How the Third Circuit's Recent Decision in SubMicron Systems Alters the Playing Field

Understanding Recharacterization

Distinguishing Recharacterization From Equitable Subordination

Both recharacterization and equitable subordination are grounded in bankruptcy courts' equitable authority to ensure that “substance will not give way to form, that technical considerations will not prevent substantial justice from being done.” 432 F.3d at 454 (quoting Pepper v. Litton, 308 U.S. 295, 305 (1939)). Yet recharacterization and equitable subordination address distinct concerns. Equitable subordination applies when equity demands that the payment priority of claims of an otherwise legitimate creditor be changed to fall behind those of other claimants. In contrast, recharacterization focuses on whether a debt actually exists or, put another way, what is the proper characterization of an advance in the first instance. The Third Circuit explained that the phrase “recharacterization” is actually misleading. The debt-versus-equity inquiry is not an exercise in recharacterizing a claim, but of characterizing the true character of an advance, ie, did the transaction create a debt or equity relationship from the outset?

Although the effect of recharacterization and equitable subordination may be similar in that in both cases a claim is subordinated to that of other creditors, each serves a different function, and the extent to which a claim is subordinated under each process may be different. See In re Autostyle Plastics, Inc., 269 F.3d 726, 748 (6th Cir. 2001) (recognizing recharacterization as a distinct claim); In re AtlanticRancher, Inc., 279 B.R. 411, 433 (Bankr. D. Mass. 2002) (same); In re Hyperion Enters. Inc., 158 B.R. 555, 560 (D.R.I. 1993) (same). As the Sixth Circuit explained:

“Recharacterization cases turn on whether a debt actually exists, not on whether the claim should be equitably subordinated. In a recharacterization analysis, if the court determines that the advance of money is equity and not debt, the claim is recharacterized and the effect is subordination of the claim as a proprietary interest because the corporation repays capital contributions only after satisfying all other obligations of the corporation. In an equitable subordination analysis, the court is reviewing whether a legitimate creditor engaged in inequitable conduct, in which case the remedy is subordination of the creditor's claim to that of another creditor only to the extent necessary to offset injury or damage suffered by the creditor in whose favor the equitable doctrine may be effective.” In re Autostyle Plastics, Inc., 269 F.3d at 748-49 (emphasis in original) (internal quotations and citations omitted).

That recharacterization and equitable subordination of claims often have the same effect has led some courts to conclude that bankruptcy courts lack the power to recharacterize claims. See In re Pacific Express, Inc., 69 B.R. 112, 115 (B.A.P. 9th Cir. 1986); In re Pinetree Ptrs, Ltd, 87 B.R. 481, 491 (Bankr. N.D. Ohio 1988) (following Pacific Express). These courts conclude that the actual result achieved by recharacterization, ie, subordination, is governed by 11 U.S.C. ' 510(c). “Where there is a specific provision governing these determinations, it is inconsistent with the interpretation of the Bankruptcy Code to allow such determinations to be made under different standards through the use of the court's equitable powers.” In re Pacific Express, Inc., 69 B.R. at 115. On the other hand, many argue that, because recharacterization determines whether an advance is debt or equity in the first instance, there is no reordering of priorities as there is in an equitable subordination analysis. In re Outboard Marine Corp., 2003 WL 21697357, at *4 (N.D. Ill. July 22, 2003) (finding that recharacterization does not reorder priorities or distributions). Accordingly, recharacterization would not run afoul of the principle that bankruptcy courts may not use 11 U.S.C. ' 105(a) to override the priority and distribution rules set forth in the Bankruptcy Code. Cf., In re Kmart Corp., 359 F.3d 866, 871 (7th Cir. 2004) (upholding reversal of bankruptcy court order that effectively caused deviation from the Code's rules of priority and distribution). In SubMicron, the Third Circuit stated that “we agree with those courts that have determined that the issues of recharacterization of debt as equity capital and equitable subordination should be treated separately.” SubMicron, 432 F.3d at 454 (citing In re Autostyle Plastics, Inc., In re Hyperion Enters. Inc., and In re AtlanticRancher) (internal quotations and citations omitted).

Because recharacterization determines whether an advance is a loan or an equity contribution in the first instance, recharacterization issues should be addressed before equitable subordination issues. If a particular advance is a capital contribution, equitable subordination never comes into play. SubMicron, 432 F.3d at 455. “Determining an equitable subordination issue prior to determining whether an advance is a loan or an equity investment is similar to taking the cart before the horse.” Id. (internal quotations and citations omitted).

