Even if a buyer doesn’t rely on representations by the seller about the value of the business, false representations about net income may still lay the foundation for a judgment that the sale was a constructively fraudulent transfer, as explained in an opinion by Bankruptcy Judge Robert E. Grossman of Central Islip, N.Y.
The buyer (later to become a chapter 7 debtor) negotiated to buy tuxedo rental stores. The seller represented that the two stores’ net income totaled about $500,000 a year. The evidence showed that the buyer was willing to pay about twice annual income. The parties therefore agreed on a $950,000 sale price.
The buyer paid the price at closing with some cash and the remainder in a note payable to the seller.
The buyer soon learned that the seller misrepresented income (which was lower than shown on the books and records) and had likewise represented expenses to be lower than they actually were. Financial problems ensued, culminating in the buyer’s chapter 7 liquidation.
The chapter 7 trustee mounted a constructively fraudulent transfer suit against the seller under Section 548(a)(1)(B) of the Bankruptcy Code and the equivalent state law. The seller-defendant made a motion to dismiss, based on the idea that the buyer had agreed not to rely on representations by the seller.
In his March 21 opinion, Judge Grossman characterized the defendant as contending that “responsibility for economic harm to [the buyer] lies with the principal of these entities for his failure to uncover the truth.”
The lack of reliance could be a winning defense to a claim for actual fraud under Section 548(a)(1)(A), but it didn’t carry water against a claim for a constructively fraudulent transfer.
The seller, Judge Grossman said, “may believe that he cleverly outwitted the principal of the debtors, but his maneuvers do little as a matter of law to protect the recipients of the fraudulent transfers from liability in these actions.”
Judge Grossman said that the defendant’s “argument fails to recognize that the statutes authorizing the recovery of constructively fraudulent transfers are drafted neither to reward the debtor, nor to punish the defendant for intentional wrongdoing.”
“Rather,” he said, “the basic intent of constructive fraudulent conveyance statutes is to protect creditors of a debtor from transactions where assets of a debtor’s estate were transferred for less than fair value.”
Because the defendant asserted no other defenses, Judge Grossman evaluated the elements of a constructively fraudulent transfer. The first is the lack of reasonably equivalent value.
Judge Grossman found that the buyer was willing to pay twice annual income. He recalculated annual income based on actual expenses and actual gross income. Also taking into consideration what the buyer paid toward the note, he found there was no reasonably equivalent value because the buyer had paid more than twice the actual net income.
Judge Grossman denied the defendant’s motion for summary judgment and entered judgment after trial in favor of the trustee for the difference between what the buyer paid in cash and the recalculated value of the business. He granted the trustee prejudgment interest at the prime rate from the time of the transfer, along with post-judgment interest at the federal rate.
Even if a buyer doesn’t rely on representations by the seller about the value of the business, false representations about net income may still lay the foundation for a judgment that the sale was a constructively fraudulent transfer, as explained in an opinion by Bankruptcy Judge Robert E. Grossman of Central Islip, N.Y.
The buyer (later to become a chapter 7 debtor) negotiated to buy tuxedo rental stores. The seller represented that the two stores’ net income totaled about $500,000 a year. The evidence showed that the buyer was willing to pay about twice annual income. The parties therefore agreed on a $950,000 sale price.
The buyer paid the price at closing with some cash and the remainder in a note payable to the seller.