United States: Tenth Circuit: Recharacterization Remedy In Bankruptcy Is Alive And Well

Last Updated: November 18 2015
Article by Nicholas J. Morin

In Redmond v. Jenkins (In re Alternate Fuels, Inc.), 789 F.3d 1139 (10th Cir. 2015), a panel of the U.S. Court of Appeals for the Tenth Circuit upheld bankruptcy courts' authority to recharacterize insider debt as equity. In so ruling, the court rejected an argument that recent U.S. Supreme Court precedent prevents bankruptcy courts from using section 105(a) of the Bankruptcy Code to recharacterize debt as equity. Nevertheless, after upholding the recharacterization doctrine, the Tenth Circuit panel split on the doctrine's application. The majority, stating that courts must "exercise caution" when determining whether recharacterization is appropriate, ultimately concluded that the insider's claims should not be recharacterized as equity. By contrast, the dissent contended that recharacterization was warranted.

Alternate Fuels

Kansas-based Alternate Fuels, Inc. (the "debtor") engaged in coal-mining operations through a subsidiary. In connection with these operations, the debtor was obligated to restore certain mining sites to their original condition, including mines located in Missouri. To assure the State of Missouri that reclamation would be performed, the debtor posted reclamation bonds which were secured by approximately $1.4 million in certificates of deposit.

Subsequent to the debtor's posting of security for the reclamation bonds, William Karl Jenkins and M. Earlene Jenkins (collectively, the "Insiders") acquired 100 percent ownership of the debtor and 99 percent ownership of the subsidiary. The Insiders, however, did not acquire the companies for the purpose of continuing mining operations. Rather, the Insiders believed that they could use their political connections to modify the debtor's reclamation arrangements, such that they could obtain the proceeds of the certificates of deposit. In furtherance of this goal, the Insiders succeeded in arranging for the certificates of deposit to be assigned to them personally.

During the years following the Insiders' acquisition of the debtor, which had ceased mining operations, the debtor executed three promissory notes evidencing in total approximately $4 million in funding provided by the Insiders. Each of the notes stated that it would mature in a period of years, while also providing that "[t]his note shall be paid in full upon reclamation bond release from the State of Missouri." Because the debtor had no operations or income of its own, the Insiders' only anticipated source of repayment was the certificates of deposit.

Several years after the Insiders had acquired the debtor, the debtor temporarily ceased its reclamation efforts when it filed suit against third parties, alleging tortious interference with its reclamation process. Realizing that their likelihood of recovering the certificates of deposit was diminishing, the Insiders agreed to continue funding the debtor only after receiving, as security for their loans, a partial assignment of the debtor's reclamation suit recovery. On the same date as that assignment, the debtor executed a new promissory note, which renewed the first three promissory notes but also included an additional source of repayment: the proceeds of the reclamation suit.

Ultimately, after recovering $5 million from the reclamation suit, the debtor filed for chapter 11 protection in the District of Kansas in January 2009. The Insiders filed secured proofs of claim in the amount of $4.3 million based on, among other things, the promissory notes.

A chapter 11 trustee was appointed in the debtor's case, and the trustee filed a complaint against the Insiders, seeking to recharacterize the Insiders' promissory note debt as equity or, in the alternative, to equitably subordinate the Insiders' claims under section 510(c) of the Bankruptcy Code. Applying the factors articulated by the Tenth Circuit in Sender v. Bronze Grp., Ltd. (In re Hedged-Investments Assocs., Inc.), 380 F.3d 1292 (10th Cir. 2004) (discussed below), the bankruptcy court ruled, among other things, that the Insiders' claims should be recharacterized as equity contributions. In the alternative, the court ruled that the claims should be equitably subordinated due to the Insiders' breach of fiduciary duties and other misconduct. After a Tenth Circuit bankruptcy appellate panel affirmed the ruling, the Insiders appealed to the Tenth Circuit.

