## Facts

- SubMicron Systems Corp. and affiliates (SubMicron) experienced serious financial distress.
- In 1997, SubMicron issued $20 million in secured notes to KB Mezzanine Fund II, LP; Equinox Investment Partners, LLC; and Celerity Silicon, LLC (collectively, the Lenders).
- The 1997 notes were secured by liens on SubMicron’s inventory, equipment, and other assets.
- In 1998 and 1999, SubMicron issued additional secured notes to the Lenders as it continued to struggle.
- In 1999, the Lenders advanced additional funds to keep SubMicron operating (the “1999 funding”).
- No new notes were issued for the 1999 funding, but SubMicron recorded it as secured debt, including in an SEC filing.
- By June 1999, each Lender had a representative on SubMicron’s board of directors.
- SubMicron later filed for Chapter 11 bankruptcy.
- Sunrise Capital Partners, LP (Sunrise) negotiated directly with the Lenders—rather than with all creditor constituencies—to acquire SubMicron’s assets.
- Sunrise formed an acquisition vehicle, Akrion LLC (Akrion), to purchase substantially all of SubMicron’s assets through a Bankruptcy Code § 363(b) sale.
- Under the transaction structure, the Lenders contributed their bankruptcy claims and new capital in exchange for equity interests in Akrion.
- Akrion submitted a bid using a “credit bid” under 11 U.S.C. § 363(k), applying the Lenders’ secured claims against the purchase price.
- Howard S. Cohen, as plan administrator for the SubMicron estates, objected and later appealed, arguing (among other things) that the 1999 funding should be treated as equity rather than debt and that the credit bid should not be permitted (or should be limited) based on collateral value.
- The U.S. District Court for the District of Delaware approved the sale and rejected Cohen’s challenges, and Cohen appealed to the Third Circuit.

## Issues

1. Whether the Lenders’ 1999 funding, despite being carried as secured debt, should be recharacterized as an equity investment.
2. Whether § 363(k) permits a secured creditor (or an entity using the creditor’s claim) to credit bid up to the full amount of its allowed secured claim, even if the collateral may be worth less than the claim.
3. Whether the district court erred in approving the § 363(b) sale process and transaction structure over the plan administrator’s objections.

## Decision

- The Third Circuit affirmed the district court’s order approving the § 363(b) sale.
- The court held that recharacterization of debt as equity is available in bankruptcy, but Cohen did not carry his burden to show the 1999 funding should be treated as equity on these facts.
- The court rejected the argument that the lack of new notes for the 1999 funding, or the Lenders’ board representation, required an equity characterization.
- The court upheld Akrion’s ability to credit bid under § 363(k) using the Lenders’ allowed secured claims.
- The court declined to cap the credit bid based on a judicial estimate of the collateral’s economic value, relying instead on the sale process to test value.
- The court concluded the sale approval should stand and did not disturb the district court’s findings supporting the transaction.

## Legal Principles

- Bankruptcy courts may recharacterize a purported loan as equity when the transaction’s substance shows it functioned as a capital contribution rather than true debt.
- Recharacterization focuses on the nature of the advance (debt vs. equity), and is distinct from equitable subordination, which addresses creditor misconduct and remedy.
- The recharacterization inquiry is fact-intensive and commonly considers multiple factors (such as documentation, repayment terms, treatment on the debtor’s books, capitalization, and the parties’ relationship), with no single factor controlling.
- The absence of a formal note or the presence of lender influence (including board participation) does not automatically convert an advance into equity.
- Under 11 U.S.C. § 363(k), absent “cause” to order otherwise, a secured creditor may credit bid at a § 363 sale up to the amount of its allowed secured claim.
- Section 363(k) does not require a court to limit credit bidding to a pre-sale estimate of the collateral’s value; the auction process may serve as a test of value.
- A structured sale in which lenders contribute claims and cash for equity in the acquisition vehicle is not invalid per se; the question remains whether the claims are properly treated as secured debt and whether the sale approval was proper.
- Appellate review gives deference to sale-approval findings where the record supports the lower court’s determination that the sale process and result were appropriate in the debtor’s circumstances.

## Conclusion

The Third Circuit affirmed approval of SubMicron’s § 363 sale to an acquisition entity formed by Sunrise, holding that the plan administrator failed to show the Lenders’ 1999 advances should be recharacterized as equity and that § 363(k) allowed a credit bid up to the full amount of the Lenders’ allowed secured claims, without a court-imposed cap based solely on collateral valuation.


Cohen v. KB Mezzanine Fund II, LP (In re SubMicron Systems Corp.), 432 F.3d 448 (2006)