2006 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

1-6-2006

In Re: Submicron Sys

Precedential or Non-Precedential: Precedential

Docket No. 03-2102

Follow this and additional works at: http://digitalcommons.law.villanova.edu/thirdcircuit_2006

This decision is brought to you for free and open access by the Opinions of the United States Court of Appeals for the Third Circuit at Villanova

University School of Law Digital Repository. It has been accepted for inclusion in 2006 Decisions by an authorized administrator of Villanova

University School of Law Digital Repository. For more information, please contact Benjamin.Carlson@law.villanova.edu.

Recommended Citation

"In Re: Submicron Sys " (2006). 2006 Decisions. Paper 1685.

http://digitalcommons.law.villanova.edu/thirdcircuit_2006/1685
PRECEDENTIAL

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

 

No. 03-2102

 

In Re: SUBMICRON SYSTEMS CORPORATION, et al,

Debtors

HOWARD S. COHEN, as Plan Administrator 

for the Estates of

SubMicron Systems Corporation, SubMicron Systems Inc.,

SubMicron Wet Process Stations Inc. and SubMicron Systems

Holdings I Inc.,

Appellants

v.

KB MEZZANINE FUND II, LP; 

EQUINOX INVESTMENT PARTNERS, LLC; and

CELERITY SILICON, LLC

 

On Appeal from the United States District Court

for the District of Delaware

(D.C. Civil Action No. 02-cv-00752)

District Judge: Honorable Sue L. Robinson

 
2

Argued September 14, 2004

Before: SCIRICA, Chief Judge, ALITO 

and AMBRO, Circuit Judges

(Filed January 6, 2006 )

Rona J. Rosen, Esquire

Klehr, Harrison, Harvey

Branzburg & Ellers

260 South Broad Street

Suite 400

Philadelphia, PA 19102

Joanne B. Wills, Esquire (Argued)

Klehr, Harrison, Harvey,

Branzburg & Ellers

919 North Market Street

Suite 1000

Wilmington, DE 19083

Attorneys for Appellant

Laura D. Jones, Esquire

Pachulski, Stang, Ziehl, Young,

Jones & Weintraub

919 North Market Street

P.O. Box 8705, 16th Floor

Wilmington, DE 19801
3

Peter J. Korneffel, Jr., Esquire

Brownstein, Hyatt & Farber

410 Seventeenth Street

22nd Floor

Denver, CO 80202

Robert A. Klyman, Esquire (Argued)

David D. Johnson, Esquire

Latham & Watkins LLP

633 West Fifth Street, Suite 4000

Los Angeles, CA 90071-2007

Attorneys for Appellees

 

OPINION OF THE COURT

 

AMBRO, Circuit Judge

Appellant Howard S. Cohen (“Cohen”), as Plan

Administrator for the bankruptcy estates of SubMicron Systems

Corporation, SubMicron Systems, Inc., SubMicron Wet Process

Stations, Inc. and SubMicron Systems Holdings I, Inc. (jointly

and severally, “SubMicron”), challenges the sale to an entity

created by Sunrise Capital Partners, LP (“Sunrise”) of

SubMicron’s assets under 11 U.S.C. § 363(b), which authorizes

court-approved sales of assets “other than in the ordinary course

of business.” Sunrise negotiated directly with several—but not
 Equinox was formed in 1996 to manage KB after it was 1

acquired by Dresdner Bank. For the sake of simplicity, we shall

refer to both entities simply as “KB/Equinox.”

 This provision reads: 2

At a sale under subsection (b) of

this section of property that is

subject to a lien that secures an

allowed claim, unless the court for

cause orders otherwise the holder

of such claim may bid at such sale,

and, if the holder of such claim

purchases such property, such

holder may offset such claim

against the purchase price of such

property.

11 U.S.C. § 363(k).

4

all—of SubMicron’s creditors before presenting its bid to the

District Court. These creditors—The KB Mezzanine Fund II,

LP (“KB”), Equinox Investment Partners, LLC (“Equinox”),1

and Celerity Silicon, LLC (“Celerity”) (collectively, the

“Lenders”)—agreed to contribute toward the purchase of

SubMicron’s assets new capital along with all of their claims in

bankruptcy against SubMicron in exchange for equity in the

entity formed by Sunrise to acquire the assets—Akrion LLC

(“Akrion”). Akrion in turn “credit bid” the full value of the

Lenders’ secured claims contributed to it as part of its bid for

SubMicron’s assets pursuant to 11 U.S.C.§ 363(k). The 2
 This bankruptcy case is before the District Court because it 3

withdrew, pursuant to 28 U.S.C. § 157(d), the reference of the

case to the Bankruptcy Court for the District of Delaware.

5

District Court approved the sale. In re SubMicron Sys. Corp.,

3

291 B.R. 314 (D. Del. 2003).

Cohen, seeking as Plan Administrator of the SubMicron

estates to aid unsecured creditors “cut out of the deal” by the

Lenders and Sunrise, attacks the sale on several fronts. First, he

argues that the purportedly secured debt investments made by

the Lenders and contributed to Akrion should have been

recharacterized by the District Court as equity investments. In

the alternative, if the District Court did not err in declining to

recharacterize the investments as equity, Cohen contends that it

erred by failing to conclude that the debt was unsecured. Even

if the District Court properly considered the debt secured, Cohen

challenges the propriety of the District Court’s allowance of the

credit bid portion of Akrion’s offer. As a last option, Cohen

asserts that the District Court erred by declining to equitably

subordinate the Lenders’ secured claims to those of creditors

with inferior claims. For the reasons discussed below, we reject

these arguments and affirm the judgment of the District Court.

I. Facts and Procedural Posture

A. SubMicron’s Financing
 Wet benches are automatic process tools used for cleaning 4

and etching operations in semiconductor processing. See

http://www.semiconductorglossary.com/default.asp?searchter

m=wet+bench (last visited Dec. 27, 2005).

