                                                                                                                           Opinions of the United
1998 Decisions                                                                                                             States Court of Appeals
                                                                                                                              for the Third Circuit


11-24-1998

Citicorp Venture Cap v. Comm Creditors
Precedential or Non-Precedential:

Docket 97-3518,97-3519




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Recommended Citation
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Filed November 24, 1998

UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT

NOS. 97-3518 and No. 97-3519

CITICORP VENTURE CAPITAL, LTD.,
a New York Corporation

v.

COMMITTEE OF CREDITORS HOLDING UNSECURED
CLAIMS, AND COMMITTEE OF CREDITORS HOLDING
UNSECURED CLAIMS AS ESTATE REPRESENTATIVE OF
PAPERCRAFT CORPORATION
(D.C. Civil No. 95-cv-01872)

COMMITTEE OF CREDITORS HOLDING UNSECURED
CLAIMS, AND COMMITTEE OF CREDITORS HOLDING
UNSECURED CLAIMS AS ESTATE REPRESENTATIVE OF
PAPERCRAFT CORPORATION

v.

CITICORP VENTURE CAPITAL LTD.,
a New York Corporation
(D.C. Civil No. 95-cv-01886)

       COMMITTEE OF CREDITORS HOLDING
       UNSECURED CLAIMS, AND COMMITTEE OF
       CREDITORS HOLDING UNSECURED CLAIMS AS
       ESTATE REPRESENTATIVE OF PAPERCRAFT
       CORPORATION,
       Appellant in No. 97-3518
CITICORP VENTURE CAPITAL, LTD.,
a New York Corporation

v.

COMMITTEE OF CREDITORS HOLDING UNSECURED
CLAIMS, AND COMMITTEE OF CREDITORS HOLDING
UNSECURED CLAIMS AS ESTATE REPRESENTATIVE OF
PAPERCRAFT CORPORATION
(D.C. Civil No. 95-cv-01872)

COMMITTEE OF CREDITORS HOLDING UNSECURED
CLAIMS, AND COMMITTEE OF CREDITORS HOLDING
UNSECURED CLAIMS AS ESTATE REPRESENTATIVE OF
PAPERCRAFT CORPORATION

v.

CITICORP VENTURE CAPITAL LTD.,
a New York Corporation
(D.C. Civil No. 95-cv-01886)

       CITICORP VENTURE CAPITAL, LTD.
       Appellant in No. 97-3519

On Appeal From the United States District Court
For the Western District of Pennsylvania
(D.C. Civil Action Nos. 95-cv-01872 and 95-cv-01886)

Argued July 21, 1998

BEFORE: STAPLETON and ROSENN, Circuit Judges,
and RESTANI,* Judge

(Opinion Filed November 24, 1998)
_________________________________________________________________

*Hon. Jane A. Restani, Judge of the United States Court of International
Trade, sitting by designation.

                                  2
Amy M. Tonti
Klett, Lieber, Rooney & Schorling
One Oxford Centre, 40th Floor
Pittsburgh, PA 15219
 and
Paul K. Vey
Pietragallo, Bosick & Gordon
One Oxford Centre, 38th Floor
Pittsburgh, PA 15219
 and
Lawrence J. Slattery (Argued)
Citibank Legal Affairs Office
425 Park Avenue, 3rd Floor
New York, NY 10043

 Attorneys for
 Citicorp Venture Capital, Ltd.
 Appellant in No. 97-3519

Philip E. Beard
Stonecipher, Cunningham, Beard &
 Schmitt
125 First Avenue
Pittsburgh, PA 15222
 and
Stephen M. Ray (Argued)
Stutman, Treister & Glatt
3699 Wilshire Boulevard
Suite 900
Los Angeles, CA 90010
 Attorneys for Committee of
 Creditors Holding Unsecured
 Claims and Committee of Creditors
 Holding Unsecured Claims as
 Estate Representative of Papercraft
 Corporation, Appellant in No.
 97-3518

                        3
OPINION OF THE COURT

STAPLETON, Circuit Judge:

