Investment or Loan?

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 the contributor expected, at the time of the contribution, to earn a share of the enterprise’s profits, then it was an investment; if there was an expectation 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.

As evident by Judge Pappas’ opinion filed yesterday in In re Gables Management, determining whether a contribution is a loan or an investment can require 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 contribution.  The Court overruled the Trustee’s objection to a proof of claim filed by three lenders of the debtor, Gables Management, finding that their contribution to the debtor was a loan, not an investment.  The Court followed the Howey-Forman test: 1. contribution of money, 2. common enterprise, & 3. a reasonable expectation of profits to be derived from the entrepreneurial or management efforts of others.  It was this 3rd factor that turned in favor of the debtors.  I’m glad I still have my thumb.

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