The Avoidance of Pre-Bankruptcy Transactions: A Comparative and Economic Approach

By Aurelio Gurrea-Martínez (Harvard Law School and Ibero-American Institute for Law and Finance)

Most insolvency jurisdictions provide several mechanisms to reverse transactions entered into by a debtor prior to the commencement of the bankruptcy procedure. These mechanisms, generally known as claw-back actions or avoiding powers, fulfill several economic goals. First, they act as an ex post alignment of incentives between factually insolvent debtors and their creditors, since the latter become the residual claimants of an insolvent firm but do not have any formal control over the debtor´s assets while the company is not yet subject to a bankruptcy procedure. Therefore, the existence of these mechanisms allows the prevention or, at least, reversal of opportunistic behaviors by factually insolvent debtors. Second, the existence of avoidance actions may also prevent, at an early stage, a destructive race to collect. Third, these legal devices also minimize the overinvestment problems potentially faced by insolvent debtors. Fourth, the existence of avoidance powers may encourage managers to take corrective actions in a timely manner. Finally, the existence of avoidance actions may also protect the interests of both the debtor and its creditors as a whole when some market participants want to take advantage of a distressed debtor.

However, the use—and even existence—of avoidance actions is not costless. On one hand, such actions bring litigation costs. On the other hand, the existence of these provisions may be harmful for legal certainty, especially in those countries in which bad faith is not required to avoid a transaction and the “twilight period” may be too long.

In a recent paper, I discuss how insolvency legislators should deal with this trade-off. Namely, by providing an economic and comparative analysis of avoidance actions, I discuss the optimal way to design claw-back actions across jurisdictions, taking into account the costs and benefits potentially generated by these provisions.

The full paper is available here.

Federal District Court Reinstates Fraudulent Transfer Challenge to Lyondell LBO

posted in: Avoidance | 0

By Richard G. Mason, David A. Katz, and Emil A. Kleinhaus (Wachtell, Lipton, Rosen & Katz)

In situations where leveraged buyouts prove unsuccessful, and the companies subject to the buyouts file for bankruptcy, it is not unusual for debtors or creditors’ committees to seek to challenge the LBOs on fraudulent transfer grounds.  In recent years, however, it is has become increasingly difficult to mount such challenges — at least in certain jurisdictions — as a result of judicial decisions that have broadly applied the Bankruptcy Code’s “safe harbor” for securities transactions to protect LBO participants from fraudulent transfer liability.

In a significant set of decisions, the District Court for the Southern District of New York has reinstated a fraudulent transfer claim to recover approximately $6.3 billion in distributions made to Lyondell Chemical shareholders in connection with Lyondell’s 2007 leveraged buyout. The decisions demonstrate that, despite the broad reach of the Bankruptcy Code’s “safe harbor,” LBOs may still be subject to challenge on fraudulent transfer grounds where the seller’s management is alleged to have acted with the actual intent to hinder, delay or defraud creditors.

The full memo is available here.

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