This appeal is from a decision in an adversary proceeding
brought by plaintiff-appellant/cross-appellee Committee of
Creditors Holding Unsecured Claims (the "Committee")
against defendant-appellee/cross-appellant Citicorp
Venture Capital, Ltd. ("CVC"). The action arises out of the
chapter 11 reorganization of Papercraft Corporationfiled in
the Western District of Pennsylvania. The Committee claims
that CVC, while a fiduciary of Papercraft, secretly
purchased millions of dollars of claims against Papercraft at
a discount, seeking to control Papercraft's assets and make
a profit at the expense of Papercraft's other creditors. CVC
contends that the claims were properly purchased and that
it acted in the best interests of both the company and its
creditors. After a trial, the bankruptcy court entered a
judgment against CVC, allowing CVC's purchased claims
only to the extent of the discounted amount CVC paid for
them and limiting its recovery to the percentage
distribution provided in the plan multiplied by that
discounted amount. On appeal, the district court agreed
with the bankruptcy court's finding that CVC had breached
its fiduciary duties, acted inequitably, and caused injury to
Papercraft and its creditors. It disagreed, however, with the
bankruptcy court's chosen remedy and remanded for a
redetermination regarding the appropriate remedial action.
This appeal followed.

I. THE FACTS FOUND BY THE BANKRUPTCY COURT*

In 1985, Papercraft completed a leveraged buyout in
which CVC invested $5.8 million. As a result of this
transaction, CVC was given a 28% equity interest in
Papercraft's direct parent, Amalgamated Investment Corp.,
and the right to seat one representative on the boards of
directors of Amalgamated, Papercraft, and Papercraft's
wholly-owned operating subsidiaries, Barth & Dreyfuss of
California and Knomark, Inc. CVC's vice president, M.
Saleem Muqaddam, became CVC's representative on these

                               4
boards of directors, and he remained such during the time
period relevant to this appeal.

Papercraft ran into financial difficulties a few years after
the transaction, which forced a restructuring of the
leveraged buyout ("LBO") debt. As part of the restructuring,
Papercraft exchanged about 98% of its indebtedness for
new First Priority Notes and Second Priority Notes.
However, beginning in 1990, Papercraft was unable to meet
the terms of the notes and sought to negotiate a second
restructuring of its unsecured debt. An informal committee
of major Papercraft creditors was formed and, after several
months of negotiations, an agreement was reached on a
restructuring plan. The plan, known as the "BDK plan,"
called for a merger of Papercraft's operating subsidiaries
(Barth & Dreyfuss and Knomark) into a single entity, BDK
Holdings, Inc., as part of a voluntary chapter 11 petition to
be filed by Papercraft. The creditors' claims against
Papercraft would then be converted into "BDK Units"
consisting of stock and bonds issued by the new venture.
The BDK plan was approved unanimously by Papercraft's
directors, including CVC's Muqaddam, in March 1991.

Papercraft filed its voluntary petition under chapter 11 on
March 22, 1991. As of the filing date, Papercraft had
outstanding $90.7 million in First Priority Notes and $56.3
million in Second Priority Notes, none of which were held
by CVC. Pursuant to the agreement among the creditors,
Papercraft filed the BDK plan with the chapter 11 petition
and an official Committee was formed to represent the
interests of unsecured creditors.

Though the chapter 11 petition and BDK plan werefiled
in March 1991, the required Papercraft disclosure
statement, a prerequisite to confirmation of the plan, was
not filed until October 1991. During this delay, CVC
managed to purchase over 40% of the outstanding notes, at
a significant discount. CVC, despite its earlier support of
the BDK plan, then objected to the confirmation of that
plan and offered its own competing plan, which called for a
CVC purchase of Papercraft's assets. An account of the
specific circumstances under which CVC took these actions
follows.

                               5
In March 1991, Muqaddam, in a memorandum to CVC's
Investment Committee, sought authorization to spend up to
$10 million purchasing Papercraft notes. CVC officials
granted the request in April 1991. Muqaddam, acting for
CVC, then began making anonymous purchases of notes
through various brokers. Between April and August 1991,
CVC purchased $60,849,575.72 face value of the Papercraft
notes for $10,553,541.88. These purchases represented a
significant proportion of the outstanding Papercraft debt:
CVC managed to acquire 38.3% of Papercraft's outstanding
First Priority Notes and 46.4% of outstanding Second
Priority Notes. In all, CVC's purchases amounted to 40.8%
of Papercraft's total unsecured claims. It thus achieved a
"blocking" position in the proposed reorganization.
Although Muqaddam was a member of Papercraft's board,
and therefore a fiduciary to the company and its creditors,
neither he nor anyone else from CVC requested or obtained
the approval of the board, the Committee, or the court
before purchasing the notes. Nor did CVC disclose to any of
the selling creditors its identity as buyer or itsfiduciary
status.

