In re Kreisler

Barry Kreisler and Marsha Erenberg (debtors) each owned an interest in two properties in Chicago. There were several mortgages on the properties, including a junior mortgage held by Community Bank of Ravenswood (Community Bank) (creditor). Kreisler and Erenberg filed separate bankruptcy petitions in 2002, and a bankruptcy trustee jointly administered the cases. In each bankruptcy case, Community Bank filed secured claims for roughly $900,000. Community Bank then approached the trustee and proposed reducing its claim against one of the two properties to $15,000 in return for the trustee’s help in getting the bankruptcy court to approve foreclosure on the other property. The trustee never reached an agreement with Community Bank. Meanwhile, however, Kreisler and Erenberg formed Garlin Mortgage Corporation (Garlin), and Kreisler negotiated with Community Bank on Garlin’s behalf for the sale of Community Bank’s claim to Garlin for $16,500. Garlin represented that its directors and owners were Kreisler’s sister and Erenberg’s friend, even though neither had contributed any capital to Garlin or participated in its management. Garlin’s purchase of Community Bank’s claim was financed through a loan to Garlin from another corporation jointly controlled by Kreisler and Erenberg. Kreisler also arranged to receive a $35,000 fee from Garlin payable when Garlin settled its claim (i.e., Community Bank’s former claim) with the bankruptcy estate. Community Bank eventually assigned its claim to Garlin. However, when Garlin sought payment of the claim in bankruptcy court, the court realized that Kreisler and Erenberg had never told Community Bank or the trustee about their relationship with Garlin. The bankruptcy court invoked the doctrine of equitable subordination and ordered that Garlin’s claim would be paid last, behind all other creditors’ claims. Ultimately, there was not enough money in the bankruptcy estate to pay all the creditors, and Garlin received nothing. Garlin appealed to the district court, which affirmed the bankruptcy court’s equitable-subordination order. Garlin then appealed to the United States Court of Appeals for the Seventh Circuit.