6

Before its sale in bankruptcy, SubMicron designed,

manufactured and marketed “wet benches” for use in the 4

semiconductor industry. By 1997, it was experiencing

significant financial and operational difficulties. To sustain its

operations in the late 1990s, SubMicron secured financing from

several financial and/or investment institutions. On November

25, 1997, it entered into a $15 million working capital facility

with Greyrock Business Credit (“Greyrock”), granting Greyrock

first priority liens on all of its inventory, equipment, receivables

and general intangibles. The next day, SubMicron raised

another $20 million through the issuance of senior subordinated

12% notes (the “1997 Notes”) to KB/Equinox (for $16 million)

and Celerity (for $4 million) secured by liens behind Greyrock

on substantially all of SubMicron’s assets. Submicron

subsequently issued a third set of notes in 1997 (the “Junior

1997 Notes”) for $13.7 million, comprising $8.7 million of 8%

notes and a $5 million note to The BOC Group, Inc. The Junior

1997 Notes were secured but junior to the security for the 1997

Notes. Despite this capital influx, SubMicron incurred a net loss

of $47.6 million for the 1997 fiscal year.

A steep downturn in the semiconductor industry made

1998 a similarly difficult year for SubMicron. By August of that
7

year, it was paying substantially all of the interest due on the

1997 Notes as paid-in-kind senior subordinated notes. On

December 2, 1998, SubMicron and Greyrock agreed to renew

the Greyrock line of credit, reducing the maximum funds

available from $15 to $10 million and including a $2 million

overadvance conditioned on SubMicron’s securing an additional

$4 million in financing. To satisfy this condition, on December

3, SubMicron issued Series B 12% notes (the “1998 Notes”) to

KB/Equinox (for $3.2 million) and Celerity (for $800,000). The

1998 Notes ranked pari passu with the 1997 Notes and the

interest was deferred until October 1, 1999. SubMicron

incurred a net loss of $21.9 million for the 1998 fiscal year, and

at year’s end its liabilities exceeded its assets by $4.2 million.

SubMicron’s financial health did not improve in 1999.

By March of that year, its management determined that

additional financing would be required to meet the company’s

immediate critical working capital needs. To this end, between

March 10, 1999 and June 6, 1999, SubMicron issued a total of

eighteen Series 1999 12% notes (the “1999 Tranche One

Notes”) for a total of $7,035,154 (comprising nine notes to

KB/Equinox totaling $5,888,123 and nine notes to Celerity

totaling $1,147,031). The 1999 Tranche One Notes proved

insufficient to keep SubMicron afloat. As a result, between July

8, 1999 and August 31, 1999, KB/Equinox and Celerity made

periodic payments to SubMicron (the “1999 Tranche Two

Funding”) totaling $3,982,031 and $147,969, respectively. No

notes were issued in exchange for the 1999 Tranche Two
8

Funding. Between the 1999 Tranche One Notes and the 1999

Tranche Two Funding (collectively, the “1999 Fundings”),

KB/Equinox and Celerity advanced SubMicron a total of

$9,870,154 and $1,295,000, respectively. (The 1999 Fundings

were recorded as secured debt on SubMicron’s 10-Q filing with

the Securities and Exchange Commission.) Despite the cash

infusions, during the first half of 1999 SubMicron incurred a net

loss of $9.9 million. On June 30, 1999, SubMicron’s liabilities

exceeded its assets by $3.1 million.

By January 1999, KB/Equinox had appointed three

members to SubMicron’s Board of Directors. All appointees

were either principals or employees of KB/Equinox. By June

1999, following resignations of various SubMicron Board

members, KB/Equinox employees Bonaparte Liu and Robert

Wickey, and Celerity employee Mark Benham, represented

three-quarters of the Board, with SubMicron CEO David Ferran

the lone Board member not employed by KB/Equinox or

Celerity.

B. The Acquisition

SubMicron began acquisition discussions with Sunrise in

July of 1999. By all accounts, it was generally understood that

if SubMicron failed to reach a deal with Sunrise, it would be

forced to liquidate, leaving secured creditors—with the

exception of Greyrock—with pennies on the dollar and

unsecured creditors and shareholders with nothing.
9

KB/Equinox, not SubMicron’s management, conducted

negotiations with Sunrise, developing and agreeing on the terms

and financial structure of an acquisition to occur in the context

of a prepackaged bankruptcy.

On August 31, 1999, SubMicron entered into an asset

purchase agreement with Akrion, the entity created by Sunrise

to function as the acquisition vehicle. The following day,

SubMicron filed a Chapter 11 bankruptcy petition and an

associated motion seeking approval of the sale of its assets to

Sunrise outside the ordinary course of business pursuant to

§ 363(b) of the Bankruptcy Code. 

The asset purchase agreement reiterated, inter alia, that

KB/Equinox and Celerity would contribute their secured claims

(i.e., the 1997 Notes, the 1998 Notes and the 1999 Fundings) in

order for Akrion to credit bid these claims under § 363 of the

Bankruptcy Code—but only contingent on the closing of the

sale. The agreement also required SubMicron, at the closing of

the sale, to pay $5,500,000 immediately to the holders of the

1999 Fundings. In return, KB/Equinox and Celerity would

receive a 31.475% interest in Akrion (KB/Equinox received a

30% interest and Celerity received a 1.475% interest). The

Court and Official Committee of Unsecured Creditors (the

“Creditors’ Commitee”) were apprised of the terms of this

agreement prior to the sale. 

At the sale hearing Akrion submitted a bid of
 These enumerated components of the cash portion of the bid 5

total $9,732,000, not $10,202,000. The District Court’s opinion

leaves unclear what accounted for the missing $470,000.

