Establishing an intercompany loan without a formal contract?

Re Organic Garage, 2025 ONSC 2476
Can a proof of claim be allowed without a formal contract?

Summary: In this case, the Court considered whether a $6.76 million unsecured intercompany claim by a parent company against its subsidiary should be admitted in bankruptcy despite lacking formal loan documentation. The claim, which included current liabilities, long-term liabilities, and a note payable, was disallowed by the trustee. On appeal to the Court, the standard set out in Mamczasz Electrical Ltd. v. South Beach Homes Ltd., 2010 SKQB 182 was applied and elaborated upon in the context of a closely-held corporation. Specifically, in deciding the validity of a claim, certainty is not the test. If the method used in calculating the amount of the claim is reasonable and the evidence in support of the claim is relevant and probative, the claim should be admitted. The creditor bears the onus of establishing its claim—by providing vouchers, statements of account or other evidence sufficient to substantiate it. The presence or absence of loan documents, rates of interest, maturity dates or other conventional documentation criteria would be evidence for the Trustee at first instance in determining whether to admit or disallow the claim by determining whether the transaction is a loan or an equity advance, but such documentation is not determinative, in and of itself, in the circumstances of a closely-held corporation. Here, the Court ruled that the "current liability component" met the standard and should be admitted, but denied the "long-term liability" and "note payable" components due to insufficient probative evidence, lack of documentation, and ambiguity regarding repayment terms.

KPMG, in its capacity as trustee in bankruptcy (the “Trustee”) of the wholly-owned subsidiary, Organic Garage (Canada), disallowed the Proof of Claim filed by Zeifman Partners Inc., as trustee in bankruptcy of the parent company creditor, Oragin Foods Inc. (“Oragin”). The unsecured claim, totaling $6,760,280.89, was based on alleged intercompany loans and a note payable, and was comprised of three components: (i) the “current liability component”; (ii) the “long term liability component”; and (iii) the “note payable component”.

The documentation appended to the proof of claim as support for the claim amount consisted of tax returns for Organic Garage and Oragin and excerpts of the general ledger for Oragin. At the request of the Trustee, Zeifman provided additional documentation, namely, the balance sheet for Organic Garage, and audited financial statements for Oragin.

In disallowing the claim, the Trustee determined that there was insufficient evidence to support the existence of the debts and suggested that the transactions resembled equity contributions rather than loans. Among other factors for disallowing the claim, the Trustee found:

1. There were no loan documents evidencing the alleged loans;

2. There was no agreed means by which Organic Garage was to repay the alleged loans;

3. There was no evidence of regular repayments made towards the alleged loans, reflective of an agreed means of repayment;

4. There was no fixed maturity date or payment schedule associated with the alleged loans; and

5. There was no fixed rate of interest or interest payments associated with the alleged loans.

Oragin, by its trustee in bankruptcy, Zeifman, requested an Order setting aside the disallowance of the proof of claim. Zeifman argued that the proof of claim was supported by the books and records of both Oragin and Organic Garage, which consistently treated the amounts as loans.

Both the Trustee and Zeifman agreed that the Zeifman characterization of the standard for the sufficiency of a proof of claim and supporting documentation was correct, as articulated in Mamczasz Electrical Ltd. v. South Beach Homes Ltd., 2010 SKQB 182 (“Mamczasz”). Specifically, in deciding the validity of a claim, certainty is not the test. If the method used in calculating the amount of the claim is reasonable and the evidence in support of the claim is relevant and probative, the claim should be admitted. The creditor bears the onus of establishing its claim—by providing vouchers, statements of account or other evidence sufficient to substantiate it. If a creditor adduces relevant and probative evidence from which a valid claim can be reasonably inferred, the test has been met and the claim is provable. In the face of that, particularly where a trustee has suspicions, the obligation shifts to the trustee to investigate further. Disallowing a claim based on a hunch or suspicion is not enough.

The Court considered whether Zeifman had established that each of the three components of the Oragin Claim represented a debt obligation owing by Organic Garage to Oragin, rather than an equity contribution. The task was to determine whether a given transaction in substance constituted a contribution to capital notwithstanding the expressed intentions of the parties that the transaction be treated as a loan. The determination of whether a particular claim is to be treated as debt or equity must address not just the expressed intentions of the parties as reflected in the transaction documentation but also the manner in which the transaction was implemented and the economic reality of the surrounding circumstances.

Zeifman asserted that the Trustee had committed a legal error in making the legal determination as to whether the intercorporate transactions between Organic Garage and Oragin were not debt but equity. However, the Trustee was not under an obligation to prove that the transactions in question were in fact debt, or were instead an “equity contribution”. The proper question was whether Zeifman met the Mamczasz standard of evidence, such that in the case of each of the three components of the Oragin Proof of Claim, Oragin had the expectation of repayment with interest of the amounts allegedly owing under each of these components.

The presence or absence of loan documents, rates of interest, maturity dates or other conventional documentation criteria would be evidence for the Trustee at first instance in determining whether to admit or disallow the claim by determining whether the transaction is a loan or an equity advance, but such documentation is not determinative, in and of itself, in the circumstances of a closely-held corporation.

With respect to the “current liability component”, the Court found that Zeifman met the Mamczasz standard and had proven that the Trustee’s disallowance was an error of mixed fact and law amounting to a palpable and overriding error of applying the facts to a legal standard. The Court, therefore, allowed the appeal and concluded that the “current liability component” would be admitted as a proven unsecured claim by Oragin in the bankruptcy estate of Organic Garage.

By comparison, the “long term liability component” was far less well documented. The quantum of this component of the claim, which appeared to vary by value in the various statements, consisted of the proceeds of various equity capital raises that were made by Oragin and its predecessors and the proceeds advanced to Organic Garage to deposit in its bank account as the operating company to build out stores but also to use in operations, but also to make payments on behalf of the bank-account-free parent Oragin for its expenses. On the totality of the evidence, the Court concluded that Zeifman had not met the Mamczasz standard of proof, and denied Zeifman’s appeal.

Finally, the “note component” was undocumented as to the existence of an actual “Note” document evidencing this transaction. No “Note” evidencing the “Note Payable” was produced by either the Trustee or Zeifman that actually substantiated the terms of this “loan”, interest payable or the terms of repayment. There was no probative evidence that such a “note” ever actually existed, or if it did whether it was still legally enforceable. On the totality of the evidence, the Court concluded that Zeifman had not met the Mamczasz standard of proof, and denied Zeifman’s appeal.

Judge: Associate Justice Ilchenko, Registrar in Bankruptcy

Professionals involved:

• Miranda Spence and Adrienne Ho of Aird & Berlis for KPMG as bankruptcy trustee of Organic Garage (Canada) Inc.

• Colby Linthwaite of Fred Tayar & Associates for Zeifman Partners as bankruptcy trustee of Oragin Foods Inc.

• Eric Peterson of the Department of Justice, Counsel to the OSB