626 B.R. 171
Bankr. S.D.N.Y.2021Background
- Live Primary, LLC (Debtor) was formed with PM (Primary Member LLC) as a significant member; the Operating Agreements contemplated PM would provide a $6,000,000 "Loan" in tranches, each evidenced by a promissory note and repayable only upon an IPO or other "Liquidity Event."
- In practice Waterbridge Capital (an affiliate owned/controlled by PM’s principal Joel Schreiber) funded more than $6M to the Debtor; PM had no bank account and no promissory notes were ever issued. Parties treated PM and Waterbridge interchangeably in conduct and records.
- PM filed Proof of Claim No. 8 asserting $6,436,184 (Purported Loan ~$6.355M; Other Loans ~$81k). Debtor objected, seeking recharacterization of the Purported Loan as equity and disallowance of Other Loans. Noteholders joined the objection. Trial proceeded on stipulated evidentiary record.
- The Court applied the 11-factor AutoStyle recharacterization test (and Delaware contract principles where relevant) and found objective indicia pointed to equity rather than bona fide debt for the Purported Loan.
- Rulings: the Court recharacterized the Purported Loan (~$6.3549M) as equity; denied recharacterizing the Other Loans as equity but sustained objection under 11 U.S.C. §502(d) to the extent PM received an avoidable preference ($40,000 within 90 days of the petition) and reduced/disallowed that portion.
Issues
| Issue | Debtor's Argument | PM's Argument | Held |
|---|---|---|---|
| Whether PM has standing as a creditor to file POC | PM lacked enforceable right because Waterbridge (not PM) advanced funds and records list Waterbridge | Operating Agreements and parties' course of conduct made PM the intended creditor; Waterbridge acted on PM’s behalf | PM had standing; course of conduct and agreements treated Waterbridge advances as PM’s, so PM is relevant creditor |
| Whether PM’s proof of claim had prima facie validity | POC lacked required documentation (no promissory notes), so loses prima facie status | Operating Agreements and schedules plus claim exhibits suffice to support prima facie validity | PM met prima facie burden (schedules, disclosure statement, and exhibits supported claim) |
| Whether recharacterization requires an adversary proceeding under Rule 7001(7) | Debtor proceeded by claim objection; argued Rule 7001 might require adversary | PM argued adversary proceeding required for equitable relief | Adversary not required; recharacterization may be resolved in claim objection (contested matter) |
| Whether the $6.3549M Purported Loan should be recharacterized as equity | Applied AutoStyle factors: labels, no promissory notes, no maturity, de minimis interest, repayment only on IPO/Liquidity Event, inadequate capitalization, unsecured, used for startup/capital improvements => equity | PM relied on contract label, §9.2 loan language, and that parties contemplated loans; argued Delaware law/court should give effect to contractual designation | Court recharacterized Purported Loan as equity (majority of AutoStyle factors favor equity) |
| Whether the "Other Loans" (~$81k) were unauthorized and thus disallowable | Other Loans were made by Waterbridge (not PM) and lacked required unanimous written approval under Operating Agreement | PM/Waterbridge argued approval was granted or waived by emails and conduct; PM is the proper creditor | Court held Other Loans were not unauthorized (approval satisfied or waived); PM may enforce them as creditor |
| Whether Other Loans should be disallowed under §502(d) as avoidable preferences | Payments to PM/affiliate within 90 days are avoidable preferences and require disallowance until turnover | PM did not repay avoidable transfer(s) | Court sustained §502(d) objection as to $40,000 paid within 90-day lookback and disallowed that portion of the claim until turnover |
Key Cases Cited
- Bayer Corp. v. MascoTech, Inc. (In re AutoStyle Plastics, Inc.), 269 F.3d 726 (6th Cir. 2001) (articulates the 11-factor recharacterization test)
- Adelphia Commc’ns Corp. v. Bank of Am. (In re Adelphia Commc’ns Corp.), 365 B.R. 24 (Bankr. S.D.N.Y.) (recharacterization paradigm where insiders control both sides of transaction)
- Weisfelner v. Blavatnik (In re Lyondell Chem. Co.), 544 B.R. 75 (Bankr. S.D.N.Y.) (look beyond labels; intent and AutoStyle factors govern recharacterization)
- Sender v. The Bronze Group, Ltd. (In re Hedged-Investments Assocs., Inc.), 380 F.3d 1292 (10th Cir. 2004) (labels cannot defeat true economic substance)
- SubMicron Sys. Corp. (In re SubMicron Sys. Corp.), 432 F.3d 448 (3d Cir. 2006) (similar multi-factor approach to characterize transactions)
- Pepper v. Litton, 308 U.S. 295 (1939) (bankruptcy courts may look beyond form to substance for priority of creditors)