Fraudulent Conveyance Exposure for Intercorporate Guaranties, Integrated Transactions and Designated-Use Loans

Transcription

1 Presenting a live 90-minute webinar with interactive Q&A Fraudulent Conveyance Exposure for Intercorporate Guaranties, Integrated Transactions and Designated-Use Loans Navigating the Contours of Section 548 Reasonably Equivalent Value Defense in Complex Lending Transactions WEDNESDAY, JANUARY 4, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Michael D. Fielding, Partner, Husch Blackwell, Kansas City, Mo. Michael W. Kaufman, Robinson & Cole, Stamford, Conn. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.

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5 Fraudulent Conveyance Exposure for Intercorporate Guaranties, Integrated Transactions and Designated-Use Loans Navigating the Contours of Section 548 Reasonably Equivalent Value Defense in Complex Lending Transactions

6 Discussion Topics I. Overview of types intercompany guaranties and integrated transactions at risk II. Fraudulent transfer analysis A. Reasonably equivalent value in multi-party transactions B. Timing of guaranty and the financial condition of the guarantor III. Loans supported by intercorporate guaranties IV. Integrated transactions and designated-use loans V. Best practices for lenders to establish reasonably equivalent value 6

7 I. Overview of Types Intercompany Guaranties and Integrated Transactions at Risk 7

8 Types of Guarantees Parent Upstream Sis. Corp. Cross-stream Debtor Cross-stream Sis. Corp. Downstream Downstream Sub. Sub. 8

9 Downstream Guarantees This is where a parent guarantees the obligations of its subsidiaries. In a secured transaction, parent holding companies are customarily required to pledge the stock of their borrower operating companies. That pledge is usually accompanied by a guaranty. Downstream guarantees are also common in situations where a lender requires a personal guaranty from the principal of a business. 9

10 Upstream Guarantees Upstream guarantees occur when a subsidiary guarantees the debt of its parent. A lender may be making a loan to an operating company, and as a condition to that loan the lender will require that all of the borrower s subsidiaries provide guarantees. The borrower and its subsidiaries are all part of a common enterprise. 10

11 Cross-Stream Guarantees This is where an entity guarantees the obligations of an affiliate. This is particularly common in a transaction where there is a holding company with multiple direct subsidiaries, one of which is a borrower and the others are guarantors. 11

12 A Guaranty by any other name... Sometimes borrowers will structure a loan so that instead of having a borrower supported by guarantors, there are multiple borrowers. Borrowers may believe that this co-borrower structure eliminates any concerns regarding guarantees This structure could still be subject to fraudulent transfer concern particularly if one or more co-borrowers do not receive the proceeds of the loan. 12

13 II. Fraudulent Transfer Analysis 13

14 When does a Constructively Fraudulent Transfer Occur? (1) When the debtor transfers a property interest (or incurs a debt obligation) but does not receive value in exchange for that transfer that is reasonably equivalent to what the debtor gave up and (2) The debtor is insolvent or becomes insolvent at the time of the transfer or the debtor is left with unreasonably small capital to conduct its business or pay its debts as they come due 14

15 Fundamental Consideration How does the Transfer Impact the Debtor s Creditors? 15

16 Normal Transaction Before the Transfer After the Transfer Payee/ Transferee Debtor The Transfer Debtor transfers property interest in exchange for reasonably equivalent value Payee/ Transferee Debtor Same amount of the debtor for unsecured creditors 16

17 Constructively Fraudulent Transaction Before the Transfer After the Transfer Payee/ Transferee Debtor The Transfer Debtor transfers property interest without getting reasonably equivalent value in exchange Payee/ Transferee Debtor More of the Debtor for Creditors Less of the Debtor for Creditors 17

18 What is a Transfer? 11 USC 101(54): Transfer means Creation of a lien Retention of title as a security interest Foreclosure of a debtor s equity of redemption Each mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with (i) property or (ii) an interest in property 18

19 General Rules for Reasonably Equivalent Value Value given is compared to value received Evaluated as of transaction date Satisfaction of debt constitutes REV 19

