Lender's Earlier Cash Advance Protects the Later Grant of a Security Interest From Attack as a Fraudulent Conveyance
April 7, 2006
Michael Weissman - Chicago
In Applied Theory Corporation, 330 B.R. 362 (S.D.N.Y. 2005), the issue was whether a pre-petition grant of a security interest could be attacked by the bankrupt debtor as a fraudulent conveyance. The court held that it could not.
A group of lenders had made a $30 million cash loan to the debtor on June 5, 2000, receiving in exchange $30 million in convertible debentures maturing June 5, 2003. The debtor was obligated to register the shares issuable upon conversion of the debentures but failed to do so.
Instead of calling the debentures and demanding payment the lenders negotiated with the debtor. As a result of these negotiations, modifications were made to the debentures in January and July of 2001. In July of 2001, the lenders agreed to loan an additional $6 million to the debtor under a revolving credit agreement. To secure the June 2000 loan, as well as the July 2001 loan, the debtor granted the lenders a security interest in all of its assets, that were worth $18 million.
On April 17, 2002, the debtor went into bankruptcy. In the course of the bankruptcy, the debtor tried to set aside the security interest as a fraudulent conveyance.
The court began its analysis by stating that “we must only determine whether the prior receipt of a $30 million cash loan constitutes reasonably equivalent value for the granting of the security interest.” Stating that the Bankruptcy Code defines “value” to include the “securing of a present or antecedent debt of the debtor,” the court said it would apply the New York approach and hold that the $30 million loan was per se reasonably equivalent value.
The court flatly rejected the approach adopted by some other courts, that engage in a fact-based analysis to determine whether the debtor received reasonably equivalent value. However, the court did make it abundantly clear that the rule it was applying was pertinent only where the antecedent debt arose from an actual cash loan. Securing an earlier guaranty, given at the behest of the debtor, with the grant of a security interest would not, in the view of the court, call for application of the per se rule.
What’s the Point?
The court’s ruling follows the New York rule that the pre-petition grant of a security interest in exchange for an earlier cash loan cannot be set aside in a subsequent bankruptcy proceeding as a fraudulent conveyance.
For more information, e-mail Michael L. Weissman at michael.weissman@hklaw.com or call toll free, 1-888-688-8500.