Equitable subordination is a legal principle that may have an impact on bankruptcy cases involving real estate. In this article, we’ll define the term “equitable subordination” and explain how it relates to real estate law.

Key Takeaways

  • Equitable subordination allows a court to rearrange the priority of claims in a debtor’s bankruptcy case if a creditor has engaged in improper conduct contributing to the debtor’s financial distress 
  • Equitable subordination prevents creditors from benefitting from inequitable behavior such as fraud or misconduct 
  • Equitable subordination can apply to real estate-related bankruptcy cases 

What Is Equitable Subordination?

Equitable subordination is a legal principle that allows a court to rearrange the priority of claims in a debtor's bankruptcy case. This is done when a creditor engages in conduct that is inequitable or improper and that has contributed to the debtor's financial distress or the loss suffered by other creditors. 

Equitable subordination allows the court to subordinate the claim of such a creditor to the claims of other creditors who did not engage in such conduct. This ensures that the creditor's claim is paid only after the claims of other creditors have been satisfied. 

The purpose of equitable subordination is to prevent creditors from benefiting from their own inequitable behavior at the expense of other creditors. The court may apply this principle in cases where creditors have engaged in fraudulent, unethical, or other forms of misconduct that have harmed the debtor or other creditors. 

Equitable subordination is discretionary and is applied only when necessary to achieve a fair and equitable distribution of the debtor's assets among creditors. The burden of proof lies with the party seeking the remedy, who must demonstrate that the creditor's conduct was inequitable and caused harm to the debtor or other creditors.

Equitable Subordination in Real Estate

Equitable subordination can affect the priority of claims against a debtor in real estate-related bankruptcies. For example, in bankruptcy cases involving real estate, creditors may include lenders, contractors, suppliers, and other parties with claims against the debtor.

In some cases, a creditor's conduct may have contributed to the debtor's financial distress, which may have led to the loss suffered by other creditors. In such cases, equitable subordination may be used to re-arrange the priority of claims against the debtor. 

Lenders should be aware that it is not enough for their actions to be permitted under loan documents. They must also ensure that their actions are not inequitable and do not contribute to the debtor's financial distress.

The application of equitable subordination in real estate cases can be complex. It is recommended to work with an experienced real estate attorney who can conduct a thorough analysis of the relevant facts and legal principles.

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