Opinion ID: 3029501
Heading Depth: 3
Heading Rank: 2

Heading: The Recharacterization Action

Text: Our task is to determine whether the Trustee’s actions for recharacterization and equitable subordination are precluded by the Settlement Agreement. We analyze these actions separately, as they are distinct. Cohen v. KB Mezzanine Fund, II, LP (In re SubMicron Sys. Corp.), 432 F.3d 448, 454 (3d Cir. 2005). In a recharacterization action, someone challenges the assertion of a debt against the bankruptcy estate on the ground that the “loaned” capital was actually an equity investment. Bayer Corp. v. Massotech, Inc. (In re AutoStylePlastics, Inc.), 269 F.3d 726, 749 (6th Cir. 2001). Because only parties that hold “right[s] to payment” against the estate hold valid 12 bankruptcy claims, 11 U.S.C. § 101(5)(a), the assertion that a would-be debt should be treated as an equity investment challenges the debt’s status as a claim. In re AutoStyle Plastics, 269 F.3d at 749. In the Bankruptcy Code, the distinction between creditors (who hold “claims” against the estate) and equity investors (who hold “interests” in the estate) is important, for holders of claims receive much more favorable treatment than holders of interests.9 Equity investment brings not a right to payment, but a share of ownership in the debtor’s assets—a 9 As the Bankruptcy Court for the Western District of Tennessee has explained: Creditors present their claims to the court by filing a proof of claim, whereas equity security holders assert their rights to distribution of the proceeds of a solvent corporate debtor by filing a proof of interest. While the filing of a proof of claim triggers the process of allowance and disallowance of claims and prompts the restructuring of the debtor-creditor relationship, the filing of a proof of interest, which applies only in Chapter 11 cases, is not recognized in the claims process and becomes significant only when the remaining assets of the solvent corporate debtor are being distributed to shareholders. Crocker v. Namer (In re AVN Corp.), 235 B.R. 417, 423 (Bankr. W.D. Tenn. 1999). 13 share that is subject to all of the debtor’s payment obligations.10 Thus, if a filed claim is rejected on the ground that it is not a claim at all, but an interest, then the holder of that interest is relegated to the end of the line, where any recovery is unlikely. Because a recharacterization action implicates the validity of the underlying claim, it is not section 4C of the Settlement Agreement (as the Bankruptcy and District Courts ruled), but section 1 that precludes the Trustee from bringing it against the Term C Lenders. In section 1, the Debtors and Creditors’ Committee conceded that the debts owed to the Term C Lenders are allowable claims. Their loans cannot be both allowable claims and equity investments; to repeat, the latter (an interest) is not a claim at all. By agreeing that the Term C Loans are an allowable claims, the Debtors and Creditors’ Committee necessarily agreed that the Term C Loans were true loans. Thus, under section 1 of the Settlement Agreement, the 10 Even in the flexible world of Chapter 11 reorganizations, the absolute priority rule, 11 U.S.C. § 1129(b)(2)(B), requires that equity holders receive nothing unless all creditors are paid in full. As the Supreme Court noted in Bank of Am. Nat’l Tr. & Sav. Ass’n v. North LaSalle St. P’ship, 526 U.S. 434 (1999), this is a long-standing principle of insolvency law. Id. at 444 (acknowledging “the pre-Code judicial response known as the absolute priority rule, that fairness and equity required that ‘the creditors . . . be paid before the stockholders could retain [equity interests] for any purpose whatever.’”) (quoting Northern Pac. R.R. Co. v. Boyd, 228 U.S. 482, 508 (1913)). 14 action of the Trustee (as successor to the Debtor and Creditors’ Committee) for recharacterization is barred.