Overextending_Insolvency Tests Mainuvta04b2testinsolvencyoverextending
OVEREXTENDING INSOLVENCY TEST
OVEREXTENDING INSOLVENCY TEST § 4(a)(2)(i)
(a) A transfer made or obligation incurred by a debtor is voidable as to a creditor, whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation:
(2) without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor:
(i) was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction . . ..
Reporter's Comment to § 4(a)(2)(i) cmt. 3.
Section 4(a)(2) is derived from §§ 5 and 6 of the Uniform Fraudulent Conveyance Act but substitutes “reasonably equivalent value” for “fair consideration.”
The transferee’s good faith was an element of “fair consideration” as defined in § 3 of the Uniform Fraudulent Conveyance Act, and lack of fair consideration was one of the elements of a fraudulent transfer as defined in four sections of the Uniform Fraudulent Conveyance Act.
The transferee’s good faith is irrelevant to a determination of the adequacy of the consideration under this Act, but lack of good faith may be a basis for withholding protection of a transferee or obligee under § 8.
Reporter's Comment to § 4(a)(2)(i) cmt. 4.
Unlike the Uniform Fraudulent Conveyance Act, this Act does not prescribe different tests for voidability of a transfer that is made for the purpose of security and a transfer that is intended to be absolute.
The premise of this Act is that when a transfer is for security only, the equity or value of the asset that exceeds the amount of the debt secured remains available to unsecured creditors and thus cannot be regarded as the subject of a voidable transfer merely because of the encumbrance resulting from an otherwise valid security transfer.
Disproportion between the value of the asset securing the debt and the size of the debt secured does not, in the absence of circumstances indicating a purpose to hinder, delay, or defraud creditors, constitute an impermissible hindrance to the enforcement of other creditors’ rights against the debtor-transferor. Cf. U.C.C. § 9-401(b) (2014) (providing that a debtor’s interest in collateral subject to a security interest is transferable notwithstanding an agreement with the secured party prohibiting transfer).
Reporter's Comment to § 4(a)(2)(i) cmt. 5.
Subparagraph (i) of § 4(a)(2) is an adaptation of § 5 of the Uniform Fraudulent Conveyance Act but substitutes “unreasonably small [assets] in relation to the business or transaction” for “unreasonably small capital.”
The reference to “capital” in the Uniform Fraudulent Conveyance Act might be interpreted, incorrectly, to refer to the par value of stock or to the consideration received for stock issued.
The special meanings of “capital” in corporation law have no relevance in the law of voidable transfers.
The subparagraph focuses attention on whether the amount of all the assets retained by the debtor was inadequate, i.e., unreasonably small, in light of the needs of the business or transaction in which the debtor was engaged or about to engage.
This is the "Overextending Insolvency Test". One might reduce it to two elements:
1. The debtor did not receive reasonable equivalent value; and
2. The debtor did not have the financial strength to pay whatever debts the debtor was about to incur.
This test applies without regarding to whether the claim occurred before the transfer or vice versa, i.e., it applies to future creditors and to existing creditors alike.
The phrase "unreasonably small" injects a factual uncertainty into this test, thus making it more difficult for a creditor to win on this test on summary judgment than the Insolvency Test, which carries no such uncertainty -- under the Insolvency Test, the debtor is either insolvent according to a balance sheet test or not. Whether the assets of the debtor are "unreasonably small" should be measured objectively according to a hypothetical "reasonable man" and not subjectively according to the intent of the debtor.
BURDEN OF PROOF
§ 4(c) A creditor making a claim for relief under subsection (a) has the burden of proving the elements of the claim for relief by a preponderance of the evidence.
Prefatory Note (UVTA 2014): Evidentiary Matters.
New §§ 4(c), 5(c), 8(g), and 8(h) add uniform rules allocating the burden of proof and defining the standard of proof with respect to claims for relief and defenses under the Act.
Language in the former comments to § 2 relating to the presumption of insolvency created by § 2(b) has been moved to the text of that provision, the better to assure its uniform application.
Reporter's Comment to §4(c) cmt. 10 ¶ 1.
Subsection (c) was added in 2014. Sections 2(b), 4(c), 5(c), 8(g), and 8(h) together provide uniform rules on burdens and standards of proof relating to the operation of this Act.
