Commercial Loan Driven by "Naked Greed" Warrants Equitable Subordination of Claim

The power to alter the relative priority of claims due to the misconduct of one creditor that causes injury to others is an important tool in the array of remedies available to a bankruptcy court in exercising its broad equitable powers. By subordinating the claim of an unscrupulous creditor to the claims of blameless creditors who have been harmed by the bad actor’s misconduct, the court has the discretion to implement a remedy that is commensurate with the severity of the misdeeds but falls short of the more drastic remedies of disallowance or recharacterization of a claim as equity. 

A Montana bankruptcy court recently had an opportunity to consider whether the alleged misdeeds of a secured lender in connection with “aggressive” financing provided to a company merited equitable subordination of the lender’s claim. In Credit Suisse v. Official Committee of Unsecured Creditors (In re Yellowstone Mountain Club, LLC), the court ordered that a senior secured claim asserted by the lender in the amount of $232 million based upon a new syndicated loan product marketed to the owner of a chapter 11 debtor be subordinated to the claims of a bank that provided debtor-in-possession financing, administrative claims, and the claims of the debtor’s unsecured creditors. According to the bankruptcy court, the lender’s actions in making the loan “were so far overreaching and self-serving that they shocked the conscience of the Court” because the lender’s conduct amounted to “naked greed,” having been “driven by the fees it was extracting from the loans it was selling.”


Equitable Subordination


“Equitable subordination” is a common-law doctrine predating the enactment of the Bankruptcy Code designed to remedy misconduct that causes injury to creditors (or shareholders) or confers an unfair advantage on a single creditor at the expense of others. The remedy is now codified in section 510(c) of the Bankruptcy Code, which provides that “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.” The statute, however, does not define the circumstances under which subordination is warranted, leaving the development of such criteria to the courts. 

In 1977, the Fifth Circuit Court of Appeals in In re Mobile Steel Co. articulated what has become the most commonly accepted standard for equitably subordinating a claim. Under the Mobile Steel test, a claim can be subordinated if the claimant engaged in some type of inequitable conduct that resulted in injury to creditors (or conferred an unfair advantage on the claimant), and if equitable subordination of the claim is consistent with the provisions of the Bankruptcy Code. Courts have since refined the test to account for special circumstances. For example, many make a distinction between insiders (e.g., corporate fiduciaries) and noninsiders in assessing the level of misconduct necessary to warrant subordination. For insiders, inequitable conduct is generally found if the claimant has: (i) committed fraud or illegality or breached its fiduciary duties; (ii) left the debtor undercapitalized; or (iii) used the debtor as a mere instrumentality or alter ego. By contrast, as expressed by many courts, subordination of the claim of a noninsider creditor requires a showing of “gross misconduct tantamount to fraud, misrepresentation, overreaching or spoliation.” 

Yellowstone Club


The Yellowstone Club and its affiliates (“Yellowstone”) operate a membership-only, master-planned unit development located on 13,500 acres of private land near the northwest corner of Yellowstone National Park. The club was established in the 1990s by Timothy L. Blixseth (“Blixseth”) and his former wife, Edra, with the intention of developing a private ski and golf community for the “ultra-wealthy.” To jump-start development, the Blixseths sold equity interests to various people referred to as “pioneer” and “frontier members.” 

In 2005, Credit Suisse was “trying to break new ground with a product by doing real estate loans in the corporate bank loan market” by means of a new kind of syndicated term loan. This syndicated loan product had previously been marketed by Credit Suisse to other master-planned residential and recreational communities such as Tamarack Resort, Promontory, Ginn, Turtle Bay, and Lake Las Vegas. The terms of the Credit Suisse loan agreements permitted equity holders to draw down sizable distributions from all or part of the loan proceeds.

In September 2005, Credit Suisse and Blixseth entered into a $375 million credit agreement. According to the agreement, $209 million of the loan proceeds were designated to be used as “distributions or loans” for “purposes unrelated” to Yellowstone. In addition, up to $142 million was authorized to be used for investments in “unrestricted subsidiaries” for “purposes unrelated” to Yellowstone’s development. Credit Suisse received a $7.5 million fee in exchange for the financing. Thus, the bulk of the loan proceeds were earmarked for purposes unrelated to Yellowstone.

