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Befuddlement Betwixt Two Fulcrums: Calibrating the Scales of Justice to Ascertain Fraudulent Transfers in Leveraged Buyouts
American Bankruptcy Institite Law Review (2010)
  • John H. Ginsberg
  • M. Katie Burgess
  • Zachary R. Caldwell
  • Daniel R. Czerwonka
In a leveraged buyout, a company goes deep into debt and grants liens on its assets to finance the purchase of itself. The company’s risk of insolvency increases with its debt burden. Unsecured creditors of the company are exposed to insolvency risk without compensation, unlike the parties to the leveraged buyout—buyer, seller and lender—all of whom expect good returns on the lesser risks to which they are exposed. When a leveraged buyout leaves the acquired company with “unreasonably small capital” such that insolvency is “reasonably foreseeable” upon consummation of the buyout, unsecured creditors may have recourse to constructive-fraudulent-transfer law. They need such recourse because: (1) they are not party to the leveraged buyout; (2) they have no good proxy among the parties; and (3) absent legal recourse, many have no ability to negotiate protection against uncompensated harm. Constructive-fraudulent-transfer law is defective in providing needed recourse. Proof of “unreasonably small capital” is exceedingly expensive. It requires hiring experts to conduct forensic financial analysis of whether insolvency was “reasonably foreseeable” when the buyout closed considering: (a) the company’s historical performance, (b) the terms of the buyout loans and (c) all foreseeable risks faced by the company. The “unreasonably small capital” standard is so vague that it is impossible for disputants to make a reasonably reliable prediction of the outcome of litigation, which in turn makes it impossible to determine a reasonable settlement figure. When cases are litigated, trials are lengthy and expensive. More often, aggrieved unsecured creditors—or, in bankruptcy, the fiduciaries charged with representing their interests—conclude that pursuing legal recourse is a high-stakes gamble with unpredictable odds, and they settle at a steep discount from the recourse purportedly offered by constructive-fraudulent-transfer law. Harm goes unremedied and, therefore, doing harm is not properly disincentivized. To correct these defects, we recommend carefully recalibrating the scales of justice through several clarifications of the standard for “unreasonably small capital.” We recommend that the law specify: • the probability at which cash-flow insolvency becomes “reasonably foreseeable;” • the post-transaction period over which the probability of insolvency is to be projected; • how margin-of-error is to be treated in determining whether insolvency is reasonably foreseeable; and • whether a transfer is fraudulent if insolvency was reasonably foreseeable ex ante but the specific conditions ultimately precipitating insolvency were not.
  • Leveraged Buyout,
  • Private Equity,
  • Fraudulent Transfer,
  • Fraudulent Conveyance,
  • Insolvency,
  • Bankruptcy
Publication Date
Spring January, 2010
Publisher Statement
To be published in the Spring, 2011 issue of the American Bankruptcy Institute Law Review.
Citation Information
John H. Ginsberg, M. Katie Burgess, Zachary R. Caldwell and Daniel R. Czerwonka. "Befuddlement Betwixt Two Fulcrums: Calibrating the Scales of Justice to Ascertain Fraudulent Transfers in Leveraged Buyouts" American Bankruptcy Institite Law Review (2010)
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