At the same time CVC was surreptitiously purchasing
claims, it also requested or otherwise obtained confidential
information about Papercraft's financial stability and
assets, including information that was not shared with
Papercraft's other creditors. In early 1991, at Muqaddam's
direction, two CVC employees visited the headquarters of
Papercraft's Barth & Dreyfuss subsidiary to obtain
information. During that visit, CVC copied financial
statements, looked at the company's product lines, held
meetings with management, and toured the facilities. A
written report was subsequently completed by CVC, drafts
of which were shared with Papercraft personnel. Indeed,
Frank Kane, Papercraft's Chief Financial Officer, reviewed
the report and gave comments directly to Muqaddam. None
of this information was shared with the Committee.
Papercraft personnel also forwarded a number offinancial
analyses and other documents directly to CVC, including a
tax analysis that had been completed by a consultingfirm
at Muqaddam's request. In addition, a valuation of
Papercraft assets and a distressed sale analysis completed

                               6
by Chanin and Company, the Committee's own financial
advisor, was given to CVC by Papercraft personnel.

As CVC accumulated Papercraft debt and information
between April and August 1991, it also formulated a
reorganization plan designed to compete with the previously
filed BDK plan. Muqaddam and his staff prepared a series
of reports evaluating the possibility of a CVC asset
purchase offer. These reports were based, in large part, on
the information about Papercraft that had been forwarded
to CVC by Kane. In the course of preparing an asset
purchase offer, Muqaddam held a meeting with Kane and
the Bank of New York Credit Corporation ("BNYCC") to
discuss financing for a CVC asset purchase offer.
Muqaddam then prepared a memorandum to CVC's
Investment Committee requesting authorization to purchase
Papercraft's assets. This authority was granted to
Muqaddam in August 1991.

In early September 1991, CVC formalized an asset
purchase offer by sending a letter to Papercraft detailing
the plan and announcing a financing arrangement with
BNYCC. Shortly before this announcement, Muqaddam
informed the Committee, for the first time, that CVC had
been purchasing claims. Soon after the asset purchase offer
was announced, it was filed as a plan of reorganization by
Papercraft. Papercraft also filed disclosure statements for
both the BDK plan and the CVC plan in October 1991.

The BDK plan disclosure statement was approved by the
bankruptcy court at a hearing in December 1991. Shortly
thereafter, CVC withdrew its plan of reorganization, but
then filed objections to confirmation of the BDK plan. The
bankruptcy court overruled those objections and confirmed
the BDK plan in January 1992.

II. THE PRIOR PROCEEDINGS

In October 1991, the Committee initiated this adversary
proceeding against CVC, objecting to the allowance of the
claims CVC had purchased and seeking equitable
subordination of those claims. After extensive discovery, a
trial was held over two days in November 1994. After
reviewing the testimony and evidence, the bankruptcy court

                                7
ruled in favor of the Committee. The court held that CVC
had failed to meet its fiduciary obligation to act in the best
interest of Papercraft and its creditors. See In re Papercraft
Corp., 187 B.R. 486, 497 (Bankr. W.D. Pa. 1995). It
identified three adverse effects from CVC's breaches of its
fiduciary duty. First, the bankruptcy court noted that the
note holders who sold their claims to CVC "were deprived of
the ability to make a fully informed decision concerning the
sale of their claims." Id. Although they might have still
decided to sell after full disclosure, "[t]he harm lies in the
fact that the selling noteholders had no opportunity to
consider pertinent information." Id.

Second, the court concluded that "CVC's actions diluted
the voting rights of prepetition creditors and resulted in
CVC's attempt to wrest from the prepetition creditors the
valuable assets of [Papercraft]." Id. Though CVC did not
ultimately vote its claims, the court concluded that
"[n]onetheless, its acquisition of claims placed it in the
controlling seat in its class," id. at 499 n. 10, and that CVC
was able to influence the negotiations surrounding the
terms of the plan despite its ultimate election not to vote.

Finally, the bankruptcy court decided that CVC's actions
created a conflict of interest which jeopardized its ability "to
make future decisions on claims as a director free of [its]
own personal interests as [an] owner of claims. Adding to
the conflict is the fact that these purchases were made at
a discount from present value. This brings into play a profit
motive, accentuating [its] personal interests." Id. at 500
(quoting In re Cumberland Farms, Inc., 181 B.R. 678, 680
(Bankr. D. Mass. 1995)).

