As the economic impact of COVID-19 continues to unfold, opportunities to purchase debt and claims at attractive prices from sellers who may be starved for liquidity have started to increase. In such periods of market dislocation, even good-faith purchasers may risk claims of “constructive fraudulent transfer”, “constructive fraudulent conveyance”, or a similar “claw-back” suit if the seller was (i) insolvent at the time of the transaction, or (ii) rendered insolvent as result of the transaction. Claw-back causes of action are typically asserted by spurned creditors of the seller that have unsatisfied debts, or by bankruptcy trustees or official committees of unsecured creditors if the seller subsequently files for bankruptcy.
While the definition of a “constructive fraudulent transfer” or a “constructive fraudulent conveyance” varies by jurisdiction, both terms mean a transfer for less than “fair consideration” was made when the seller was insolvent or rendered insolvent by the transfer, or that the remaining assets of the seller after the transfer are unreasonably small in relation to the seller’s ongoing business. To remedy the situation, the buyer may have to return the asset (or its value) in order to satisfy the seller’s liabilities to creditors, liabilities that the buyer did not agree to assume – and which buyer may have expressly provided were to remain with the seller.
Assuming the seller was insolvent at the time of the transaction, one of the main prongs in analyzing whether the transaction is categorized as a constructive fraudulent transfer is whether buyer paid “fair consideration” or “reasonable equivalent value.” (Whether an entity is “insolvent” is another major factor that should be analyzed in any defense to such an action, but that is a topic to be covered in another article.)
To protect against this risk, buyers of distressed assets should work with counsel to support the fairness of the purchase price, including by taking one or more of the following precautions, depending on the circumstances surrounding the sale process and the debt or claim at issue:
The current market dislocation will provide buyers of distressed debt, claims and other assets with significant opportunities -- but these opportunities should be thoughtfully undertaken given the inherent risks of detailed future scrutiny by creditors of insolvent sellers. Please contact us for further information or guidance.