Subordination and Recharacterization
This practice note discusses how a bankruptcy court may recharacterize documents that purport to create a loan transaction and determine that the transaction, despite labels, is something else—a transaction providing for a contribution to the debtor’s capital. Although lawyers can structure a transaction to look like debt, most appellate courts agree that bankruptcy courts have the authority to determine what a transaction really is despite nomenclature used by the parties to an agreement. A true lender will always want to ensure that a transaction is treated as debt by a bankruptcy court, and therefore must structure the transaction in a way that will reduce the recharacterization risk. Private equity investors in a project who take back paper at different levels of the capital stack, will have carefully consider the structure of a transaction and determine their tolerance for the recharacterization of the portion of their investment that they have intended to be debt.
This practice note also discusses subordination of claims under Section 510 of the Bankruptcy Code.
Finally, this practice note introduces the notion that a party in interest in a bankruptcy case may object to a competing creditor’s claims for strategic purposes. Creditors will do this to increase their share of a finite bankruptcy pie. The Bankruptcy Code provides objecting parties with a robust “tool box” to accomplish this task, including recharacterization, subordination, and disallowance.
This practice note discusses the requirements that must be met for recharacterization, as follows:
- Subordination of Claims
- Recharacterization Requirements
- Recharacterization Factors
- Conclusion
To read the full practice note, please click here.
“Subordination and Recharacterization,” by Ira L. Herman was published as a Lexis Practice Advisor® Practice Note on March 16, 2020. Reprinted with permission.