To remedy the adverse consequences of CVC's behavior,
the bankruptcy court applied a "per se rule" that when a
claim is purchased by an insider at a discount without
adequate disclosure to the debtor and creditors, "the
insider's newly acquired claim will be limited to the amount
paid by the acquiring insider and recovery on the claim will
be limited to the percentage distribution provided in the
plan, as applied to the allowed claim." Id. at 491. However,
the bankruptcy court declined to equitably subordinate
CVC's claims.

                               8
On appeal, the district court first reviewed the findings of
fact made by the bankruptcy court and found none of them
clearly erroneous. Applying the facts to the test for
equitable subordination, the district court agreed that CVC
had acted inequitably and that this behavior had injured
creditors. As for a remedy, the district court held that
CVC's recovery should, at a minimum, be limited to the
amount paid for its claims so as to eliminate any potential
profits from the purchase of the notes. It disapproved of the
bankruptcy court's per se rule, however, and remanded to
the bankruptcy court for a determination of "the amount
CVC's claims should be subordinated." Id.1

III. THE RIGHT TO RELIEF

Before ordering equitable subordination, most courts
have required a showing involving three elements: (1) the
claimant must have engaged in some type of inequitable
conduct, (2) the misconduct must have resulted in injury to
the creditors or conferred an unfair advantage on the
claimant, and (3) equitable subordination of the claim must
not be inconsistent with the provisions of the bankruptcy
code. U.S. v. Noland, 116 S. Ct. 1524 (1996) (describing
existing case law as consistent with the three part test
identified in In re Mobile Steel Co., 563 F.2d 692, 700 (5th
Cir. 1977)).2
_________________________________________________________________

1. The bankruptcy court had jurisdiction over this adversary proceeding
pursuant to 28 U.S.C. SS 157(b) & 1334(b). The district court had
appellate jurisdiction over the bankruptcy court'sfinal judgment
pursuant to 28 U.S.C. S 158(a)(1). We have jurisdiction over the final
decision of the district court pursuant to 28 U.S.C.S 158(d). See In re
Indian Palms Associates, Ltd., 61 F.3d 197, 199 n. 2 (3d Cir. 1995).

2. This court, in In re Burden, 917 F.2d 115, 120 (3d Cir. 1990),
concluded that "creditor misconduct is not [always] a prerequisite for
equitable subordination." Burden involved subordination of a tax penalty
in the absence of government misconduct. The Supreme Court, in two
recent cases regarding the standards for tax penalty subordination, has
refused to decide whether misconduct is required under S 510(c),
resolving each case on the principle that "categorical" subordination is
not permissible. See United States v. Reorganized CF & I Fabricators of
Utah, Inc., 518 U.S. 213, 229 (1996); Noland, 517 U.S. at 543. We need
not here resolve the issue of whether misconduct is always a prerequisite
to equitable subordination because the bankruptcy court properly found
misconduct.

                               9
A. Inequitable Conduct

1. The Legal Sufficiency of the Findings of the
       Bankruptcy Court

CVC acknowledges that it and its representative,
Muqaddam, owed a fiduciary duty to Papercraft and its
creditors at all times relevant here. It asserts, however, that
neither breached a fiduciary duty. It insists that it is not
improper per se for a fiduciary to purchase claims against
the debtor in a bankruptcy at a discount and it stresses
that the bankruptcy court made no finding that the prices
paid for the Papercraft notes were unfair or inequitable at
the time of the purchases.

We accept, arguendo, that the purchase of notes at a
discount by a fiduciary of a debtor in bankruptcy is not
improper under all circumstances,3 and we acknowledge
the absence of a finding on the fairness of the purchase
price. The bankruptcy court found, however, that the
Papercraft notes (1) were purchased for the dual purpose of
making a profit for CVC on the notes and of being able to
influence the reorganization in its own self-interest, (2) were
purchased with the benefit of non-public information
acquired as a fiduciary, and (3) were acquired without
disclosure of its purchasing plans to the bankruptcy court,
the Papercraft board, the Committee, or the selling note
holders. The bankruptcy court further pointed out that
under Brown v. Presbyterian Ministers, 484 F.2d 998, 1005
(3d Cir. 1973), the opportunity to purchase the notes was
a corporate opportunity of which CVC could not avail itself,
consistent with its fiduciary duty, without giving the
corporation and its creditors notice and an opportunity to
participate.
_________________________________________________________________

3. There is authority arguably to the contrary, but, in light of the
findings of the bankruptcy court, we need not, and do not, resolve the
issue here. In Manufacturers Trust Co. v. Becker, 338 U.S. 304, 313-14
(1949) the court observed, ". . . [I]f it is clear [as it is] that a
fiduciary
may ordinarily purchase debt claims in fair transactions during the
solvency of the corporation, the lower federal courts seem agreed that he
cannot purchase after judicial proceedings for the relief of a debtor are
expected or have begun." (citing cases).

