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Treatment of Claims in Insolvency Proceedings - Debt vs. Equity

If monies are advanced to a company by its shareholders, is such advance debt or equity? This can be an important question in insolvency matters. If the monies are debt and secured by a registered security agreement, then the shareholder will be entitled to payment ahead of the ordinary, unsecured creditors of the company. On the other hand, if the monies are equity, then the shareholder's right to repayment of them will be postponed behind the rights of all of the company's creditors, both secured and unsecured.

In Tudor Sales Ltd., (Re), 2017 BCSC 119, an unsecured creditor applied for an order that the claim of the shareholder be subordinated to the claims of the other creditors; the shareholder applied for an order that the funds held by the trustee in bankruptcy were loans to be repaid to him ahead of other creditors by virtue of his priority as a secured creditor.

Saunders J. held that the monies advanced were on account of equity in the company, not debt, basing his findings on the fact that shares were issued to the shareholder at around the time that the two advances were made by the shareholder to the company, which implied that the advances were equity contributions and not loans. The court also pointed to the fact that there was no schedule for repayment of the advances, no certain formula to determine the interest amount, and that payments were discretionary based on the advice of accountants, and varied with the company's profitability. The court found that all of these circumstances were hallmarks of ownership and not debt. The court also held that, even if the advances could be characterized as debt and not capital contribution, the shareholder's claim must still fail because of section 139 of the BIA, which postpones loans for which the return varies with the profits of the company.

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