Opinion ID: 2807852
Heading Depth: 3
Heading Rank: 1

Heading: Is there an appearance of debt?

Text: a. Factor 1: The names given to the certificates evidencing the indebtedness I agree with the majority that this factor weighs in favor of a finding of debt. The names of the instruments evincing debt (promissory notes) “are plainly instruments of indebtedness.” Maj. Op. at 18. I also agree that this remains so despite the parties not completing all portions of the preprinted promissory-note forms. Id. Moreover, contrary to the Bankruptcy Appellate Panel, I agree with the majority that the notes are not rendered invalid merely because they “roughly reflect” the advances that Mr. Jenkins made. Maj. Op. at 19. I disagree with the bankruptcy court’s view that, because AFI had no realistic ability to pay the debt on the first three notes, this factor only superficially favors loans and not equity. The name “promissory notes” suggests indebtedness. This factor does not set an onerous standard, and Mr. Jenkins meets it. b. Factor 2: The presence or absence of a fixed maturity date I agree with the majority that the notes set a fixed maturity date, see Maj. Op. at 22, but for a slightly different reason. I believe that the notes require payment no later than five years after their execution. That the payment might become fully due “upon reclamation bond release” or, with the fourth note, also “upon . . . proceeds from 4 lawsuit,” contemplates possible payment before five years have passed from execution of the notes. Supporting this view that the two contingencies did not indeterminately extend the due date past five years, I read the contingencies as being consistent with the fourth note’s direction that the “[p]rincipal balance plus accrued interest shall be due and payable on or before five (5) years from the date shown above. . . .” Appellants’ App., vol. VI, at 1151 (emphasis added). c. Factor 4: The right to enforce payment of principal and interest I agree with the majority that Mr. Jenkins had a right to enforce payment on his notes regardless of whether AFI had any assets. In my view, as in the majority’s, it is unimportant under this factor that Mr. Jenkins did not exercise his contractual right to enforce payment when it became due. Maj. Op. at 22. I agree with the majority that “[t]he fact that he did not exercise this contractual right does not render it meaningless.” Id. In my view, the bankruptcy court confuses Mr. Jenkins’s “right” to enforce payment with his “ability” to do so. Because the factor does not ask about the debtor’s ability to pay, the bankruptcy court erred by discounting this factor because in its view the “right was illusory.” In re Alternate Fuels I, 2012 WL 6110429, at . 2. Is there a reality of debt based on the conduct, knowledge, and intent of the parties?
The majority does not discuss this factor. The bankruptcy court does though, concluding that it “strongly indicates a capital infusion.” Id. at . “The question is whether the lender has any reasonable expectation of payment if the business fails.” In re 5 Lexington Oil & Gas Ltd., Co., 423 B.R. 353, 366 (Bankr. E.D. Okla. 2010). In evaluating this question, the bankruptcy court found that AFI “had no business other than the completion of reclamation,” which reclamation “would not generate revenue for AFI, but it would result in the release of the Certificates of Deposit which were assigned to the Jenkinses and were looked to by the parties as the source of payment of the Notes.” In re Alternate Fuels I, 2012 WL 6110429, at . When we eliminate the certificates of deposit as a source of repayment of the three loans because they already belonged to Mr. Jenkins, no source of repayment remained. In that setting, I agree with the bankruptcy court that this factor favors a finding of investment equity and not loans. b. Factor 5: Participation in management flowing as a result Because Mr. Jenkins did not increase his participation in management because of the asserted debt AFI owed on the promissory notes, the majority contends that this factor favors Mr. Jenkins and a finding of loans. I am unpersuaded. We must remember that Mr. Jenkins owned one-hundred percent of AFI and could manage it as he pleased. I cannot see how his inability to manage it beyond one-hundred percent favors either side’s argument. In that situation, I say this factor is neutral and favors neither side. c. Factor 6: The status of the contribution in relation to regular corporate creditors The majority ignores this factor, and the bankruptcy court deemed it irrelevant. See id. at . I do not weigh it in favor of either party. 