10

$55,507,587 for SubMicron. The cash component of the bid

totaled $10,202,000 and included $5,500,000 in cash from

Akrion, $3,382,000 to pay pre- and post-petition Greyrock

secured debt, and $850,000 to cover administrative claims. The 5

credit portion of the bid consisted of the $38,721,637

outstanding for the 1997 Notes, the 1998 Notes, and the 1999

Fundings (all of which KB/Equinox and Celerity had

contributed to Akrion), plus $1,324,138 in individual secured

claims, for a total of $40,045,775. Finally, the bid included

SubMicron’s liabilities that would be assumed by

Akrion—$681,346 in lease obligations and $4,578,466 in other

assumed liabilities for a total of $5,259,812. No other bid for

SubMicron’s assets was made, SubMicron’s Board and the

Court both approved Akrion’s bid over the objection of the

Creditors’ Committee, and on October 15, 1999, the asset sale

closed. 

On April 18, 2000, the Creditors’ Committee brought

against the Lenders, among others, an adversary proceeding in

which it made the claims before us on appeal. (Cohen was

subsequently substituted for the Creditors’ Committee.) After

a bench trial before Judge Sue Robinson in late July/early

August 2001, she ruled against Cohen, setting out her reasoning

in a comprehensive opinion. Cohen appeals.
11

II. Jurisdiction and Standard of Review

Because the typical reference of bankruptcy cases to

bankruptcy courts was withdrawn here by the District Court, our

appellate jurisdiction stems from 28 U.S.C. § 1291, not 28

U.S.C. § 158(d). In re PWS Holding Corp., 228 F.3d 224, 235

(3d Cir. 2000); In re Marvel Entm’t Group, Inc., 140 F.3d 463,

470 (3d Cir. 1998). “We review the District Court’s legal

determinations de novo, its factual findings for clear error, and

its exercise of discretion for abuse thereof.” In re PWS Holding

Corp., 228 F.3d at 235 (citing In re O’Brien Envtl. Energy, Inc.,

188 F.3d 116, 122 (3d Cir. 1999)).

III. Recharacterization as Equity

Cohen argues that the District Court erred by failing to

recharacterize the infusion of the 1999 Fundings as an equity

investment. To succeed with this argument, he must

demonstrate that the District Court abused its discretionary

authority or premised its determination on clearly erroneous

findings of fact. Because he has failed to do so, we affirm the

District Court’s recharacterization holding.

A. Recharacterization / Equitable Subordination

At the outset, it is important to distinguish

recharacterization from equitable subordination. Both remedies
 Bankruptcy courts’ general powers of equity are codified at 6

11 U.S.C. § 105(a), which states that a “court may issue any

order, process, or judgment that is necessary or appropriate to

carry out the provisions of [the Bankruptcy Code].” The power

of equitable subordination is specifically codified at 11 U.S.C.

§ 510(c), which states that, 

after notice and a hearing, the court may (1) 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; or (2) order that

any lien securing such a subordinated claim be

transferred to the estate.

12

are grounded in bankruptcy courts’ equitable authority to ensure 6

“that substance will not give way to form, that technical

considerations will not prevent substantial justice from being

done.” Pepper v. Litton, 308 U.S. 295, 305 (1939). Yet

recharacterization and equitable subordination address distinct

concerns. Equitable subordination is apt when equity demands

that the payment priority of claims of an otherwise legitimate

creditor be changed to fall behind those of other claimants. See,

e.g., Citicorp Venture Capital, Ltd. v. Comm. of Creditors

Holding Unsecured Claims, 160 F.3d 982, 986–87 (3d Cir.

1998); Bayer Corp. v. MascoTech, Inc. (In re Autostyle Plastics,

Inc.), 269 F.3d 726, 749 (6th Cir. 2001). In contrast, the focus

of the recharacterization inquiry is whether “a debt actually

exists,” In re Autostyle Plastics, 269 F.3d at 748 (internal
 In this context, the label “recharacterization” is misleading. 7

See Citicorp Real Estate, Inc. v. PWA, Inc. (In re Georgetown

Bldg. Assocs. Ltd. P’ship), 240 B.R. 124, 137 (Bankr. D.D.C.

1999) (“The debt-versus-equity inquiry is not an exercise in

recharacterizing a claim, but of characterizing the advance’s

true character.” (emphases in original)); In re Cold Harbor

Assocs., L.P., 204 B.R. 904, 915 (Bankr. E.D. Va. 1997)

(“Rather than recharacterizing the exchange from debt to equity,

or subordinating the claim for some reason, the question before

this Court is whether the transaction created a debt or equity

relationship from the outset.”).

13

quotation marks omitted) or, put another way, we ask what is the

proper characterization in the first instance of an investment.7

For these reasons, we agree with those courts that have

determined that “the issues of recharacterization of debt as

equity capital and equitable subordination should be treated

separately.” Blasbalg v. Tarro (In re Hyperion Enters., Inc.),

158 B.R. 555, 560 (D.R.I. 1993); see, e.g., In re Autostyle

Plastics, 269 F.3d at 749 (explaining that “[b]ecause both

recharacterization and equitable subordination are supported by

the Bankruptcy Code and serve different purposes, we join those

courts that have concluded that a bankruptcy court has the power

to recharacterize a claim from debt to equity” and collecting

cases); Aquino v. Black (In re AtlanticRancher, Inc.), 279 B.R.

411, 433 (Bankr. D. Mass. 2002) (stating that “while once

considered solely in conjunction with the doctrine of equitable

subordination, bankruptcy courts now consider
 In Roth Steel Tube Co. v. Comm’r, 800 F.2d 625 (6th Cir.

8

1986), the Court of Appeals for the Sixth Circuit laid out eleven

factors to determine whether an investment was debt or equity

in the context of assessing income tax liability. Id. at 630. In re

Autostyle Plastics extended the use of those factors to the

recharacterization context. 269 F.3d at 749–50. They are:

14

recharacterization a separate cause of action”).

