Redmond v. Jenkins (In Re Alternate Fuels, Inc.), 789 F.3d 1139

Background

Alternate Fuels, Inc. (AFI) was a reorganized coal company that ceased mining and retained reclamation obligations; John Warmack sold AFI to William Jenkins in 1999. Jenkins paid $549,250 and received AFI stock (held in a straw name), 99% of Cimarron, equipment, and assignment of 24 certificates of deposit (CDs) which he owned personally.
Jenkins advanced funds to AFI (delivered via checks from his Green Acres Farms entity), and AFI executed three promissory notes (2000–2001) in favor of Green Acres Farms totaling $2M and a 2003 note purportedly renewing/aggregating those notes; Jenkins later filed a proof of claim for ~$4.3M secured by a March 1, 2003 $3M assignment of proceeds from AFI’s litigation (the Cabanas judgment).
The bankruptcy court recharacterized Jenkins’s claimed loans as equity under 11 U.S.C. §105(a) using this Circuit’s Hedged‑Investments 13‑factor test, alternatively found Jenkins failed to prove claim amount/validity, and alternatively subordinated his claim under §510(c); the BAP affirmed.
On appeal to the Tenth Circuit, the majority reviewed (factual findings for clear error; legal application de novo) and reversed: it held recharacterization and equitable subordination were not warranted and Jenkins met his burden on claim validity/amount.
Dissent would have affirmed recharacterization and would remand to determine whether Jenkins holds a valid security interest in the Cabanas proceeds under Kansas law.

Issues

Issue	Plaintiff's Argument (Jenkins)	Defendant's Argument (Trustee/Bankruptcy Court)	Held
Source of authority to recharacterize debt as equity	Hedged‑Investments test under §105(a) is valid; recharacterization permissible	Travelers and Law limit §105(a); claim treatment should follow §502(b)/state law	Majority: Hedged‑Investments §105(a) approach remains valid; Travelers and Law do not displace it
Whether Jenkins’s advances are debt or equity under Hedged‑Investments factors	Notes are labeled promissory, have fixed maturity, enforceable, and were intended to be repaid upon CD release or litigation proceeds	Many factors (single owner, inability to obtain outside financing, lack of realistic repayment source, failure to repay/maturity lapse) support equity	Majority: On balance, factors support characterization as loans (reverse bankruptcy court). Dissent: factors favor equity (would affirm recharacterization).
Equitable subordination under §510(c)	Jenkins did not engage in inequitable conduct; funds enabled reclamation; no fraud or gross misconduct	Jenkins acted inequitably (straw ownership, retention of proceeds, using notes to prefer himself) and controlled AFI as insider	Held: Bankruptcy court erred; equitable subordination not warranted
Validity/amount of claim and existence of security interest in Cabanas proceeds	Jenkins produced notes, assignments, and accounting evidence to support amount and security	Trustee argued insufficient documentation and that the instruments/assignment did not create a valid security interest under Kansas law	Majority: Jenkins met burden on validity/amount and holds a claim; dissent would remand to resolve adequacy of security interest and doubts about whether instruments satisfy Kansas secured‑transaction formalities

Key Cases Cited

In re Hedged‑Investments Assocs., Inc., 380 F.3d 1292 (10th Cir. 2004) (adopting 13‑factor test for recharacterizing debt as equity under §105(a))
Travelers Cas. & Sur. Co. v. Pac. Gas & Elec. Co., 549 U.S. 443 (2007) (bankruptcy claim allowance presumption under §502(b) and deference to state‑law created property rights)
Law v. Siegel, 134 S. Ct. 1188 (2014) (limits on §105(a): courts may not use §105(a) to contravene explicit Code provisions)
In re AutoStyle Plastics, Inc., 269 F.3d 726 (6th Cir. 2001) (recharacterization principles and relation to §105(a))
Pepper v. Litton, 308 U.S. 295 (1939) (substance over form doctrine in bankruptcy)
In re Dornier Aviation (N. Am.), Inc., 453 F.3d 225 (4th Cir. 2006) (recharacterization inquiry and priority determination)
Butner v. United States, 440 U.S. 48 (1979) (property interests in bankruptcy are created by state law)