equitable subordination
Equitable subordination is a common law doctrine that courts use to ensure fairness in ranking debts during a bankruptcy proceeding .
During a bankruptcy proceeding, debts are paid in a certain order. According to section 510(c) of the Bankruptcy Code , courts can change this order if a creditor behaves in an unethical or fraudulent manner. An example of this would be a shareholder taking out a large loan from the company , and then trying to collect on that before other legitimate creditors.
Therefore, unaffiliated creditors (i.e., outsiders, bona fide third parties ) may gain rights to corporate assets superior to those of creditors who happen to also be significant shareholders of a firm. This statute empowers the bankruptcy court to determine whether a claim is superior to another claim, which even converts a first priority secured claim into a general unsecured claim. In doing so, a court may consider a variety of factors, such as whether the conduct of a creditor is equitable or not; and if not, whether it is for the purpose of counteracting damages to other creditors. For this doctrine to apply, the creditor to be subordinated must be an equity holder and an insider at the company, typically a corporation officer , and must have in some manner behaved unfairly or wrongly toward the corporation and its outside creditors. This doctrine is designed to remedy the situation that confers an unfair advantage on a single creditor at the expense of others.
[Last reviewed in February of 2025 by the Wex Definitions Team ]
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