When a company files for bankruptcy, creditors often wonder about the likelihood of getting paid. The answer largely depends on the priority and treatment of each creditor’s claim in the bankruptcy process. The doctrines of recharacterization and equitable subordination can significantly impact the priority of a claim, potentially postponing or eliminating payment.

Recharacterization involves recategorizing debt as equity, which can drastically affect a creditor’s chances of recovery. Courts analyze the substance of financial transactions to determine whether an asserted debt should be treated as equity. If deemed equity, the claim is subordinated to all other claims, making it last in line for payment. This process ensures that genuine debt claims are prioritized over equity interests. The analysis for recharacterization is fact-intensive, considering factors such as the wording of debt documents, the presence of fixed maturity dates, and the company’s ability to secure third-party financing.

Equitable subordination, on the other hand, lowers the priority of a claim based on the creditor’s inequitable conduct, such as fraud. This doctrine assumes the claim is legitimate but reorders its priority to prevent unfair distribution among creditors. To equitably subordinate a claim, it must be shown that the creditor engaged in misconduct that harmed other creditors or conferred an unfair advantage. Unlike recharacterization, equitable subordination does not require the entire debt to be recategorized but only adjusts the priority to offset the creditor’s bad acts. Both doctrines are crucial in ensuring fair treatment of claims in bankruptcy, and creditors should seek competent legal counsel to navigate these complex issues. Read the full article here.

Photo of David Fournier David Fournier

David represents various interests in complex bankruptcy proceedings in the District of Delaware and other jurisdictions. His clients include corporate debtors, secured and unsecured creditors, official creditors’ committees, foreign representatives, and others. David also has extensive experience as a mediator in bankruptcy litigation.

Photo of Evelyn Meltzer Evelyn Meltzer

Evelyn focuses her practice on corporate bankruptcy, insolvency, distressed M&A, and creditors’ rights. With more than 20 years of experience, Evelyn understands all facets of a problem or opportunity, strategically devising insightful, innovative, and practical solutions that protect and advance her clients’ interests.

Photo of Kenneth Listwak Kenneth Listwak

Ken has broad experience in bankruptcy and reorganization matters, including adversary proceedings and contested matters in complex bankruptcy cases, and advising and guiding clients through complex issues involving bankruptcy law and Delaware legal practice.

Photo of Tori Lynn Remington Tori Lynn Remington

Tori is an associate in the firm’s Finance and Financial Restructuring + Insolvency practice groups. She has been involved in complex chapter 11 proceedings and litigation matters, representing various parties in interest, including debtors-in-possession, DIP lenders, stalking horse purchasers, and creditors. Tori also…

Tori is an associate in the firm’s Finance and Financial Restructuring + Insolvency practice groups. She has been involved in complex chapter 11 proceedings and litigation matters, representing various parties in interest, including debtors-in-possession, DIP lenders, stalking horse purchasers, and creditors. Tori also has experience in the Court of Chancery representing assignees in Delaware ABCs.