The Framework of Recharacterization

The Third Circuit noted that, in making the recharacterization inquiry, courts have adopted a variety of multi-factored tests borrowed from non-bankruptcy case law. In Roth Steel Tube Co. v. Comm'r, 800 F.2d 625 (6th Cir. 1986), the Sixth Circuit Court of Appeals identified 11 factors used in the context of assessing income tax liability to determine whether an investment was debt or equity. Id. at 630. In re Autostyle Plastics extended the use of those factors to the bankruptcy recharacterization context. 269 F.3d at 749-50. They are: 1) the names given to the instruments, if any, evidencing the indebtedness; 2) the presence or absence of a fixed maturity date and schedule of payments; 3) the presence or absence of a fixed rate of interest and interest payments; 4) the source of repayments; 5) the adequacy or inadequacy of capitalization; 6) the identity of interest between the creditor and the stockholder; 7) the security, if any, for the advances; 8) the corporation's ability to obtain financing from outside lending institutions; 9) the extent to which the advances were subordinated to the claims of outside creditors; 10) the extent to which the advances were used to acquire capital assets; and 11) the presence or absence of a sinking fund to provide repayments. Roth Steel Tube Co., 800 F.2d at 630.

The Eleventh and Fifth Circuit Courts of Appeal have employed a 13-factor recharacterization test in the tax context. These are: 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 regular corporate creditors; 7) the intent of the parties; 8) “thin” or adequate capitalization; 9) identity of interest between creditor and stockholder; 10) source of interest payments; 11) the ability of the corporation to obtain loans from outside lending institutions; 12) the extent to which the advance was used to acquire capital assets; and 13) the failure of the debtor to repay on the due date or to seek a postponement. Stinnett's Pontiac Serv., Inc. v. Comm'r, 730 F.2d 634, 638 (11th Cir. 1984) (citing Estate of Mixon v. United States, 464 F.2d 394, 402 (5th Cir. 1972)).

The court in In re Hillsborough Holdings Corp., 176 B.R. 223, 248 (M.D. Fla. 1994), applied these factors to recharacterization in the bankruptcy context. [The Eleventh Circuit employs a different standard when considering whether shareholder loans should be recharacterized as equity. "Shareholder loans may be deemed capital contributions in one of two circumstances: where the trustee proves initial under-capitalization or where the trustee proves that the loans were made when no other disinterested lender would have extended credit." In re N&D Properties, Inc., 799 F.2d 726, 733 (11th Cir. 1986); Diasonics, Inc. v. Ingalls, 121 B.R. 626, 631 (Bankr. N.D. Fla. 1990) (finding the N&D Properties standard is the appropriate standard in the Eleventh Circuit).]

A third set of factors has been used by bankruptcy courts in the First and Seventh Circuits, as follows: 1) the adequacy of capital contributions; 2) the ratio of shareholder loans to capital; 3) the amount or degree of shareholder control; 4) the availability of similar loans from outside lenders; and 5) certain relevant questions, such as: a) whether the ultimate financial failure was caused by under-capitalization; b) whether the note included payment provisions and a fixed maturity date; c) whether a note or other debt document was executed; d) whether advances were used to acquire capital assets; and e) how the debt was treated in the business records. In re Hyperion Enters., 158 B.R. at 561. See also In re AtlanticRancher, 279 B.R. at 433 (listing same factors); In re Kids Creek Ptrs., L.P., 212 B.R. 898, 931 (Bankr. N.D. Ill. 1997) (listing same factors).

In re Cold Harbor Assocs., L.P., 204 B.R. 904, 916 (Bankr. E.D. Va. 1997), identified three themes that run through the foregoing multi-factor tests. These are: 1) the formality of the alleged loan agreement; 2) the financial situation of the corporation at the time the purported loan is made; and 3) the relationship between the equity holders and the lender.

The district court in SubMicron applied a seven-factor test from Official Comm. of Unsecured Creditors of Color Tile, Inc. v. Blackstone Family Inv. P'ship. (In re Color Tile), No. Civ. A. 98-358-SLR, 2000 WL 152129 (D. Del. Feb. 9, 2000) (Robinson, J.). Those factors are: 1) the name given to the instrument; 2) the intent of the parties; 3) the presence or absence of a fixed maturity date; 4) the right to enforce the payment of principal and interest; 5) the presence or absence of voting rights; 6) the status of the contribution in relation to regular corporate contributors; and 7) certainty of payment in the event of the corporation's insolvency or liquidation. SubMicron Systems Corp., 291 B.R. 314, 323 (D. Del. 2003).

