould (In re Commodore Int’l Ltd.),
262 F.3d 96, 100 (2d Cir. 2001) (affirming dismissal of lawsuit brought by creditors’ committee
for lack of standing because the suit was not necessary or beneficial to the estate).
134 11 U.S.C. § 330. Professionals retained by committees are “professional persons” under the
statute. 11 U.S.C. §§ 327 and 328.
135 11 U.S.C. § 330(a)(4)(A); Barron & Newburger, P.C. v. Texas Skyline, Ltd. (In re Woerner),
783 F.3d 266, 271 (5th Cir. 2015) (holding that a “hindsight” or “material benefit” standard
conflicts with 11 U.S.C. § 330 and applying a “reasonable at the time” standard for attorney
compensation).
136 In re AppliedTheory, 493 F.3d at 86.
137 Algonquin Powe Income Fund v. Ridgewood Heights, Inc. (In re Franklin Indus. Complex, Inc.),
No. 06–80254, 2007 WL 2509709, at *11 (Bankr. N.D.N.Y. Aug. 30, 2007).
138In re AppliedTheory, 493 F.3d at 86.
139 See 11 U.S.C. § 503(b)(3)(D); In re Franklin Indus. Complex, Inc., No. 06–80254, 2007 WL
2509709, at *8-9 (noting difficulties that an individual creditor bringing equitable subordination
action would likely face in seeking to have its fees paid by the estate).
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this policy concern of unequal distribution really has no application to equitable
subordination cases.
Another major distinction is that the duties and powers of creditors’
committees are defined by statute and do not expressly include the right to seek this
sort of relief.140 Instead, that right is accorded to a committee only under a judicially
created “for cause” exception, carefully restricted perhaps for the very reason that,
as noted above, its fees may diminish the estate’s resources for no real return.141
In sum, there are substantial reasons to “gatekeep” committee action and deny
them standing without approval. But most of these concerns do not apply to
individual creditors, whose own resources underwrite their efforts to seek
subordination (whether on their own behalf or that of some group of similarly
situated creditors), and whose existence and powers are not as closely circumscribed
by statute. Insofar as AppliedTheory’s concerns include both individual creditors and
committees, those concerns seem to be inapplicable to equitable subordination
actions.
Thus, despite the serious divisions in the case law, this Court has no trouble
concluding that individual creditors have standing to bring equitable subordination
actions whenever it could potentially affect their distribution and even if the
inequitable conduct was targeted at the debtor and not the individual creditor. The
140 11 U.S.C. §§ 1102, 1103; Azby Fund v. Wadsworth Ests., L.L.C., No. 22-30092, 2022 WL
17582273, at *2 (5th Cir. Dec. 12, 2022) (quoting In re CoServ, L.L.C., 273 B.R. 487, 497 (Bankr.
N.D. Tex. 2002) in noting the distinction between the duties of the trustee as opposed to the
committee, stating that “[i]mplicit in the duties of a Chapter 11 trustee or a debtor in possession as
set out in §§ 1106 and 704 of the Bankruptcy Code is the duty of such a fiduciary to protect and
preserve the estate”). In contrast, a committee’s duty is to “the interest of those represented.” 11
U.S.C. § 1103(c)(5). See also 7 COLLIER ON BANKRUPTCY ¶ 1103.05 (16th ed. 2026). (“A member
of a committee owes a fiduciary duty to the class the committee represents.”).
141 See, e.g., In re AppliedTheory, 493 F.3d at 86 (denying the committee’s request that the Second
Circuit adopt a bright-line rule authorizing creditors to bring equitable subordination claims and
noting its reason for not doing so); Louisiana World Exposition, Inc. v. Fed. Ins. Co. (In re
Louisiana Exposition, Inc.), 832 F.2d 1391, 1397 (5th Cir. 1987) (articulating a similar test in the
Fifth Circuit, requiring that the creditors’ committee’s “claim be colorable, that the debtor-in-
possession have refused unjustifiably to pursue the claim, and that the committee first receive leave
to sue from the bankruptcy court.”).
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Court notes that some of this analysis applies only in chapter 11 cases; cases in other
chapters may or may not require a different outcome.142
C. The particularized injury test applied by some courts is analytically
problematic and difficult or impossible to apply.
Having explained why the Court thinks standing should be freely given, this
section now raises doubts about the alternative approach endorsed by other, more
restrictive courts: the “particularized injury” test to determine when an individual
creditor should be granted standing to pursue equitable subordination.
