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[1]The New York State Court of Appeals’ decision in Geron v. Seyfarth Shaw LLP[2] reflects the New York courts’ evolving view of the mobility of partners and their clients in large firms. In this decision, the court of appeals held that under New York law, pending hourly fee matters are not “property” or “unfinished business” of a dissolved law firm partnership.

In June 2015, the Tenth Circuit Court of Appeals decided In re Alternate Fuels Inc.,[1] clarifying its position on debt-equity recharacterization in light of two Supreme Court decisions and further entrenching a circuit split on recharacterization analysis. This article provides an in-depth discussion of the case, as well as some thoughts on the implications for recharacterization analysis going forward.

Case Summary

Section 510(b) of the Bankruptcy Code expressly subordinates claims arising from the purchase or sale of a security in the debtor or an affiliate to the level of equity. It thus functions as a form of recharacterization. Despite its broad scope, § 510(b) is relatively underused, making it a potentially powerful tool for creative debtors, committees and trustees.

Section 510(b) Plain Language

Sandwiched between the enforceability of subordination agreements in § 510(a) and equitable subordination in § 510(c), § 510(b) provides:

Courts have held that bankruptcy courts have the authority to recharacterize debt to equity if the circumstances warrant such treatment. However, circuit courts are divided as to which provision of the Bankruptcy Code provides such authority. The majority looks to the court’s equitable powers. The minority holds that the ability must be grounded in the allowance of claims pursuant to state law.

The Majority Approach: Authority to Recharacterization Pursuant to General Equitable Powers

Private-equity funds typically provide capital to portfolio companies through equity infusions and debt financing depending on the fund’s investment strategy and the needs of the portfolio company. These strategies utilized by private-equity funds often unlock value for investors, but in the case of bankruptcy may make the fund a target of a recharacterization action by the trustee or other investors and creditors of a debtor.

The Bankruptcy Litigation Committee had a tremendous 2015!  We strived to continue to provide our members with enlightening and useful substantive information, while also offering enjoyable and valuable social and networking opportunities.