Recharacterization Generally and in the Tenth Circuit

Recharacterization is a tool used by bankruptcy courts to ensure that the Bankruptcy Code's payment priority scheme is properly implemented. When a court recharacterizes putative debt as equity, the court essentially ignores the label attached to the relevant transaction and instead recognizes its true substance. A claim that has been recharacterized as equity is moved to a lower rung on the bankruptcy priority ladder and generally is paid only after all claims have been satisfied in full.

In Hedged-Investments, the Tenth Circuit implicitly recognized section 105(a) of the Bankruptcy Code as a basis for recharacterization. Section 105(a) provides, in relevant part, that a bankruptcy court "may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code]." The Third, Fourth, and Sixth Circuits have also relied on section 105(a) to provide authority for recharacterization. See Cohen v. KB Mezzanine Fund, II, LP (In re SubMicron Systems Corp.), 432 F.3d 448 (3d Cir. 2006); Comm. of Unsecured Creditors for Dornier Aviation (North America), Inc., 453 F.3d 225 (4th Cir. 2006); Bayer Corp. v. MascoTech, Inc. (In re AutoStyle Plastics, Inc.), 269 F.3d 726 (6th Cir. 2001).

The Fifth and Ninth Circuits have taken a different approach, holding instead that section 502(b)(1) of the Bankruptcy Code, which provides that "the court . . . shall allow [a] claim . . . except to the extent that . . . such claim is unenforceable against the debtor and property of the debtor, under any agreement or applicable law," is the proper statutory authority for recharacterization. See Grossman v. Lothian Oil Inc. (In re Lothian Oil Inc.), 650 F.3d 539 (5th Cir. 2011); Official Comm. of Unsecured Creditors v. Hancock Park Capital II, L.P. (In re Fitness Holdings Int'l, Inc.), 714 F.3d 1141 (9th Cir. 2013).

In Hedged-Investments, the Tenth Circuit instructed bankruptcy courts, when analyzing whether to recharacterize debt as equity, to examine the following 13 nonexclusive factors:

  1. the names given to the certificates evidencing the indebtedness;
  2. the presence or absence of a fixed maturity date;
  3. the source of payments;
  4. the right to enforce payment of principal and interest;
  5. participation in management flowing as a result;
  6. the status of the contribution in relation to other corporate creditors;
  7. the intent of the parties;
  8. "thin" or adequate capitalization;
  9. the identity of interest between the creditor and stockholder;
  10. the source of interest payments;
  11. the ability of the corporation to obtain loans from outside lenders;
  12. the extent to which funds were used to acquire capital assets; and
  13. the failure of the debtor to repay on the due date or to seek a postponement.

Hedged-Investments, 380 F.3d at 1298 (citation omitted).

In Alternate Fuels, the Tenth Circuit reaffirmed a bankruptcy court's authority to recharacterize a debt as equity under section 105(a) in accordance with the multifactor test set down in Hedged-Investments.

The Tenth Circuit's Ruling

The Insiders argued to the Tenth Circuit that Hedged-Investments was abrogated by two recent Supreme Court decisions—Travelers Cas. & Surety Co. of America v. Pac. Gas & Electric Co., 549 U.S. 443 (2007), and Law v. Siegel, 134 S. Ct. 1188 (2014).

In Travelers, the Supreme Court reversed a circuit court ruling that an unsecured creditor could not recover attorneys' fees that were authorized by a pre-petition agreement but incurred post-petition. The Supreme Court stated that, when applying section 502(b), "we generally presume that claims enforceable under applicable state law will be allowed in bankruptcy unless they are expressly disallowed." Travelers, 549 U.S. at 452. The Insiders argued that the Court thereby abrogated the Hedged-Investments test by holding that "a court may not fashion a test 'solely of its own creation' in determining what constitutes a 'claim' for purposes of bankruptcy."

In Law, the Supreme Court reversed a bankruptcy court's order under section 105(a) that expressly contravened another provision of the Bankruptcy Code (section 522, which specifies exempt property). The Supreme Court explained that although section 105(a) allows a bankruptcy court to issue orders "necessary or appropriate" to carry out the provisions of the Bankruptcy Code, it is "hornbook law" that section 105(a) does not allow a bankruptcy court to "override explicit mandates of other sections of the Bankruptcy Code." Law, 134 S. Ct. at 1192. Citing this analysis, the Insiders argued that recharacterization under section 105(a) is not permissible where it conflicts with section 502(b).