Prior to entering into the credit agreement with Credit Suisse, Yellowstone carried a debt loan ranging from a low of between $4 million and $5 million to a high of approximately $60 million under a revolving line of credit. Yellowstone’s debts on the day before the closing amounted to no more than $20 million owed under a revolving line of credit and a term loan with American Bank. In the nine months that Yellowstone had been operating prior to executing the credit agreement with Credit Suisse, the club missed its profitability projections by a substantial amount.

Credit Suisse maintained that it did a “fair amount of due diligence” prior to making the loan but acknowledged that it never requested audited financial statements from Yellowstone and appeared to have relied exclusively on historical and future projections provided by Blixseth and Yellowstone. Credit Suisse relied almost exclusively on a new form of appraisal methodology—“total net value”—which does not comply with the Financial Institutions Recovery, Reform, and Enforcement Act of 1989.

On the closing date of the loan transaction in September 2005, Credit Suisse wired approximately $342 million to Yellowstone, representing the total loan amount of $375 million less fees, administrative costs, and $24 million to pay off pre-existing debt. On the same day, Blixseth caused approximately $209 million of the loan proceeds to be transferred out of Yellowstone to Blixseth Group Inc. (“BGI”), a Blixseth-owned holding company that controlled Yellowstone. Nearly all of the $209 million proceeds were then disbursed to various personal accounts and to satisfy Blixseth’s obligations. The immediate transfer of funds out of Yellowstone was not memorialized in any contemporaneous loan documents but was instead reflected on Yellowstone’s books with a simple journal entry. No promissory note was created until May 2006, when BGI executed a $209 million unsecured demand note, which was backdated to September 30, 2005. 

After the loan closing in 2005, Yellowstone was never current in its accounts payable. Although faced with chronic cash-flow problems, Yellowstone sought additional capital infusions from members rather than make a demand on the BGI note. In November 2008, Yellowstone filed for chapter 11 protection in Montana. Shortly after the filing and in anticipation of an auction sale of Yellowstone’s assets, Credit Suisse commenced litigation seeking a judgment fixing the allowed amount of its secured claim against Yellowstone and determining the priority of its liens. Yellowstone and its official committee of unsecured creditors responded by commencing an adversary proceeding seeking equitable subordination of Credit Suisse’s secured claim to the claims of all other pre- and post-bankruptcy creditors. The two proceedings were ultimately consolidated.

The Bankruptcy Court’s Interim Ruling

In an interim and expedited ruling designed to facilitate the anticipated auction of Yellowstone’s assets, the bankruptcy court concluded that equitable subordination was appropriate, observing that “Credit Suisse’s actions in the case were so far overreaching and self-serving that they shocked the conscience of the court.” In offering a new financial product for sale, the court explained, Credit Suisse was offering the owners of luxury second-home developments the opportunity to extract their profits upfront by “mortgaging their development projects to the hilt.” Credit Suisse would lend on a nonrecourse basis, earn a substantial fee, and minimize its potential exposure by selling off most of the credit to loan participants. The development owners would take most of the money out as a profit dividend, which saddled their developments with enormous debt. 

Credit Suisse and Yellowstone’s owners would benefit, the bankruptcy court emphasized, “while their developments—and especially the creditors of their developments—bore all the risk of loss.” The court further noted that other resorts that had borrowed from Credit Suisse under the same or similar syndicated loan products ultimately failed, including Tamarack Resort, Promontory, Lake Las Vegas, Turtle Bay, and Ginn. According to the court, “If the foregoing developments were anything like this case, they were doomed to failure once they received their loans from Credit Suisse.” Explaining that Credit Suisse earned fees by selling loans under a loan scheme whereby developers of high-end residential resorts were encouraged to take unnecessary loans, the court observed that “[t]his program essentially puts the fox in charge of the hen house and was clearly self-serving for Credit Suisse.”

