Subordination and Recharacterization of Claims in Bankruptcy: Avoiding Pitfalls for Lenders, Creditors, and PE Sponsors

Junior or unsecured creditors often assert equitable subordination and recharacterization claims against secured creditors to enhance recovery from highly leveraged debtors. When addressing the liquidity of their portfolio companies, PE sponsors are vulnerable to attacks on their claims.

The Bankruptcy Code also provides for subordination of claims based on the purchase or sale of securities of a debtor or its affiliate, so that such claims are treated as having equal or lesser priority of claims based on the relevant securities.

Recharacterization claims usually involve insiders like stockholders, directors, and officers. However, the doctrine is not limited to corporate insiders, and courts will scrutinize both the debt instrument and the creditor's status.

The subordination and recharacterization doctrines are heavily litigated with recent cases that reflect the continued inconsistency among circuit courts and differing standards used among courts to scrutinize various loan transactions.

Listen as our authoritative panel of bankruptcy attorneys discusses the looming threats of equitable subordination and recharacterization in bankruptcy and how lenders, creditors, and PE sponsors can minimize exposure and protect their claims.

1. Overview of subordination and recharacterization in bankruptcy
   1. Equitable subordination
   2. Subordination of claims based on purchase or sale of securities
   3. Recharacterization
   4. Recent case law
   5. Litigation considerations
2. Minimizing attacks on the claim
   1. Secured lenders
      1. Underwriting
      2. Collateral review
   2. PE sponsors
      1. Anticipating liquidity problems
      2. Internal governance procedures
      3. Arm's length transactions
      4. Management rights or other control of business operations
   3. Creditors
      1. Non-statutory insiders
      2. Claimants with securities purchase/sale-related claims

The panel will review these and other key issues:

• How have the courts defined "inequitable conduct" to justify equitable subordination?
• How do courts analyze potential subordination of claims related to the purchase or sale of securities?
• What factors do the courts use to distinguish a loan transaction from equity investment to justify recharacterization?
• How can PE sponsors loaning money to their portfolio companies protect themselves from attack?