Presenting a live 90-minute webinar with interactive Q&A Fraudulent Transfer Claims: LBOs and Sec. 546(e), Law Partner Profit Clawbacks, Jurisdiction, and Limiting Damages Leveraging Latest Case Law Developments in Bringing and Defending Against Claims in Fraudulent Transfer Recovery Litigation TUESDAY, JULY 22, 2014 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today’s faculty features: Michael E. Comerford, Of Counsel, Milbank Tweed Hadley & McCloy , New York Corey R. Weber, Partner, Ezra Brutzkus Gubner , Woodland Hills, Calif. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10 .
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Fraudulent Transfer Claims: LBOs and Sec. 546(e), Law Partner Profit Clawbacks, Jurisdiction, and Limiting Damages Leveraging Latest Case Law Developments in Bringing and Defending Against Claims in Fraudulent Transfer Recovery Litigation July 22, 2014 Michael E. Comerford Corey R. Weber Of Counsel Partner Milbank, Tweed, Hadley & M c Cloy LLP Ezra Brutzkus Gubner LLP mcomerford@milbank.com cweber@ebg-law.com The views and opinions expressed herein are those of the authors and do not necessarily reflect the views of Milbank, Tweed, Hadley & McCloy LLP or Ezra Brutzkus Gubner LLP, their affiliates, or their employees.
Table of Contents Page • Leveraged Buy-Out Transactions and the Limitations of Section 546(e) Safe Harbors 7 • Limits on Fraudulent Transfer Damages 35 • Clawbacks From Law Firms Or Former Partners Based On “Unfinished Business” 44 • The U.S. Supreme Court’s Ruling In Executive Benefits Insurance Agency V. Arkison 67 6
SECTION I Leveraged Buy-Out Transactions and the Limitations of Section 546(e) Safe Harbors 7
Leveraged Buy- Out (“ LBO ”) Transactions – Basic Structure • LBO, generally: A company borrows funds to finance the purchase of its own outstanding stock • LBOs are the typical investment method for private equity firms, but can arise in other contexts as well. • LBOs are attractive to new purchasers because financing costs of the acquisition are incurred by the asset, itself, rather than the new purchaser. • Generally, this structure is attractive to the LBO sponsor (e.g., a private equity fund), which is able to pay relatively little in cash and finance the bulk of the transaction with debt in the target company. • Private equity LBO structure is similar to a typical down payment on a house, except that the house ( i.e. , the asset), rather than the buyer is the borrower on the mortgage. 8
Typical LBO Structure Bank debt/ Existing Senior credit lenders facility and bond- holders Limited Partners LBO High yield / (Pension funds, Financial Target Purchase insurance companies, Sponsor Mezzanine Price individuals, Company (GP) debt endowments, fund-of- Proceeds funds, family offices, etc. Private Selling Equity Fund Private share- (Limited Partnership) holders Equity (Preferred / Common Stock) 9
MacMenamin’s Grill: “Classic LBO writ Small” • MacMenamin’s Grill is an example of a much smaller, simpler LBO transaction. • Clark, Mooney and Hantho each owned 31% of outstanding stock in MacMenamin’s Grill in New Rochelle, New York (the “ Restaurant ”). • On August 31, 2007, the Company entered into two contemporaneous transactions: • SBA Loan : Restaurant borrowed $1.15 million through a federally-backed small business loan • Stock Purchase : Restaurant bought out Clark, Mooney, and Hantho for approximately $1.15 million. • The Restaurant became insolvent upon closing the transaction. • On November 18, 2008, the Restaurant filed for bankruptcy. 1 1 In re MacMenamin’s Grill Ltd. , 450 B.R. 414, 417-18 (Bankr. S.D.N.Y. 2011) 10
MacMenamin’s Grill : Simplified LBO Structure LENDER $1.15 million federally-backed small business loan MACMENAMIN’S GRILL 93% of Outstanding $1.15 million cash Stock EXISTING SHAREHOLDERS 11
LBOs and Fraudulent Transfer Risk • The amount of debt incurred in an LBO transaction can put significant pressure on the target company. • A bankruptcy trustee (or debtor in possession) has the authority to avoid a fraudulent transfer (or obligation fraudulently incurred by the debtor) under sections 548 or 544 of the Bankruptcy Code. • Debt level may leave a leveraged company susceptible to economic downturns. A successful LBO enables the leveraged company to repay the buy-out debt from cash flow or sale of assets. • The economic downturn contributed to the prevalence of restructurings and bankruptcies following failed LBOs, and has resulted in increased scrutiny of LBOs. • It can be questionable whether a target company receives sufficient benefit or value for incurrence of debt and grant of security. • The typical upstream transfer (loan proceeds to shareholders) could be deemed fraudulent. 12
Overview of Fraudulent Transfer Actions • Section 548 of the Bankruptcy Code provides two types of fraudulent transfer actions: • Actual fraudulent transfer actions (section 548(a)(1)(A)), and • Constructive fraudulent transfer actions (section 548(a)(1)(B)) • Section 544 of the Bankruptcy Code ( i.e. , the trustee’s strong arm powers) incorporates state law remedies that are very similar to section 548 and actions may be brought under this provision because certain states have a longer reach-back period than the federal analog in section 548. 13
Actual Fraudulent Transfer: Section 548(a)(1)(A) • For a successful actual fraudulent transfer claim, it must be demonstrated that: • There was a transfer of an interest of the debtor in property or any obligation incurred by the debtor, • The transfer must have been made or incurred within two years of the petition date (or, if brought under state law, within the relevant statute of limitations in the state), and • The transfer was made with the actual intent to hinder, delay or defraud a creditor. • LBOs are not typically challenged as intentional fraudulent transfers. 14
Constructive Fraudulent Transfer: Section 548(a)(1)(B) • Under constructive fraud, a transfer is deemed fraudulent if: • The debtor received less than reasonably equivalent value in exchange for the transfer, and • The debtor: – Was insolvent on the date of the transfer or became insolvent as a result of the transfer, – Was engaged or about to engage in a business transaction for which any property remaining with the debtor was an unreasonably small capital, or – Intended to incur or believed that it would incur debt that would be beyond the debtor’s ability to repay as such debts matured. 15
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