Everyone loves a bargain and
businesses and individuals that deal in distressed assets really love cheap
stuff. But if it looks too good to be
true, it might turn out to be very expensive.
If you are considering purchasing the assets of a distressed business, you
need to consider the implications of the Pennsylvania Uniform Fraudulent Transfer
Act.
The typical situation involves a
business with significant debts. Some
creditors have initiated collection actions, others have threatened. The owners have decided to throw in the towel
and want to salvage what value they can by selling the assets at “fire sale”
prices to third parties. The purchaser completes
the purchase only to be sued by creditors of the defunct company. The creditors
claim that sale violated the Pennsylvania Uniform Fraudulent Transfer Act and
want the purchaser to pay them the full value of the assets.
The Pennsylvania Uniform Fraudulent
Transfer Act prohibits three types of transfers. First, it prohibits debtor from transferring
assets “with actual intent to hinder, delay or defraud any creditor of the
debtor.” In determining whether a debtor
had such “actual intent,” courts look to a variety of factors and there is no
bright line test for making such a determination. The factors include: (1) whether the transfer
was made to an insider; (2) whether the debtor retained possession or control
of the possession property after the transfer; (3) whether the transfer was
concealed; (4) whether the debtor had been sued or threatened with a lawsuit at
the time the transfer was made; (5) whether the transfer was of substantially
all of the debtors assets; (6) whether the debtor absconded; (7) whether the
debtor removed or concealed assets; (8) whether the value received for the
assets was reasonably equivalent to the value of the assets; (9) whether the
debtor was insolvent; (10) whether the transfer occurred shortly before or
after a substantial debt was incurred; and (11) whether the purchaser of the
assets subsequently transferred the assets to an insider of the debtor.
Second, the act prohibits a debtor
from transferring assets [when] “without receiving a reasonably equivalent
value in exchange for the transfer or obligation, and the debtor: (1) was
engaged or was about to engage in a business or transaction for which the
remaining assets of the debtor were unreasonably small in relation to the
business or transaction; or (2) intended to incur, or believed or reasonably
should have believed the debtor would have incurred, debts beyond the debtors
ability to pay as they became due.” This
provision, known as the “constructive fraud” prohibition, is somewhat better
defined then the actual “actual intent” provision, in that receipt of
“reasonably equivalent value” renders the debtor in compliance with the
provision.
Third, “a transfer made [] by a debtor
is fraudulent to a creditor whose claim arose before the transfer was made []
if the debtor made the transfer or incurred the obligation without receiving a
reasonably equivalent value in exchange for the transfer [] and the debtor was
insolvent at the time or the debtor became insolvent as a result of the
transfer.”
Notice that a purchaser need not know that
the seller is insolvent or engaging in duplicitous behavior to be liable for
the seller’s debts. So what is a
purchaser to do? If a deal seems too
good to be true, some due diligence is in order. Why are the assets being sold? Do the public
records indicate that the seller has judgments against it? Are all or substantially all of the assets of
a company for sale? Are the assets
encumbered by security interests?
If a transaction raises red flags,
there are a number of strategies to reduce the risk but you cannot address
unknown risk.
