Opinion ID: 2973623
Heading Depth: 3
Heading Rank: 1

Heading: Stockholder Advances to Indmar

Text: Indmar, a Tennessee corporation, is a marine engine manufacturer. In 1973, Richard Rowe, Sr., and Marty Hoffman owned equal shares of Indmar. In 1987, after Hoffman passed away, Richard and his wife, Donna Rowe, together owned 74.44% of Indmar, with their children and children’s spouses owning the rest. By all accounts, Indmar has been a successful company. From 1986 to 2000, Indmar’s sales and costs-of-goods sold increased from $5m and $3.9m to $45m and $37.7m, respectively. In addition, Indmar’s working capital (current assets minus current liabilities) increased from $471,386 to $3.8m. During this period, Indmar did not declare or pay formal dividends. Since the 1970s, Indmar’s stockholders have advanced funds to it, receiving a 10% annual return in exchange. Hoffman started the practice in the 1970s. Beginning in 1987, the Rowes (as well as their children) began to make advancements on a periodic basis. Indmar treated all of the advances as loans from stockholders in the corporate books and records, and made monthly payments calculated at 10% of the advanced funds. Indmar reported the payments as interest expense deductions on its federal income tax returns. Consistent with Indmar’s reporting, the Rowes reported the payments as interest income on their individual income tax returns. The parties did not initially document the advances with notes or other instruments. Beginning in 1993, the parties executed notes covering all of the advances at issue. Specifically, Indmar executed a promissory note in 1993 with Donna Rowe for $201,400 (i.e., her outstanding balance). The note was payable on demand and freely transferable, had no maturity date or monthly payment schedule, and had a fixed interest rate of 10%. In 1995, Indmar executed a similar promissory note with Richard Rowe for $605,681 (i.e., his outstanding balance). In 1998, when the outstanding transfers totaled $1,222,133, Indmar executed two line of credit agreements with the Rowes for $1m and $750,000. The line of credit agreements provided that the balances were payable on demand and the notes were freely transferable. In addition, the agreements provided a stated interest rate of 10% and had no maturity date or monthly payment schedule. None of the advances were secured. Repayments of the advances were paid on demand, based on the needs of the stockholders, and not subject to set or predetermined due dates. The record indicates that between 1987 and 2000, the total advance balances ranged from $634,000 to $1.7m, and Indmar made purported interest payments between $45,000 and $174,000 each year. The parties structured the advances as demand loans to give the Rowes flexibility as creditors. Moreover, as demand loans, the advances were treated by the Rowes as short-term debt under Tennessee law, thereby excepting interest payments from a 6% state tax on dividends and interest on long-term debts. Tenn. Code Ann. §§ 67-2-101(1)(B)(i), 67-2-102 (2005). Indmar, however, reported the advances as long-term liabilities on its financial statements to avoid violating loan agreements with First Tennessee Bank (“FTB”), its primary creditor, who required a minimum ratio of current assets to current liabilities. No. 05-1573 Indmar Prods. Co. v. Comm’r Page 3 In order to reconcile the treatment and execution of the advances as demand loans versus listing them as long-term debt in its financial reports, Indmar received waivers from the Rowes agreeing to forego repayment on the notes for at least 12 months. From 1989 to 2000, the notes to Indmar’s financial statements disclosed that “The stockholders have agreed not to demand payment within the next year,” and in 1992 and 1993, the Rowes signed written agreements stating that they would not demand repayment of the advances. Indmar did all of this under the direction of its accountant. Despite the annual waivers, the Rowes demanded and received numerous partial repayments of the advances. Specifically, in 1994 and 1995, Richard Rowe demanded repayment of $15,000 and $650,000, respectively, to pay his taxes and purchase a new home. He also demanded repayment of $84,948, $80,000, $25,000, and $70,221 from 1997-2000 to pay litigation expenses, boat repairs, and tax expenses. Donna Rowe demanded repayment of $180,000 in 1998 for boat repairs. The Rowes made additional advances in 1997 and 1998 of $500,000 and $300,000, respectively. The balance of notes payable to stockholders on December 31, 2000, totaled $1,166,912. As Indmar was a successful, profitable company, numerous banks sought to lend money to it. FTB worked hard to retain Indmar’s business, made funds immediately available upon request, and was willing to lend Indmar 100% of the stockholder advances. In its loan agreements with Indmar, FTB required the company to subordinate all transfers, including stockholder advances, to FTB’s loans. FTB did not strictly enforce the subordination provision, however, as Indmar repaid – with FTB’s knowledge – some of the stockholder advancements at the same time FTB loans remained outstanding. As an example, when Richard demanded repayment of $650,000 to purchase a new home, Indmar borrowed the entire amount from FTB at 7.5% (the prime lending rate was 8.75%). Indmar secured the loan with inventory, accounts and general intangibles, equipment, and the personal guarantee of the Rowes. Richard Moody, the FTB lending officer who worked with Indmar on the loan, testified that he knew Indmar used the proceeds to repay Richard. Indmar had loans outstanding with FTB at the time. As stipulated by the parties, the prime lending rate ranged from a low of 6% to a high of 10.5% between 1987-1998. In 1997, Indmar and FTB executed a promissory note for $1m that was modified in 1998. The interest rate on the note (7.85%) was below the prime lending rate. Indmar also had a collateralized line of credit with FTB. Similar to the stockholder advances, the bank line of credit was used for short-term working capital. FTB charged the following rates for the secured line of credit: 1995 – 9% 1996 – 8.75% 1997 – 9% 1998 – 8% 1999 – 8.75% 2000 – 9.5% (rates as of December 31st of each year).