Cohen advances both arguments. He argues that the

infusion of the 1999 Fundings is most accurately characterized

as an equity investment—a recharacterization argument—and,

in the alternative, that if the infusion is deemed a debt

investment, the Lenders’ claims should be equitably

subordinated. We turn first to the recharacterization argument,

as “[d]etermining [an] equitable subordination issue prior to

determining whether [an] advance is a loan or [an equity

investment] is similar to taking the cart before the horse.”

Diasonics, Inc. v. Ingalls, 121 B.R. 626, 630 (Bankr. N.D. Fla.,

1990). If a “particular advance is a capital contribution, . . .

. then equitable subordination never comes into play.” In re

Georgetown Bldg. Assocs., 240 B.R. at 137.

B. Recharacterization Framework

In defining the recharacterization inquiry, courts have

adopted a variety of multi-factor tests borrowed from nonbankruptcy caselaw. While these tests undoubtedly 8
(1) the names given to the instruments, if any,

evidencing the indebtedness; (2) the presence or

absence of a fixed maturity date and schedule of

payments; (3) the presence or absence of a fixed

rate of interest and interest payments; (4) the

source of repayments; (5) the adequacy or

inadequacy of capitalization; (6) the identity of

interest between the creditor and the stockholder;

(7) the security, if any, for the advances; (8) the

corporation’s ability to obtain financing from

outside lending institutions; (9) the extent to

which the advances were subordinated to the

claims of outside creditors; (10) the extent to

which the advances were used to acquire capital

assets; and (11) the presence or absence of a

sinking fund to provide repayments.

Roth Steel Tube Co., 800 F.2d at 630.

The Courts of Appeal for the Eleventh and Fifth Circuits

also employ a multi-factor test in the tax context. They have

identified the following thirteen factors:

(1) the names given to the certificates evidencing

the indebtedness; (2) the presence or absence of a

fixed maturity date; (3) the source of payments;

(4) the right to enforce payment of principal and

interest; (5) participation in management flowing

as a result; (6) the status of the contribution in

relation to regular corporate creditors; (7) the

intent of the parties; (8) “thin” or adequate

capitalization; (9) identity of interest between

15
creditor and stockholder; (10) source of interest

payments; (11) the ability of the corporation to

obtain loans from outside lending institutions;

(12) the extent to which the advance was used to

acquire capital assets; and (13) the failure of the

debtor to repay on the due date or to seek a

postponement.

Stinnett’s Pontiac Serv., Inc. v. Comm’r, 730 F.2d 634, 638

(11th Cir. 1984) (citing Estate of Mixon v. United States, 464

F.2d 394, 402 (5th Cir. 1972)). 

In re Cold Harbor Assocs., L.P., 204 B.R. at 915,

discussed both of the above tests in the recharacterization

context and applied the factors relevant to that case, and In re

Georgetown Bldg. Assocs., 240 B.R. at 137, cited with approval

Cold Harbor’s use of these factors in the recharacterization

context (but found it unnecessary to adopt formally a specific set

of factors).

In this case, the District Court applied a seven-factor test

used in an unpublished District of Delaware case that was

bankruptcy related, Official Comm. of Unsecured Creditors of

Color Tile, Inc. v. Blackstone Family Inv. P’ship (In re Color

Tile, Inc.), No. Civ. A. 98-358-SLR, 2000 WL 152129 (D. Del.

Feb. 9, 2000) (Robinson, J.). Those factors are

(1) the name given to the instrument; (2) the

intent of the parties; (3) the presence or absence

of a fixed maturity date; (4) the right to enforce

payment of principal and interest; (5) the presence

or absence of voting rights; (6) the status of the

contribution in relation to regular corporate

16
contributors; and (7) certainty of payment in the

event of the corporation’s insolvency or

liquidation. 

In re SubMicron Sys., 291 B.R. at 323 (citing In re Color Tile,

2000 WL 152129, at *4).

17

include pertinent factors, they devolve to an overarching

inquiry: the characterization as debt or equity is a court’s

attempt to discern whether the parties called an instrument one

thing when in fact they intended it as something else. That

intent may be inferred from what the parties say in their

contracts, from what they do through their actions, and from the

economic reality of the surrounding circumstances. Answers lie

in facts that confer context case-by-case. 

No mechanistic scorecard suffices. And none should, for

Kabuki outcomes elude difficult fact patterns. While some

cases are easy (e.g., a document titled a “Note” calling for

payments of sums certain at fixed intervals with market-rate

interest and these obligations are secured and are partly

performed, versus a document issued as a certificate indicating

a proportional interest in the enterprise to which the certificate

relates), others are hard (such as a “Note” with conventional

repayment terms yet reflecting an amount proportional to prior

equity interests and whose payment terms are ignored). Which

course a court discerns is typically a commonsense conclusion

that the party infusing funds does so as a banker (the party

expects to be repaid with interest no matter the borrower’s
 Research has uncovered only one bankruptcy case 9

discussing whether the capital contribution versus loan

determination question is primarily one of law or fact. There the

Court concluded that “[t]he issue of classification of an advance

presents a question of law subject to de novo review.” Celotex

Corp. v. Hillsborough Holdings Corp. (In re Hillsborough

Holdings Corp.), 176 B.R. 223, 248 (M.D. Fla. 1994) (citing

Lane v. United States (In re Lane), 742 F.2d 1311 (11th Cir.

1984), a tax refund case).

18

fortunes; therefore, the funds are debt) or as an investor (the

funds infused are repaid based on the borrower’s fortunes;

hence, they are equity). Form is no doubt a factor, but in the end

it is no more than an indicator of what the parties actually

intended and acted on.

C. R e v iew o f the D istrict C o u rt’s

Recharacterization Holding

i) Standard of Review

We must first determine whether the District Court’s

recharacterization conclusion is a finding of fact we review for

clear error or a conclusion of law over which we exercise

plenary review. Direct precedent on this issue is lacking, but 9

several courts have considered this issue in the tax context.

