In re Lemco Gypsum, Inc.

L. E. Miller and his sons (creditors) owned Lemco Gypsum, Inc. (Lemco) (debtor). Lemco obtained $3 million in financing through the sale of bonds secured by Lemco’s assets and personally guaranteed by the Millers. In 1982, Lemco and the Millers defaulted on the bonds. The indenture trustee sued the Millers to enforce the guaranties, and the Millers eventually paid the $1.37 million balance due on the guaranties in exchange for assignment of the bonds to the Millers. Under the Millers’ control, Lemco struggled. The Millers arranged business deals between Lemco and other Miller-controlled entities to save money instead of pursuing deals with third parties, the Millers raised their relatives’ salaries while creditors went unpaid, and Lemco faced litigation threats from creditors. The Millers also unsuccessfully tried to obtain refinancing for Lemco. In October 1986, the Millers put Lemco into bankruptcy. The Millers asserted claims against Lemco in the bankruptcy including (1) a $1.37 million secured claim based on the bond guaranty payment and (2) a judgment claim for a $132,000 judgment against Lemco, which the original judgment creditor had assigned to the Millers after Lemco’s bankruptcy filing in exchange for $30,000. Three of Lemco’s unsecured creditors (collectively, the creditors) asked the bankruptcy court to equitably subordinate the Millers’ claims to the creditors’ claims. The bankruptcy court subordinated the bond and judgment claims to all other unsecured claims, with the exception of the $30,000 paid to obtain the judgment claim. The district court affirmed, and the Millers appealed.