On appeal, the Third Circuit eschewed the adoption of any particular multi-factor test in favor of a fact-intensive inquiry into the intent of the parties. “While these tests undoubtedly include pertinent factors, they devolve to an overarching inquiry: [T]he characterization as debt or equity is a court's attempt to discern whether the parties called an instrument one thing when in fact they intended it as something else. That intent may be inferred from what the parties say in their contracts, from what they do through their actions, and from the economic reality of the surrounding circumstances. Answers lie in facts that confer context case-by-case.” SubMicron, 432 F.3d at 455-56.

According to the Third Circuit, in the search for intent, “no mechanistic scorecard suffices. And none should, for Kabuki outcomes elude difficult fact patterns.” Id. at 456. Rather, the characterization of an advance “is typically a common sense conclusion that the party infusing funds does so as a banker (the party expects to be repaid with interest no matter the borrower's fortunes; therefore, the funds are debt) or as an investor (the funds infused are repaid based on the borrower's fortunes; hence they are equity).” Id. This common-sense approach is in accord with the Third Circuit's recent important opinion on substantive consolidation in which it also refused to adopt any specific list of factors. In re Owens Corning, 419 F.3d 195, 210 (3d Cir. 2005). Though the Third Circuit did not say so, the following quote from Owens Corning could just as well appear in the SubMicron decision: “Too often, the factors in a check list fail to separate the unimportant from the important, or even to set out a standard to make the attempt. This often results in rote following of a form containing factors where courts tally up and spit out a score without an eye on the principles that give the rationale for [the decision] … ” Id. Similarly, the recharacterization analysis involves a fact-intensive search for the intent of the parties in which no one factor or group of factors is always determinative.

Is Recharacterization a Question of Fact or of Law?

The standard of review on recharacterization in the bankruptcy context was a question of first impression at the federal appellate level. The Third Circuit noted that, in the tax context, the Courts of Appeal are split, with the Sixth and Ninth Circuits concluding that recharacterization is an issue of fact to be reviewed for clear error, and the Fifth and Eleventh Circuits concluding it is primarily an issue of law subject to de novo review. SubMicron, 432 F.3d at 456.

Because the Third Circuit framed the determinative inquiry as the intent of the parties at the time of the transaction, it held that recharacterization is a question of fact that, once determined by a district court, cannot be overturned unless clearly erroneous. Concluding that recharacterization is a question of fact is very significant, because it is quite difficult to prove on appeal that a trial court's factual findings are clearly erroneous. Indeed, some circuit courts of appeal have stated that to be clearly erroneous, “a decision must strike the court as more than just maybe or probably wrong; it must … strike [the court] as wrong with the force of a five-week-old, unrefrigerated dead fish.” See, eg, In re Papio Keno Club, Inc., 262 F.3d 725, 729 (8th Cir. 2001); U.S. v. Searan, 259 F.3d 434, 447 (6th Cir. 2001); Ocean Garden, Inc. v. Marktrade Co., Inc., 953 F.2d 500, 502 (9th Cir. 1991); Parts and Electric Motors, Inc. v. Sterling Electric, Inc., 866 F.2d 228, 233 (7th Cir. 1988); In re Uni-Rty Corp., 1998 WL 299941, at *2 (S.D.N.Y. June 9, 1998), aff'd, 175 F.3d 1008 (2d Cir. 1999).

Part Two of this Article, which will appear in next month's issue, discusses in more detail the SubMicron case and the implications of the Third Circuit's decision.

Part One of a Two-Part Article

Consider the following scenario. A manufacturing company is experiencing significant financial and operational difficulties. A lender provides it with $20 million secured by a second priority lien and, in connection with this financing, is given two seats on the manufacturer's board of directors. For the next 3 years, the manufacturer continues to suffer losses and the lender continues to extend additional financing. By the third year, the lender has selected three of the company's four board members. At this point, the manufacturer is insolvent, undercapitalized and no disinterested third party will lend it additional money. Nevertheless, the lender extends new financing. No notes are issued for portions of this financing, and the lender does not obtain a valuation to determine whether the manufacturer has collateral to support the new financing. Then the lender, not management, negotiates a sale of the company to occur in the context of a pre-negotiated bankruptcy, with the lender to acquire more than 30% of the stock in the newly formed buyer. The manufacturer files a bankruptcy petition and immediately moves for approval of the sale. The buyer credit bids the lender's claim at the section 363(b) sale, and acquires the company's assets over the objection of the creditors' committee. Should the lender's third-year advances — made while the company was insolvent and undercapitalized and at a time when no disinterested third party would lend money — be recharacterized as equity? After examining all of the facts and circumstances, the Third Circuit answered no. In re SubMicron Systems Corporation, et al., 432 F.3d 448 (3d Cir. 2006).

