It’s hard to determine sometimes whether the contribution to an enterprise is an investment or a loan. The rule of thumb that I always went by was that if it was expected, at the time of the contribution, that the the contributor would earn a share of the enterprise’s profits, then it was an equity investment. If it was expected that the contribution just be repaid (albeit with interest), then it is a loan. An investor takes more risk that there might not be a return on his investment – and thus will have no recourse against the enterprise for it simply failing – but should the enterprise thrive, the investor will thrive as well. The lender too has risk, but not as great as the investor. And should the enterprise not repay the funds, the lender can seek legal remedies to collect on the loan. However the lender does not get to thrive with the enterprise as the investor does – the lender simply gets paid back per the terms of the loan.
A recent case in our district, In re Gables Management, had this very issue at matter when a chapter 7 trustee contended that a contribution to an enterprise was not a loan, but an investment and therefore not entitled to distribution from the estate. In undertaking his analysis, Judge Pappas noted that the determination of whether a contribution is a loan or an investment requires a labor intensive analysis of the facts surrounding the contribution and the relationship of the parties at the time of the contribution and after. The Court then applied the Howey-Forman factors: 1. contribution of money, 2. common enterprise, & 3. a reasonable expectation of profits to be derived from the entrepreneurial or management efforts of others. The court found that the creditors’ contribution to the debtor was a loan, not an expectation of profits, and overruled the Trustee’s objection to creditors’ proof of claim. It was this 3rd factor that turned in favor of the creditors. I’m glad I still have my thumb.
Idaho BK 