                                10
CVC primarily protests that the bankruptcy court's
findings of fact concerning inequitable conduct on its part
are clearly erroneous. We will address that contention in
the following section. We hold here, however, that the above
noted findings reflect ample inequitable conduct to support
a subordination remedy. Indeed, those findings make this a
paradigm case of inequitable conduct by a fiduciary as that
concept has been developed in the case law, and we believe
further elaboration is not required. Before turning to an
analysis of the record support for these findings, we will
only comment briefly on two of CVC's justifications for its
conduct.

CVC insists that the opportunity to purchase the notes
was not a corporate opportunity, and that notice to
Papercraft's Board and the Committee was not required
because Papercraft could not have purchased the notes at
discount and the members of the Committee had no
interest in doing so. We agree with the Committee, however,
that CVC's argument is fundamentally at odds with our
decision in Brown.

In Brown, we held that the availability of claims for
purchase at a discount constitutes a corporate opportunity.
After noting that a director of a solvent corporation may
take advantage of a corporate opportunity only if he
discloses the opportunity to the corporation, we further
held that a director of a corporation in bankruptcy owes a
fiduciary duty to creditors and cannot seize a corporate
opportunity without disclosure to the creditors or their
representative. Even though the director in Brown had
purchased a note at discount with the consent of the
corporation and its stockholders, we concluded that a
breach of fiduciary duty had occurred: "The opportunity
should have been disclosed to the receiver as representative
of the creditors." Id. at 1005.

CVC contends that Brown is distinguishable because
Papercraft was not in a financial or legal position to
purchase the notes and because the members of the
Committee must have been well aware that a market
existed in Papercraft debt. It necessarily follows, according
to CVC, that neither could have been injured by its
purchases. We believe this argument more relevant to the

                               11
remedy issue than to whether a breach of fiduciary duty
occurred. That duty required that it share everything that
it knew with Papercraft's board and the Committee before
commencing its purchases. Its failure to do so would alone
support a subordination depriving it of its profit from the
note transactions. The absence of a disclosure in
circumstances of this kind makes it extremely difficult to
say with confidence what would have happened had no
breach of duty occurred4 and that, in itself, is a compelling
reason for insisting on disclosure.

CVC also argues that its failure to disclose its identity to
note sellers was not inequitable because its identity was not
material to the purchases. It stresses that no note sellers
have thus far complained. We agree with the bankruptcy
court, however, that CVC's identity and purchasing plans
were clearly material to the purchase transaction. The fact
that CVC, a party with access to inside information, was
seeking to purchase over $10 million in Papercraft debt and
to steer the reorganization towards a sale to it of
Papercraft's assets would certainly have been of interest to
a creditor considering a CVC offer to purchase in the
summer of 1991.

In short, we agree with the bankruptcy court, the district
court, and the Committee that CVC violated its fiduciary
duty in a number of significant respects.

2. Record Support for the Bankruptcy Court's Findings

CVC's most fundamental challenge to the factual findings
of the bankruptcy court relates to the disclosure issue. It
asserts that the court clearly erred in concluding that CVC
anonymously purchased the Papercraft notes. While CVC
makes no claim that it acted affirmatively to notify anyone
_________________________________________________________________

4. If the attention of the Papercraft board and the Committee had been
focused on the potential CVC perceived in its note purchases, it is not
at all clear that Papercraft or its creditors would have been unable to
tap
additional resources, just as CVC did. Either or both might have been
able to seize or participate in the opportunity through borrowing, court
approved purchases or amendment to the plan of reorganization to
include a cash-out option. See, e.g., In re Cumberland Farms, Inc., 181
B.R. 678 (Bankr. D. Mass. 1995).

