In re Bellucci

• Decision Date: 09 November 1982
• Docket Number: Bankruptcy No. 4-80-00213-G.
• Citation: 24 BR 493
• Parties: In re Elio C. BELLUCCI, Debtor.
• Court: U.S. Bankruptcy Court — District of Massachusetts

24 B.R. 493 (1982)

In re Elio C. BELLUCCI, Debtor.

Bankruptcy No. 4-80-00213-G.

United States Bankruptcy Court, D. Massachusetts.

November 9, 1982.

Michael B. Katz, Bacon, Wilson, Ratner, Cohen, Salvage, Fialky & Fitzgerald, P.C., Springfield, Mass., for plaintiff.

John P. McAllister, Tax Division, Dept. of Justice, Washington, D.C., for defendant.

Office of the U.S. Trustee, Boston, Mass., for Trustee.

MEMORANDUM AND ORDER ON TRUSTEE'S APPLICATION FOR EQUITABLE SUBORDINATION

PAUL W. GLENNON, Bankruptcy Judge.

The trustee in bankruptcy, Michael B. Katz ("trustee") filed the within application requesting that the court equitably subordinate the tax claims of the Internal Revenue Service ("IRS") to the claims of a class of creditors to be created and comprised of former clients ("clients") of the debtor, Elio C. Bellucci ("Bellucci"), who were defrauded by the illegal activities of Bellucci.

FACTS

Bellucci was an attorney practicing law in Springfield, Massachusetts. Due to certain fraudulent and illegal activities, he is no longer licensed to practice law. These activities included the misuse of more than $500,000 of his clients' funds. On April 14, 1980, the clients filed an involuntary chapter 11 petition. The IRS then filed a proof of claim for unpaid taxes owing, plus interest, for the years 1977 through 1979. For the reasons set forth more fully below, I am of the opinion that the claims of the IRS may not be subordinated to the claims of the clients, however much I sympathize with the clients.

DISCUSSION

Under § 510(c)(1) of the Bankruptcy Code, (11 U.S.C. §§ 101 et seq.), the court may: "under principles of equitable subordination, subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim or all or part of an allowed interest to all or part of another allowed interest. . . ." An examination of the legislative history provides an insight into the intent of Congress in enacting this provision. In H.R.Rep. No. 595, 95th Cong. 1st Sess. 359 (1977) U.S.Code Cong. & Admin.News, pp. 5787, 6315 it is provided:

Subsection (b) now subsection (c) permits the court to subordinate, on equitable grounds, all or any part of an allowed claim or interest to all or any part of another allowed claim or interest, and permits the court to order that any lien securing claim subordinated under this provision to be transferred to the estate. This section is intended to codify case law, such as Pepper v. Litton, 308 U.S. 295 60 S.Ct. 238, 84 L.Ed. 281 (1939), and Taylor v. Standard Gas and Electric Co., 306 U.S. 307 59 S.Ct. 543, 83 L.Ed. 669 (1938), and is not intended to limit the court\'s power in any way. The bankruptcy court will remain a court of equity, proposed 28 U.S.C. 1481; Local Loan v. Hunt, 292 U.S. 234, 240 54 S.Ct. 695, 697, 78 L.Ed. 1230 (1934). Nor does this subsection preclude a bankruptcy court from completely disallowing a claim in appropriate circumstances. See Pepper v. Litton, supra. The court\'s power is broader than the general doctrine of equitable subordination, and encompasses subordination on any equitable grounds.

S.Rep. No. 989, 95th Cong. 2d Sess. 74 (1978) U.S.Code Cong. & Admin.News, p. 5860 reads, in relevant part, as follows:

Subsection (b) now subsection (c) authorizes the bankruptcy court, in ordering distribution of assets, to subordinate all or any part of any claim to all or any part of another claim, regardless of the priority ranking of either claim. In addition, any lien securing such a subordinated claim may be transferred to the estate. The bill provides, however, that any subordination ordered under this provision must be based on principles of equitable subordination. These principles are defined by case law, and have generally indicated that a claim may normally be subordinated only if its holder is guilty of misconduct. As originally introduced, the bill provided specifically that a tax claim may not be subordinated on equitable grounds. The bill deletes this express exception, but the effect under the amendment should be much the same in most situations since, under the judicial doctrine of equitable subordination, a tax claim would rarely be subordinated.

And, finally, in 124 Cong.Rec.H. 11,095 (daily ed. Sept. 28, 1978) (statement of Rep Edwards) it is stated:

It is intended that the term "principles of equitable subordination" follow existing case law and leave to the courts development of this principle. To date, under existing law, a claim is generally subordinated only if the holder of such claim is guilty of inequitable conduct, or the claim itself is of a status susceptible to subordination, such as a penalty or a claim for damages arising from the purchase or sale of a security of the debtor.

See also 124 Cong.Rec. S17,412 (daily ed. Oct. 6, 1978) (statement of Sen. DeConcini).

