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
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
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
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: https://scholar.google.com/scholar_case?case=11865234986206902320&q=in+re+live+primary+llc&hl=en&as_sdt=6,44.
Lessons / Questions
What do you think this means to Joel Schreiber – did he lose his investment
due to the recharacterization of his funding?
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
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.