Abstract
Courts have repeatedly stated that equitable subordination is a compensatory remedy. This view is demonstrably mistaken; if equitable subordination is compensatory, only injured creditors, and not trustees or debtors in possession, would have Constitutional standing to bring equitable subordination actions. Rather, equitable subordination is quasi-punitive remedy akin to unjust enrichment, which looks to the actions of the inequitable party, not the harm caused. The proper compensatory remedy for injured creditors is direct tort suits against the inequitable creditor. Equitable subordination should be granted only when an injured creditor cannot bring a direct action against the inequitable creditor or when a creditor has engaged in inequitable behavior in the bankruptcy process itself. A quasi-punitive view of equitable subordination could resolve the problem of Constitutional standing for trustees and DIPs. More significantly, if equitable subordination is a punitive remedy, it changes litigation leverage and implies different limits on the action, particularly in regard to the liability of transferees of the inequitable party.
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