There appears to be a consensus that individual creditors can at least
sometimes seek equitable subordination relief, subject to the “particularized injury”
test. Courts generally say that such relief is appropriate when the creditors have
suffered a “particularized injury” that equitable subordination can remedy. 143
Ultimately, under many common bankruptcy scenarios, the test must be understood
either very broadly or very strictly. The Court hold that both the strict and broader
version of the test are unsatisfactory. The Court addresses the issues with both tests
below.
1. The strict version of the particularized injury test may be analytically
coherent but is neither textually grounded nor easily applied.
First, there are situations in which a creditor can genuinely have suffered a
particularized injury and thus have standing to seek equitable subordination under
even the most exacting standard. For instance, if a senior secured creditor misleads
142 See, e.g., White Family Companies, Inc. v. PNC Bank (In re Dayton Title Agency, Inc.), 527
B.R. 289, 299 (S.D. Ohio 2015) (explaining that case law draws distinctions between a creditor’s
standing to bring an equitable subordination claim in chapter 7 versus chapter 11). For clarity, this
Court is not expressing an actual conviction that the outcome should in fact be different in the
chapter 7 context. The outcome would likely be the same under either chapter 7 or 11, provided
that the would-be plaintiff has an actual interest in the outcome, as an individual creditor probably
would. However, an analysis of this issue under chapter 7 is outside of the scope of this opinion.
143 See Cadleway Properties Inc. v. Andrews (In re Andrews), No. 02-00001, 2009 WL 1076831
at *5-6 (Bankr. S.D. Tex. Apr. 2, 2009) (collecting cases); Picard v. Merkin (In re Bernard L.
Madoff Inv. Sec. LLC), 515 B.R. 117, 159 (Bankr. S.D.N.Y. 2014) (stating, in dicta, that a “creditor
may bring an equitable subordination claim only if he can allege a particularized injury resulting
from the defendant’s inequitable conduct”); Black Palm Dev. Corp. v. Barlage, No. 1:09cv220,
2011 U.S. Dist. LEXIS 118734 at *11 (W.D.N.C. Oct. 13, 2011); NM Enters. v. Harrington (In re
Flying Star Cafes, Inc.), 568 B.R. 129, 135 (Bankr. N.M. 2017); Miller v. Elway (In re Elrod
Holdings Corp.), 392 B.R. 110, 114 (Bankr. D. Del. 2008).
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or otherwise behaves inequitably in order to procure the consent of a junior secured
creditor to consent to lower priority status, then that would be a direct injury suffered
by the junior secured creditor, and it would make sense for the junior creditor both
to have standing to bring an equitable subordination claim and, ultimately, to receive
a remedy of reversing the subordination to the extent it was caused by the deception
or other targeted, inequitable acts. This is the most straightforward sort of
“particularized injury” that could give a creditor standing to bring an equitable
subordination claim. Under this Court’s characterization, an injury that meets these
criteria of direct harm to the plaintiff creditor will be said to have passed the strict
test.144
A caveat is that even this basic scenario could get complicated very quickly.
A broad range of inequitable conduct can fall within the scope of equitable
subordination, and the injured party is not always as clear cut as the above example.
Unlike, say, a breach of contract claim or a trademark dispute, where the injured
party or parties will usually be fairly clear, this is by no means always the case when
inequitable conduct has been perpetrated by a creditor of a financially distressed
debtor. Often both the debtor and other creditors may suffer both directly and
indirectly as a result of alleged inequitable conduct. For instance, creditors may
suffer indirectly by seeing the debtor’s value decline which leads to a decline in the
value of the creditor’s collateral and a dwindling of their financial investments.
Creditors may also suffer direct injury as a result of inequitable conduct if it affects
their rights to participate in the debtor’s business or if the inequitable conduct
damages their financial ventures, which depend on the debtor. Under such
circumstances, which are common, extricating “individual” versus “general” injury
will often be difficult.
In fact, in this very case it is difficult to parse out what is “particularized
injury” and what is not. The Panache Parties claim, for instance, that Romspen
starved the debtor of funding, thereby causing a decline of the Debtor’s value and
(indirectly) of the Panache Parties’ collateral and equity.145 But this is tied up with
an alleged scheme in which some of the Panache Parties are specifically named as
144 The strict test appears to have been applied, for instance, in Lyme Regis Partners, LLC v. Icahn
(In re Blockbuster Inc.), No. 10-05524, 2011 Bankr. LEXIS 1025, at *4 (Bankr. S.D.N.Y. Mar. 17,
2011). There, the court denied standing to an unsecured bondholder because its injuries of
recovering a lower value and being at a lower priority in the bankruptcy were not sufficiently
“distinct from other creditors” so as to satisfy that particularized injury requirement. Id. at *6.