According to the bankruptcy court, the fee structure was the catalyst for the most shocking aspect of the new loan product. A sophisticated lender such as Credit Suisse, the court noted, knew or should have known the impact on Yellowstone’s balance sheets of immediately distributing the loan proceeds, yet Credit Suisse proceeded with the transaction, turning a “blind eye” to Yellowstone’s financial statements after having performed no meaningful due diligence. The only plausible explanation for Credit Suisse’s actions, the court concluded, was that the lender’s conduct was “driven by the fees it was extracting from the loans it was selling, and letting the chips fall where they may.” The court had little trouble concluding that Credit Suisse’s claim should be equitably subordinated under section 510(c):


The naked greed in this case combined with Credit Suisse’s complete disregard for the Debtors or any other person or entity who was subordinated to Credit Suisse’s first lien position, shocks the conscience of this Court. While Credit Suisse’s new loan product resulted in enormous fees to Credit Suisse in 2005, it resulted in financial ruin for several residential resort communities. Credit Suisse lined its pockets on the backs of the unsecured creditors. The only equitable remedy . . . is to subordinate Credit Suisse’s first lien position to that of CrossHarbor’s superpriority debtor-in-possession financing and to subordinate such lien to that of the allowed claims of unsecured creditors.


Having subordinated Credit Suisse’s secured claim, the court nevertheless directed that, at the upcoming auction of Yellowstone’s assets, Credit Suisse would be permitted to credit-bid its allowed secured claim of $232 million. However, because Credit Suisse’s claim had been equitably subordinated, the court decreed that Credit Suisse was obligated to provide sufficient funds to pay Yellowstone’s post-petition lenders, all administrative claims, and the allowed unsecured claims asserted by Yellowstone’s nonmember creditors. The bankruptcy court did not subordinate Credit Suisse’s claim to the claims of Yellowstone Club members who had received distributions.



Yellowstone Club
is emblematic of the aggressive lending practices that transpired during the real estate boom that preceded a recession triggered by the sub-prime mortgage meltdown. The case illustrates that these practices during the height of the boom were not limited to the residential home mortgage industry, but also occurred in connection with commercial loans. Tellingly, most commercial lenders, including Credit Suisse, abandoned this variety of syndicated loan product in short order, after it became clear that the transactions were fraught with lender liability exposure.

In many respects, Yellowstone Club is a primer on the kind of conduct lenders should avoid to minimize the risk of equitable subordination in a bankruptcy case. Equitable subordination of the claims of a noninsider is very rare and requires a showing of mis- or malfeasance bordering on egregious misconduct—which is precisely what the bankruptcy court found. Other cases are likely to impose a greater strain on a bankruptcy court’s mental compass in deciding whether to deploy its broad equitable discretion to subordinate a claim. Yellowstone Club is also one of the few cases holding that a noninsider’s claim can be equitably subordinated for actions that were not based on insider information or special access or control over the debtor.



At the time its assets were to be auctioned, Yellowstone had in hand a stalking-horse bid of $100 million. As noted, Credit Suisse sought the right to credit-bid the remainder of its secured claims, agreeing to pay a cash portion to pay off those claims ahead of it. In early June 2009, the parties held a live auction in court, which ultimately concluded in a sale to CrossHarbor Capital Partners LLC, the stalking-horse bidder, for $115 million. On June 29, 2009, Yellowstone, Credit Suisse, and the Official Committee of Unsecured Creditors filed a stipulation effecting a global settlement. The parties agreed, among other things, that: (i) the interim and partial order of May 13, 2009, equitably subordinating Credit Suisse’s claim would be vacated; and (ii) all claims brought by or against Credit Suisse would be dismissed with prejudice. Later that day, the bankruptcy court issued an order vacating its interim and partial order of May 13, 2009. Thus, the court’s equitable subordination ruling has no precedential value. Still, the message borne by it for lenders is unmistakable.



Benjamin v. Diamond (In re Mobile Steel Co.), 563 F.2d 692 (5th Cir. 1977).

Credit Suisse v. Official Committee of Unsecured Creditors (In re Yellowstone Mountain Club LLC), Adv. Proc. No. 09-00014 (Bankr. D. Mont. May 13, 2009) (partial and interim order).


Credit Suisse v. Official Committee of Unsecured Creditors (In re Yellowstone Mountain Club LLC), Adv. Proc. No. 09-00014 (Bankr. D. Mont. June 29, 2009) (order vacating May 13, 2009, order).