Fraudulent Transfer: 'Reasonably Equivalent Value' Meets Debt Recharacterization

Official Comm. of Unsecured Creditors v. Hancock Park Capital II, L.P. (In re Fitness Holdings International, Inc.) , 714 F.3d 1141 (9th Cir. 2013) -

A chapter 11 unsecured creditors' committee sought to recover payments made to the debtor's shareholder as a fraudulent transfer. The bankruptcy court dismissed the claims, and the district court affirmed. On appeal the 9th Circuit focused on whether there was "reasonably equivalent value" for the payments, and remanded the matter to the district court for further proceedings.

Over the course of several years, the debtor executed 11 subordinated promissory notes to its shareholder (Hancock Park) totaling ~$24 million. During this period, the debtor also obtained a $7 million revolving credit loan and a $5 million installment loan from a bank secured by all of its assets and guaranteed by Hancock Park.

After various modifications of the bank debt the parties agreed to refinance. The refinancing consisted of a $17 million term loan and an $8 million revolving line of credit from the bank. At closing ~$9 million was used to pay off the original bank loan and ~$12 million was used to pay off the Hancock Park subordinated notes. This also had the effect of releasing Hancock Park's guaranty.

Fitness Holdings filed bankruptcy a little more than a year later. The unsecured creditors committee brought an action on behalf of the bankruptcy estate to recover the money paid to Hancock Park as a constructive fraudulent transfer.

As outlined by the 9th Circuit, a constructive fraudulent transfer requires a showing that the debtor (1) "received less than a reasonably equivalent value in exchange for such transfer or obligation," and (2) was insolvent, was left with unreasonably small capital, believed that it incurred debts beyond its ability to pay as they matured, or made a transfer to or for the benefit of an insider under an employment contract and not in the ordinary course of business. Consequently, if the debtor received reasonably equivalent value, the payments would not be constructive fraudulent transfers.

Although the Bankruptcy Code does not define reasonably equivalent value, Section 548(d)(2)(A) defines "value" to include "satisfaction or securing of a ... antecedent debt;" Section 101(12) defines "debt" to mean "liability on a claim;" and Section 101(5)(A) defines "claim" to include a "right to payment."

Taking to heart a prior U.S. Supreme Court rebuke of the court for relying on a rule of...