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LJN NewslettersNewsSectionsThe Bankruptcy Strategist

Recharacterization

By ALM Staff | Law Journal Newsletters |
October 30, 2006

In the recent case of In re Dornier Aviation (North America), Inc., 453 F.3d 225 (4th Cir. 2006) the United States Court of Appeals for the Fourth Circuit held that
' 105(a) of the Bankruptcy Code provides the bankruptcy court with authority to recharacterize a claim from debt to equity. In upholding the recharacterization of a parent's $84 million claim against its wholly owned subsidiary, the Fourth Circuit made clear that form will not prevail over substance in the context of inter-company transactions. The Fourth Circuit failed, however, to provide any guidance on how inter-company transactions might be structured to avoid recharacterization under ' 105(a). This article presents one obvious, albeit not often utilized, solution: Parent corporations should collect debts due and owing from their subsidiaries to avoid the possibility of being relegated to the unenviable position of an equity investor in the event of a bankruptcy proceeding.

The Case

Dornier Aviation (North Ameri-ca) (DANA) was a wholly owned indirect subsidiary of Fairchild Dornier GmbH (GmbH), a Ger-man aircraft manufacturer. Dor-nier Aviation, 453 F.3d at 229. GmbH and DANA had a close business relationship pursuant to which GmbH provided DANA with spare aircraft parts, which DANA either used to provide services to GmbH's customers, or resold for a profit. Id. GmbH invoiced DANA regularly for the spare parts it provided. Id. GmbH's invoices provided that payment was due within 30 days unless otherwise agreed by the parties. Id. at 230. The parties also performed annual reconciliations of amounts owed from DANA to GmbH as a result of outstanding invoices. Id.

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