Reporter's Comment to §4(c) cmt. 10 ¶ 2.
Pursuant to subsection (c), proof of intent to “hinder, delay, or defraud” a creditor under § 4(a)(1) is sufficient if made by a preponderance of the evidence.
That is the standard of proof ordinarily applied in civil actions. Subsection (c) thus rejects cases that have imposed an extraordinary standard, typically “clear and convincing evidence,” by analogy to the standard commonly applied to proof of common-law fraud.
That analogy is misguided.
By its terms, § 4(a)(1) applies to a transaction that “hinders” or “delays” a creditor even if it does not “defraud,” and a transaction to which § 4(a)(1) applies need not bear any resemblance to common-law fraud. See Comment 8.
Furthermore, the extraordinary standard of proof commonly applied to common-law fraud originated in cases that were thought to involve a special danger that claims might be fabricated.
In the earliest such cases, a court of equity was asked to grant relief on claims that were unenforceable at law for failure to comply with the Statute of Frauds, the Statute of Wills, or the parol evidence rule.
In time, extraordinary proof also came to be required in actions seeking to set aside or alter the terms of written instruments. See Herman & MacLean v. Huddleston, 459 U.S. 375, 388-89 (1983) and sources cited therein.
Those reasons for extraordinary proof do not apply to claims for relief under § 4(a)(1).
Reporter's Comment to §4(c) cmt. 10 ¶ 3.
For similar reasons, a procedural rule that imposes extraordinary pleading requirements on a claim of “fraud,” without further gloss, should not be applied to a claim for relief under § 4(a)(1).
The elements of a claim for relief under § 4(a)(1) are very different from the elements of a claim of common-law fraud.
Furthermore, the reasons for such extraordinary pleading requirements do not apply to a claim for relief under § 4(a)(1).
Unlike common-law fraud, a claim for relief under § 4(a)(1) is not unusually susceptible to abusive use in a “strike suit,” nor is it apt to be of use to a plaintiff seeking to discover unknown wrongs.
Likewise, a claim for relief under § 4(a)(1) is unlikely to cause significant harm to the defendant’s reputation, for the defendant is the transferee or obligee, and the elements of the claim do not require the defendant to have committed even an arguable wrong. See Janvey v. Alguire, 846 F.Supp.2d 662, 675-77 (N.D. Tex. 2011); Carter-Jones Lumber Co. v. Benune, 725 N.E.2d 330, 331-33 (Ohio App. 1999). Cf. Federal Rules of Civil Procedure, Appendix, Form 21 (2010) (illustrative form of complaint for a claim for relief under § 4(a)(1) or similar law, which Rule 84 declares sufficient to comply with federal pleading rules).
Reporter's Comment to §4(c) cmt. 11.
Subsection (c) allocates to the party making a claim for relief under § 4 the burden of persuasion as to the elements of the claim. Courts should not apply nonstatutory presumptions that reverse that allocation, and should be wary of nonstatutory presumptions that would dilute it.
The command of § 13—that this Act is to be applied so as to effectuate its purpose of making uniform the law among states enacting it—applies with particular cogency to nonstatutory presumptions.
Given the elasticity of key terms of this Act (e.g., “hinder, delay, or defraud”) and the potential difficulty of proving others (e.g., the financial condition tests in § 4(a)(2) and § 5), employment of divergent nonstatutory presumptions by enacting jurisdictions may render the law nonuniform as a practical matter.
It is not the purpose of subsection (c) to forbid employment of any and all nonstatutory presumptions. Indeed, in some instances a judicially-crafted presumption applied under this Act or its predecessors has won such favor as to be codified as a separate statutory creation.
Examples include the bulk sales laws, the absolute priority rule applicable to reorganizations under Bankruptcy Code § 1129(b)(2)(B)(ii) (2014), and the so-called “constructive fraud” provisions of § 4(a)(2) and § 5(a) of this Act itself.
However, subsection (c) and § 13 mean, at the least, that a nonstatutory presumption is suspect if it would alter the statutorily-allocated burden of persuasion, would upset the policy of uniformity, or is an unwarranted carrying-forward of obsolescent principles.