                                12
of its purchases prior to the consummation of its
purchasing plan, it maintains that the sophisticated
investors on the Committee knew that CVC was buying
claims and chose to keep quiet about it in order to gain a
"litigation windfall" by filing suit once CVC announced its
position. Specifically, CVC claims that the courts below
clearly erred in finding that the Committee had no
knowledge of CVC's claims purchases until after CVC
announced its competing reorganization plan.

To support its argument, CVC relies upon minutes of a
conference call held by the Committee on April 15, 1991.
Those minutes reflect that "there was mention of the fact
that American Money [a creditor of Papercraft] had sold its
notes to Citicorp." App. at 1558. In addition, CVC points to
testimony of the Committee's chair, Pamela Cascioli, that
she had been made aware of rumors that CVC had
purchased American Money's claims. However, the minutes
of the conference call and the testimony of Cascioli were
illuminated by witnesses at trial, who testified that the
discussion during the conference call lasted thirty seconds
and that such rumors are commonplace, generally
unfounded, and would not normally warrant additional
inquiry. The bankruptcy court credited this testimony and
specifically found that, other than the rumor, the
"committee heard no more about [claims purchasing
activity] until CVC made its asset purchase offer in
September of 1991." 187 B.R. at 492. It appears that the
bankruptcy court weighed the effect of the rumor in light of
the explanatory testimony and credited the Committee's
explanation. CVC provides no convincing reason to
conclude that this determination was clearly erroneous.5

CVC next challenges the court's finding as to its motive
in purchasing the notes. It suggests that it was acting in
the best interest of the company by offering a cash-out
_________________________________________________________________

5. CVC strenuously argues that the bankruptcy court should not be
allowed to simply rest on a credibility determination when documentary
evidence supports a different conclusion. However, in this case the
documentary evidence was explained by the testimony at trial, which the
court found credible. There is nothing unusual about a court finding
credible one plausible explanation of the significance of documentary
evidence.

                               13
option to creditors that was not available under the BDK
plan. As we have noted, however, the court found that CVC
intended to profit not only from the purchase of the notes
at discount but also from gaining control of the
reorganization. These findings were supported, inter alia, by
the testimony of CVC's own people. Muqaddam admitted
that he expected to make a profit from the note purchases,
and the chairman of CVC stated that those purchases
would help CVC "influence something." Id. at 495-96, 500.
The evidence clearly permits an inference that CVC was
primarily motivated by its own self-interest in purchasing
claims. Accordingly, the court did not clearly err in drawing
that inference.

CVC also contests the court's determination that its
access to material, non-public information as an insider
influenced its purchases of Papercraft notes. The court
relied upon evidence establishing that Papercraft's then-
Chief Financial Officer, Frank Kane, conducted valuations
of the company based on CVC's proposed asset purchase --
analyses that were not provided to the Committee. In
addition, the court found that some of CVC's information
was not public when received, and that CVC was given
priority treatment by Papercraft in responding to requests
for information. As the court accurately put it,"CVC had
virtually unrestricted access to inside information and
significant assistance from [Papercraft] through its
employees and staff and its control over employees." Id. at
496.

CVC argues that though it was an insider, the
information it received did not differ materially from that
available to the other creditors, who were all sophisticated
institutional investors. The bankruptcy court's conclusion
to the contrary is supported, however, by evidence that
CVC obtained special financial information andfinancial
and tax valuations in order to evaluate its own asset
purchase proposal, which was itself directly supported by
the note purchases. CVC's argument that the special
analyses it received were immaterial rings hollow in light of
its use of that information in purchasing claims and
preparing its asset purchase offer.

                               14
In short, our review of the record convinces us that the
crucial findings we have referenced as demonstrating
inequitable conduct are not clearly erroneous.

B. Injury or Unfair Advantage

As we have noted, the bankruptcy court identified three
areas of injury or unfair advantage suffered by the
Committee and Papercraft as a result of CVC's secret
purchase of claims at a discount. First, the court found
that selling note holders were deprived of the ability to
make a fully informed decision to sell their claims. Second,
the court concluded that CVC diluted the voting rights of
members of the Committee. Though CVC ultimately did not
vote its claims, the court indicated that its purchased
claims secured a position of influence over the
reorganization negotiations. Finally, the court held that
CVC's actions created a conflict of interest which
jeopardized its ability to make decisions in the best interest
of the company, free from its competing profit motive.

