Shareholder Loans: Are They Equity or Debt?

March 23, 2017

Tudor Sales Ltd. (Re), 2017 BCSC 119 is a case from British Columbia that dealt with whether shareholder loans, as a non-arm’s length transaction, are properly characterized as debt, or as equity. The Court explained that the critical determination between debt and equity requires an examination of the circumstances surrounding the economic reality of the transactions and not the superficial appearance arising from the loan documentation. The Court considered the nature of the bankrupt’s liabilities and found that the loan was more consistent with equity than debt in that there was no schedule for repayment of advances, and no certain formula to determine the amount of interest.


Tudor Sales Ltd. (“Tudor”) made an assignment in bankruptcy in November 2013. At that time, Tudor’s most recent financial statements recorded shareholder loans to Tavi Eggertson (“Mr. Eggertson”), a shareholder of Tudor and Tudor’s sole officer and director, in the amount of $1.36 million. The applicant, Cascade Steel Rolling Mills Inc. (“Cascade”), was an unsecured creditor of Tudor and sought an order under s. 135(5) of the Bankruptcy and Insolvency Act (“BIA”), that the proof of claim and proof of security of Mr. Eggertson should be expunged, reduced, or subordinated to the claims of other creditors on the basis that the loans are properly characterized as equity, and must be subordinated to the claims of Tudor’s creditors.


The Court considered that the purported loans were a non-arm’s-length transaction and looked to the description of the court’s role in characterizing, or re-characterizing, such payments, as set out by Justice Wilton-Siegel in U.S. Steel:

[167] Where . . . the parties are not at arm’s length, the issue is not what the parties say they intended regarding the substance of the transaction as a matter of contractual interpretation. The expressed intention of the parties is clear. However, given the absence of any arm’s length relationship, there can be no certainty that the language of the agreements reflects the underlying substantive reality of the transaction. Accordingly, the issue for a court is whether, as actually implemented, the substance of the transaction is, in fact, different from what the parties expressed it be in the transaction documentation.1

The Court found that the variable nature of the interest payments recorded in the financial statements strongly supported the characterization of the loans as equity, and not debt.  There was no schedule for repayment of the advances and there was no certain formula to determine the amount of interest. The Court found repayments were discretionary and varied with Tudor’s profitability. Tudor’s ability to make payments in this manner was inconsistent with the rights of a creditor and was a hallmark of an equity holder.

The close proximity between the advances made by Mr. Eggertson and his first acquisition of shareholder interest, followed by the increase in value of that interest, strongly implied that the advances were consideration paid for his ownership stake, in substance. Therefore, they were held to be equity contributions. In the alternative, if the transactions ought to have been characterized as debt, rather than equity, the Court found that Mr. Eggertson’s claim would fail by reason of s. 139 of the BIA and his claim would be postponed. As the advances were non-arm’s length, the alleged creditor bears the onus of proving the transactions were “proper” and Mr. Eggertson failed to meet his burden.

Key Takeaway

Tudor Sales Ltd., Re, shows that the superficial appearance of transactions arising out of loan documentation isn’t important. The critical determination concerns the manner in which the transaction or transactions were actually implemented in the circumstances of the surrounding economic reality.  The Court considered the nature of the bankrupt’s liability to the shareholder and determined it was more consistent with equity than debt in that there was no schedule for repayment of advances, and no certain formula to determine interest payable.

1    U.S. Steel Canada Inc., Re, 2016 ONSC 569.

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