Upon incorporation of a company, a shareholder invested hundreds of thousands as a loan against allocation shares. The company refused to repay the loan, arguing that it is in losses.
The Court rejected the claim and held that the Court should adopt the holding at Autostyle Plastics, Inc. 269 F. 3d 726, 750-751 (6th Cir 2001), under which, in order to classify funds as a loan (to be repaid) or capital (although it is recorded as a shareholders loan it will be repaid in the same manner as dividends are paid, including the profit test and a requirement for a board of directors resolution). Thus, a series of material tests should be applied: the name given to the loan; The existence or absence of a due date and a repayment schedule; The existence or absence of an interest rate and interest payments; The source of repayment (whether repayment is conditional on the existence of profits); Whether the company's capital is sufficient or is it highly leveraged; The identity between the lenders and the shareholders and the ratio between the amount of the loan and the share of the lenders in the share capital; The existence of a security for the loan; The ability of the Company to receive external financing; The extent to which loans are subject to external creditors' claims; The extent to which loans were used to purchase assets; and the existence or absence of funds set aside to ensure repayment of the loan. In this case most of the tests show that this is a capital investment and not a loan and the lender may not demand repayment.