The district court also found these "injuries and unfair
advantages" to be sufficient to warrant an equitable
subordination remedy. It emphasized that CVC had
"engaged in a comprehensive information collection effort
made possible by its position on Papercraft's Board . . . and
then used this information to prepare its own asset
purchase offer which directly competed with the BDK plan."
Op. at 21. While the district court makes no express
reference to it, the Committee points us to trial testimony
from its financial advisor indicating that this competing
reorganization plan and CVC's associated objections to the
BDK plan resulted in confirmation delay that inflicted
substantial injury on Papercraft's non-selling creditors.

The bankruptcy court did not attempt to quantify the
harms caused in economic terms, and CVC characterizes
them as "noneconomic" harms. We do not agree with this
characterization, however, and, like the bankruptcy and
district courts, we conclude that they are sufficient to
justify subordination.

                                15
C. Consistency with the Code

Finally, a remedy of equitable subordination under
S 510(c) must not be inconsistent with other provisions of
the bankruptcy code. This requirement "has been read as a
`reminder to the bankruptcy court that although it is a
court of equity, it is not free to adjust the legally valid claim
of an innocent party who asserts the claim in good faith
merely because the court perceives the result is
inequitable.' " Noland, 517 U.S. at 539 (quoting DeNatale &
Abram, The Doctrine of Equitable Subordination as Applied
to Nonmanagement Creditors, 40 Bus. Law 417, 428 (1985).

CVC makes the argument that other provisions of the
bankruptcy code, including those related to voting of claims
and transfer of claims, provide all the remedy necessary for
inappropriate insider activity. While these provisions may
also be applicable, we perceive no reason why the
availability of alternative remedies makes equitable
subordination under S 510(c) incompatible with the Code
under the circumstances of this case.

IV. THE REMEDY

The bankruptcy court and the district court agreed that
CVC's inequitable conduct warranted a remedy and that, at
a minimum, it should not be permitted to profit by its
purchase of Papercraft notes. Their agreement ended there,
however. The bankruptcy court applied a per se rule that
whenever an insider purchases a claim of a debtor without
disclosure to the debtor and its creditors, that claim will be
"allowed" under S 201 only to the extent of the amount paid
and "recovery on the claim will be limited to the percentage
distribution provided in the plan, as applied to the allowed
claim." 187 B.R. at 491. Having imposed that remedy, the
bankruptcy court concluded that equitable subordination of
CVC's entire claim would "not [be] consistent with the
Code." Id. at 502. As it explained:

       In the instant case we find that the first two[elements
       of equitable subordination] have been met but, because
       of our limitation on the allowance of CVC's claims,
       equitable subordination is not consistent with the
       Code. We have previously held that "principles of

                               16
       fairness would be violated if insiders who create an
       unfair advantage for themselves were permitted to
       share equally with other creditors." In re I.D. Craig
       Service Corp., 1991 WL 155750 at *7 (Bankr. W.D. Pa.
       August 8, 1991). Because we are limiting the allowed
       amount of CVC's claim to the amount it paid for the
       claims, with recovery under the plan gauged to that
       amount, we have adhered to principles of fairness
       without the necessity of subordinating CVC's claim.

Id. at 502.

The district court held that the bankruptcy court's per se
remedy did more than deprive CVC of its profit on its
investment in Papercraft notes, an objective that could be
accomplished by subjecting CVC claims to subordination to
the extent necessary to limit its recovery to the amount
paid. The district court estimated that the remedy imposed
by the bankruptcy court would reduce CVC's recovery
approximately $7.5 million below the amount necessary to
deprive it of profit. While it acknowledged that
subordination beyond that necessary to deprive CVC of
profit might be warranted here, it declined to approve
further subordination in the absence of appropriate
findings. The court thus held:

       [B]ecause it adopted a per se rule, the Bankruptcy
       Court did not have the opportunity to make factual
       findings as to how an additional $7,489,941.88
       reduction in CVC's recovery comports with the
       principles of equitable subordination. We do not
       conclude today, however, that CVC's claims may not be
       subordinated by such an amount but only that any
       amount of subordination beyond the limitation of
       CVC's recovery to the amount paid for such claims
       should be supported by factual findings and reconciled
       with the principles of equity. We believe this to be a
       finding of fact best left to the Bankruptcy Court, not
       this Court sitting as a court of appeal. Accordingly, we
       will remand the case to the Bankruptcy Court for a
       finding on the amount CVC's claims should be
       subordinated pursuant to the principles of equitable
       subordination.