In Alternate Fuels, the Tenth Circuit rejected these arguments. First, the court noted that neither Travelers nor Law considered the doctrine of recharacterization or expressly overruled Hedged-Investments.

Next, the Tenth Circuit explained that the Insiders' expansive reading of Travelers and Law improperly conflates disallowance with recharacterization. According to the Tenth Circuit, the two concepts, although related, require different inquiries and serve different functions. Whereas disallowance of a claim under section 502(b) is appropriate "when the claimant has no rights vis-à-vis the bankrupt," recharacterization is an inquiry into the nature of the transaction underlying an asserted claim. Unlike disallowance, recharacterization of a loan as equity does not ultimately relieve the debtor from its obligation to repay the claimant. Rather, the Tenth Circuit emphasized, recharacterization simply moves the claimant's right to payment to a lower position in the priority scheme.

The Tenth Circuit panel thus unanimously reaffirmed section 105(a) as an appropriate statutory authority for recharacterizing debt as equity.

However, the Tenth Circuit panel split on whether the Insiders' claims should be treated as equity under the Hedged-Investments multifactor test.

The majority emphasized that the Insiders were "engaged in a venture with substantial risk," highlighting factors that weighed against recharacterization. For example, the majority explained that the first factor had been met because the instruments at issue were labeled "promissory notes." Here, the majority rejected the argument that this factor's inquiry is controlled by the sufficiency of consideration furnished to the debtor for incurring the indebtedness or that the consideration furnished in this case was insufficient. With regard to the fifth and 12th factors of the test, the majority noted that: (i) the Insiders did not increase their participation in the debtor's management following the loans; and (ii) the debtor used the Insiders' advances to fund operating expenses.

The majority also disagreed with the bankruptcy court's conclusions regarding a number of the other Hedged-Investment factors. For example, the majority stated that a court should not place too much emphasis on the eighth factor—the debtor's undercapitalization—as it would create an "unhealthy deterrent effect," disincentivizing business owners from providing capital to save their struggling businesses. Regarding the ninth factor—the identity of interest between the creditor and stockholder—the majority explained that this factor cannot be weighed too heavily in a single equity holder situation. "Otherwise," the court wrote, "this factor would militate against finding true debt in any situation involving a single stockholder."

While finding that some of the factors weighed in favor of recharacterization, the majority counseled that courts should "exercise caution in this arena" and held that, on balance, the factors weighed against recharacterizing the Insiders' claims as equity.

The dissent highlighted the Insiders' self-interested business purpose: the Insiders "made a business gamble—[they] bet that [they] would spend less helping [the debtor] reclaim the coal land than [they] would make from . . . collecting 24 certificates of deposit."

Although the dissenting judge agreed with the majority that certain of the factors signaled debt in "name and form," he went on to analyze the other factors concerning the "real-world backdrop" of the transaction. In the end, he concluded that four factors weighed against recharacterization, three factors were neutral, and six factors weighed in favor of recharacterization. On balance, the dissenting judge concluded that the Hedged-Investments test supported recharacterization.

Finally, emphasizing that equitable subordination is "an extraordinary remedy to be employed by courts sparingly," the Tenth Circuit panel unanimously ruled that the remedy did not apply because the Insiders had not engaged in inequitable or unfair conduct.


The Tenth Circuit stated the rationale for its ruling in Alternate Fuels as follows: "Recharacterization under [section] 105(a) is essential to a court's ability to properly implement the priority scheme of the Bankruptcy Code." In reaffirming its recharacterization precedents, the Tenth Circuit declined to read recent Supreme Court precedent as invalidating section 105(a) as a source of authority for the remedy. Even so, the Tenth Circuit panel split on whether that remedy should be employed in the case before it. Thus, while Alternate Fuels may provide a road map for rebutting similar attacks on the use of section 105(a) as authority for recharacterization, it is also a reminder that the recharacterization analysis itself is difficult to apply and may be subject to different applications by different judges.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.