In tax cases addressing whether for tax purposes a
Of course, it could be argued that the Eleventh Circuit did 10

not reach this conclusion of its own accord. When the former

Fifth Circuit was split into the Fifth and Eleventh Circuits on

October 1, 1981, the Eleventh Circuit adopted as precedent the

decisions of the Fifth Circuit handed down as of September 30,

1981. Bonner v. City of Prichard, 661 F.2d 1206, 1209 (11th

Cir. 1981). Thus, Mixon was binding precedent for the Lane

Court.

19

contribution should be treated as debt or equity, courts of appeal

are split. The United States Courts of Appeals for the Sixth and

Ninth Circuits have concluded the issue is one of fact to be

reviewed for clear error. Roth Steel Tube, 800 F.2d at 629

(citing Smith v. Comm’r, 370 F.2d 178, 180 (6th Cir. 1966));

Bauer v. Comm’r, 748 F.2d 1365, 1367 (9th Cir. 1985) (citing

A.R. Lantz Co. v. United States, 424 F.2d 1330, 1334 (9th Cir.

1970)). The Fifth and Eleventh Circuit Courts of Appeals, on

the other hand, have held the issue to be primarily one of law

subject to de novo review. Lane v. United States (In re Lane),

742 F.2d 1311, 1315 (11th Cir. 1984); Estate of Mixon v. United

States, 464 F.2d 394, 402–03 & n.13 (5th Cir. 1972). In our 10

Court, we were called upon to review a debt versus equity

determination in the tax context in Geftman v. Comm’r, 154

F.3d 61 (3d Cir. 1998), but we eschewed entering the thicket of

deciding whether we were reviewing a finding of fact or a

conclusion of law. See id. at 68 n.9.

As discussed above, the determinative inquiry in
20

classifying advances as debt or equity is the intent of the parties

as it existed at the time of the transaction. So framed, we agree

with our Sixth and Ninth Circuit colleagues that this is a

question of fact that, “once resolved by a district court, cannot

be overturned unless clearly erroneous.” A.R. Lantz Co., 424

F.2d at 1334.

ii) The District Court’s Determination Was

Not Clearly Erroneous

The District Court’s opinion includes ample findings of

fact to support its recharacterization determination. Because

these findings are not clearly erroneous and overwhelmingly

support the Court’s decision to characterize the 1999 Fundings

as debt (under any framework or test), we affirm its factual

determination.

The District Court set out numerous facts to support a

debt characterization. Looking to the lending documents, it

found “beyond dispute in the record that . . . the name given to

the 1999 fundings was debt . . . and . . . the 1999 fundings had

a fixed maturity date and interest rate.” In re SubMicron Sys.,

291 B.R. at 325. The Court also found evidence of the parties’

intent to create a debt investment outside the lending documents.

For example, it noted that “[t]he 1999 notes were recorded as

secured debt on SubMicron’s 10Q SEC filing and UCC-1

financing statements.” Id. at 319. 
21

The District Court could not find, on the other hand,

convincing evidence to support an equity investment

characterization of the 1999 Fundings. It rejected Cohen’s

argument that the dire financial circumstances surrounding the

infusion of the 1999 Fundings supported an equity

characterization. Instead, it concluded, with reference to the

conflicting testimony and relative credibility of witnesses

presented by both parties, that Cohen “failed to prove that[,]

under SubMicron’s dire circumstances, [the Lenders’]

transactions were improper or unusual [as debt investments].”

Id. at 325. Recognizing that “‘[w]hen a corporation is

undercapitalized, a court is more skeptical of purported loans

made to it because they may in reality be infusions of capital,’”

id. (quoting In re Autostyle Plastics, 269 F.3d at 746–47), the

District Court also noted that “when existing lenders make loans

to a distressed company, they are trying to protect their existing

loans and traditional factors that lenders consider (such as

capitalization, solvency, collateral, ability to pay cash interest

and debt capacity ratios) do not apply as they would when

lending to a financially healthy company,” id. Weighing these

competing considerations, it did not find SubMicron’s

undercapitalization greatly supported an equity characterization.

Id.

Similarly, the Court found the Lenders’ participation on

the SubMicron Board did not, in and of itself, provide support

for an equity characterization. Again relying on expert

testimony, it emphasized that it is “not unusual for lenders to
22

have designees on a company’s board, particularly when the

company [is] a distressed one.” Id. at 325–26. After reviewing

conflicting evidence on the issue, the Court concluded that

Cohen “[did] not prove[] that [Lenders] or their designees

controlled or dominated SubMicron’s Board in any way.” Id. at

326. Based on these factual determinations, the conclusion was

inevitable that the Lenders’ representation on SubMicron’s

Board did not necessarily support an equity characterization.

Lastly, the Court found unpersuasive Cohen’s argument

that SubMicron’s failure to issue notes for the 1999 Tranche

Two Funding should be understood as evidence of the parties’

understanding that the 1999 Fundings were, in effect, equity

investments. It noted that “[t]he record is clear that

SubMicron’s accounting department made numerous mistakes

and errors when generating notes,” concluding that “[t]he fact

that notes were generated for some fundings and not others is

not sufficient, in and of itself, to recharacterize the 1999

fundings as equity.” Id. at 326. 

In short, the District Court found ample evidence to

support a debt characterization and little evidence to support a

characterization of equity infusion. On the basis of these

findings, which comport with the record, it was hardly clear

error for the Court to conclude that “[Cohen] ha[d] not proven

by a preponderance of the evidence that the 1999 [F]undings

should be recharacterized as equity.” Id. at 325.
 Since then, a revised Article 9 has been adopted in each

11

state.

23

IV. The 1999 Fundings Were Secured Debt

Having established that the District Court properly

concluded the 1999 Fundings were debt, we turn to Cohen’s

assertion that the Lenders did not present a valid secured claim.