As case law provides, and the legislative history reflects, the court, as a court of equity may equitably subordinate one claim to another claim. In Pepper v. Litton, 308 U.S. 295, 307-308, 60 S.Ct. 238, 245-246, 84 L.Ed. 281 (1939), perhaps the leading case on equitable subordination, the Supreme Court held that: "In the exercise of its equitable jurisdiction the bankruptcy court has the power to sift the circumstances surrounding any claim to see that injustice or unfairness is not done in administration of the bankrupt estate." See also Providence Realization Corp. v. Geist, 316 U.S. 89, 62 S.Ct. 978, 86 L.Ed. 1293 (1942); Sampsell v. Imperial Paper & Color Corp., 313 U.S. 215, 61 S.Ct. 904, 85 L.Ed. 1293 (1941); Taylor v. Standard Gas & Electric Co., 306 U.S. 307, 59 S.Ct. 543, 83 L.Ed. 669 (1939); In re Multiponics, Inc., 622 F.2d 709 (5th Cir.1980); In re Mobile Steel Co., 563 F.2d 692 (5th Cir.1977); In re Ahlswede, 516 F.2d 784 (9th Cir.), cert. denied, Stebbins v. Crocker Citizens National Bank, 423 U.S. 913, 96 S.Ct. 218, 46 L.Ed.2d 142 (1975); Central States Corp. v. Luther, 215 F.2d 38 (10th Cir.1954), cert. denied, 348 U.S. 951, 75 S.Ct. 438, 99 L.Ed. 743 (1955); Columbia Gas & Electric Corp. v. United States, 153 F.2d 101 (6th Cir.1946); Corley v. Cozart, 115 F.2d 119 (5th Cir.1940); and In re Loewer's Gambrinus Brewery Co., 74 F.Supp. 909 (S.D.N.Y.1947), aff'd, 167 F.2d 318 (1948).

Traditionally, it has been held that absent some showing of fraud or inequitable conduct on the part of the claimant injurious to other creditors, no equitable ground exists for subordination of a claim. In In re Columbia Ribbon Co., 117 F.2d 999, 1002 (3d Cir.1941) (referring to Pepper v. Litton, supra) the court stated: "That case holds that a court of bankruptcy under its equitable powers may disallow or subordinate a particular claim in bankruptcy which, because of the fraudulent nature of the claim or the bad faith or improper conduct of the claimant, ought not in equity and good conscience to be allowed or paid on a parity with other claims. It does not hold that the court may set up a subclassification of claims within a class given equal priority by the Bankruptcy Act and fix an order of priority for the subclasses according to its theory of equity." In In re Ahlswede, supra, at 787, the court stated:

The bankruptcy court\'s power to impose a result different from that prescribed by the statutory distribution scheme is not unlimited. The standard is that "a claim\'s disallowance or subordination may be necessitated by certain cardinal principles of equitable jurisprudence." Pepper v. Litton, supra 308 U.S. at 306 60 S.Ct. at 245. . . . In defining the nebulous "cardinal principles of equitable jurisprudence," it is important to keep in mind that the bankruptcy judge never did, and does not now, exercise unrestricted power to contradict statutory or common law when he feels a fairer result may be obtained by application of a different rule. Courts of equity have long applied standards of conscience to conduct on an individual basis to prevent formally proper but unconscionable applications of legal rules; they have not engaged in the practice of making abstract legislative judgments about the fairness of a result contemplated by the legislature\'s statutory scheme if it has otherwise been followed in good faith and without overreaching. (citations omitted).

The court continued by summarizing the position stated in a trio of Supreme Court cases:

Before a bankruptcy court may disallow or subordinate a claim, some basis must exist of the sort traditionally cognizable by equity as justifying its intervention, such as fraud, breach of fidiciary duties, mismanagement, overreaching; in fact any breach of the multitudes of "rules of fair play and good conscience" (citation omitted) traditionally enforced by a court of equity will suffice. A supposed inequity resulting when an innocent party in good faith asserts a legally valid claim will not (citations omitted). Id. at 788.

Likewise, in In re Branding Iron Steak House, 536 F.2d 299, 302 (9th Cir.1976) it was stated: "We acknowledge that a claim may be subordinated even in the absence of fraud or mismanagement (citations omitted). Nevertheless, a Bankruptcy Court is a court of equity, and subordination requires some showing of suspicious, inequitable conduct. . . ." See also Central States Corp. v. Luther, 215 F.2d 38, 46 (10th Cir.1954), cert. denied, 348 U.S. 951, 75 S.Ct. 438, 99 L.Ed. 743 (1955) (subordination is within the court's powers where "it is necessary to prevent the consummation of conduct which is inequitable . . ."); McDonell v. Sampsell, 193 F.2d 954, 956 (9th Cir.1952) (quoting In re Bowman Hardware & Electric Co., 67 F.2d 792, 794 (7th Cir.1933) (for a court to order subordination of a claim, "it must appear that the claimant has been guilty of some act involving moral turpitude or some breach of duty or some misrepresentation whereby other creditors were deceived to their damage"); Columbia Gas & Electric Corp. v. United States, 153 F.2d 101, 101 (5th...