Since there are few federal appellate level decisions discussing recharacterization of debt to equity in the bankruptcy context, this decision deserves careful consideration.

Understanding Recharacterization

Distinguishing Recharacterization From Equitable Subordination

Both recharacterization and equitable subordination are grounded in bankruptcy courts' equitable authority to ensure that “substance will not give way to form, that technical considerations will not prevent substantial justice from being done.” 432 F.3d at 454 (quoting Pepper v. Litton , 308 U.S. 295, 305 (1939)). Yet recharacterization and equitable subordination address distinct concerns. Equitable subordination applies when equity demands that the payment priority of claims of an otherwise legitimate creditor be changed to fall behind those of other claimants. In contrast, recharacterization focuses on whether a debt actually exists or, put another way, what is the proper characterization of an advance in the first instance. The Third Circuit explained that the phrase “recharacterization” is actually misleading. The debt-versus-equity inquiry is not an exercise in recharacterizing a claim, but of characterizing the true character of an advance, ie, did the transaction create a debt or equity relationship from the outset?

Although the effect of recharacterization and equitable subordination may be similar in that in both cases a claim is subordinated to that of other creditors, each serves a different function, and the extent to which a claim is subordinated under each process may be different. See In re Autostyle Plastics, Inc., 269 F.3d 726, 748 (6th Cir. 2001) (recognizing recharacterization as a distinct claim); In re AtlanticRancher, Inc., 279 B.R. 411, 433 (Bankr. D. Mass. 2002) (same); In re Hyperion Enters. Inc., 158 B.R. 555, 560 (D.R.I. 1993) (same). As the Sixth Circuit explained:

“Recharacterization cases turn on whether a debt actually exists, not on whether the claim should be equitably subordinated. In a recharacterization analysis, if the court determines that the advance of money is equity and not debt, the claim is recharacterized and the effect is subordination of the claim as a proprietary interest because the corporation repays capital contributions only after satisfying all other obligations of the corporation. In an equitable subordination analysis, the court is reviewing whether a legitimate creditor engaged in inequitable conduct, in which case the remedy is subordination of the creditor's claim to that of another creditor only to the extent necessary to offset injury or damage suffered by the creditor in whose favor the equitable doctrine may be effective.” In re Autostyle Plastics, Inc., 269 F.3d at 748-49 (emphasis in original) (internal quotations and citations omitted).

That recharacterization and equitable subordination of claims often have the same effect has led some courts to conclude that bankruptcy courts lack the power to recharacterize claims. See In re Pacific Express, Inc., 69 B.R. 112, 115 (B.A.P. 9th Cir. 1986); In re Pinetree Ptrs, Ltd, 87 B.R. 481, 491 (Bankr. N.D. Ohio 1988) (following Pacific Express). These courts conclude that the actual result achieved by recharacterization, ie, subordination, is governed by 11 U.S.C. ' 510(c). “Where there is a specific provision governing these determinations, it is inconsistent with the interpretation of the Bankruptcy Code to allow such determinations to be made under different standards through the use of the court's equitable powers.” In re Pacific Express, Inc., 69 B.R. at 115. On the other hand, many argue that, because recharacterization determines whether an advance is debt or equity in the first instance, there is no reordering of priorities as there is in an equitable subordination analysis. In re Outboard Marine Corp., 2003 WL 21697357, at *4 (N.D. Ill. July 22, 2003) (finding that recharacterization does not reorder priorities or distributions). Accordingly, recharacterization would not run afoul of the principle that bankruptcy courts may not use 11 U.S.C. ' 105(a) to override the priority and distribution rules set forth in the Bankruptcy Code. Cf., In re Kmart Corp., 359 F.3d 866, 871 (7th Cir. 2004) (upholding reversal of bankruptcy court order that effectively caused deviation from the Code's rules of priority and distribution). In SubMicron, the Third Circuit stated that “we agree with those courts that have determined that the issues of recharacterization of debt as equity capital and equitable subordination should be treated separately.” SubMicron, 432 F.3d at 454 (citing In re Autostyle Plastics, Inc., In re Hyperion Enters. Inc., and In re AtlanticRancher) (internal quotations and citations omitted).

