Page 5 - John Hundley 2010

Sharp Thinking

No. 30 Perspectives on Developments in the Law from The Sharp Law Firm, P.C. March 2010
Court Clarifies Fraudulent Transfer

Law in Leveraged Buyout Context

By Terry Sharp, Law@lotsharp.com, 618-242-0246
A leveraged buyout (“LBO”) consists of an investor group, frequently the
corporation’s managers, buying the corporation with the proceeds of a loan
obtained from a bank or other source and secured by the corporation’s assets.
These transactions can take the form of asset purchases, stock purchases, and
purchases through employee stock ownership plans. If the burden of the debt
created by the transaction is so heavy that the corporation has limited prospects
of surviving and does in fact end up in a bankruptcy court, the transaction could
be deemed a fraudulent conveyance.
In a case arising under Indiana law, which appears substantially identical to
Illinois law, the Seventh Circuit Court of Appeals recently produced a primer on
fraudulent conveyance law in dealing with leveraged buyouts. Boyer v. Crown
Stock Dist., Inc., 587 F.3d 787 (7th Cir. 2009). Sharp

Crown was a manufacturing company whose president, Smith, through a new corporation, acquired all
the assets of the old corporation for $3.1 million in borrowed cash, secured by the assets of the
corporation, and a $2.9 million promissory note, secured by a second lien on the same assets. The
president’s actual investment was $500.00. In addition to receiving the borrowed $3.1 million, the
shareholders of old Crown received dividends of nearly $600,000 representing earnings which old Crown
had accrued prior to the buyout.
The new company was a flop and filed bankruptcy some 3½ years later. The assets were sold to a
new company, also owned by Smith. The 4-year look-back provisions of the Uniform Fraudulent Transfer
Act (“UFTA”) in Indiana (Ind. Code § 32-18-2-19(2)), substantially identical to Illinois’ (740 ILCS 160/10),
applied, so the trustee in bankruptcy, as was his duty, challenged the original transaction. The bankruptcy
judge ruled in favor of the bankruptcy trustee and ordered the return of $3.1 million in cash and the two
payments that had been made on the note.
Affirming in substantial part, Judge Richard Posner explained that “[i]n a
conventional LBO, an investor buys the stock of a corporation from the stock-
holders with the proceeds of a loan secured by the corporation’s own assets.”
However, “if the burden of debt created by the transaction was so heavy that
the corporation had no reasonable prospect of surviving[,] the payment to
the shareholders by the buyer of the corporation is deemed a fraudulent
conveyance because in exchange for the money the shareholders received they
provided no value to the corporation but merely increased its debt and by doing so
pushed it over the brink.”

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