Thursday, July 1, 2021


             10 years ago Lisa Skye Hain was a Manager at WeWork in NYC, where she met Joel Schreiber, one of the original investors in WeWork. Joel was also the founder of Waterbridge Capital, a real estate investment firm in NYC.

            Lisa decided to start her own shared office space – Live Primary, LLC – in 2015, and Joel agreed to invest $6 million in exchange for a 40% membership interest. Lisa received 30%, and another member received the final 30% interest.

            Joel produced an Operating Agreement for the LLC that described his contribution as a loan, instead of equity. Joel then caused Primary Member LLC to be formed as the vehicle for the Live Primary project.

            Lisa received a salary from Live Primary. Primary Member did not, nor did the other 30% investor. Primary Member had no day-to-day involvement in business matters but retained consent rights related to major decisions.

            Lisa and Joel later formed Primary, LLC. The Operating Agreement for Primary, LLC, stated that Primary Member would make several loans to the entity totaling $6 million, to establish two shared office facilities and fund start-up expenses. Each loan was intended to be formalized with a Loan Agreement and Promissory Note; each of the loans accrued interest at 1% per year; accrued interest and the principal balance were payable only upon a “Liquidity Event.”

            All loans were required to be repaid before distributions to any other members.

            The Operating Agreement provided that the LLC Managers would deliver disbursement requests to Primary Member. If Primary Member failed to fund the request, then Primary Member became obligated to pay a 5% default fee and the LLC could recover portions of Primary Member’s ownership interest in the LLC, diluting Primary Member’s ownership accordingly.

            Although it was Primary Member’s obligation to fund disbursement requests, it never did so. Apparently Primary Member never opened a bank account. Instead, all advances came from Waterbridge Capital, the real estate investment company founded by Joel, even though Waterbridge was legally a stranger to the Live Primary transaction.

            More than 60 disbursements were made through Waterbridge in a three-year period, without issuance of any Promissory Notes or Loan Agreements. Then additional fundings occurred from June 2018 to July 2020, based on emails from Lisa to Joel.

            Live Primary, LLC, filed a bankruptcy petition and Primary Member filed a Proof of Claim stating that it was a lender-creditor and had loaned the debtor $6.4+ million. Live Primary challenged Primary Member’s lender-creditor position and requested that Primary Member’s interest be reconstituted as an equity investment in the start-up company.

            As background, in bankruptcy law creditors of the debtor may have a right to receive payment based on Proof of Claim forms tendered to the court. And bankruptcy courts can use equitable powers to review contested matters – evidently these are different from adversary proceedings – and potentially recharacterize a loan as an equity interest.

            Basically, recharacterization cases turn on whether a debt actually exists. If not, then the claim might be reconstituted as an equity investment.

            Lenders, particularly secured creditors, are entitled to priority treatment in the context of bankruptcy distributions. Equity investors are not. No lender desires to be reconstituted as an investor, and consequently surrender their priority status when distributions are made.

            In analyzing a determination of loan vs. equity, bankruptcy courts examine facts such as: (a) did the same persons or entities control both the transferor and transferee; (b) were funds paid to an enterprise with little or no expectation that they would be repaid; and (c) is an individual or entity merely attempting to thwart the company’s legitimate outside creditors.

            True loans, says this court: (d) are named as such; (e) have fixed maturity dates and payment schedules; (f) provide for a source of repayment; (g) can be secured but it is not a strict requirement; and (h) might involve reserve accounts and sinking funds to provide a source of repayment.

            The ultimate test is to ascertain the intent of the parties. Claims of creditors who were corporate insiders are closely scrutinized.

            Finding a failure to issue promissory notes and loan agreements, the absence of a fixed, realistic date for repayment, the minimal 1% per year interest rate, the lack of any security or requirement that Live Primary fund a reserve account to secure repayment, and the use of the funds for initial operating expenses “. . . all reveal the economic reality that the [purported loan] functioned as equity.”

            Consequently, Primary Member’s funding was recharacterized as equity. See In Re Live Primary, LLC; Case No. 20-11612 (MG), United States Bankruptcy Court, S.D. New York, March 21, 2021:,44.             

            Lessons / Questions / Observations:

  1. Lesson: What do you think this means to Joel Schreiber – did he lose his investment due to the recharacterization of his funding?
  1. Observation: I am not a bankruptcy lawyer, but some of this was a surprise to me. It seems logical that a bankruptcy court has the equitable power to make this decision to prevent people from gaming the system, but I would have guessed that the initial characterization of the funding as a “loan” would carry more weight.
  1. Questions: Do you have investors who insist on making loans to avoid being recharacterized as equity? A close read of this case will grant those investors the safe harbors they need to avoid having their contributions be challenged and possibly reconstituted years later by a bankruptcy court.

                                                                                    Stuart A. Lautin, Esq.*


* Board Certified, Commercial (1989) and Residential (1988) Real Estate Law, Texas Board of Legal Specialization

Licensed in the States of Texas and New York


Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.


No comments:

Post a Comment