145 Adversary Proceeding, ECF No. 147, Ex. A ¶ 27 (Response and Objection to Romspen Motion
for Summary Judgment).
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intended targets of the alleged bad acts.146 The Panache Parties also allege breach of
a fiduciary duty arguably owed directly to some of the Panache Parties under the
Binding Term Sheet; but at the same time these actions arguably damaged the
Debtor.147
If this Court were to adopt the strict test, the statute would require the exact
degree of requisite harm to be ascertained because the equitable subordination
doctrine requires the court to calibrate the remedy to the precise amount of
particularized harm.148 In other words, a plaintiff would only have standing to assert
(and to receive a remedy based on) the particular injuries done to it, not injuries also
done to the debtor. This would require a remarkable and probably unrealistic
precision in separating out injuries, victims, and harm.
Thus, while the outcome might not be unjust in theory, applying the strict test
would be very difficult in practice. Even a creditor who has suffered alongside a
debtor who has suffered a mix of direct and indirect injuries might receive less relief
than that creditor would otherwise be warranted. The Court will turn next to whether
a somewhat broader particularized injury test might make more sense.
2. Some courts appear to adopt a slightly broader understanding of
particularized injury, but this does not appear sustainable either.
Other courts appear to have recognized that the strict test would bar too many
claims because the creditor might not have been directly injured, in the sense of the
being the object or target of harm; but they might be the most or only direct
beneficiary of the remedy of equitable subordination. These courts appear to have
adopted what this opinion will call the “broader test,” allowing creditors to bring a
claim for equitable subordination if they would receive direct or special benefits if
the equitable subordination action were successful.149 In other words, the broader
test concedes that the injury might have been directed at the debtor but due to the
harms actually suffered as a result, the appropriate remedy might flow to one or more
particularly harmed creditors. Courts have not always been specific as to how much
146 See, e.g., Adversary Proceeding, ECF No. 54-1 ¶ 2 (Second Amended Complaint).
147 See, e.g., Id. ¶ 112-15; 67-69 (Second Amended Complaint).
148 11 U.S.C. § 510(c); In re Andrews, No. 02-0001, 2009 WL 1076831, at *7 (collecting cases on
how courts “have routinely read a general remedy into § 510(c), subordinating a claim to all claims
or an entire class of claims”).
149 Miller v. Elway (In re Elrod Holdings Corp.), 392 B.R. 110, 114 (Bankr. D. Del. 2008).
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benefit or what type of benefit might be enough, although “junior secured creditors”
appear to be the standard example of a party receiving relief under this approach.150
The Court notes from the outset that several courts have drawn attention to
the fact that the whole dichotomy of “general” versus “particular” injury is hard to
apply rigorously.151 In fact, if “general” is understood to refer to a remedy benefitting
the creditor body as a whole, which is what much of the case law appears to mean,
then a truly “general” equitable subordination claim is actually hard to imagine,
given that the statute only allows the subordination of a particular claim (or set of
claims) to another claim (or set of claims).152 Judge Taylor in Hoffinger thoughtfully
questioned “whether there can ever be a ‘general’ equitable subordination claim that
only belongs to the trustee or debtor-in-possession.”153 He noted that “there will
always be at least one or more other creditors the alleged generalized harm has not
harmed, and the cure will not benefit; specifically, the creditor(s) against whom the
action is brought.”154 This was an observation also made in the most on-point circuit
court case, the Seventh Circuit’s opinion in In re Vitreous Steel Products Co.155 In
that case, the court granted an unsecured creditor standing to pursue equitable
subordination of another unsecured claim. It noted that the sought-after equitable
subordination was “not a benefit to all unsecured creditors equally” because it was
“a detriment to the creditor whose debt is subordinated.”156
A hypothetical, generally based on allegations that are sometimes made
against aggressive lenders, illustrates the problems with the broader understanding
of “particularized injury.” This hypothetical explores who has standing to raise an
equitable subordination claim and demonstrates that, under the existing framework
150 In re Elrod Holdings Corp., 392 B.R. at 115.
151 Bunch v. J.M. Cap. Fin., Ltd. (In re Hoffinger Indus., Inc.), 327 B.R. 389, 413-14 (Bankr. E.D.
Ark. 2005); In re Vitreous Steel Prods. Co., 911 F.2d 1223, 1231 (7th Cir. 1990).
152 The Fifth Circuit has cast significant doubt on whether the characterization of an injury as
“general” is helpful in any case. See Highland Cap. Mgmt. LP v. Chesapeake Energy Corp. (In re
Seven Seas Petroleum, Inc.), 522 F.3d 575, 588 (5th Cir. 2008) (noting that it is not illuminating
exercise to label certain claims of creditors personal or general).
