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Ninth Circuit Clarifies Bankruptcy Court’s Power to Recharacterize

In a significant decision acknowledging the bankruptcy court’s power to recharacterize debt to equity, the Ninth Circuit Court of Appeals ruled that a court has the authority to recharacterize a purported loan as an equity investment for purposes of actual and constructive fraudulent transfer actions (In the Matter of Fitness Holdings International, Inc., Official Committee of Unsecured Creditors of the Estate of Fitness Holdings International, Inc. v. Hancock Park Capital II, L.P., Pacific Western Bank, et. al., No. 11-56677, United States Court of Appeals for the Ninth Circuit) (2013 WL 1800000 (C.A.9 (Cal.)).

This was an issue of first impression for the Ninth Circuit Court of Appeals, which rejected the Bankruptcy Appellate Panel’s long standing decision In re Pacific Express (69 B.R. 112, 115 (B.A.P. 9th Cir. 1986)).  The lower courts had found that courts lacked the authority to make such a recharacterization determination.  As a result, the Ninth Circuit Court of Appeals found that this error of law infected much of the District Court’s rulings, and vacated and remanded the District Court’s rulings with respect to the claims: (i) seeking avoidance of fraudulent transfers as to Hancock Park Capital II, L.P.; (ii) determining that the transactions between Hancock and Fitness Holdings be characterized as equity rather than debt; (iii) for breach of fiduciary duty; and, (iv) aiding and abetting breach of fiduciary duty.

The Ninth Circuit Opinion also appears to clarify the 9th Circuit’s position with respect to properly pleading a claim for relief.

The case was successfully presented to the Ninth Circuit by Larry Gabriel and Robyn Sokol.

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