Tuesday, September 1, 2015

“You have no idea how expensive it is to look this cheap” – Pennsylvania Uniform Fraudulent Transfer Act

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.