153 In re Hoffinger Indus., Inc., 327 B.R. at 414.
154 In re Hoffinger Indus., Inc., 327 B.R. at 413; see also Algonquin Powe Income Fund v.
Ridgewood Heights, Inc. (In re Franklin Indus. Complex, Inc.), No. 06–80254, 2007 WL 2509709,
at *8-9 (Bankr. N.D.N.Y. Aug. 30, 2007).
155 In re Vitreous Steel Prods. Co., 911 F.2d at 1231.
156 In re Vitreous Steel Prods. Co., 911 F.2d at 1231.
The Court’s further minor caveats on Vitreous Steel are above in note 85Error! Bookmark not
defined. and accompanying text.
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adopted by many courts (and viewed by this Court as unworkable), creditor standing
is evaluated based off of the potential remedy rather than the alleged injury.
Imagine a debtor with a waterfall of secured claims. Call them secured
creditors (“SC”) SC1, SC2, SC3, and SC4, with claims in that order of seniority and
with security interests in all of the debtor’s assets as their collateral. For simplicity,
assume that SC1 is owed $500,000, and the three others are each owed $100,000.
Also assume that all of these creditors have held their various priority positions for
a significant period of time.
Now assume that SC1 is tired of being a mere creditor. It sees potential to take
over the debtor, and it acts on its plan. By various inequitable machinations, it
destroys a considerable part of the debtor’s value. It “slow-walks” various agreed-
upon loan advances. It refuses to relieve the debtor of some terms in its loan
documents in order for the debtor to embark on a growth-enhancing course of action
of which the lender had previous indicated likely approval. It bickers with debtor’s
management to force delays and increase costs, etc. Now assume that these efforts
are successful, the value of the debtor’s business declines, and it fails to generate the
necessary cash to continue operations or make payments. Then, having stripped
away all other claims on the property and put itself in control, SC1 calls a default
and prepares to foreclose on the debtor’s remaining assets, so that it can repurpose
them in a way it sees fit.
In desperation, and on the eve of foreclosure, the debtor files for bankruptcy.
At that time, the debtor’s assets are worth only $500,000, although credible evidence
establishes that they were worth considerably more before SC1 embarked on the
actions described above. In the bankruptcy, the various secured creditors file their
claims, totaling $800,000, and so do unsecured creditors whose claims total
$500,000. A creditor’s committee is not formed because a sufficient number of
creditors decline to serve.
This is a situation where equitable subordination seems likely warranted.157
Under the facts, SC1 appears to have engaged in inequitable conduct, it has received
an advantage (control of the debtor and a first lien position in bankruptcy) as a result
of that potentially inequitable conduct, and subordinating its claim does not appear
inconsistent with the Bankruptcy Code. Depending on how much value was
destroyed as a result of the inequitable conduct, the appropriate remedy might be
157 Other remedies, including damages for tortious conduct against both debtor and creditor(s)
might also be warranted, but the focus here is merely standing to seek equitable subordination.
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subordination of SC1’s claim to one or more of the other secured creditors, or to all
claims.
Now assume that the debtor’s analysis is that the inequitable conduct only
destroyed about $300,000 in value. Thus, without the inequitable conduct, all of the
other secured creditors would have been paid, but none of the unsecured creditors.
Accordingly, the appropriate remedy would likely be to subordinate SC1 to the other
secured creditors, such that they will each be paid in full, but then SC1 will receive
the remaining $200,000. Under this scenario, the unsecured creditors get nothing,
with or without the inequitable conduct.158 Because all that would happen is re-
allocation of value among secured creditors, the debtor decides not to bring the
action on behalf of the estate.
The first question that arises from this scenario: Can SC2, SC3, and/or SC4
bring the equitable subordination action?
This Court believes that most courts would answer “yes” to that question. But
even on this basic question, the analysis is a bit murky: Did these creditors each
suffer a “particularized injury”? The only direct injury in this fact pattern appears to
be inflicted on the debtor itself. It is true that SC2, SC3, and SC4’s security interests
were devalued, but that is only as an indirect or collateral effect of the injury inflicted
directly on the debtor. In the fact pattern, there is no suggestion these lenders were
in any way involved with or even aware of the injury. Thus, this arguably should be
characterized as a “general” injury, such that perhaps the individual creditors should
not have standing (unless perhaps they receive derivative standing from the debtor).