In determining whether claims asserted by creditors in

bankruptcy are secured, state law applies. See In re Bollinger

Corp., 614 F.2d 924, 925 n.1 (3d Cir. 1980). Cohen concedes

that, whether one applies Delaware, Pennsylvania, California or

New York law, the requirements to obtain a security interest are

the same. Thus each state’s codification of Uniform

Commercial Code (“U.C.C.”) §§ 9-203 and 9-302 existing in

1999 requires a written security agreement in favor of the 11

lender describing the collateral and, for the collateral in question

(inventory, equipment, receivables and general intangibles), the

filing of a properly executed financing statement (unless the

inventory and equipment are possessed by the lender or its

representative, something normally, and here highly,

impractical).

Cohen contends that the Lenders did not comply with

state U.C.C. law (and thus the requirements for assertion of a

secured claim). The main source of contention is that financing

statements filed by the Lenders only list “Equinox Investment
 No claim is made that a security interest in the collateral 12

was not created (the security agreements for the 1997 Notes and

the 1998 Notes state that the collateral secures “the payment of

all present and future indebtedness”), only that it was not

properly perfected. 

24

Partners, LLC, as Collateral Agent,” as the secured party.12

Cohen asserts that the listing of Equinox solely (and not also KB

and Celerity) rendered the financing statement ineffective under

the then-extant U.C.C. § 9-402(1), which stated that a

“financing statement is sufficient if it gives the names of the

debtor and the secured party, is signed by the debtor, gives an

address of the secured party from which information concerning

the security interest may be obtained, gives a mailing address of

the debtor and contains a statement indicating the types, or

describing the items, of collateral.” Official Comment 2 to thenU.C.C. § 9-402 indicated that Article 9 employed a “notice

filing” system whereby financing statements needed only to

indicate that a secured party “may have a security interest in the

collateral described. Further inquiry from the parties concerned

. . . [may] be necessary to disclose the complete state of affairs.”

(Emphasis added.) In this context, “[t]he Uniform Commercial

Code does not require that the secured party as listed in [a

financing] statement be a principal creditor and not an agent.”

Indus. Packaging Prods. Co. v. Fort Pitt Packaging Int’l, Inc.,

161 A.2d 19, 21 (Pa. 1960). Because the financing statements

name both SubMicron as debtor and Equinox as secured party,

provide mailing addresses for both entities, and describe the
 This provision reads in pertinent part: 13

An allowed claim of a creditor secured by a lien on

25

collateral that is subject to the security agreement, we conclude

that any interested party would be on notice to communicate

with Equinox regarding the status of its (and its principals’)

interest in SubMicron’s assets. This is sufficient for Article 9

perfection purposes. Id.

We also conclude that, on the record before us, there can

be no doubt that KB and Celerity were intended secured parties

served by their agent, Equinox. Indeed, in the schedule of

liabilities filed with the District Court, SubMicron lists KB and

Celerity as secured noteholders. The District Court found on the

basis of overwhelming evidence that KB and Celerity were

intended secured parties with respect to the 1999 Fundings and

we discern no basis to believe this determination was erroneous.

In sum, we conclude that the Lenders presented valid secured

claims for the 1999 Fundings.

V. Propriety of § 363 Credit Bid

Having determined that the 1999 Fundings represented

an extension of secured debt, we turn to Cohen’s argument that

the § 363(k) credit bid was improper because the Lenders did

not (and could not) demonstrate that some portion of their

claims remained secured by collateral as defined in Bankruptcy

Code § 506(a). The District Court determined that “there was 13
property in which the estate has an interest . . . is a secured claim

to the extent of the value of such creditor’s interest in the

estate’s interest in such property . . . and is an unsecured claim

to the extent that the value of such creditor’s interest . . . is less

than the amount of such allowed claim.

11 U.S.C. § 506(a).

26

no collateral available to actually secure the 1999 fundings.” In

re SubMicron Sys., 291 B.R. at 327. As a result, Cohen argues

that, because the secured debt had no actual (or economic)

value, it could not be credit bid under § 363(k). Because that

section empowers creditors to bid the total face value of their

claims—it does not limit bids to claims’ economic value—we

disagree and hold that the District Court did not err in allowing

the Lenders to credit bid their claims.

It is well settled among district and bankruptcy courts

that creditors can bid the full face value of their secured claims

under § 363(k). See, e.g., In re Suncruz Casinos, LLC, 298 B.R.

833, 839 (Bankr. S.D. Fla. 2003) (“[T]he plain language of

[section 363(k)] makes clear that the secured creditor may credit

bid its entire claim, including any unsecured deficiency portion

thereof.” (emphasis in original)); In re Morgan House Gen.

P’ship, Nos. 96-MC-184 & 96-MC-185, 1997 WL 50419, at *1

(E.D. Pa. Feb. 7, 1997) (holding that secured creditors may bid

“to the extent of [their] claim” under § 363(k)); In re Midway

Invs., Ltd., 187 B.R. 382, 391 n.12 (Bankr. S.D. Fla. 1995) (“[A]

secured creditor may bid in the full amount of the creditor’s
27

allowed claim, including the secured portion and any unsecured

portion thereof” (citing legislative history) (alteration in

original) (internal quotation marks omitted)); In re Realty Invs.,

Ltd. V, 72 B.R. 143, 146 (Bankr. C.D. Cal. 1987) (same); see

also Criimi Mae Servs. Ltd. P’ship v. WDH Howell, LLC (In re

WDH Howell, LLC), 298 B.R. 527, 532 n.8 (D.N.J. 2003). 

In fact, logic demands that § 363(k) be interpreted in this

way; interpreting it to cap credit bids at the economic value of

the underlying collateral is theoretically nonsensical. 

A hypothetical is illustrative.

Assume that Debtor has a single asset: a truck, T.

Lender is a secured creditor that has loaned

Debtor $15, taking a security interest in T.

Debtor is in Chapter 11 bankruptcy and has filed

a § 363 motion to sell T to Bidder for $10.

