When the title to real property is transferred for the express purpose of placing it out of reach of a known creditor, the transfer is a fraudulent conveyance.
Fraudulent conveyance (or fraudulent transfer) under bankruptcy law occurs when a debtor’s property is transferred within two years of the filing a) with the intent to hinder delay or defraud creditors or b) in exchange of such transfer receives less than a reasonably equivalent value in exchange for such transfer while insolvent or such transfer renders the transferor insolvent. (See 11 U.S.C. § 548.)
So, how would a creditor construct deal terms to prevent this?
Fraudulent Conveyance and the “Safe Harbor Rule”
In a 2024 bankruptcy proceeding (Holliday v. Credit Suisse Sec. LLC (In re Bos. Generating, LLC)), the Second Circuit Court of Appeals ruled that a properly structured leveraged buyout invoking the “Safe Harbor Rule” under Section 546(b) of the Bankruptcy Code cannot be set aside as a fraudulent conveyance.
Section 546(e) of the Bankruptcy Code provides:
(e) Notwithstanding [certain sections giving the trustee a right to claw back transfers], the trustee may not avoid a transfer that is a margin payment, …, made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, or that is a transfer made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, …, except under section 548(a)(1)(A) [regarding a transfer made with the intent to hinder, delay or defraud creditors]….
11 U.S.C. § 546(e) (emphasis added)
Whereas the United States Supreme Court in Merit Management Group LP v. FTI Consulting Inc., 583 U.S. 366 (2018) had ruled that that the presence of a financial institution as a conduit in the chain of payments in a leveraged buyout will not invoke the safe harbor rule in Section 546(e). IfIf, however, the loan agreement states the manner in which the loan proceeds are used to fund dividends and redemption of equity interests, then the trustee may be precluded from clawing back proceeds paid to equity.
Holliday v. Credit Suisse Securities and Fraudulent Transfer Claims
In Holliday v. Credit Suisse Securities (USA) LLC (In re BosGen Liquidating Trust), the Second Circuit affirmed the dismissal of fraudulent transfer claims against Credit Suisse, ruling that pre-bankruptcy recapitalization payments made through a “financial institution” are protected by the Bankruptcy Code’s securities safe harbor.
Here, the debtor Boston Generating LLC (BosGen) entered into a leveraged recapitalization transaction in which its member (EBG Holdings, LLC (EBG)) received a distribution from the loan proceeds. The key to this transaction was that the lender deposited the loan proceeds into BosGen’s bank account at U.S. Bank. At BosGen’s direction, U.S. Bank then transferred a portion of the loan proceeds to EBG’s account at Bank of America, as trustee, which then funded the $925 million tender offer and distributed $35 million to EBG’s members in exchange for their equity interests in EBG. Several years later, BosGen filed Chapter 11 bankruptcy along with several of its subsidiaries.
The liquidating trustee filed a fraudulent transfer suit, alleging that BosGen was insolvent at the time of the leveraged restructuring. The bankruptcy court granted defendant’s motion for Summary Judgment, and the U.S. District Court and Second Circuit Cout of Appeals affirmed.
In its opinion, the Second Circuit noted that the loan agreement was written in such a way that the transfers were made as part of a securities transaction. First, the Second Circuit noted that the loan proceeds went through two financial institutions with Bank of America, as EBG’s trustee, paying the $925 million as part of the tender offer and distributing the $35 million to EBG’s members, all of which were deemed as part of a securities transaction.
Deal Structure and Avoiding Fraudulent Conveyance
To fit within the Safe Harbor Rule under Section 546(e) and avoid the holding in Merit Management Group LP v. FTI Consulting Inc, supra, the Second Circuit found that both BosGen and EBG were financial institutions as defined in Section 101(22) of the Bankruptcy Code in that a customer of a bank or such other entity may be defined as a financial institution when the bank or such other entity is acting as an agent for the customer in connection with a securities contract. Here, both U.S. Bank and Bank of America were acting as BosGen’s and EBG’s agent. And, because the transfers of the $925 million and $35 million were structured as a securities contract whereby qualifying financial institutions were utilized as intermediaries/agents, the liquidating trustee was precluded from pursuing his fraudulent conveyance claim under Section 546(e) of the Bankruptcy Code.
The key take away from this opinion is that a leveraged buyout can be structured in a way such that if the parties structure the deal as a securities transaction and utilize qualified financial institutions (as defined under Section 101(22) of the Bankruptcy Code) as agents/intermediaries in distributing funds, creditors may be precluded from clawing back said transfers. Further, if a claw back lawsuit is filed prior to a bankruptcy filing, there may be an incentive to filing the parties into bankruptcy in order to take advantage of the Safe Harbor Rule under Section 546(e) of the Bankruptcy Code.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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