When is a “shareholder loan” truly equity?
A recent case (“Tudor”) involved an unsecured creditor who argued in a bankruptcy fight that a shareholder loan should be classified as equity instead of debt.
The Court held that the determination of whether a “shareholder loan” is to be deemed equity instead of debt depends on the economic realities surrounding the capital outlay. Substance dominates form, especially since a shareholder loan, by its nature, constitutes a non-arm’s length transaction.
When we think of a loan certain economic attributes come to mind. These usually include a principal outlay by the creditor, a payment schedule, a rate of interest, and a maturity date. The shareholder loan in Tudor did not include any of these attributes except a principal outlay that was made at nearly the same time that a shareholder gained an equity interest in the company. Accordingly, the Court held that the “shareholder loan” was in actuality equity rather than debt.
The key takeaway is that parties need to be mindful of the economic realities of the capital injection. If the shareholder loan does not function like a loan, it may very well not be found to be one. At the same time, it should be borne in mind that the Court in the case is silent about the details of the noted attributes. It says nothing of how periodic the payment schedule should be, the length of amortization, and certainly nothing about the amount of interest. The important thing is that the outlay should not function as an equity investment if the goal is for it to stand as debt.
Invitation for Discussion:
Our business litigation lawyers are skilled in shareholder matters and disputes, and our commercial lawyers are skilled in transactional matters. If you would like to discuss this blog in greater detail, or any other business matter, please do not hesitate to contact Mohamed Amery or one of the business lawyers at Nerland Lindsey LLP.
Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.