Grossman v. Lothian Oil Inc. (In re Lothian Oil Inc.)

Summarized by Aaron Kaufman , Gray Reed LLP
14 years 6 months ago

Citation:

Grossman v. Lothian Oil Inc. (In re Lothian Oil Inc.), Case No. 1050683, --- F.3d --- (5th Cir. 2011)

Tag(s):

Ruling:

The Fifth Circuit held that a claim objection seeking to recharacterize debt to equity, which frequently concerns the same factors as equitable subordination, is a distinguishable concept. Recharacterization is a manner of objecting to a claim under section 502(b) on the basis that applicable state law would not recognize the claim as debt and would, instead, treat the applicable debt instruments as an “equity” investment. See Butner v. United States, 404 U.S. 48, 54, 99 S. Ct. 914, 918 (1979) (“Congress has generally left the determination of property rights in the assets of a bankrupt’s estate to state law.”). In this case, the reorganized debtor argued that Texas law would recognize Grossman’s pre-petition “loan” as an equity investment, not a claim for repayment of debt. The Fifth Circuit agreed, applying the applicable tests for debt/equity under Texas law, and found that the bankruptcy court’s analysis was proper and affirmed the bankruptcy court’s order recharacterizing the claims as equity. The Court of Appeals also explained that a Grossman’s “insider” status was not a per se requirement for the debtor/trustee to seek recharacterization of debt to equity, unless applicable state law provides that only an “insider” may have a claim for a return on his investment.

Procedural context:

Appeal from the United States District Court for the Western District of Texas, San Antonio Division, which reversed the Bankruptcy Court's recharacterization of a non-insider’s claims to equity.

Facts:

Prior to the bankruptcy filing, the debtor’s corporate secretary, Israel Grossman, signed a handwritten documents stating that he was loaning $200,000 to the debtor, which would be repaid by: (i) a 1% royalty of the gross production received by the debtor on a specified piece of property, and (ii) “from the proceeds of the $0.75 placement or any other equity placements.” The bankruptcy filing followed. Grossman and certain non-debtor entities which he controlled filed numerous proofs of claims, both related and unrelated to this “loan” transaction. As it pertains to this decision, Grossman and his controlled non-debtor entities asserted claims for the repayment of the pre-petition “loan.” The debtor objected to these claims, arguing that the “loan” transaction was truly an equity investment, not a debt. The Bankruptcy Court sustained the debtor’s objection, recharacterizing Grossman’s claims as equity investments, which received different treatment under the confirmed liquidating chapter 11 plan. Grossman appealed to the District Court, which reversed the portion of the Bankruptcy Court’s decision on recharacterization of claims as equity investments. The reorganized debtor appealed to the Court of Appeals for the Fifth Circuit.

Judge(s):

Jones, Higginbotham and Southwick. Opinion by Edith H. Jones, Chief Judge.

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