This conclusion, however, seems at odds with various cases, including
Elrod.159 Indeed, some courts have spoken in terms of such junior creditors as having
a “special interest” that is affected.160 But the meaning of this is unclear: perhaps it
means simply they are most affected, or the only parties affected? Aside from
potentially being entitled to be paid more if the relief is granted, what is so “special”
158 Obviously, this hypothetical is stylized in various ways, including in that it ignores
administrative fees, but hopefully that can be forgiven for the sake of analytical focus.
159 Miller v. Elway (In re Elrod Holdings Corp.), 392 B.R. 110, 115 (Bankr. D. Del. 2008) (holding
that “a secured creditor had standing to seek equitable subordination of another secured creditor’s
claim to the extent that it seeks relief for a particularized injury”). See also In re Vitreous Steel
Prods. Co., 911 F.2d at 1231.
160 Black Palm Dev. Corp. v. Barlage, No. 1:09cv220, 2011 WL 4858420 at *6 (W.D.N.C. 2011)
(citing Bezanson v. Bayside Enter., Inc. (In re Medomak Canning), 922 F.2d 895, 902 (1st Cir.
1990).
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or “particular” about their interest? Is simply getting paid more in the “distribution”
enough? The strict test seems not met here; it seems clear that only the broad
understanding of the particularized injury test would permit the creditors to bring
this action: the remedy seems properly to benefit them, and so it seems appropriate
to allow them to bring the action even though they did not directly suffer the injury.
This is a hypothetical that seems to favor the broad test as an equitable and coherent
outcome.
Ending the analysis here in favor of the broader test, though, is insufficient.
More questions help to clarify why the existing framework for establishing standing
to bring an equitable subordination claim under either test is unworkable: Can
unsecured creditors bring the equitable subordination action? And if not, why not?
To see why this is revealing, add some facts to the hypothetical: Assume that there
is an unsecured creditor who has a large unsecured claim, who is commercially
sophisticated, who understands the debtor’s business well, and who is well-informed
about the events described above. This creditor disagrees with the debtor’s
professionals’ analysis and believes that in fact the debtor’s value was much higher
before the inequitable conduct, such that actually, there would have been enough to
pay off all or most of the unsecured claims but for the inequitable conduct.
If this is true, then the appropriate remedy should be a deeper subordination
of SC1, such that the unsecured creditors would receive the $200,000 remaining after
SC2, SC3, and SC4 are paid in full.
A court has no way from the outset to say that this unsecured creditor is wrong
about its valuation argument. Accordingly, if the junior secured creditors had
standing, why shouldn’t this unsecured creditor have standing to bring the equitable
subordination claim too? What’s so different about the “interest” or “particularized
injury” of this unsecured creditor versus the junior secured creditors SC2, SC3, and
SC4? There is certainly no statutory basis for a refusal to permit unsecured creditors
to seek equitable subordination while granting that right to junior secured creditors,
and the analytical basis seems lacking as well, on the by-no-means-farfetched
hypothetical facts as presented above. But the Court thinks that most courts would
deny standing to this unsecured creditor.
It is no answer to say that in such a situation, the Court should grant derivative
standing so long as it finds this unsecured creditor’s argument sufficiently
reasonable. That is not a principled distinction for allowing SC4 to seek standing
without any such requirement and imposing the additional requirement on the
unsecured creditor.
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In the end, the Court simply cannot understand how a particularized injury
test that rests the standing determination on whether or not the plaintiff will receive
a particularized remedy is unsustainable. Yet this appears to be how most courts
currently apply the particularized injury test.
For this reason, if it is to avoid this analytical inconsistency, the particularized
injury test must either be jettisoned entirely (as this opinion advocates); broadened
even more, such that equitable subordination claims can be brought by any creditor
with any sort of plausible argument that they will see a greater distribution if
successful (which is functionally the same as jettisoning it entirely and following
this Court’s approach); or given the narrow interpretation to mean that only a creditor
who was directly injured by the defendant can bring an equitable subordination claim
(which has no basis in the statute and could present inequitable or absurd results as
discussed in section C.1).161 For these reasons, this Court believes that both the strict
and broad version of the particularized injury test are unworkable, and a creditor
alleging even an indirect injury based on generalized harm to the estate has standing
to bring an equitable subordination claim.
D. Some of the Panache Parties allegations constitute particularized injury
and thus they would have standing to seek at least some of the relief
requested.
