Equitable Subordination: What a Secured Lender Should Know
Jennifer Hildebrandt represents banks and alternative lenders in commercial finance transactions, leveraged finance transactions (including acquisition financings and recapitalizations), asset-based finance transactions, multi-tranche and multi-lien transactions, and restructurings. In particular, Jennifer has extensive experience representing lenders in two lien deals, unitranche transactions, and bank-bond deals. In addition, Jennifer has experience in various business sectors and in cross-border transactions.
Asecured lender to a distressed borrower will often use its leverage and negotiating power to improve its position as much as possible and maximize recovery in the event that the borrower files bankruptcy or liquidates. If the distressed borrower does file bankruptcy, the trustee and unsecured creditors will look for ways to maximize recovery for all of the unsecured creditors. Secured lenders become obvious targets of various claims and actions in the bankruptcy (e.g., preference, fraudulent transfer, equitable subordination), given that avoidance of their liens or subordination of their claims can significantly improve recovery for unsecured creditors.
This article discusses the types of secured lender conduct that can lead to "equitable subordination" of a secured lender’s claim in a bankruptcy. This article also discusses the circumstances in which a secured lender could find itself determined to be an "insider" of the debtor (which, as discussed in more detail below, could mean that the secured lender would be subject to special scrutiny in connection with an equitable subordination claim). As will become evident later in this article, the determination of what conduct of a non-insider secured lender provides sufficient basis for equitable subordination is not entirely clear, given that it is a relatively rare outcome (though the fact that it is a rare outcome is in and of itself a good thing). This uncertainty, coupled with the disastrous consequences to a secured lender that would result from a successful equitable subordination claim, is what makes equitable subordination such a troubling and often-talked-about prospect. The good news is that analysis of equitable subordination case law and a little forethought can help mitigate the risk. The end of the article sets forth some practical observations for secured lenders.