An example of a nonstatutory presumption that should be rejected for those reasons is a presumption that the transferee bears the burden of persuasion as to the debtor’s compliance with the financial condition tests in § 4(a)(2) and § 5, in an action under those provisions, if the transfer was for less than reasonably equivalent value (or, as another example, if the debtor was merely in debt at the time of the transfer). See Fidelity Bond & Mtg. Co. v. Brand, 371 B.R. 708, 716-22 (E.D. Pa. 2007) (rejecting such a presumption previously applied in Pennsylvania).
DEFENSES PECULIAR TO §§ 4(a)(2) AND 5
§ 8(e) A transfer is not voidable under Section 4(a)(2) or Section 5 if the transfer results from:
A creditor cannot void all but an intent-based fraudulent transfer if it involves: (1) Termination of a lease; or (2) Enforcement of a UCC Article 9 security interest.
(1) termination of a lease upon default by the debtor when the termination is pursuant to the lease and applicable law; or
Reporter's Comment to § 8(a) cmt. 5.
Subsection (e)(1) rejects the rule adopted in Darby v. Atkinson (In re Farris), 415 F.Supp. 33, 39-41 (W.D.Okla. 1976), that termination of a lease on default in accordance with its terms and applicable law may constitute a voidable transfer.
(2) enforcement of a security interest in compliance with Article 9 of the Uniform Commercial Code, other than acceptance of collateral in full or partial satisfaction of the obligation it secures.
Prefatory Note (UVTA 2014). Defenses.
The amendments refine in relatively minor respects several provisions relating to defenses available to a transferee or obligee, as follows: (3) Section 8(e)(2) as originally written created a defense to an action under § 4(a)(2) or § 5 to avoid a transfer if the transfer results from enforcement of a security interest in compliance with Article 9 of the Uniform Commercial Code.
The amendments exclude from that defense acceptance of collateral in full or partial satisfaction of the obligation it secures (a remedy sometimes referred to as “strict foreclosure”).
Reporter's Comment to § 8(e)(2).
Subsection (e)(2) protects a transferee that acquires a debtor’s interest in an asset as a result of the enforcement by a secured party (which may but need not be the transferee) of rights pursuant to and in compliance with the provisions of Part 6 of Article 9 of the Uniform Commercial Code. Cf. Calaiaro v. Pittsburgh Nat’l Bank (In re Ewing), 33 B.R. 288, 9 C.B.C.2d 526, CCH B.L.R. ¶ 69,460 (Bankr. W.D.Pa. 1983) (sale of pledged stock held subject to avoidance under § 548 of the Bankruptcy Code), rev’d, 36 B.R. 476 (W.D.Pa. 1984) (transfer held not voidable because deemed to have occurred more than one year before bankruptcy petition filed).
The global requirement of Article 9 that the secured party enforce its rights in good faith, and the further requirement of Article 9 that certain remedies be conducted in a commercially reasonable manner, provide substantial protection to the other creditors of the debtor. See U.C.C. §§ 1-304, 9-607(b), 9 610(b) (2014).
The exemption afforded by subsection (e)(2) does not extend to acceptance of collateral in full or partial satisfaction of the obligations it secures.
That remedy, contemplated by U.C.C. §§ 9-620–9-622 (2014), is sometimes referred to as “strict foreclosure.”
An exemption for strict foreclosure is inappropriate because compliance with the rules of Article 9 relating to strict foreclosure may not sufficiently protect the interests of the debtor’s other creditors if the debtor does not act to protect equity the debtor may have in the asset.
BANKRUPTCY CODE § 548(a)(1)(B)(II) AND (III)
(1) The trustee may avoid any transfer (including any transfer to or for the benefit of an insider under an employment contract) of an interest of the debtor in property, or any obligation (including any obligation to or for the benefit of an insider under an employment contract) incurred by the debtor, that was made or incurred on or within 2 years before the date of the filing of the petition, if the debtor voluntarily or involuntarily—
(i) received less than a reasonably equivalent value in exchange for such transfer or obligation; and
(II) was engaged in business or a transaction, or was about to engage in business or a transaction, for which any property remaining with the debtor was an unreasonably small capital;
(III) intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor’s ability to pay as such debts matured; . . .
OVEREXTENDING INSOLVENCY OPINIONS