20 Other Key Factors Arm s length transaction Good faith Market conditions 20

21 How is Insolvency Determined? Balance Sheet Test Do Assets Exceed Liabilities? 21

22 Who Pursues a Constructively Fraudulent Transfer? Constructively fraudulent conveyances are typically pursued through a bankruptcy proceeding by the Trustee Constructively fraudulent conveyances can be brought by creditors outside of bankruptcy Most states have a 4-year lookback period (but be careful a few states have a longer lookback period) 22

23 A. Reasonably Equivalent Value in Multi-Party Transactions 23

24 Remember This! In a constructively fraudulent conveyance action involving a multi-party transaction the defendant has the burden of proving that the debtor received reasonably equivalent value as part of the transaction. 24

25 Also Remember This! Whether or not reasonably equivalent value is given will be viewed from the perspective of the debtor s creditors. 25

26 Reasonably Equivalent Value ( REV ) and Indirect Benefits General Rule: Transfers solely for the benefit of third parties do not furnish REV Exception: REV can come from someone other than the recipient of the payments 26

27 Normal Transaction Payee/ Transferee Transfer of Interest in property Some value or other contractual relationship Debtor REV the debtor indirectly receives because of the transfer Transferor of REV 27

28 Test for Indirect REV Totality of the Circumstances 28

29 Indirect REV Factors include: Fair market value Arm s length Economic circumstances Relationship of the parties Maturity, competitiveness, and efficiency of market Industry standards 29

30 Indirect REV & Intangibles: Goodwill Increased ability to borrow Synergy Retention of important supply source or customer 30

31 Be Careful Intangible REV is Not Without Limits The indirect REV must be fairly concrete 31

32 Fundamental Consideration Is it balanced i.e., is the realizable going concern value of the debtor following the transaction equal to the going concern value before the transaction? 32

33 Examples Where Debtor RECEIVED Indirect REV 33

34 Security Interest to Secure Shareholder Loan Where Proceeds were Given to Debtor Lender Security interest in debtor s property Loan Debtor Loan proceeds Shareholder 34

35 Payment on Line of Credit where Debtor Received the LOC Draws Lender Payments on line of credit Line of credit draws Debtor Actual recipient of all draws Shareholder 35

36 Guaranty Which Resulted in Synergy and Increased Ability to Borrow Lender Guarantee & security interest $$$$ Debtor Increased ability to borrow Synergy Parent Corp. 36

37 Examples Where Debtor DID NOT RECEIVE Indirect REV 37

38 Payments to Creditors of Affiliated Corporation Sis. Corp s Creditors Satisfaction of Sis. Corp. s debts Payments Debtor Use of Sis. Corp. s real property Sis. Corp. 38

39 Husband s Pension Fund used to pay Wife s Debts Wife s Creditors Satisfaction of Wife s debts Payments $ $ $ $ $ Debtor Hubby Peace & harmony in the home $ $ Wife $ $ $ 39

40 Property Transferred to Subsidiary as Part of Restructuring Plan Subsidiary Real property Parent s shareholders eventually get Debtor s shares in subsidiary Debtor (Parent Corp.) Ownership Shareholders 40

41 $52 Million Loan Participation Facility $10 Million Loan Participation Spirit Bank Loan Proceed $2 Million CD Contingent Repurchase Obligation Aleritas Majority Owner Brooke Corp. (Insolvent Subsidiary) (Insolvent Parent) 41

42 New Lenders Lien in Assets Tousa Satisfaction of Debt Old Lenders Lien in Assets Ownership Cash Cash Debtors (Subsidiaries) 42

43 Guarantees General Rule: Direct payments on an existing guarantee considered REV But Beware: A constructive fraudulent transfer may occur when the guarantee is given Consider impact of upstream, downstream and cross-stream guarantees 43

44 Types of Guarantees Parent Upstream Sis. Corp. Cross-stream Debtor Cross-stream Sis. Corp. Downstream Downstream Sub. Sub. 44

