Recharacterization

In the recent case of In re Dornier Aviation (North America), Inc., 453 F.3d 225 (4th Cir. 2006) the United States Court of Appeals for the Fourth Circuit held that
' 105(a) of the Bankruptcy Code provides the bankruptcy court with authority to recharacterize a claim from debt to equity. In upholding the recharacterization of a parent's $84 million claim against its wholly owned subsidiary, the Fourth Circuit made clear that form will not prevail over substance in the context of inter-company transactions. The Fourth Circuit failed, however, to provide any guidance on how inter-company transactions might be structured to avoid recharacterization under ' 105(a). This article presents one obvious, albeit not often utilized, solution: Parent corporations should collect debts due and owing from their subsidiaries to avoid the possibility of being relegated to the unenviable position of an equity investor in the event of a bankruptcy proceeding.