Recently, the Tenth Circuit considered a case involving the question of whether the U.S. Supreme Court’s decisions in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., 549 U.S. 443 (2007) and in Law v. Siegel, 134 S. Ct. 1188 (2014) affected established Tenth Circuit precedent that a bankruptcy court’s authority to recharacterize debt as equity arises under 11 U.S.C. § 105(a).  In its decision inRedmond v. Jenkins, et al (In re Alternate Fuels, Inc.), 789 F.3d 1139 (10th Cir. 2015), the Tenth Circuit held that neither Supreme Court decision eliminated a bankruptcy court’s authority under § 105(a) to recharacterize debt as equity.  In so ruling, the Tenth Circuit reiterated the continued application of its decision in In re Hedged-Invsetments Assocs., Inc., 380 F.3d 1292 (10th Cir. 2004) and its factors for determining when debt should be recharacterized as equity.

In Hedged-Investments, the Tenth Circuit held that recharacterization of debt as equity involves a mixed question of law and fact which a bankruptcy court addresses pursuant to its general equitable powers under § 105(a) of the Bankruptcy Code.  In recharacterizing debt as equity, a court “effectively ignores the label attached to the transaction at issue and instead recognizes its true substance.”  In re Hedged-Investments, 380 F.3d at 1297.  In Alternate Fuels, the appellant/creditor argued that the U.S. Supreme Court’s decisions in Travelers Casualty and Law v. Siegel eliminated a bankruptcy court’s ability to recharacterize debt under § 105(a), leaving a court to do so only under § 502(b).   The appellant urged the court to follow the conclusions of the Fifth Circuit in In re Lothian Oil, Inc., 650 F.3d 539 (5th Cir. 2011) and the Ninth Circuit in In re Fitness Holdings Int’l, Inc., 714 F.3d 1141 (9th Cir. 2013), both of which rejected reliance on § 105(a) as a source of authority to recharacterize debt.  The Tenth Circuit declined and instead reiterated its conclusions in In re Hedged-Investments.  First, the Tenth Circuit noted that the Supreme Court did not expressly overrule Hedged-Investments in either opinion, nor did either opinion mention—much less deal with—recharactierization of debt.  The Tenth Circuit stated that disallowance of claims and recharacterization of debt require different inquiries and serve different functions.  In fact, the court noted that a claim can be allowed under § 502 and still recharacterized as equity as appropriate under the court’s equitable powers of § 105(a).  The court held that disallowance is appropriate where the claimant has not right of recovery against the debtor, whereas recharacterization is not an inquiry into the enforceability of the claim but rather an inquiry into the nature of the transaction between the claimant and the debtor. 

For these reasons, the Tenth Circuit held that courts continue to have equitable power under § 105(a) to recharacterize debt as equity.