45 Transfers Based on Contingencies Value of the transfer depends on the likelihood that the contingency will occur 45

46 Potential Defenses Debtor remained solvent & viable following transaction Part of an integrated transaction Debtor is a mere conduit Debtor received the benefit of the property for which it made payment 46

47 Good Faith for Value Defense General rule: transferor has lien on or retains the interest transferred to the extent value given Two requirements: (1) Good faith (objective) and (2) Provide value 47

48 Potential Weakness to the Good Faith Defense 548(c) requires the transferee to give value to the debtor 48

49 The Perils of Lacking Good Faith under 548(c) Lenders Lenders Lenders Lenders Pledge of Assets to Secure $300 Million Loan Lender Loan Debtors (Cash Management Firm) $3 Million Capital Court concludes lender did not act in good faith and voids the security interest leaving a $300 million unsecured claim Investors in Low Risk Securities 49

50 B. Timing of the Guaranty and the Financial Condition of the Guarantor 50

51 Timing of the Guaranty Not after you know what happens You evaluate the transaction when it occurs 51

52 Financial Condition of the Guarantor Just because someone says they are solvent doesn t necessarily mean they really are solvent Book value does not equal market value Liabilities may not be properly stated Can you get an independent, third-party valuation to document the solvency of the transferor? 52

53 III. Loans Supported by Intercorporate Guaranties 53

54 Typical Bank Financing Arrangement Operating Company is the Borrower Holding Company grants a pledge of stock of the Borrower and provides a guaranty Subsidiaries of the Borrower provide a guaranty Sometimes there will be a sister company at the Borrower level that is either a co-borrower or a guarantor 54

55 Solvency If solvency is established at the time of the financing, the reasonably equivalent value analysis becomes moot. Generally speaking, the solvency analysis is made at the time of the initial advance of funds to borrower under the loan documents. If there is a secured guaranty, the analysis is also made upon the filing of an initial financing statement. 55

56 Solvency Certificate Require delivery of a solvency certificate at close, which certifies as to: Solvency at the time of the transaction Not rendered insolvent as a result of the transaction Not left with unreasonably small capital with which to conduct present or future business Not incurring, or intending to incur, debts beyond ability to pay as such debts come due 56

57 Common Enterprise If basing Reasonably Equivalent Value analysis on indirect benefits or synergies, say so! Establish identity of interests or indirect benefits 57

58 IV. Integrated Transactions and Designated-use Loans 58

59 Examples Where Debtor Received Indirect REV Security interest to secure shareholder loan where proceeds were given to debtor Payment on line of credit where debtor received draws Guaranty which resulted in synergy and increased ability to borrow 59

60 Security Interest to Secure Shareholder Loan Where Proceeds were given to Debtor Lender Security interest in debtor s property Loan Debtor Loan proceeds Shareholder 60

61 Payment on Line of Credit Where Debtor Received the LOC Draws Lender Payments on line of credit Line of credit draws Debtor Actual recipient of all draws Shareholder 61

62 Lender $$$$$ Guarantee & Security Interest Debtor Increased ability to borrow Parent Corp. Synergy 62

63 V. Best Practices for Lenders to Establish Reasonably Equivalent Value 63

64 Best Practices Closely analyze each party in the transaction. Identify what value is being provided and what value is being received Make sure real value is being given and received If the solvency of the transferor is questionable, get an independent valuation of the company Don t get caught up in the rush of the deal. Ask yourself: How would an objective third-party evaluate this situation? 64

65 Consider Limiting the Guaranty Limit guaranty to net worth (or 80%-90% of net worth) of guarantor, so that guaranty can never render a guarantor insolvent. These are rarely used Could potentially exclude assets from guaranty Monitoring and determination issues Savings Clauses These limit guarantees to an amount not constituting a fraudulent conveyance. Widely used, but may not survive court scrutiny 65

66 Thank You! Q&A 66

67 Michael D. Fielding Michael W. Kaufman