Avoid Fraudulent Transfer Requests from Loan Workouts

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By Hanna Lahr and James Roberts

Durging and after an economic downturn, an increase in fraudulent transfer actions is almost inevitable. Economic instability leads to an increase in distressed borrowers who, in turn, have distressed loans that banks and financial institutions must settle or restructure.

The management of distressed loans can take many forms, including forbearance agreements, orderly liquidations and, where consensual resolution is not possible, litigation or often bankruptcy. Practices may also involve the lender protecting its interests by demanding collateral or additional collateral, including from the borrower’s affiliates. These transactions can make lenders more vulnerable to fraudulent transfer requests – a special category of federal and state laws that require a lender, in certain circumstances, to return what they received in a disputed transaction, with interest.

The basics of fraudulent transfers

The majority of state fraudulent transfer laws are based on the adoption of the Uniform Fraudulent Transfers Act or the revised Voidable Transactions Act. Federal law has similar fraudulent transfer laws that are applicable in bankruptcy cases. In a bankruptcy case, the bankruptcy trustee or debtor may make fraudulent transfer requests under federal law and applicable state law, which is often preferable because of the longer time frames during which transfers can be recovered.

There are two types of fraudulent transfers: actual fraudulent transfers and implied fraudulent transfers.

An actual fraudulent transfer occurs when the debtor makes a transfer with the intention of defrauding his creditors (such as transferring assets for little or no consideration in order to prevent the creditor from preying on those assets) . Because intent is generally difficult to prove, it can be circumstantially demonstrated through certain “fraud badges” including, but not limited to: transfer to an insider, concealment of transfer, pending proceedings against the debtor, a value received that is less than the reasonably equivalent value for the transfer and insolvency of the debtor. An assignee can defend against an actual request for a fraudulent transfer by demonstrating that it acted in good faith (for example, without knowing the fraudulent intent of the debtor) and that it provided “reasonably equivalent value” for the transfer. , as shown below.

An implied fraudulent transfer occurs when the debtor makes a transfer without receiving a reasonably equivalent value for the transferred property during a period when the debtor is insolvent or in financial difficulty, or when the transfer itself renders the debtor insolvent.

The value given need not be dollar for dollar to be considered “reasonably equivalent”, and courts will consider both direct benefits (including a debtor’s payment on a loan reducing the amount of the debt. debt owed by that debtor) and collateral benefits (such as financing that allows the business to bridge a sale) in determining whether a reasonably equivalent value has been given.

An assignee can defend against an implied fraudulent transfer request by demonstrating that it acted in good faith, for example without knowledge of the debtor’s insolvency or fraudulent purpose.

Five tips to guard against fraudulent transfer requests

A lender cannot prevent a borrower from intending to defraud his creditors or from being insolvent. The lender should, however, be aware of the liability risk associated with fraudulent transfers and take steps to help minimize exposure to fraudulent transfers and to prepare the lender in the event that there is a request for cancellation in the future. Here are five steps banks can take to avoid problems:

1. Exercise due diligence. The courts are not inclined to protect lenders who appear to have overlooked the fraudulent intent or insolvency of a debtor. If a lender is therefore unaware of a debtor’s fraudulent intent or insolvency because the lender willfully failed to exercise due diligence, the good faith defense is unlikely to be available to protect the debtor. lender against fraudulent transfer liability. Due diligence should be tailored to the proposed transaction at issue, but will generally include updating the financial records of all parties involved, especially for any new party to the transaction, and analyzing collateral, including through through field reviews and updated assessments. Through this process, the lender will also be able to better analyze whether a reasonably equivalent value is likely to be exchanged.

2. Follow the policies for reporting suspicious activity. As noted above, fraudulent transfer situations sometimes involve actual fraudulent activity on the part of the debtor. If there are suspicions about the debtor’s activities, follow internal policies to report those suspicions.

3. If the suspicions are confirmed, leave the relationship. Getting out of a relationship can look different in every situation. Immediate exit may not be possible or reasonable depending on the circumstances, so the lender may, for example, default on the loan, refuse to provide additional funds to the debtor and / or start liquidating the collateral. Whichever route is ultimately deemed appropriate, the assessment of options should take into account the potential for fraudulent transfer liability if the exit is not immediate and the lender continues to work with the debtor.

4. Be careful with non-debtors. Adding new guarantees or collateral from non-debtors is a common way to further secure a lender’s position when a loan becomes problematic. If the non-debtor is himself in financial difficulty and does not receive a reasonably equivalent value in connection with the transaction, fraudulent transfer liability may arise. A reasonably equivalent value may include indirect benefits, for example when the non-debtor receives the benefit of the goods or services for which the debt is incurred by the debtor.

5. Document your process. In the event that a fraudulent transfer action is brought, it is important that the due diligence and actions taken in connection with the above actions are well documented so that the lender can demonstrate their efforts to determine whether the debtor had an intention fraudulent or was in financial difficulty. If the investigation has been diligently conducted but fraudulent intent or the debtor’s financial hardship has not been discovered, the good faith defense will still be available.

Hanna Lahr is a partner and James Roberts is a partner in Burr and Forman LLP’s Creditors and Bankruptcy group.


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