Fraudulent conveyance is one of the major risks facing all participants in a leveraged buyout. In the event that an LBO is found to have involved a fraudulent conveyance, senior lenders may lose their seniority and significant selling shareholders may have to return the proceeds of their sales.
A court attempting to determine whether fraudulent conveyance has occurred focuses on two issues. It looks at whether the firm bought out received “fair consideration” for the security interest it provided as collateral for the loan to the acquiring company. That fair consideration was not given is a necessary but not a sufficient condition to prove a fraudulent conveyance claim. The LBO transaction must also result in the insolvency or inadequate capitalization of the firm.
For secured lenders, selling shareholders, analysts, buyers, investment bankers and unsecured lenders, a fraudulent conveyance judgment is likely to prove costly in terms of litigation expense, dollar loss and reputation damage. Fortunately, a little financial planning and attention to some simple guidelines can minimize fraudulent conveyance risk.