While there is considerable disagreement, as reflected in the lengthy
preceding analysis, about whether individual creditors have standing to seek
equitable subordination for injuries suffered by the bankruptcy estate and only
indirectly affecting the distribution that would be paid to those creditors, courts
appear to be in agreement that those who have suffered “particularized injury” have
standing to seek the equitable subordination of the claims of those who have injured
them.162 While the boundaries of this test are, as the preceding section argued,
161 See, e.g., Lyme Regis Partners, LLC v. Icahn (In re Blockbuster Inc.), No. 10-05524, 2011 WL
1042767, at *2-3 (Bankr. S.D.N.Y. Mar. 17, 2011) (applying a strict version of the particularized
injury test).
162 In re of Vitreous Steel Prods. Co., 911 F.2d at 1231 (holding that an individual unsecured
creditor had standing to seek equitable subordination because it asserted a particularized injury);
SAM REI, LLC v. Cont’l Grp., LLC (In re Strata Title, LLC), No. 2:14–ap–00319, 2014 WL
6685470 at *3-4 (Bankr. D. Ariz. Nov. 25, 2014) (holding that an administrative claim creditor
had standing separate and apart from interests of the estate as a whole and so could pursue equitable
subordination without court approval); In re Elrod Holdings Corp., 392 B.R. at 115 (holding that
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difficult to understand or apply, some “particularized injuries” are clear. Such is the
case here, at least in part.
In this case, the Panache Parties assert a large number of injuries suffered by
both themselves and the Debtor.163 Although the boundaries among the various
alleged harms are difficult to discern, the Court is confident that some of these can
be characterized as general injuries to the Debtor and some as particularized injuries
to themselves as stakeholders in the Debtor.164 While some of the allegations refer
to injuries to the Debtor and the Debtor’s other creditors, in large part the Panache
Parties allege that Romspen, an insider, used its position to the detriment of the non-
“a secured creditor had standing to seek equitable subordination of another secured creditor’s claim
to the extent that it seeks relief for a particularized injury”); Hartford Holding, LLC v. Mladen (In
re Eternal Enter., Inc), 557 B.R. 277, 281 (Bankr. D. Conn. 2016) (finding that a secured creditor
had standing to seek recharacterization and equitable subordination); Citizens Bank & Tr. Co. v.
Riederer (In re Brooke Cap. Corp.), No. 08-6132, 2011 Bankr. LEXIS 210 at *22 (Bankr. D. Kan.
Jan. 20, 2011) (finding that a secured creditor could bring a recharacterization action because the
action appeared to be a priority dispute and creditors can ordinarily dispute another creditor’s
asserted priority); Bunch v. J.M. Cap. Fin., Ltd. (In re Hoffinger Indus., Inc.), 327 B.R. 389, 413-
14 (Bankr. E.D. Ark. 2005) (holding that a judgment creditor had standing to bring an equitable
subordination action because she had a particularized injury based on the reduced distribution she
would receive if the court did not equitably subordinate the challenged claims). See also Variable-
Parameter Fixture Dev. Co. v. Comerica Bank-California (In re Morpheus Lights, Inc.), 228 B.R.
449, 454 (Bankr. N.D. Ca. 1998) (holding that a general unsecured creditor did not have standing
to bring an equitable subordination action because it did not assert a particularized injury to itself);
White Family Companies, Inc. v. PNC Bank (In re Dayton Title Agency, Inc.), 527 B.R. 289, 301
(Bankr. S.D. Ohio 2015) (holding that a general unsecured creditor did not have standing to bring
an equitable subordination action because it did not assert a particularized injury to itself); Lone
Star State Bank of West Texas v. Rabo Agrifinance, LLC (In re Waggoner Cattle, LLC), No. 18-
02007, 2019 WL 469367 at *7-8 (Bankr. N.D. Tex. Feb. 6, 2019) (holding that a creditor asserting
a particularized injury may bring equitable subordination action). Ultimately, the Waggoner court
dismissed the unsecured creditor’s equitable subordination action without prejudice because at the
time of the ruling the claim was not “ripe.” In re Waggoner Cattle, 2019 WL 469367 at *8. This
Court simply disagrees with Waggoner that an “adjudication of allegations in favor” of the plaintiff
should be necessary for it to show it has standing to pursue the remedy, so long as it is prepared to
demonstrate its particularized injuries before the bankruptcy court. The cases cited by the court in
Waggoner in support of its contrary holding appear apposite; they deal with standing to seek
remedies for injuries not yet suffered. But in Waggoner (as in this case), the injuries were claimed
to already have been suffered, even if an adjudication has not yet been obtained. Respectfully, this
Court believes that Waggoner was likely wrongly decided in this respect.
163 See generally Adversary Proceeding, ECF No. 54-1 (Second Amended Complaint).
164 Id. ¶¶ 122, 132 (Second Amended Complaint).
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insider stakeholders, the Panache Parties.165 Therefore, under the case law available,
the Panache Parties have standing to bring recharacterization and equitable
subordination actions because they have adequately alleged at least some
particularized injuries.
