Justices to Take On Circuit Split on Bankruptcy Issue

(CN) – The Supreme Court said Tuesday that will resolve a circuit split on whether federal or state rules should apply when deciding to recharacterize a debt claim in bankruptcy as a capital contribution.

The case, PEM Entities LLC v.Eric M. Levin, et al., comes to the court from the Fourth Circuit, and involves a third-party loan secured on a real estate development and gold course in North Carolina.

As described in a petition for a writ of certiorari filed by PEM Entities in October, the petitioner purchased a loan taken out by an entity called Province Grande Olde Liberty and secured on the Olde Liberty Club development.

When PEM Entities bought the loan, it was in default and the real estate was in foreclosure. Without PEM’s intervention Province Grande Olde Liberty would have lost the property. The loan purchase allowed the real estate company to state in business and successfully file a Chapter 11 bankruptcy plan.

At this point, however, other creditors sought to recharacterize PEM’s loan as capital, invoking a federal multi-factor test for doing so.

As adopted by the Fourth Circuit, the federal rule of decision allowed petitioner’s secured, third-party loan to be recharacterized as a capital contribution.

But, as noted in PEM’s petition, the Fourth Circuit ruling highlights the differences between applying, as the rule of decision, a federal, court-created doctrine of debt recharacterization, as five circuits do, and state law, as two circuits do.

Although the law of North Carolina, where the debtor was incorporated and where the loan was made, would recognize petitioner’s loan as a valid and enforceable debt, the bankruptcy court recharacterized the debt as a capital
contribution under the Fourth Circuit’s federal multi-factor test.

“The Bankruptcy Code provides no basis to recharacterize petitioner’s loan using a federal rule of decision,” the petition says. “Petitioner asks this Court to grant a writ of certiorari in order to resolve the circuit split and to establish that state law governs the recharacterization of debt claims as capital contributions in bankruptcy.”

 

As is their custom, the justices on Monday did not explain their reasons for taking the case.

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