Debt Recharacterization Is A Factual Issue and Cannot Be Resolved At Summary Judgment In the Face of Conflicting Evidence

Case:
Idaho Development, LLC v. Teton View Golf Estates, LLC, Docket No. 37123
Court:
Supreme Court of Idaho
Date Issued:   
December 12, 2011
Judges:
Opinion Author: W. Jones, Justice
Concurring in Opinion: Burdick, Chief Justice; Eismann, Justice; Horton, Justice
Specially Concurring: J. Jones, Justice
Issue:
Under what circumstances is it appropriate to grant summary judgment on the basis of recharacterizing a loan as a capital contribution?
Summary of Ruling:
Idaho Development, LLC (“Idaho Development”) advanced 1.1 million dollars to Teton View Golf Estates (“Teton View”), a joint venture in which Idaho Development had a 33.3% interest.  Idaho Development obtained a promissory note from Teton View that was secured by a deed of trust.  After Teton View failed to pay according to the terms of the note, Idaho Development filed a complaint to foreclose its deed of trust against all junior interests.

DePatco, Inc. (“DePatco”) recorded a lien on the property after Idaho Development recorded its deed of trust.  Ordinarily, therefore, Idaho Development’s interest would have priority over DePatco’s.  DePatco filed a motion for partial summary judgment to recharacterize Idaho Development’s advancement of $1,100,000 as a capital contribution and, alternatively, to equitably subordinate Idaho Development’s lien to its own.  The Supreme Court’s analysis of the equitable subordination issue is summarized here.

On the issue of debt recharacterization, the Supreme Court began its analysis with a history of debt recharacterization, noting that it “‘rests on the substance of the transaction giving rise to the claimants demand’ instead of the court’s ‘assessment of the creditor’s behavior,’” and that most courts do not require inequitable conduct in order to recharacterize debt.  In re Official Comm. Of Unsecured Creditors for Dornier Aviation, Inc., 453 F.3d 225, 232 (4th Cir. 2006). Additionally, the Ninth Circuit, in Bauer v. C.I.R., 748 F.2d 1365, 1367 (9th Cir. 1984), stated that the “real aim of the trial court is to make the determination whether an advance is debt or equity,” which depends on the distinction between a creditor who seeks a definite obligation and a shareholder who seeks to make an investment.  As such, the term “recharacterization” is, in fact, a misnomer as the court is actually making a determination of the debt classification for the first time—a characterization. Therefore, the question is one of fact and the “determinative inquiry in classifying advances as debt of equity is the intent of the parties as it existed at the time of the transaction.” In re SubMicron Sys. Corp., 432 F.3d 448, 457 (3d Cir. 2006).  Thus, summary judgment in the instant case would only be appropriate if all evidence in favor of Idaho Development could not create a reasonable inference that the amount was to be a loan rather than a capital contribution.

Turning to the evidence in the summary judgment record, the Court noted: “[E]very document pointed to by the parties, including the Joint Venture Agreement, the promissory note, and the deed of trust, call the advance a loan, or at the least an advance that is to be repaid.  The advance had a fixed monthly payment, and it had an original maturity date of ninety days.”  Noting that the party seeking to recharacterize the advance carries the burden of showing how much was intended to be a capital contribution, the Court held that there was a clear issue of material fact as to what portion of the advance was to be a loan and what portion was to be considered a capital contribution. As such, summary judgment was improper and the case was remanded for further consideration in accordance with the Supreme Court’s opinion.
Link to Opinion:
Teton
Link to Court:
http://www.isc.idaho.gov/
Attorneys of Record:
For Appellant:
Alan R. Harrison
For Respondent ZBS:
Holden, Kidwell, Hahn & Crapo
Karl R. Decker argued.
For Respondent DePatco, Inc.:
Fuller & Carr
Mark Fuller argued.
For Respondent Schiess & Associates:
Beard, St. Clair, Gaffney, P.A.
Summary Author:
Luke Howarth

This entry was posted in Debt Recharacterization, Hon. Warren E. Jones, IDAHO BUSINESS LAW TOPIC, Luke Howarth, OPINION AUTHOR, PROPERTY SECURITY, SUMMARY AUTHOR. Bookmark the permalink.

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