UNITED STATES BANKRUPTCY COURT

EASTERN DISTRICT OF KENTUCKY

ASHLAND DIVISION

IN RE:

MARTIN L. VAUGHN

NICCOLETTE G. VAUGHN

DEBTORS CASE NO. 94-10441

CHAPTER 11

MEMORANDUM OPINION

This matter comes before the Court to resolve the question of whether a general unsecured creditor has a right to bring, in addition to any action brought by the duly appointed trustee (Atrustee@ or Aplaintiff@), a separate and additional action against a secured creditor for equitable subordination pursuant to 11 U.S.C. '510(c). The question arises in the context of a proposed settlement between the trustee and Amsouth Bank (AAmsouth@ or Adefendant@), a secured creditor. While most of the memoranda and related filings have been filed with the style of Adversary Proceeding 96-1002, Bulleit, Trustee v. Amsouth Bank, also pending in this court, the issues involved here are part of the bankruptcy proceeding not the adversary proceeding.

This Court has jurisdiction of this matter pursuant to 28 U.S.C. '1334(b); the trustee has alleged that it is a core proceeding pursuant to 28 U.S.C. '157(b).

On February 11, 1997, Amsouth filed a Motion for an Order Approving Compromise and Settlement of Adversary Proceeding. By this settlement the parties proposed to allot to the defendant an allowed secured claim in the amount of $900,000.00, secured by a first priority security interest in and to a percentage of a partnership interest known as the "Nine Mile Gang Partnership" which debtor Martin L. Vaughn owned at the commencement of the bankruptcy proceeding. The settlement further proposed to allot to the defendant an allowed unsecured claim in the amount of $1,100,000.00. The plaintiff and defendant further proposed by this settlement to release each other of and from all claims, liabilities, and causes of action.

The Florida Department of Insurance, as Receiver of Dealers Insurance Company ("the Receiver"), a creditor of the debtors, filed an Objection to Settlement on March 4, 1997, having received notice of hearing on the proposed settlement pursuant to FRBP 2002(a)(3). The Receiver stated therein that it objected to the proposed settlement only insofar as it might prejudice or impair the ability of the Receiver or any other unsecured creditor to object to the secured status of or the priority of any claim of the defendant herein. The Receiver further stated that it has filed an action against the defendant herein which could establish a basis whereby any claim of the defendant's would be subordinate to that of the Receiver and other unsecured creditors.

The defendant filed a Response to the Receiver's Objection on March 20, 1997. Therein it contended that if the Objection were sustained, it would constitute a material alteration of the Disclosure Statement and Plan of Reorganization, especially insofar as the rights of all the creditors of the estate were concerned. At a hearing conducted on the Motion by the defendant for an Order to Approve Compromise and Settlement, and the Receiver's Objection thereto, the Court gave the parties herein and the Receiver ten days to submit additional authority on the right of the Receiver to bring an action for equitable subordination. After the expiration of the allotted time, the matter was submitted for decision.

The defendant argues that the Receiver does not have standing to pursue a claim for equitable subordination in addition to that of the bankruptcy trustee. It contends that the trustee represents the creditors of a bankruptcy estate, and that an unsecured creditor does not have an independent right to object to a claim or bring an action for equitable subordination against a secured creditor of the estate unless the trustee fails to do so, and the unsecured creditor petitions the court to proceed in the trustee's name.

The defendant cites several cases which stand for the proposition that the trustee is the proper party to seek equitable subordination of a claim to the claims of other creditors, because the trustee acts as the representative of the creditors, not the debtor. The most comprehensive treatment of this position is found in In re Fargo Financial, Inc., 80 B.R. 247 (Bkrtcy.N.D.Ga. 1987). It stands with earlier cases such as In re Ludwig Honold Manufacturing Company, 30 B.R. 790 (Bkrtcy.E.D.Pa. 1983) and In re Lockwood, 14 B.R. 374 (Bkrtcy.E.D.N.Y. 1981) in holding that only the trustee may bring equitable subordination actions. Fargo Financial does, however, note exceptions for secured creditors and debtors in possession in Chapter 11 cases standing in the place of a trustee.

The Receiver counters this position by asserting that since the trustee acts as the representative of all creditors, he can only assert the non-specific claims of creditors that affect them as a class. Thus, the Receiver argues, where an unsecured creditor has suffered a "unique injury" it has standing to seek subordination of a claim to its own. The Receiver cites Matter of Vitreous Steel Products Co., 911 F.2d 1223 (7th Cir. 1990), wherein the court held:

Equitable subordination is not a benefit to all unsecured creditors equally, at least where the creditor whose claim is objected to is partially unsecured; it is a detriment to the creditor whose debt is subordinated. Thus, when a party seeks equitable subordination, it is not acting in the interests of all the unsecured creditors. ...

[I]ndividual creditors have an interest in subordination separate and apart from the interest of the estate as a whole. The individual creditor should have an opportunity to pursue its separate interest.

At page 1231.

Further support for the Receiver's position is found in In re M. Paolella & Sons, Inc., 85 B.R. 965 (Bkrtcy.E.D.Pa. 1988). There the court elaborated on the difference between the interests the trustee seeks to protect, and the interest of an individual creditor:

The trustee seeks to subordinate the MNC claim to all unsecured claims contending that all creditors have been harmed by MNC; plaintiff seeks to elevate their claims above that of MNC with MNC's claim remaining ahead of other unsecured claims. If the plaintiffs prevail, only they would benefit from the subordination, ....If the trustee prevails, all unsecured creditors, including but not limited to plaintiffs, would benefit, but plaintiffs would benefit to a lesser degree because they would be forced to share the estate equally with other creditors.

. . . . .

Therefore, since there has been no challenge to plaintiffs' right to seek relief unique to themselves, ...., they have standing to press their claims even though the trustee seeks somewhat contradictory relief albeit based upon the same statutory provision.

At pages 973-974. Even in In re Medomak Canning, 922 F.2d 895 (1st Cir. 1990), a case cited by the defendant and generally supportive of its position, the court acknowledged that the interests of an unsecured creditor

may, in certain respects be distinguished from, and may perhaps even conflict with, those of the Trustee and other general creditors ....[W]e accept that it may be possible to imagine some equitable reordering that could put them ahead of other creditors. We also recognize that in different circumstances creditors may sometimes litigate equitable subordination claims separately.

At page 902.

The foregoing authorities convince this Court that an unsecured creditor such as the Receiver has standing to bring an independent action for equitable subordination when it seeks to subordinate a claim only to its own claim, and does not purport to represent all other general creditors. An order in conformity with this opinion will be entered separately.

Dated:

By the Court -

____________________________

Judge

Copies to:

Debtors

David T. Faughn, Esq.

Schuyler J. Olt, Esq.

Stanton L. Cave, Esq.