Recharacterization: It's Not All About Equity or Insiders

The ability of a bankruptcy court to reorder the priority of claims or interests by means of equitable subordination or recharacterization of debt as equity is generally recognized. Even so, the Bankruptcy Code itself expressly authorizes only the former of these two remedies. Although common law uniformly acknowledges the power of a court to recast a claim asserted by a creditor as an equity interest in an appropriate case, the Bankruptcy Code is silent upon the availability of the remedy in a bankruptcy case. This has led to uncertainty in some courts concerning the extent of their power to recharacterize claims and the circumstances warranting recharacterization. The Fifth Circuit Court of Appeals recently had an opportunity to weigh in on this issue as an apparent matter of first impression in that court. In Grossman v. Lothian Oil Inc. (In re Lothian Oil Inc.), 650 F.3d 539 (5th Cir. 2011), the court ruled that a bankruptcy court's ability to recharacterize debt as equity is part of the court's authority to allow and disallow claims, and the remedy is not limited to claims asserted by corporate insiders.