6 d. Factor 7: The intent of the parties Although not directly saying so, the bankruptcy court appears to have weighed this factor in favor of investment equity and not loans. It found that “Jenkins never intended the loans to be paid by AFI.” Id. at . This sounds like a finding of fact subject to the clear error standard. See In re Blinder, Robinson & Co., Inc., 124 F.3d 1238, 1241 (10th Cir. 1997). And because AFI lacked any prospect of ever obtaining any assets when the first three notes were signed, I disagree with the majority that the bankruptcy court erred in its finding. See Maj. Op. at 23–24. Indeed, the bankruptcy court bolstered its finding by quoting Jenkins’s own stipulation that the “real purpose of the [three Notes] . . . was to secure Jenkins[’s] investments in AFI and Cimarron.” In re Alternate Fuels I, 2012 WL 6110429, at . I gather that the bankruptcy court reads this as saying that Jenkins’s three notes served solely to doubly-ensure that his personally-owned certificates of deposit were safe from AFI’s many creditors. That reading is also consistent with Mr. Pommier’s testimony that, “if Mr. Jenkins received the proceeds of the release of the certificates of deposit upon the completion of reclamation, AFI would owe no money on the note.” Maj. Op. at 5 (citing Appellant’s App., vol. IV, at 697). But here the majority takes a different view, saying that “the evidence indicates that [Jenkins] intended the notes to be satisfied pursuant to their second clause: ‘upon reclamation bond release by the State of Missouri.’” Maj. Op. at 24. If the majority is suggesting that the notes were to be repaid from the $1.4 million of certificates of deposit, it fails to explain why Mr. Jenkins would repay himself from his personally 7 owned certificates of deposit. And if the majority indeed reads this promissory-note language as requiring repayment from the certificates of deposit, the bankruptcy court on remand should first apply the $1.4 million against Mr. Jenkins’s proof of claim before looking to AFI’s other assets.2 The fourth note incorporates and cumulates the principal and interest owed on the first three notes. But any debt owed on the first three notes was old debt. While the bankruptcy court and majority agree that consideration (the promise to provide further funds to reclaim the coal property) supported the fourth note, I believe that consideration would support only a loan for newly lent money, not for money already lent and spent. Before I could agree that Mr. Jenkins can so easily cut ahead of AFI’s other creditors, I would need to see some legal justification allowing it. Absent that, I believe the intent of the parties favors a finding that the loans in reality were equity investment. e. Factor 8: “Thin” or inadequate capitalization The majority finds “no support” for the bankruptcy court’s conclusion that this factor favored recharacterization. Maj. Op. at 21. Instead, the majority suggests that the bankruptcy court placed too heavy an emphasis on undercapitalization in using this factor to favor recharacterization. See Maj. Op. at 23. No one disputes that AFI was inadequately capitalized to engage in coal mining. Its lack of capital or any other assets certainly made any repayment unrealistic. I agree with the majority that heavily 2 Mr. Jenkins sought outside lending to fund the reclamation, but no outside lenders were willing to lend money. Had an outside lender been found, it would have made sense that its promissory note would have included the certificates of deposit as collateral. Whether the promissory notes here are a vestige of that earlier lending attempt is unknown from the record. 8 emphasizing “undercapitalization in our recharacterization analysis would create an ‘unhealthy deterrent effect,’ causing business owners to fear that, should their ‘rescue efforts’ fail, a court will ‘give disproportionate weight to the poor capital condition of their failing companies and thus too quickly refuse to treat their cash infusions as loans.’” Maj. Op. at 23 (quoting In re Hedged-Investments, 380 F.3d at 1298 n.1). But that concern simply does not apply here. In a case like the majority describes, I would wholeheartedly agree to discount this factor. In a case like this one, however, where Mr. Jenkins was in no way seeking to “rescue” AFI, it is wrong to underemphasize this factor for him because it might weigh too heavily against others unlike him. I agree with the bankruptcy court that this factor favors a finding of investment equity and not debt. f. Factor 9: Identity of interest between the creditor and stockholder The majority again finds “no support” for the bankruptcy court’s reliance on this factor to support investment equity instead of loans. Maj. Op. at 21. While agreeing that “this factor may indicate a capital contribution when two or more shareholders own debt in the same proportion as their underlying equity interests,” the majority declares that “the same reasoning does not automatically apply when a single shareholder owns the entirety of a company’s stock.” Id. Because Mr. Jenkins owns 100% of AFI and provided all funds to it, I agree with the bankruptcy court that “[a]n equity contribution is indicated.” In re Alternate Fuels I, 2012 WL 6110429, at . g. Factor 10: Source of interest payments The majority is silent on this factor, and the bankruptcy court deemed it irrelevant because AFI paid no interest payments. Id. at . I believe it favors neither party. 