Billionaire Frank Stronach must face allegations he used bogus loans to try to prevent his favorite horse-racing tracks from being sold to repay bondholders of Magna Entertainment Corp., a judge ruled.

U.S. Bankruptcy Judge Mary Walrath today denied Magna’s request to dismiss a lawsuit filed by junior creditors. Those creditors, who include bondholders, say they won’t collect any money owed to them unless a court throws out about $375 million in loans that Stronach-affiliated companies made to Magna.

“Their ultimate desire was to keep the key assets,” creditor attorney Timothy Harness told Walrath today during a hearing in Wilmington, Delaware.

Magna, based in Aurora, Ontario, sought court protection on March 5, listing assets of more than $1 billion and debt of $958.6 million as of Dec. 31.

The creditors contend that Stronach loaded Magna with secured loans to keep the company afloat temporarily. In 2004, Magna owed MI Developments $23.4 million and had assets to cover the debt. At the time of the bankruptcy, that debt was more than $371 million and senior to the debt owed to unsecured bondholders and other creditors, court papers show.

Walrath said that she felt obligated to allow the lawsuit to go to trial because there was evidence supporting the creditors’ position. She warned them that they would face a higher legal standard should the case actually come to trial.

Close Case

“I do acknowledge that this is a very close case,” she said in court.

Since filing for bankruptcy, the company has been selling its smaller tracks to help it pay creditors.

The company’s most valuable assets include Pimlico Race Course in Maryland, Santa Anita Park in California and Gulfstream Park in Florida. Creditors say that Stronach will use the secured loans to retain ownership of those tracks by “credit bidding” at any court-ordered auction.

Under bankruptcy court rules, secured lenders often have the right add the value of what they are owed to any bid they make. A competing bidder would have to pay off that debt in full and top whatever cash the secured lender added in order to win.

The case is In re Magna Entertainment Corp., 09-10720, U.S. Bankruptcy Court, District of Delaware (Wilmington).

To contact the reporters on this story: Steven Church in Wilmington, Delaware, at schurch3@bloomberg.net.

Last Updated: September 22, 2009 17:05 EDT