626 B.R. 171
Bankr. S.D.N.Y.2021Background
- Live Primary, LLC (the Debtor) and Primary Member LLC (PM) executed operating agreements under which PM agreed to fund a $6,000,000 “Loan” in tranches in exchange for membership units; each tranche was to be evidenced by a promissory note and repayment was payable only on an IPO or other defined "Liquidity Event."
- In practice, Schreiber’s entity Waterbridge Capital advanced funds (over $6M) to the Debtor on PM’s behalf; no promissory notes or separate loan agreements were executed and PM never maintained a bank account.
- PM filed Proof of Claim No. 8 asserting $6,436,184 (the Purported Loan of $6,354,900 plus $81,284 in “Other Loans”); the Debtor objected seeking recharacterization of the Purported Loan as equity and disallowance of the Other Loans.
- The parties submitted declarations, depositions and exhibits and agreed the trial would proceed on counsel arguments only; the court considered AutoStyle’s multi-factor test for recharacterization.
- The court recharacterized the $6,354,900 Purported Loan as equity; it denied recharacterization of the $81,284 Other Loans but sustained objection as to those Other Loans to the extent PM received an avoidable preference of $40,000 within 90 days of the petition (disallowing that portion under §502(d)).
Issues
| Issue | Plaintiff's Argument (Debtor) | Defendant's Argument (PM) | Held |
|---|---|---|---|
| Standing / real party in interest to file POC | PM lacks standing because Waterbridge actually funded and was listed in Debtor’s books; PM is a shell | PM is the intended creditor per the Operating Agreements and course of conduct treated Waterbridge as PM’s funding vehicle | PM had standing; court treated PM (not Waterbridge) as the relevant creditor based on the parties’ course of conduct |
| Prima facie validity / documentary requirements (Fed. R. Bankr. P. 3001) | POC lacks required promissory notes and supporting documents and thus loses prima facie effect | Operating Agreements, Amended Schedules and claim exhibits suffice to establish prima facie validity | PM met its prima facie burden; POC entitled to prima facie validity |
| Procedural vehicle: adversary proceeding required? (Bankr. R. 7001(7)) | Recharacterization is equitable relief that must be sought via adversary proceeding | Recharacterization may be litigated in a contested-claim objection under Rule 3007/9014 | Adversary proceeding not required; objection to claim (contested matter) was appropriate |
| Recharacterization and Other Loans (AutoStyle factors / §502(d)) | Purported Loan is really equity under AutoStyle (no notes, no fixed maturity, de minimis interest, repayment only on liquidity event, subordination, startup capitalization, funds used for capital/operations); Other Loans unauthorized and/or preference | PM says documentation and labels show bona fide debt; Delaware contract terms control; Other Loans were authorized or waived | Court applied AutoStyle and recharacterized the $6,354,900 Purported Loan as equity. The Other Loans were not invalid for lack of approval but $40,000 transferred within 90 days is an avoidable preference and disallowed under §502(d). |
Key Cases Cited
- Bayer Corp. v. MascoTech, Inc. (In re AutoStyle Plastics, Inc.), 269 F.3d 726 (6th Cir. 2001) (articulated the eleven-factor test for recharacterizing debt as equity)
- In re Lyondell Chem. Co., 544 B.R. 75 (Bankr. S.D.N.Y. 2016) (discussed intent and application of AutoStyle factors in recharacterization analysis)
- Sender v. The Bronze Group, Ltd. (In re Hedged-Investments Assocs., Inc.), 380 F.3d 1292 (10th Cir. 2004) (explained limits on honoring a party’s label when substance indicates equity)
- In re SubMicron Sys. Corp., 432 F.3d 448 (3d Cir. 2006) (endorsed a factors-based approach to determine creditor vs. equity characterization)
- Pepper v. Litton, 308 U.S. 295 (1939) (bankruptcy courts may look beyond form to substance under equitable powers)
- In re Adelphia Commc’ns Corp., 365 B.R. 24 (Bankr. S.D.N.Y. 2007) (illustrative recharacterization precedent applying multifactor analysis)
- Roth Steel Tube Co. v. Comm’r, 800 F.2d 625 (6th Cir. 1986) (absence of formal indebtedness instruments supports characterization as equity)