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How to Structure a Multiparty Transaction to Minimize Risk (1); By Michael D. Fielding.

Introduction

Do you know what risks your company faces if it is part of a three-party transaction and one of the players later files bankruptcy? The simple answer is that a bankruptcy trustee may avoid and recover the assets your company received in that tri-party deal. This may occur even if more than three years has passed since the transaction was completed. But do not be dismayed because there is hope! This article discusses proactive steps you can take in structuring a multi-party transaction so as to minimize the future risk of an avoidance claim. (2)

Constructively Fraudulent Conveyances

Section 548 of the Bankruptcy Code allows a bankruptcy trustee to avoid a transfer as constructively fraudulent where (a) the debtor did not receive reasonably equivalent value for the transaction and (b) the debtor was insolvent at the time of the transfer. The first element can be satisfied in various ways. Section 548 specifies in part that satisfaction of antecedent debt constitutes reasonably equivalent value.

Thus, a payment made on a long past-due account will not be constructively fraudulent (although it may qualify as a preferential transfer under s. 547 of the Bankruptcy Code if it is made within the 90-day period preceding the bankruptcy petition date). Similarly, a debtor who gives a security interest in its assets to secure a loan will be deemed to have received reasonably equivalent value if it receives the loan proceeds. The second element - solvency of the debtor - is determined on a balance sheet basis. If there is positive stockholder equity then the company is deemed solvent. Conversely, negative stockholder equity means debtor is insolvent.

Unlike preferential transfers (which typically only involve a 90-day reach back period from the bankruptcy petition date), there is a significantly greater reach back period to avoid constructively fraudulent transfers. Specifically, the Bankruptcy Code provides the trustee with a two-year reach back period from the bankruptcy petition date. Moreover, nearly all states have adopted either the Uniform Fraudulent Transfer Act or Uniform Fraudulent Conveyance Act. These uniform acts have provisions similar to the Bankruptcy Code for avoiding constructively fraudulent conveyances. Notably, these uniform acts generally allow a four-year reach back period which makes the breadth of the trustee's avoiding powers even more potent.

It is relatively easy to determine whether a transaction was constructively fraudulent in the context of a two party transaction involving just a debtor and creditor. In those situations, the trustee bears the burden of proving that the debtor did not receive reasonably equivalent value in exchange for the transfer that it made to the creditor. Hence, a creditor can proactively protect itself by taking steps to document the value a debtor received for a transaction.

Multi-Party Transactions & Fraudulent Conveyances.

In contrast to a two-party deal, a transaction involving three or more parties presents significantly greater difficulty in determining whether it is fraudulent or not. As a general rule, "transfers made or obligations incurred (including guarantees) solely for the benefit of third parties do not furnish reasonably equivalent value." But notwithstanding this general rule, "[i]t is well settled that reasonably equivalent value (3) can come from one other than the recipient of the payments, a rule which has become known as the indirect benefit rule." (4)

An example of a multi-party transaction is a situation where a debtor gives a security interest in its assets to a lender who, in turn, loans money to the debtor's parent corporation. In that scenario, is the debtor's security interest a voidable fraudulent conveyance? The answer depends on what the parent corporation does with the loan proceeds. If the loan proceeds are funneled back to the debtor, then there will be no fraudulent conveyance because the debtor has received reasonably equivalent value. But if the parent company uses the assets for its own purposes, the transfer will be deemed fraudulent if the debtor does not receive any indirect reasonably equivalent value.

Whether reasonably equivalent value is given in a multi-party transaction will ultimately depend on the facts and circumstances of each case. Indeed, it can often be difficult to quantify the value the debtor received for the transfer. Intangible benefits such as goodwill, increased ability to borrow and/or expected synergies from a corporate merger can furnish reasonably equivalent value. (5) However, those intangible benefits must also be fairly concrete. (6)

Additionally, a creditor receiving funds in satisfaction of existing debt must be wary of the source of those funds. For instance, where a debtor husband uses non-marital assets to pay the debts of his wife, those monies can be avoided and recovered from the creditor because the husband will not be deemed to have received reasonably equivalent value for the payment. (7) That same rationale would hold true in the corporate context where a debtor company pays the creditors of a sister corporation and there is no corresponding transfer of value back to the debtor company.

How to Protect Your Company

What should a credit manager do to protect his company against voidable fraudulent conveyances in a multi-party setting? First, he must be aware of the risks associated with transfers in a multi-party setting so that proper protective measures can be taken in structuring the deal. This article provides a good start for educating one's self. Additionally, one can attend seminars where this topic is addressed.

Second, a credit manager should regularly obtain financial statements from the entities with whom he deals. Remember, insolvency is determined by looking at a company's balance sheet. If the company is solvent, then a constructively fraudulent conveyance action fails as a matter of law. But if the company is insolvent (i.e., if there is negative stockholder equity), then a credit manager must be vigilant to ensure that the debtor receives reasonably equivalent value every time it transacts with the creditor.

Third, clearly identify (a) what is being transferred, (b) to whom it is being transferred, and (c) what is being received in exchange for the transfer. The examples set forth above are a good illustration as to why this is important. By critically analyzing these three points a person can ascertain with much greater certainty whether a transaction is subject to voidance in the future.

Finally, consult an experienced bankruptcy attorney. The reality of the matter is that multi-party transactions create a myriad of risks. An attorney well-versed in fraudulent conveyance law can provide critical advice so as to maximize protection against a future avoidance action.

1 This article was originally published in the June 2008 edition of Managing Credit, Receivables & Collections which is a publication of IOMA.

2 Neither the Supreme Court of Missouri nor the Missouri Bar reviews or approves certifying organizations or specialist designations

3 In re R.M.L., Inc., 195 B.R. 602, 618 (Bankr. M.D. Pa. 1996).

4 In re Northern Merchandise, Inc., 371 F.3d 1056, 1058 (9th Cir. 2004) (citations omitted).

5 See e.g., In re Jumer's Castle Lodge, Inc., 338 B.R. 344, 354 (C.D. Ill. 2006).

6 Id.

7 In re Bargfrede, 117 F.3d 1078 (8th Cir. 1997).

Michael D. Fielding is an attorney in the Insolvency and Commercial Bankruptcy practice group of Husch Blackwell Sanders LLP. He is certified as a Business Bankruptcy Specialist by the American Board of Certification.

Michael may be reached at;

Husch Blackwell Sanders LLP

4801 Main Street, Suite 1000

Kansas City, MO 64112

(816) 983-8000 Ph.

Email:michael.fielding@huschblackwell.com

www.huschblackwell.com
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Publication:The Corporate Advisor
Article Type:Reprint
Date:Apr 1, 2009
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