Technological innovation has changed the landscape of domestic natural gas production from shortage to surplus. The result: a glut of natural gas and historically low prices. While many producers have successfully hedged against this risk to date, as older hedges roll off, many companies are unable to obtain replacement hedges at attractive prices. Some have even resorted to monetizing their in-the-money hedges to raise capital today (and borrowing against the future). In order to meet capital obligations, some natural gas companies are forced into selling reserves exactly when gas prices are at record lows – creating a buyer’s market for the acquisition of distressed natural gas assets.
Before seizing upon a deal that appears too good to be true, buyers should consider that the transaction may be challenged years later as a fraudulent transfer, leaving the bargain buyer without the assets and nothing but an unsecured claim against an insolvent seller. A sophisticated buyer needs to know the ground rules.
There are two types of fraudulent transfers: transfers made with an actual intent to hinder, delay or defraud creditors, and transfers that are “constructively” fraudulent, meaning transfers that the law deems fraudulent. Generally, under bankruptcy law and most states’ laws, transfers are constructively fraudulent if the seller (1) receives less than reasonably equivalent value for what is sold and (2) the seller was insolvent, undercapitalized or unable to pay its debt as they came due either at the time of the transfer or as a result of the transfer. In most instances, a sale can be challenged as a fraudulent transfer by the seller’s creditors within two years under the bankruptcy code, and possibly longer under state law.
The easiest way to avoid a constructive fraudulent transfer claim is to pay reasonably equivalent value for what you buy. If a company trades one asset for another of equal value, its creditors cannot claim to have been harmed. Its balance sheet stays the same. However, it is not always easy to determine reasonably equivalent value during difficult economic times.
How does the smart purchaser protect itself from fraudulent transfer risk? While there are no failsafe strategies, reasonably equivalent value may be established by:
- appraisals or valuations made by well-recognized third party experts immediately before a purchase;
- a recent valuation performed on behalf of the seller’s secured lenders accompanied by the lenders’ consent;
- comparable prices for similar assets in a public market; and
- sales prices secured at properly advertised public sales for comparable assets.
Insider transactions present the greatest fraudulent transfer risks. Insider purchases are highly likely to be challenged as fraudulent transfers if the seller is unable to pay its creditors after the sale. While payment of reasonably equivalent value should offset claims of a fraudulent transfer, insider transactions are often challenged as having been made with actual intent to hinder, delay or defraud creditors.
Insider relationships can be pervasive in the corporate context. A corporation, its affiliate corporations, the officers and directors of either, and certain shareholders may all be insiders of each other. As a result, transactions between them are likely to be subject to heightened scrutiny because of the risk of a sweetheart, non-arm’s length deal. In assessing actual fraudulent transfer risk, the parties need to consider the transaction from the perspective of the selling entity’s creditors. Does the transaction have the indicia of an arm’s length transaction for reasonably equivalent value? Concealed transactions are more likely to raise suspicion than disclosed and transparent transactions. For example, a competitive public sale process is far less likely to be scrutinized for fraudulent conduct, even in today’s economic environment where no competing bidders may participate.
In some circumstances, it may be preferable (or necessary) to acquire distressed assets through a Chapter 11 bankruptcy proceeding.