Guaranty and Mortgage Granted by Debtor to Secure Affiliate’s Loan Voidable as Fraudulent Transfer Due To Inadequate Capital
Guaranty and Mortgage Granted by Debtor to Secure Affiliate’s Loan Voidable as Fraudulent Transfer Due To Inadequate Capital
A debtor’s guarantee and granting of a mortgage to secure an affiliate’s loan was constructively fraudulent and thus voidable under Section 548(a)(1)(B) of the Bankruptcy Code, according to the U.S. Bankruptcy Appellate Panel for the Ninth Circuit.
To avoid a transfer under Section 548, a movant must establish the following:
- a transfer of debtor’s property;
- made within two years of the bankruptcy filing;
- debtor received less than reasonably equivalent value in exchange for the transfer; and
- debtor was insolvent, made insolvent by the transfer, operating or
about to operate without sufficient capital, or unable to pay debts as they become due. On appeal, only the fourth element was at issue. The debtor was unable to establish that it was balance-sheet insolvent when the transfer was made (its assets exceeded its liabilities at that point).
However, the bankruptcy court found that debtor met the “adequate” or “unreasonably small” capital test, since it was engaged in a business for which its remaining capital was unreasonably small.
Although the creditor contested such finding, the BAP agreed with the bankruptcy court in that, when the transfer was made, it was more likely than not that the debtor would stop receiving the equity infusions which had enabled its survival up to that point.
For the same reason, the bankruptcy court found (and the BAP agreed), that the debtor also met the “cash flow” insolvency test since, when the transfer was made, the debtor knew it would not be able to pay the debts as they came due.
Finally, the BAP also affirmed the bankruptcy court’s rejection of the creditor’s good faith defense, concluding that there was no clear error in the finding that the creditor knew or should have known that the debtor was in financial distress at the time of the transfer.