The Tenth Circuit Bankruptcy Appellate Panel declined an invitation to recharacterize a modestly complex transaction. Understanding the transaction as documented, the BAP upheld the bankruptcy court’s grant of summary judgment finding no constructively fraudulent transfer because the debtor had received reasonably equivalent value.
Writing for the BAP in an opinion on February 21, Bankruptcy Judge Terrence L. Michael said, “Dollar-for-dollar exchanges are seldom questioned; this appeal represents one such rare occasion.”
The Loan to Cover Salary
The man who would become the debtor years later had an idea, but no money. Ultimately, he convinced a lender to invest, on the condition that the two would form an LLC to carry on the business.
The lender was to make loans to the LLC, in return for which the operating agreement gave the lender 82% ownership. The debtor was given 15% ownership and a salary, with the opportunity to increase the debtor’s ownership interest if the business were a success. The parties understood that the debtor’s salary would come from the lender’s loans.
Part of the operating agreement was the debtor’s personal guarantee to repay the full amount of the lender’s loans up to $750,000. As security for the personal guarantee, the agreement gave the lender a security interest in a $15 million judgment in favor of the debtor.
A few months later, the debtor collected the $15 million judgment. The debtor gave $750,000 of the proceeds to the lender in full satisfaction of the lender’s personal guarantee, given that the lender had already advanced more than $750,000.
Soon thereafter, the lender stopped making advances. By that time, the lender had advanced almost $900,000 to the LLC under the loan agreement. About one-third was for the debtor’s salary. The LLC stopped doing business and had not been able on its own income to pay the debtor’s salary or repay the lender’s loans.
Three years later, the debtor filed a chapter 7 petition. When the two-year statute of limitations was about to run, the chapter 7 trustee sued the lender in bankruptcy court, alleging that the lender’s receipt of the $750,000 was a constructively fraudulent transfer recoverable under Sections 544 and 550 and the Utah Uniform Fraudulent Transfer Act.
After several years of litigation, Chief Bankruptcy Judge Kevin R. Anderson of Salt Lake City granted summary judgment in favor of the lender and dismissed the adversary proceeding. The trustee appealed, to no avail.
Reasonably Equivalent Value
We recommend reading Judge Michael’s opinion to appreciate his refreshingly conversational language (e.g., “Value, like beauty, is often in the eye of the beholder. Reasonably equivalent value, perhaps even more so. But not always.”)
The trustee was operating on the theory that the debtor had not received reasonably equivalent value for paying off the $750,000 personal guarantee because the loan had been made to the LLC, and not all of the loan proceeds paid the debtor’s salary.
Judge Michael said that the Utah UFTA does not define reasonably equivalent value. However, he found a court in Utah that said that “the primary consideration in analyzing the exchange for value for any transfer is the degree to which the [debtor’s] net worth is preserved.”
In evaluating the grant of summary judgment in favor of the lender, Judge Michael examined the record to decide whether the bankruptcy court properly found reasonably equivalent value given to the debtor. Among other things, both sides agreed that the advances were direct loans to the debtor. Also, the loans paid the debtor’s salary and enabled the debtor to have an ownership interest in the LLC.
With regard to finding value in the debtor’s ownership interest in the LLC, Judge Michael cited the Third Circuit for saying that value is conveyed “so long as there is some chance that a contemplated investment will generate a positive return.” In that regard, he was not convinced that the LLC “was doomed from the start.”
Based on the plain language of the absolute and unconditional personal guarantee, Judge Michael rejected the trustee’s argument that the guarantee was a contingent liability, not antecedent debt. He said that the personal guarantee “plainly evinces the parties’ contemplation that [the debtor] would repay the loans regardless of the operation or success of [the LLC].”
Judge Michael found “nothing remarkable or nefarious” in the loans or the repayment of the loans and decided that the bankruptcy court had correctly determined that the debtor had received reasonably equivalent value for the $750,000. He affirmed the bankruptcy court’s grant of summary judgment in favor of the lender.
The Tenth Circuit Bankruptcy Appellate Panel declined an invitation to recharacterize a modestly complex transaction. Understanding the transaction as documented, the BAP upheld the bankruptcy court’s grant of summary judgment finding no constructively fraudulent transfer because the debtor had received reasonably equivalent value.
Writing for the BAP in an opinion on February 21, Bankruptcy Judge Terrence L. Michael said, “Dollar-for-dollar exchanges are seldom questioned; this appeal represents one such rare occasion.”