Loans and Investments: Which Are You Making?

If you are in the business of lending or you are letting someone borrow money, you know there is always the chance that you don’t get paid back. But while this is an inherent risk in lending, the last thing you want to have happen is to not get paid back because of a mistake that you made.

Which Is It?

One common mistake in lending agreements is the failure to specify whether money being given is a loan, or an investment.

You would be surprised how many times people talk and discuss money, and they have what they think is an understanding of whether money is a loan or an investment, but later, when the agreement needs to be enforced, they then look at their agreement and find that it isn’t so clear.

Certainly, there are times when this is obvious. Certain kinds of loans have nothing to do with investing. But in other cases, it may not be so clear, and the wording of the loan agreement can create more confusion or ambiguity.

Why it Matters

The difference is a crucial one: generally, investors don’t have to be paid, if the business legitimately falters, or if there is no money to pay the investment back, whereas, a loan needs to be paid back no matter what.

Many people purposely play fast and loose with the rules, and confuse the two: for example, they may want the money to seem like an investment to try to avoid interest and usury rules, but also, they want the money to be a loan, to ensure that they get paid back. The result is a loan document and is ambiguous and confusing.

When There is Confusion

To see if a contract is a loan or an investment, courts will look beyond what you call the document. Rather, courts will look at what the context of the document says, and whether there are the typical hallmark signs of a loan.

For example, if the document calls for regular payments, interest or late penalties, end payment dates, acceleration, or default terms, these are elements that are common in loan contracts, and thus, courts will construe it as a loan regardless of whether the word “investment” is in the agreement.

Loans typically have regularly owed, consistent repayments, whereas investments don’t; they will be sporadic and not paid on a regular basis.

Loan repayments will be stated: whatever the contract says they are, is what they are. Investment repayments will usually need calculation: for example, calculating what the profit of the business is, or what percentage of the profits get repaid to the investor.

 Unenforceability Problems

Investments that courts see as loans can end up unenforceable because of usury; many of the repayment terms on an investment would be usurious, if they are considered interest on a principal balance.

Trying to collect on a loan or are you owed investment money? Call our Fort Lauderdale business lawyers at Sweeney Law P.A. at 954-440-3993 today.

Sources:

economics.stackexchange.com/questions/18531/what-is-the-difference-between-a-loan-and-an-investment

nationalfunding.com/blog/investor-vs-loan-which-is-smarter-for-your-business/