As noted in Part 1 of this series, any buyer of assets from a company in any degree of financial stress should be concerned about the transaction being attacked as a fraudulent transfer. Officers and directors of a selling entity also have concerns about this risk due to potential personal liability. Such an attack can result in the transaction being “undone” (with the parties being returned to their positions prior to the transaction) or, since it is often difficult to return the parties to their prior positions, such an attack can result in a judgment against the buyer and selling officers and directors for the difference between what the buyer paid and what the court determines the buyer should have paid. Most parties mitigate this risk by getting certain information prior to closing their transaction. But the adequacy of that information is debatable until litigation is pursued.
On December 12, 2013, after 34 trial days involving 68 witnesses (including 14 expert witnesses) and over 6,000 exhibits, the U.S. Bankruptcy Court for the Southern District of New York entered a 166 page memorandum opinion holding that certain affiliates of Anadarko Petroleum owed Tronox somewhere between $5 billion and $14 billion as damages for a fraudulent transfer that began in 2002 and was completed in 2006. Several months later, the parties settled for about $5 billion, subject to a public comment period and court approval that remains pending.
The ruling addresses many issues, each of which was hotly contested. A complete discussion of all these issues is beyond the scope of this post. Part 1 of this series discussed the facts in Tronox, the typical methods used to minimize fraudulent transfer liability, and the first lesson from Tronox – the relevant statute of limitations.
Proof of Legitimate Business Purposes Other Than to Hinder Delay or Defraud Creditors.
One type of fraudulent transfer claim is “actual” fraud – that the buyer and seller arranged the transfer with intent to “hinder, delay or defraud” the seller’s creditors. Proving “intent” is difficult unless the parties make incriminating admissions. Instead, “intent” often is implied based on various “badges of fraud.” Buyers often dispute the requisite intent by asserting numerous independent reasons for the transaction other than to “hinder, delay, or defraud” the seller’s creditors.
In Tronox, the court acknowledged that Anadarko established that Tronox had many reasons for entering the disputed transfers, such as concerns about fair valuation of the combined chemical and oil businesses in comparison to stand-alone chemical and gas companies, and concerns about future business opportunities (rather than historical liabilities). But the bankruptcy court held that these independent reasons for entering the transfers are irrelevant if Tronox knew that the consequence of entering the transfers was to hinder, delay or defraud creditors. The bankruptcy court also held the testimony on this point was not credible based on (a) “mordant humor” from the investment banker showing a weed choking a flower (to show how the chemical company – the weed – was depriving the gas company – the flower – from realizing its full value), (b) board minutes, memos and presentations that clearly focused on legacy liability issues to justify the actions taken, and (c) subsequent destruction of records making evidence on this point unavailable.
Thus, the third lesson from Tronox is that the business records surrounding and supporting a transaction need to (a) be preserved, and (b) show truly independent business reasons for a transfer without any intended consequence to hinder, delay or defraud creditors. In this regard, drafts of board documents can be just as important as the final documents because changes from the drafts to the final documents were highlighted in the Tronox case to prove intent to defraud.