Pre-Petition Capital Contributions: The Road to Equitable Treatment in Bankruptcy

Friday, January 1st, 1999 at 12:00 am by Jonathan A. Carson
Jonathan A. Carson, Pre-Petition Capital Contributions: The Road to Equitable Treatment in Bankruptcy, 1999 Colum. Bus. L. Rev. 403

Pre-petition infusions of capital into a financially-troubled business are oftentimes crucial to the entity’s potential return to a healthy existence, yet the treatment of these cash inflows in the bankruptcy context can be dangerously uncertain. When an equity holder of a business contributes cash to the distressed entity prior to bankruptcy, the contributor is assuming an increased risk in the failure of the organization; however, to date, the contributor has not been afforded any increased protection once inside the bankruptcy arena. This Article introduces the capital-contribution dilemma, examines the current treatment of this unknown class of claims or interests inside bankruptcy, and concludes that certain pre-petition capital infusions belong separately classified between general unsecured debt and equity within the Bankruptcy Code’s priority scheme. Realizing that only Congressional action could effectuate such a change in bankruptcy law, the Article suggests a vehicle by which bankruptcy courts could reach the same result without rewriting the Code. This Article begins with the preliminary analysis a bankruptcy court undertakes in determining the nature of this new capital. In particular, courts consider various factors in deciding whether the infusion represents debt or equity, and this analytical process will be presented and examined in Section I. Section II introduces the broad structure of the Code’s priority scheme and the question of whether there is a position for capital contributions on the existing distribution chain. In addition, this Section will examine four states’ Corporation Codes – namely, those of Delaware, New York, Illinois and California – to determine whether applicable non-bankruptcy law considers the treatment of capital contributions.

Author Information

The author is an associate in the Bankruptcy/Workouts Department at Kirkland & Ellis in Chicago.