Memorandum of Decision Re: Subordination

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Decisions
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE NORTHERN DISTRICT OF CALIFORNIA
In re KING STREET INVESTMENTS,                                                                                           No. 95-11922 INC.,              Debtor. ___________________________/
Memorandum of Decision
     The debtor is a defunct mortgage broker. It filed a Chapter 7 petition in 1995, faced with lawsuits by several investors who claimed they were defrauded.      There is about $40,000.00 in the debtor's Chapter 7 estate. The claims total about $500,000.00, mostly from investors claiming fraud. However, one $38,000.00 claim was filed by Tommy and Ann Hardin, principals of the debtor. Rather than accept the 8-cent-on -the-dollar dividend, the Hardins embarked upon a campaign to disallow the other claims in the hopes of increasing their dividend. Those efforts have not been successful, and four of the defrauded investors now seek to have the Hardin claim subordinated pursuant to section 510(c) of the Bankruptcy Code.      The Hardins were the sole owners of the debtor corporation. Tommy Hardin was the qualifying individual on the corporation's corporate broker's license. Under California law, he had a duty to supervise all of the activities of the corporation and its agents.      The evidence submitted to the court on the hearing on the Hardins' objections clearly showed that the investors had been defrauded by an agent of the corporation. The agent made false statements to the claimants regarding the value of the property which the claimants accepted as security for a loan. The claimants relied on the statements of value, which proved to be grossly overstated. As a result of this fraud, the investors lost thousands of dollars; some of them lost their life's savings.      The court confesses to astonishment at the unmitigated gall of the Hardins. Having played a substantial role in the disastrous losses suffered by the investors, they set out to claim the meager estate for themselves at the expense of the defrauded investors. However, subordination is not intended as a penalty for outrageous conduct. The purpose of subordination is to promote a just and equitable distribution of the bankruptcy estate. In re Westgate-California Corp., 642 F.2d 1174, 1177 (9th Cir.1981). Under the facts of this case, justice and equity require that claim of the Hardins be subordinated.       An insider's claim is not subject to subordination merely because of insider status. However, where the insider has engaged in inequitable or otherwise culpable conduct in his role as an insider which resulted in injury to creditors, subordination is proper. In re Dominelli, 820 F.2d 313, 318-19 (9th Cir.1987). This is especially so where creditors were defrauded or deceived by the debtor. Matter of Herby's Foods, Inc., 2 F.3d 128, 133-34 (5th Cir.1993). The insider's conduct need not rise to the level of actual fraud before subordination is justified. Id.      In this case, Tommy Hardin had a duty to supervise the corporation's agents. He failed to do this properly, and as a direct result the investors lost thousands of dollars. It would be manifestly unjust to force the investors to share the meager estate with the Hardins.      The Hardins only substantial argument is that a state court ruled that they were not personally liable to the investors for their losses. However, for purposes of subordination it is not necessary to show that the insiders are liable to the other creditors. In this case, Tommy Hardin negligently supervised the corporation's agents, allowing them to defraud the investors. This caused the collapse of the corporation and the losses of the investors. This conduct is sufficient to mandate subordination regardless of whether the Hardins are directly liable to the investors. In fact, lack of an alternative remedy is an argument in favor of subordination. See Matter of Missionary Baptist Foundation of America, 818 F.2d 1135, 147 (5th Cir.1987).      For the foregoing reasons, the motion to subordinate will be granted. Since there will not be enough assets in the estate to pay the claims of the investors under any circumstances, the Hardins' pending objections to investor claims will be denied due to the Hardins' lack of standing.      Counsel for the investor claimants shall submit appropriate forms of order.
Dated: April 16, 1998                                                                                       _______________________                                                                                                                        Alan Jaroslovsky                                                                                                                        U.S. Bankruptcy