9 h. Factor 12: The extent to which the advance was used to acquire capital assets The bankruptcy court says that this factor superficially weighs in favor of a loan because Mr. Jenkins’s money was used to fund operating expenses and not to acquire capital assets. Id. at . It gives this factor “reduced significance” because AFI in reclamation-mode had only operating expenses and did not acquire capital assets. Id. Even so, the factor itself does not delve into the reasons a business expends funds one way or the other—it simply asks how they were spent. Because the funds here were spent on operating expenses, I agree with the majority that this factor weighs in favor of debt, although not nearly so much as in an ordinary ongoing-business situation. Finally, this brings us to two factors the majority concedes support the bankruptcy court’s view that the Jenkins loans were equity investment and not loans. i. Factor 11: The ability of the corporation to obtain loans from outside lending institutions The majority notes that Mr. Jenkins tried and failed to obtain loans from outside lending institutions on behalf of AFI. Maj. Op. at 23. It further observes that “[w]hen there is no evidence of other outside financing, the fact that no reasonable creditor would have acted in the same manner is strong evidence that the advances were capital contributions rather than loans.” Maj. Op. at 24 (quoting In re AutoStyle Plastics, Inc., 269 F.3d 726, 752 (6th Cir. 2001)). In view of AFI’s financial condition, Mr. Jenkins’s failure to find outside lenders was hardly a surprise. This factor supports the bankruptcy court’s decision recharacterizing Mr. Jenkins’s loans as investment equity. 10 j. Factor 13: The failure of the debtor to repay on the due date or to seek a postponement The majority agrees that this factor favors recharacterization because “AFI did not pay the notes by their five-year maturity dates and did not seek an extension.” Maj. Op. at 24. Again, it is not just the failure to pay that weighs in favor of investment equity and against loans. It is also why AFI did not pay. Quite simply, AFI had no ability to pay the debts when due, and Mr. Jenkins knew when he wrote the promissory notes that this would happen. Again, this factor supports the bankruptcy court’s decision to recharacterize the loans as investment equity. 3. Considering the 13 Factors as a Whole By my count, seven factors weigh in favor of recharacterization of the loans as investment equity, three factors in favor of treating the loans as debt, and three factors as neutral. Those factors favoring Mr. Jenkins largely concern the name and form of the promissory notes, and those against him concern the real-world backdrop behind the notes. Despite Mr. Jenkins’s promissory-note forms suggesting debt, little else does. Mr. Jenkins entirely owned AFI and had it sign promissory notes it could not pay or hope to pay. Unlike with arms-length promissory notes, the object was not repayment, but instead was to protect Mr. Jenkins’s 24 certificates of deposit from AFI’s creditors and later to elevate his claims under the notes to a secured status. On balance, under these circumstances, the Hedged-Investments factors support the bankruptcy court’s recharacterization of the loans as investment equity. 11 In concluding otherwise, the majority relies on a policy of encouraging (or at least not discouraging) hypothetical business owners—unlike Mr. Jenkins—who lend their businesses money to keep them running in hopes of future profits. In this regard, the majority urges caution on grounds that “[w]e have been careful not to ‘discourage owners from trying to salvage a business’ by requiring ‘all contributions to be made in the form of equity capital.’” Maj. Op. at 25 (quoting In re Mid-Town Produce Terminal, Inc., 599 F.2d 389, 392 (10th Cir. 1979)). Similarly, it notes that “[i]ndeed, owners may often be ‘the only party willing to make a loan to a struggling business,’ In re Dornier Aviation [(North America), Inc.], 453 F.3d [225,] 234 [(4th Cir. 2006)], and needlessly punishing their efforts is neither ‘desirable as social policy’ nor required by our precedent. In re Mid-Town Produce, 599 F.2d at 392.” Maj. Op. at 25. While those are sensible policies in those sorts of cases, this case does not fit that bill. Here, Mr. Jenkins was in no way lending to sustain or revive a struggling business. Giving him the benefit of policies assuming that he was doing so skews the HedgedInvestments analysis. Thus, I disagree with the majority that the “unique circumstances of this case” justify treating Mr. Jenkins’s money advances as loans under HedgedInvestments. Maj. Op. at 26. Instead, I believe that the actual circumstances here (Mr. Jenkins’s advancing AFI money not to mine coal but instead to reclaim coal lands so Mr. Jenkins could obtain release of his certificates of deposit) favor recharacterizing the loans as equity investment.3 3 I do not agree with the majority that any of my analysis would mean that we are “empowered to pick winners and losers based upon our view of the social utility of their 12