The Court notes that the standing obtained by the particularized injury test is
apparently limited. Keep in mind that the statutory remedy for equitable
subordination must be carefully calibrated to the relevant inequitable behavior for
which relief is sought.166 Under the “particularized injury” test, it may be the case
that the creditor can only obtain a remedy insofar as its particular injuries requires.
It cannot receive relief for any injuries that are the exclusive province of the
bankruptcy estate. Here, for instance, if the Panache Parties had to rely on
particularized injuries alone, relief might be severely curtailed, as most of the
conduct in this action probably impacted the Debtor more directly than the Panache
Parties.
So, thus, while this alternative holding is that the Panache Parties do indeed
have standing to seek equitable subordination, this alternative holding would limit
the relief, if it were not for the broader primary holding that the particularized injury
test does not restrict standing.
E. The Panache Parties would have derivative standing to assert equitable
subordination or recharacterization on behalf of the estate in any case.
Finally, the Court will address derivative standing. This issue is made
somewhat difficult because the Panache Parties did not actually seek derivative
standing.167 But ultimately the Court holds that even if the Panache Parties would
not have standing to seek remedies for all of the alleged inequitable behavior on their
behalf, the facts in this case support their having derivative standing to urge these
remedies on behalf of the estate.
The Fifth Circuit has repeatedly permitted trustees and creditors’
committees—when acting with derivative standing—to pursue relief under the
165 Adversary Proceeding, ECF No. 54-1 ¶¶ 58, 77, 122, 132, 142 (Second Amended Complaint;
ECF No. 147, p. 14 (Response and Objection to Romspen).
166 SI Restructuring, Inc. v. Faulkner (In re SI Restructuring, Inc.), 532 F.3d 355, 361 (5th Cir.
2008).
167 The Court understands that the Panache Parties’ lead counsel was a solo practitioner who
unfortunately passed away suddenly when this case was already fairly advanced, and that may well
have played a role in the lack of a request for derivative standing from replacement counsel.
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umbrella of equitable subordination. 168 The well-known Louisiana World case
explored when a creditor committee should have standing to bring claims on behalf
of a bankruptcy estate. There, the Fifth Circuit recognized that committees typically
have standing to sue on behalf of the trustee or debtor-in-possession where (1) the
claim is colorable; (2) the debtor-in-possession unjustifiably refused to pursue the
claim; and (3) leave is requested. 169 While agreeing with these “relevant
considerations,” the Fifth Circuit emphasized they are “not necessarily a formalistic
checklist.”170 It went on to find that the committee was pursuing a colorable claim
and that, based on the record, the debtor would have refused to pursue the claim.171
Under the circumstances of that case, the Fifth Circuit found “it inappropriate and
unnecessary to now go through the empty, formalistic ritual of remanding the case
so that the Committee may more punctiliously seek action from [the debtor] and
prior permission from the bankruptcy court, with obviously foreordained results, and
then again present its complaint, so that we may deny it on the merits.”172 In other
words, although the Fifth Circuit ultimately denied the committee’s claim on the
merits, it did so after rejecting formalistic requirements to confer derivative standing.
168 Wilson v. Huffman (In re Missionary Baptist Found. of Am.), 818 F.2d 1135, 1148 (5th Cir.
1987) (remanding the case brought by the trustee to the bankruptcy court for further identification
of inequitable conduct and extent of harm without questioning trustee’s standing to bring the
claim); Official Comm. of Unsecured Creditors v. Cajun Elec. Power Coop., Inc. (In re Cajun
Elec. Power Coop., Inc.), 119 F.3d 349, 353 n.2 (5th Cir.1997) (“A trustee in bankruptcy has
standing to bring an equitable subordination claim on behalf of the bankruptcy estate’s creditors.”);
Summit Coffee Co. v. Herby’s Foods, Inc. (In re Herby’s Foods, Inc.), 2 F.3d 128, 135 (5th
Cir.1993) (holding that a secured lender’s claim was subject to equitable subordination as brought
by the creditors’ committee).
169 Louisiana World Exposition, Inc. v. Fed. Ins. Co. (In re Louisiana Exposition, Inc.), 832 F.2d
1391, 1397 (5th Cir. 1987).
170 In re Louisiana Exposition, Inc., 832 F.2d at 1397.
171 In re Louisiana Exposition, Inc., 832 F.2d at 1397–98 (“The Committee did ask LWE to bring
an action for malfeasance against its directors and officers. LWE refused, apparently being unable
to act because of the conflict of interest presented to its decision makers . . . . Given LWE’s refusal
to file that suit, there is no reason to believe that LWE would have begun, or would begin, the
present action if requested.”).
