Distressed Sale Recharacterized as Secured Loan Resulting in Voidable Preferences
Distressed Sale Recharacterized as Secured Loan Resulting in Voidable Preferences
Under Article 9 of the UCC, transactions labeled as (and intended to be) purchases, sales, or assignments can be trated as secured loans, depending on their substance.
This is important in the bankruptcy context for several reasons, one of which is that such transactions—sales recharacterized as loans—can give rise to voidable preferences. This is precisely what happened in a recent case decided by the U.S. Court of Appeals for the Ninth Circuit.
The debtor and an affiliate executed an “Assignment, Sale, and Transfer” pursuant to which the debtor would sell certain spare parts to an affiliate for $800,000. The affiliate promptly furnished payment but never took possession of the spare parts.
Immediately after executing the assignment, the parties entered into an oral agreement under which the debtor would store, maintain, and try to sell (presumably on behalf of the affiliate) the parts to a third party, and the affiliate would receive $800,000 from the proceeds, while the debtor would keep proceeds above such amount.
Eventually a third-party was willing to pay $1.2 million for the parts, to be paid in three installments. However, the third-party demanded (and the parties agreed) that the parts be sold by the debtor and not by the affiliate.
The debtor and affiliate also agreed that the debtor would retain the first payment, and the two remaining payments would be remitted to the affiliate after received by the debtor. The third-party eventually sent two payments of $400,000 payment to the debtor, one of which the debtor kept and the other which the debtor remitted to the affiliate.
Four days after the second payment was received, and before the third payment was made, the debtor filed for bankruptcy. Afterwards, the affiliate instructed the buyer to remit the last payment directly to the affiliate, instead of paying the debtor. The buyer refused and did not remit payment to any party.
Eventually the Chapter 7 trustee sued to recover the second payment from the affiliate as a preferential transfer, and for a declaration that the trustee was entitled to receive the third payment from the buyer.
The only controversy between the parties was whether the requirement that the transfer be made on account of an antecedent debt was met, since the affiliate claimed that the transaction in question was a sale and not a loan.
The bankruptcy court ruled in favor of the trustee, finding that the transaction was, in substance, a loan based on the following:
- the debtor kept and used the spare parts after the sale;
- the transaction occurred only because the debtor needed an immediate cash infusion;
- the affiliate would only receive $800,000 from the eventual sale of the parts, while the debtor would keep any proceeds above such amount, and
- the debtor acted as the owner in the sale to the third-party.
The Ninth Circuit Affirmed.