When is a loan document not evidence of a loan, but rather of an equity investment?
In their article, “9th Circ. Favors Substance Over Form In Fitness Holdings,” Thompson & Knight Partner Ira L. Herman and Associate Evelyn Breithaupt discuss the nuances of the Ninth Circuit decision in In re Fitness Holdings International Inc. (2013 U.S. App. LEXIS 8729). This ruling and similar decisions permit the recharacterization of an obligation labeled as debt, as equity.
This decision is an important reminder that although parties may structure a transaction to look like a loan, courts have the inherent authority to determine what the transaction really is and are not bound by what it is called. The decision warns that payments made on account of a recharacterized loan may constitute a distribution on account of an equity interest, subject to “clawback” as a fraudulent transfer.