Debtor argues that Lender can only credit bid $10

for T and must bid any excess in cash if it wishes

to outbid B.

This hypothetical reveals the logical problem with an actual

value bid cap. If Lender bids $12 for T, by definition $12

becomes the value of Lender’s security interest in T. In this

way, until Lender is paid in full, Lender can always overbid

Bidder. (Naturally, Lender will not outbid Bidder unless Lender

believes it could generate a greater return on T than the return
 Precisely this logical argument was presented in In re 14

Realty Invs., Ltd V:

An argument might be made that the

“allowed claim” referred to in the Congressional

Record is only the secured portion of [the

creditor]’s claim. But this is an argument of form

and not of substance.

Until [the nonrecourse undersecured

lender] is paid in full, any bid received is subject

to overbid by [the lender]. If [the bidder]’s bid

were valued [below the full value of the lender’s

claim], [the lender] could overbid it, and [the

lender]’s bid would then become, by definition,

the “allowed” claim. . . . [I]t is practical that [the

lender] will bid in its entire obligation and

therefore that is its “allowed” claim. Because no

one could buy the property without [the lender]’s

consent, unless [the lender] is paid in full, the

“allowed claim” of [the lender] must (for

purposes of credit bidding) be its total claim

without reference to the “value” of the property.

72 B.R. at 146.

28

for Lender represented by Bidder’s offer.) As Lender holds a

security interest in T, any amount bid for it up to the value of

Lender’s full claim becomes the secured portion of Lender’s

claim by definition. Given the weight of reason’s demand that 14

“it must be so,” we see no reason to catalog the myriad other

arguments that have been advanced to support this
 We pause nonetheless to note one such argument, in the 15

mode of statutory interpretation, that is based on the exception

for § 363 sales contained in § 1111(b)(1)(A)’s statutory

protection for nonrecourse creditors (that is, in the event of the

borrower’s default, the creditor may not look to the borrower for

repayment, and thus is limited to its security, if any). The latter

was “enacted by Congress to cure the harsh result of Great

National Life Ins. Co. v. Pine Gate Associates, Ltd., 2 B.C.D.

1478 (Bankr. N.D. Ga. 1976).” Tampa Bay Assocs., Ltd. v.

DRW Worthington, Ltd. (In re Tampa Bay Assocs., Ltd.), 864

F.2d 47, 49 (5th Cir. 1989). In Pine Gate, a secured creditor

holding a nonrecourse lien against real property unsuccessfully

objected to the bankruptcy sale of the property at a dramatically

depressed price. The case made clear that “under the former

Bankruptcy Act a debtor could file bankruptcy proceedings

during a period when real property values were depressed,

propose to repay secured [nonrecourse] lenders only to the

extent of the then-appraised value of the property, and ‘cram

down’ the secured lender class, preserving any future

appreciation of the property for the debtor.” Id. at 50. Congress

attempted to remedy this problem by enacting § 1111(b)(1)(A),

which “provid[es] such creditors with an opportunity to elect to

have their liens treated as recourse claims if their debtors intend

to retain the property secured . . . .” Id. The provision explicitly

excepts sales of property under § 363, however. 11 U.S.C.

§ 1111(b)(1)(A)(ii). 

The rationale for this exception presupposes that § 363(k)

credit bidders can bid the full value of their secured claims.

29

“interpretation.”15
“Congress intended to protect the nonrecourse undersecured

creditor only if such a creditor is not permitted to purchase the

collateral at a sale or if the debtor intends to retain the collateral

after bankruptcy and not repay the debt in full.” In re Tampa

Bay Assocs., 864 F.2d at 50. Congress deemed the undersecured

nonrecourse creditor’s ability to credit bid the full value of his

claim adequate protection in the § 363 context, rendering

§ 1111(b)(1)(A) unnecessary:

The legislative history verifies this congressional

intent in limiting the applicability of the statutory

recourse status: “Sale of property under [§] 363 or

under the plan is excluded from treatment under

[§] 1111(b) because of the secured party’s right to

bid in the full amount of his allowed claim at any

sale of collateral under section 363(k) . . . .”

Id. (quoting 124 Cong. Rec. H11,103-04 (1978)) (omission in

original) (emphasis added). Because an undersecured

nonrecourse creditor is protected to the full extent of its claim by

virtue of its ability to bid up to the full value of that claim under

§ 363(k), Congress concluded that § 1111(b)(1)(A) need not

apply to § 363 sales.

30

Cohen is not out of plausible arguments, however, as he

claims that because the Lenders were not partially undersecured

but completely undersecured—that is, because the collateral was

found to have no economic value—this case is different. Yet

nothing about the logic of allowing credit bids up to the full face

value of the collateral changes if the collateral has no actual

value. Because the Lenders had a valid security interest in
31

essentially all the assets sold, by definition they were entitled to

the satisfaction of their claims from available proceeds of any

sale of those underlying assets. Their credit bid did nothing

more than preserve their right to the proceeds, as credit bids do

under § 363(k).

Unable squarely to rest this argument on a theoretically

sound construction of the Bankruptcy Code’s credit bidding

provisions, Cohen enlists the aid of 11 U.S.C. § 506(a), which

provides for the splitting of partially secured claims into their

secured claim and unsecured claim components. Yet § 506(a)

is inapplicable. As one member of the Supreme Court has

explained, “[w]hen . . . the Bankruptcy Code means to refer to

a secured party’s entire allowed claim, i.e., to both the ‘secured’

and ‘unsecured’ portions under § 506(a), it uses the term

‘allowed claim’—as in 11 U.S.C. § 363(k) . . . .” Dewsnup v.

Timm, 502 U.S. 410, 422 (1992) (Scalia, J., dissenting) (first

emphasis in original). That is, § 363(k) speaks to the full face

value of a secured creditor’s claim, not to the portion of that

claim that is actually collateralized as described in § 506.