                               17
Op. at 26-27.

We agree with the district court. At a minimum, the
remedy here should deprive CVC of its profit on the
purchase of the notes. That can be accomplished by
subordinating CVC's claim under S 510(c) to the extent
necessary in order to limit its recovery to the purchase
price of the notes.6 Further subordination may be
appropriate, but only if supported by findings that justify
the remedy chosen by reference to equitable principles.7 In
the absence of such findings, neither the district court nor
we are in a position to fulfill our assigned responsibility of
review.

By so concluding, we do not suggest that a bankruptcy
court can never impose a subordination remedy beyond
disgorgement of profit without putting a specific price tag
on the loss suffered by those who will benefit from the
subordination. Such quantification may not always be
feasible and, where that is the case, it should not redound
to the benefit of the wrongdoer. A bankruptcy court should,
however, attempt to identify the nature and extent of the
harm it intends to compensate in a manner that will permit
_________________________________________________________________

6. We do not read the case law cited by the Committee and the
bankruptcy court to suggest the contrary.

7. In the course of reaching its holding, the district court concluded
that
S 510(c) is the exclusive remedy available to a bankruptcy court in
circumstances like these and that the bankruptcy court was accordingly
without authority to fashion a "disallowance" remedy. We do not endorse
that conclusion. In Pepper v. Litton, 308 U.S. 295 (1939), the Supreme
Court held that the bankruptcy court exercised its statutory
responsibilities as a court of equity and indicated that a purchase of
claims against a debtor in bankruptcy by a fiduciary, when consistent
with principles of equity, may properly lead either to the "disallowance"
of the fiduciary's claim or to the subordination thereof. The rationale of
Pepper would suggest that under pre-Code law a bankruptcy court was
authorized to disallow a portion of the fiduciary's claim when that would
produce an equitable result. We find it unnecessary here to resolve the
issue as to whether equitable "disallowance" remains an available
remedy. The Committee sought subordination under S 510(c), the district
court has appropriately remanded this matter to the bankruptcy court
for application of S 510(c), and neither side maintains that the authority
granted by that section cannot be utilized to fashion a just remedy.

                               18
a judgment to be made regarding the proportionality of the
remedy to the injury that has been suffered by those who
will benefit from the subordination. If that is not possible,
the court should specifically so find.

Inherent in what we have just said is the equitable
principle that any subordination should not result in a
windfall to those benefitted by it based on injury to others
outside the benefitted class. Stoumbos v. Kilimnik, 988 F.2d
949, 960 (9th Cir. 1993) ("A claim will be subordinated only
to the claims of other creditors whom the inequitable
conduct has disadvantaged."); Matter of Herby's Foods, Inc.,
2 F.3d 128, 131 (5th Cir. 1993) (subordination proper only
to the extent necessary to offset the harm the creditors
suffered as a result of the inequitable conduct). This
principle is applicable here because the Papercraft creditors
who sold their claims to CVC will not benefit from any
subordination. Accordingly, any injury to them must play
no role in determining the extent of any subordination here
of CVC's claims. If they consider themselves aggrieved, they
must be left to the other remedies afforded them by law.

While we agree with CVC's criticism of the bankruptcy
court's remedy, we decline to accept its argument that the
record is devoid of any evidence that would support a
remedy going beyond disgorgement of profit. Without
limiting the inquiry of the bankruptcy court in any way, we
note that there is evidence which would support afinding
that the non-selling Papercraft creditors suffered injury
from CVC's attempt to control the reorganization. While the
bankruptcy court held, with record support, that the delay
between the filing of the petition and the filing of the
disclosure statement was not attributable to CVC's
machinations, it made no similar finding with respect to the
period of delay between the filing of the disclosure
statement and confirmation of the BDK plan. Moreover,
while the bankruptcy court found "no evidence that CVC
engaged in conduct designed to delay the plan process," if
CVC's pursuit of its own interest in fact resulted in delay of
the confirmation, we do not read that finding as
inconsistent with subordination based on injury resulting
from that delay. On remand, the bankruptcy court should
consider whether the record supports the proposition that

                               19
the non-selling creditors suffered loss as a result of a delay
in confirmation caused by CVC advocacy of its competing
plan and objections to the BDK plan.

V. CONCLUSION

The judgment of the district court will be affirmed. In
accordance with that judgment, this case will be remanded
to the bankruptcy court for further proceedings consistent
with this opinion.

A True Copy:
Teste:

       Clerk of the United States Court of Appeals
       for the Third Circuit

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