Because recharacterization determines whether an advance is a loan or an equity contribution in the first instance, recharacterization issues should be addressed before equitable subordination issues. If a particular advance is a capital contribution, equitable subordination never comes into play. SubMicron, 432 F.3d at 455. “Determining an equitable subordination issue prior to determining whether an advance is a loan or an equity investment is similar to taking the cart before the horse.” Id. (internal quotations and citations omitted).

The Framework of Recharacterization

The Third Circuit noted that, in making the recharacterization inquiry, courts have adopted a variety of multi-factored tests borrowed from non-bankruptcy case law. In Roth Steel Tube Co. v. Comm'r , 800 F.2d 625 (6th Cir. 1986), the Sixth Circuit Court of Appeals identified 11 factors used in the context of assessing income tax liability to determine whether an investment was debt or equity. Id. at 630. In re Autostyle Plastics extended the use of those factors to the bankruptcy recharacterization context. 269 F.3d at 749-50. They are: 1) the names given to the instruments, if any, evidencing the indebtedness; 2) the presence or absence of a fixed maturity date and schedule of payments; 3) the presence or absence of a fixed rate of interest and interest payments; 4) the source of repayments; 5) the adequacy or inadequacy of capitalization; 6) the identity of interest between the creditor and the stockholder; 7) the security, if any, for the advances; 8) the corporation's ability to obtain financing from outside lending institutions; 9) the extent to which the advances were subordinated to the claims of outside creditors; 10) the extent to which the advances were used to acquire capital assets; and 11) the presence or absence of a sinking fund to provide repayments. Roth Steel Tube Co., 800 F.2d at 630.

The Eleventh and Fifth Circuit Courts of Appeal have employed a 13-factor recharacterization test in the tax context. These are: 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 regular corporate creditors; 7) the intent of the parties; 8) “thin” or adequate capitalization; 9) identity of interest between creditor and stockholder; 10) source of interest payments; 11) the ability of the corporation to obtain loans from outside lending institutions; 12) the extent to which the advance was used to acquire capital assets; and 13) the failure of the debtor to repay on the due date or to seek a postponement. Stinnett's Pontiac Serv., Inc. v. Comm'r , 730 F.2d 634, 638 (11th Cir. 1984) (citing Estate of Mixon v. United States , 464 F.2d 394, 402 (5th Cir. 1972)).

The court in In re Hillsborough Holdings Corp., 176 B.R. 223, 248 (M.D. Fla. 1994), applied these factors to recharacterization in the bankruptcy context. [The Eleventh Circuit employs a different standard when considering whether shareholder loans should be recharacterized as equity. "Shareholder loans may be deemed capital contributions in one of two circumstances: where the trustee proves initial under-capitalization or where the trustee proves that the loans were made when no other disinterested lender would have extended credit." In re N&D Properties, Inc., 799 F.2d 726, 733 (11th Cir. 1986); Diasonics, Inc. v. Ingalls , 121 B.R. 626, 631 (Bankr. N.D. Fla. 1990) (finding the N&D Properties standard is the appropriate standard in the Eleventh Circuit).]

A third set of factors has been used by bankruptcy courts in the First and Seventh Circuits, as follows: 1) the adequacy of capital contributions; 2) the ratio of shareholder loans to capital; 3) the amount or degree of shareholder control; 4) the availability of similar loans from outside lenders; and 5) certain relevant questions, such as: a) whether the ultimate financial failure was caused by under-capitalization; b) whether the note included payment provisions and a fixed maturity date; c) whether a note or other debt document was executed; d) whether advances were used to acquire capital assets; and e) how the debt was treated in the business records. In re Hyperion Enters., 158 B.R. at 561. See also In re AtlanticRancher, 279 B.R. at 433 (listing same factors); In re Kids Creek Ptrs., L.P., 212 B.R. 898, 931 (Bankr. N.D. Ill. 1997) (listing same factors).

