Are those funds you put into the company a loan or capital contribution? One would think such a question would be easy to answer. However, the case of Ghassemvand v. Premium Weatherstripping Inc., 2017 BCCA 309, demonstrated that in circumstances where the original documentation is not clear, that question can become difficult and expensive to determine.

The appellant/plaintiff was a shareholder and employee in the respondent company. A shareholders’ agreement was executed by all shareholders which was not a model of clear drafting and included terms that were cut and pasted from the internet. One of the key terms related to "capital call" contributions and provided as follows:

The company raises funds only by way of issuing shares and selling them to the shareholders. The shareholders will not be required to make loans to the company.

Shareholders are required to contribute cash (cash call) to provide sufficient funding to the corporation in proportion to their shares when the board of directors makes a cash call.

Over the years, the plaintiff contributed $180,000 to the company.

On the advice of the company’s accountant, all funds provided by shareholders were treated as loans to the company. However, after the accountant saw the shareholders’ agreement (which occurred after litigation had been commenced), he re-classified the funds as capital contributions on the basis that the agreement appeared to preclude shareholder loans.

The plaintiff was subsequently terminated from his employment. The plaintiff sued for the return of $180,000 from the company on the basis that those funds were loans.

Trial Decision

At trial, the judge held the funds were capital contributions and relied significantly on the accountant’s re-classification of those funds as investments and the fact that the shareholder’s agreement appeared to preclude a requirement for shareholders to loan the company money. The plaintiff appealed.

Appeal

A majority of the Court of Appeal concluded that the trial judge erred on the basis that he had not considered “all the surrounding circumstances” in the manner in which the funds were advanced to the company. Importantly, the majority found that judge erred when he concluded that a loan must be supported by a shareholder’s agreement and in his reliance on the accountant’s re-designation.

The characterization of whether funds are provided by way of loan or investment is primarily a question of fact. The “substance of the transaction” has to be examined and all of the surrounding circumstances – not only the words used in documenting the transaction – should be considered. If monies are initially advanced as a capital contribution, and it is later decided that such funds should have been advanced as a loan, the initial transaction must be undone and a new transaction entered into. You cannot simply re-characterize it.

The majority could not determine the true character of the funds and sent that back to trial for determination.