172 In re Louisiana Exposition, Inc., 832 F.2d at 1397–98. See also Louisiana Dep’t of Env’t
Quality v. Tidewater Landfill LLC (In re Tidewater Landfill LLC), 674 B.R. 218, 224–25 (Bankr.
E.D. La. 2025) (noting that ‘“[t]here is no explicit authority in the Bankruptcy Code that allows a
bankruptcy court to grant an individual creditor or a creditors’ committee standing to initiate
adversary proceedings in the name of the debtor or trustee”; however, “[t]he Fifth Circuit Court of
Appeals and a majority of other Circuit Courts have held that such statutory authority nonetheless
is implied”’) (quoting In re On-Site Fuel Serv., Inc., No. 18-04196, 2020 WL 3703004, at *9
(Bankr. S.D. Miss. May 8, 2020)).
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Although Louisiana World involved creditors’ committee’s claims, courts
also apply its test to determine whether to grant derivative standing to claims brought
by individual creditors.173 In terms of the first prong (whether the claim is colorable),
the Court need not dwell on it at any length here. Based on the allegations and
evidence presented so far in this adversary proceeding, the Panache Parties’
recharacterization and equitable subordination causes of action are at least
colorable.174 “Colorable” is defined as a cause of action “appearing to be true, valid,
or right.”175 Based on the legal sophistication and litigious history between the
parties, the Court also suspects that the Romspen Parties would have filed a motion
to dismiss and a motion for summary judgment on the merits regarding the
recharacterization and equitable subordination causes of action if they had not been
colorable as pled.
Similarly, the second prong is easily satisfied under these facts. Here, as in
Louisiana World, the Debtor clearly would not have sought recharacterization and
equitable subordination if asked. For one, under the Binding Term Sheet, Romspen
ultimately controlled the Debtor and would stand to lose its secured position—a
catastrophic outcome—if its first lien claim were recharacterized as equity or
equitably subordinated.176 Under the terms of the Debtor’s current plan, Reomaster,
another entity controlled by Romspen, stands as stalking horse bidder to purchase
the equity of the reorganized debtor, in a sale which if approved would further
solidify Romspen’s control and render the Panache Parties’ claims unsecured.177 If
the Debtor (represented by sophisticated counsel and an outside Chief Restructuring
Officer)178 had intended to bring the claims for recharacterization and equitable
subordination, it certainly would have done so long before proposing a plan that
prioritizes paying Romspen and granting Reomaster stalking horse bidder status.179
For this reason, although best practices would have recommended that the Panache
173 Wooley v. Haynes & Boone, L.L.P. (In re SI Restructuring Inc.), 714 F.3d 860, 863–64 (5th Cir.
2013) (applying the analysis in Louisiana World to claims brought by an individual creditor); MLN
Co. v. Clear the Air, LLC (In re Clear the Air, LLC), 631 B.R. 286, 295–96 (Bankr. S.D. Tex.
2021) (holding that individual creditors had derivative standing to pursue claims on behalf of the
estate and applying the Louisiana World analysis).
174 Adversary Proceeding, ECF No. 54-1 ¶¶ 122, 132 (Second Amended Complaint).
175 Colorable, Black’s Law Dictionary (12th ed. 2024).
176 Adversary Proceeding, ECF No. 139, Ex. I (Romspen Motion for Summary Judgment).
177 Main Case, ECF 288, p. 8-9.
178 Main Case, ECF 59-3 (letter engaging Harney Partners and Gregory S. Milligan).
179 Main Case, ECF 288 (Debtor’s Combined Disclosure Statement and Second Am. Plan of
Reorganization).
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Parties seek derivative standing, the Court excuses the Plaintiffs from the second
element of the Louisiana World test.
Finally, as to the third element, the Court construes the argument in the
Panache Parties’ Response that a bankruptcy court can grant standing retroactively
“where the claims are colorable” as constituting a request for leave.180
Thus, even if the Panache Parties would not have had standing to bring claims
based on inequitable actions directly against the Debtor (and only indirectly
affecting them and other creditors), the Court finds that they should be granted
derivative standing to pursue equitable subordination based on these injuries.
180 Adversary Proceeding, ECF No. 147, p. 15 (Response and Objection to Romspen).
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Conclusion
For these reasons, the Panache Parties had standing to bring their
recharacterization and equitable subordination actions, and for this reason, the Court
denied summary judgment on this issue.
# # #
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