Moreover, as a practical matter, no § 506 valuation is

required before a § 363 sale of the underlying collateral can be

approved. Section 363 attempts to avoid the complexities and

inefficiencies of valuing collateral altogether by substituting the

theoretically preferable mechanism of a free market sale to set

the price. The provision is premised on the notion that the

market’s reaction to a sale best reflects the economic realities of
32

assets’ worth. Naturally, then, courts are not required first to

determine the assets’ worth before approving such a market sale.

This would contravene the basis for the provision’s very

existence. 

For these reasons, we conclude that the District Court

properly allowed the Lenders to contribute their credit bids

under the §363 sale.

VI. Equitable Subordination

Cohen also argues that the Lenders’ claims related to the

1999 Fundings should be equitably subordinated to the claims

of the general unsecured creditors. In Citicorp Venture Capital,

Ltd. v. Comm. of Creditors Holding Unsecured Claims, we

explained that 

[b]efore 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 [B]ankruptcy [C]ode. 

160 F.3d 982, 986–87 (3d Cir. 1998) (citing United States v.
 Our hesitancy to adopt an inequitable conduct requirement 16

in Citicorp Venture Capital stemmed from our prior holding in

In re Burden v. United States, 917 F.2d 115, 120 (3d Cir. 1990),

that “creditor misconduct is not [always] a prerequisite for

equitable subordination.” As we explained, “Burden involved

subordination of a tax penalty in the absence of government

misconduct.” 160 F.3d at 987 n.2.

33

Noland, 517 U.S. 535 (1996)). We declined, however, to adopt

the first generally recognized element as a formal requirement

for equitable subordination, noting instead that because the

Bankruptcy Court in Citicorp Venture Capital properly found

inequitable conduct, there was no “need . . . [to] resolve the

issue of whether misconduct is always a prerequisite to equitable

subordination . . . .” 160 F.3d at 987 n.2. In a similar vein, 16

because the District Court found in our case, through a proper

exercise of its discretion, that no injury resulted to SubMicron’s

unsecured creditors as a result of the Lenders’ dealings with

Akrion, we need not reach the issue of inequitable conduct in

order to affirm the District Court’s equitable subordination

holding.

As the District Court explained, the doctrine of equitable

subordination “is remedial, not penal, and should be applied

only to the extent necessary to offset specific harm that creditors

have suffered on account of the inequitable conduct.” 291 B.R.

at 327 (citing Trone v. Smith (In re Westgate-California Corp.),

642 F.2d 1174, 1178 (9th Cir.1981)); see also Citicorp Venture
34

Capital, 160 F.3d at 991 (“A bankruptcy court should . . .

attempt to identify the nature and extent of the harm it intends

to compensate in a manner that will permit 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.”); Stoumbos v. Kilimnik, 988 F.2d 949, 960 (9th

Cir. 1993) (“A claim will be subordinated only to the claims of

creditors whom the inequitable conduct has disadvantaged.”);

Estes v. N & D Props., Inc. (In re N & D Props., Inc., 799 F.2d

726, 733 (11th Cir. 1986) (stating that “equitable subordination

operates only to redress the amount of actual harm done”). 

Considering Cohen’s equitable subordination claim, the

District Court held:

[P]laintiff has failed to show that . . . the

unsecured creditors suffered any harm as the

result of defendants’ actions.

The trial testimony is uncontradicted that

had defendants not made the 1999 [F]undings to

SubMicron, the company would have been forced

to close down and liquidate, leaving the

unsecured creditors with nothing.

Furthermore, the record shows that there

were no other parties interested in acquiring

SubMicron at the time of the bid. Plaintiff has
While the last major heading in Cohen’s Opening Brief is 17

that “The Record Contains Overwhelming Evidence That The

Appellees Breached Their Fiduciary Duties and Their Claims

Should be Equitably Subordinated,” Cohen Op. Br. at 51, little

argument even implies the District Court’s findings were

entered in error. 

As an aside, we note that Cohen recites the generalization

that Delaware courts have held that directors’ fiduciary duties

extend to creditors as well as shareholders once a debtor is in the

“vicinity of insolvency.” Id. at 52 (citing Geyer v. Ingersoll

Publ’ns Co., 621 A.2d 784, 789 (Del. Ch. 1992); Credit

Lyonnais Bank Nederland, N.V. v. Pathe Commc’ns Corp., Civ.

A. No. 12150, 1991 WL 277613, at *34 & n.55 (Del. Ch. Dec.

30, 1991)). The recent Delaware Chancery Court opinion of

Vice Chancellor Strine in Production Resources Group, L.L.C.

35

failed to show that any other party was willing to

bid on SubMicron at any price. In fact, the

testimony shows that Sunrise/Akrion was the deal

of last resort for SubMicron and the company

aggressively sought other suitors prior to the

Sunrise/Akrion deal. Given these facts, plaintiff

has not proven that any harm resulted from any

improper double bidding or inflated bid price.

 In re SubMicron Sys., 291 B.R. at 329. 

The record supports the Court’s findings, and Cohen

barely argues otherwise. Further, Cohen points to no evidence 17
v. NCT Group, Inc., 863 A.2d 772 (Del. Ch. 2004), addresses

the extent of director duties when a corporation is insolvent. Id.

at 787–93. In so doing, the Vice Chancellor clarifies inaccurate

generalizations of Credit Lyonnais that have gained traction

from uncritical repetition.

 Indeed, it appears the 1999 Fundings benefitted unsecured 18

creditors by enabling SubMicron to pay operating expenses and

to avoid a Chapter 7 liquidation.

36

showing that unsecured creditors were in any way disadvantaged

or harmed by the sale of assets. In this context, equitable 18

subordination would serve no purpose and the Court thus

properly denied Cohen’s claim.

* * * * *

We affirm the District Court’s approval of the § 363 sale

of SubMicron’s assets.