In a recently issued decision, the Ninth Circuit reversed long-standing precedent and held that, at least in the context of constructively fraudulent transfers, courts have the power to recharacterize debt as equity. See 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). More precisely, in Fitness Holdings, the Ninth Circuit held that a transfer is for value, and therefore is not avoidable, if it is made in repayment of a “claim,” i.e., a right to payment under state law.
In Fitness Holdings, the company executed several subordinated notes in favor of its sole shareholder, Hancock Park Capital. In 2007, the company refinanced its debt. It paid off Hancock Park’s
unsecured notes using secured debt. About 16 months later, the company filed for bankruptcy protection. Its unsecured creditors committee brought suit to recover the payments made to Hancock Park as constructively fraudulent transfers pursuant to Bankruptcy Code § 548(a)(1)(B).
That section allows the bankruptcy trustee to recover transfers made within two years of bankruptcy if the debtor was insolvent and did not receive “reasonably equivalent value” in exchange for the transfer.