In re Cold Harbor Assocs., L.P., 204 B.R. 904, 916 (Bankr. E.D. Va. 1997), identified three themes that run through the foregoing multi-factor tests. These are: 1) the formality of the alleged loan agreement; 2) the financial situation of the corporation at the time the purported loan is made; and 3) the relationship between the equity holders and the lender.

The district court in SubMicron applied a seven-factor test from Official Comm. of Unsecured Creditors of Color Tile, Inc. v. Blackstone Family Inv. P'ship. (In re Color Tile), No. Civ. A. 98-358-SLR, 2000 WL 152129 (D. Del. Feb. 9, 2000) (Robinson, J.). Those factors are: 1) the name given to the instrument; 2) the intent of the parties; 3) the presence or absence of a fixed maturity date; 4) the right to enforce the payment of principal and interest; 5) the presence or absence of voting rights; 6) the status of the contribution in relation to regular corporate contributors; and 7) certainty of payment in the event of the corporation's insolvency or liquidation. SubMicron Systems Corp., 291 B.R. 314, 323 (D. Del. 2003).

On appeal, the Third Circuit eschewed the adoption of any particular multi-factor test in favor of a fact-intensive inquiry into the intent of the parties. “While these tests undoubtedly include pertinent factors, they devolve to an overarching inquiry: [T]he characterization as debt or equity is a court's attempt to discern whether the parties called an instrument one thing when in fact they intended it as something else. That intent may be inferred from what the parties say in their contracts, from what they do through their actions, and from the economic reality of the surrounding circumstances. Answers lie in facts that confer context case-by-case.” SubMicron, 432 F.3d at 455-56.

According to the Third Circuit, in the search for intent, “no mechanistic scorecard suffices. And none should, for Kabuki outcomes elude difficult fact patterns.” Id. at 456. Rather, the characterization of an advance “is typically a common sense conclusion that the party infusing funds does so as a banker (the party expects to be repaid with interest no matter the borrower's fortunes; therefore, the funds are debt) or as an investor (the funds infused are repaid based on the borrower's fortunes; hence they are equity).” Id. This common-sense approach is in accord with the Third Circuit's recent important opinion on substantive consolidation in which it also refused to adopt any specific list of factors. In re Owens Corning, 419 F.3d 195, 210 (3d Cir. 2005). Though the Third Circuit did not say so, the following quote from Owens Corning could just as well appear in the SubMicron decision: “Too often, the factors in a check list fail to separate the unimportant from the important, or even to set out a standard to make the attempt. This often results in rote following of a form containing factors where courts tally up and spit out a score without an eye on the principles that give the rationale for [the decision] … ” Id. Similarly, the recharacterization analysis involves a fact-intensive search for the intent of the parties in which no one factor or group of factors is always determinative.

Is Recharacterization a Question of Fact or of Law?

The standard of review on recharacterization in the bankruptcy context was a question of first impression at the federal appellate level. The Third Circuit noted that, in the tax context, the Courts of Appeal are split, with the Sixth and Ninth Circuits concluding that recharacterization is an issue of fact to be reviewed for clear error, and the Fifth and Eleventh Circuits concluding it is primarily an issue of law subject to de novo review. SubMicron, 432 F.3d at 456.

Because the Third Circuit framed the determinative inquiry as the intent of the parties at the time of the transaction, it held that recharacterization is a question of fact that, once determined by a district court, cannot be overturned unless clearly erroneous. Concluding that recharacterization is a question of fact is very significant, because it is quite difficult to prove on appeal that a trial court's factual findings are clearly erroneous. Indeed, some circuit courts of appeal have stated that to be clearly erroneous, “a decision must strike the court as more than just maybe or probably wrong; it must … strike [the court] as wrong with the force of a five-week-old, unrefrigerated dead fish.” See, eg, In re Papio Keno Club, Inc., 262 F.3d 725, 729 (8th Cir. 2001); U.S. v. Searan , 259 F.3d 434, 447 (6th Cir. 2001); Ocean Garden, Inc. v. Marktrade Co., Inc. , 953 F.2d 500, 502 (9th Cir. 1991); Parts and Electric Motors, Inc. v. Sterling Electric, Inc. , 866 F.2d 228, 233 (7th Cir. 1988); In re Uni-Rty Corp., 1998 WL 299941, at *2 (S.D.N.Y. June 9, 1998), aff'd, 175 F.3d 1008 (2d Cir. 1999).

Part Two of this Article, which will appear in next month's issue, discusses in more detail the SubMicron case and the implications of the Third Circuit's decision.