5.4.15.4 Necessary Elements.

• Jurisdiction: Arizona

Equitable subordination generally requires a showing that: (1) the claimant is guilty of inequitable conduct; (2) the conduct injured other creditors or took unfair advantage of them; and (3) there is no inconsistency between subordination and the provisions of the Bankruptcy Code.^[33] See In re Westgate-California Corp., 642 F.2d 1174 (9th Cir. 1981); In re Missionary Baptist Found. of America, 712 F.2d 206 (5th Cir. 1983); In re Multiponics, Inc., 622 F.2d 709, 713 (5th Cir 1980); In re Mobile Steel Co., 563 F.2d 692, 700 (5th Cir. 1977); In re Bellucci, 29 B.R. 814 (Bankr. 1st Cir. 1983); In re Wilnor Drilling, Inc., 29 B.R. 72, 75 (S.D. Ill. 1982); In re Washington Plate Glass Co., 27 B.R. 550 (D.D.C. 1982); see also In re Pacific Express, Inc., 69 B.R. 112 (9th Cir. BAP 1986) (mere existence of “equity kicker” in loan document is not basis, per se, for equitable subordination).

^[33] Prior to 1996, there was a conflict between circuits as to how tax penalties that were found to be equal to general unsecured creditors could be equitably subordinated to general unsecured creditors pursuant to Bankruptcy Code § 510(c). In May 1996, the Supreme Court held that the Internal Revenue Service’s (IRS) postpetition, noncompensatory tax penalty claims could not be equitably subordinated on a categorical basis in derogation of Congress’ scheme of priorities. United States v. Noland, 517 U.S. 535 (1996). The circumstances that prompt the court to order equitable subordination must not occur at the level of policy choice. Id. at 541. Nonetheless, the “‘principles of equitable subordination’ may allow a bankruptcy court to reorder a tax penalty” when justified by particular facts. Id. at 540 (emphasis added). The Supreme Court specifically left open the question whether a bankruptcy court must always find creditor misconduct before a claim may be equitably subordinated. Id. at 1543.

With respect to the necessity of inequitable conduct requirement, it is generally held that the claimant’s misconduct need not be directly related to the creation or assertion of the claim. In re Mobile Steel Corp., 563 F.2d at 700; In re Multiponics, Inc., supra; In re Kansas City Journal-Post Co., 144 F.2d 791, 804 (8th Cir. 1944); In re Reed, 11 B.R. 258 (Bankr. D. Utah 1981). However, there is some authority to the contrary. See Prudence Realization Corp. v. Geist, 316 U.S. 89, 95 (1942); In re Ahlswede, 516 F.2d 784, 788 (9th Cir.), cert. denied, 423 U.S. 913 (1975).

In Pepper, the...