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90 Second Lesson: What is the Difference Between Recharacterization and Equitable Subordination?

Editors’ Note: this is part of our irregular series in which we answer readers’ questions. If you have a question, submit it to info@dailydac.com and we will try to answer it.

90 Second Lesson

QUESTION:

Jeff P. from Los Angeles emailed asking us to explain the interplay between recharacterization and equitable subordination?

ANSWER:

While recharacterization and equitable subordination are often mentioned in the same breath, the underlying purposes of these doctrines—and the analysis conducted by courts in evaluating claims asserted thereunder—are quite different. As Thomas Fawkes and Devon Eggert explain in great detail here, while the doctrine of equitable subordination authorizes a court to subordinate a creditor’s claim based on the conduct of the creditor, a recharacterization requires no such finding. Rather, recharacterization rests entirely on the substance of the transaction giving rise to the claim; i.e., whether “a debt actually exists.” In re AutoStyle Plastics, Inc., 269 F.3d 726, 748 (6th Cir. 2001); In re Official Committee of Unsecured Creditors for Dornier Aviation (North America), Inc, 453 F.3d 225, 232 (4th Cir. 2006). Conversely, a claim of equitable subordination generally assumes that the subject debt is legitimate, but the priority of that debt should be adjusted based on the bad acts of the creditor. In re SubMicron Systems Corp., 432 F.3d 448, 454 (3d Cir. 2006).

Note: This 90 Second Lesson is based, in substantial part, in material reprinted from Commercial Bankruptcy Litigation 2d and Strategic Alternatives for and Against Distressed Businesses, with permission of Thomson Reuters. For more information about these publications, please visit www.legalsolutions.com.

About The DailyDAC Editors

The editors and editorial board of DailyDAC include preeminent restructuring and insolvency professionals, journalists, and editors. They are devoted to providing reliable and plain English education and deal intelligence about assignments, corporate bankruptcy, receiverships, out-of-court workouts an similar topics.

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