Restructuring

An important issue in determining whether a transfer is avoidable as a constructive fraudulent transfer is determining whether the debtor received reasonably equivalent value in exchange for the transfer.  If the debtor receives reasonably equivalent value in exchange for assets transferred prior to the bankruptcy, there is no constructive fraud.  While section 548(d)(2)(A) of the Bankruptcy Code defines “value” as “property or satisfaction or securing of a present or antecedent debt of the debtor,” the Bankruptcy Code does not define “reasonably equivalent value.”
Courts treat reasonably equivalent value as a question of fact and determine whether a value is reasonably equivalent on a case-by-case basis.  “Reasonably equivalent” is not synonymous with fair market value; instead, fair market value is one of a number of important elements in a “totality of the circumstances” analysis.  Another important element used in courts’ analysis is good faith.  A recent decision from the Bankruptcy Court for the District of Colorado, Mercury Companies, Inc. v. FNF Security Inc. (In re Mercury Companies, Inc.), advises that a purchaser’s mere knowledge of a seller’s financial distress does not preclude a finding of a good faith transfer.
Background
Prepetition, Mercury Companies, Inc.’s secured lender swept Mercury’s bank accounts, which, for reasons that are not explained in the decision, led Mercury to begin closing subsidiaries and downsizing operations and employees.  As a result of the downsizing, Mercury’s only remaining operations were its Colorado subsidiaries, which were engaged in the title business.  According to the court’s decision, approximately 30% of all real estate actions pending in Colorado were closed through offices of the Colorado subsidiaries.  Mercury’s management believed the subsidiaries were attractive assets to sell and, in fact, did sell several of its Colorado-based subsidiaries to defendant FNF Security Acquisition, Inc. 23 days before filing the debtor’s chapter 11 petition.  Postpetition, Mercury sought to recover the sale to FNF as a constructively fraudulent transfer under section 548(a)(1) of the Bankruptcy Code.
Mercury’s management wanted an immediate sale of stock, for several reasons.  First, it appears that management held an incorrect belief that the secured lender’s sweep of Mercury’s accounts left Mercury without sufficient cash to meet payroll, and therefore it had to resort to a quick sale of assets to make payroll.  The court found the evidence indicated Mercury did have sufficient cash to meet payroll – it had other property interests, including equity in a “land bank” and cash from its nonqualified deferred compensation plan ($13 million) and its overfunding of its health and benefits plan ($4 million).  Second, management mistakenly believed there was a risk that the Colorado Department of Insurance would close Mercury (although the decision does not describe why management held this belief).  These circumstances led management to “panic.”  As a result, management pursued a quick sale of the subsidiaries’ stock and offered a discounted price to get it.
Mercury first offered to sell the subsidiaries for $1 million to its largest underwriter, First American Title.  First American wanted to purchase only assets and requested additional time for due diligence.  Mercury then contacted FNF, another major national title insurance company, proposing a sale of the subsidiaries’ stock for $5 million.
The stock purchase agreement Mercury negotiated with FNF called for a purchase price of $5 million to be paid in cash.  After immediately wiring $1 million of the purchase price, Mercury transferred the shares free and clear of liens and claims, and FNF took control of the subsidiaries.  FNF later paid an additional $1,484,004 toward the purchase price directly to Mercury’s secured lender, in satisfaction of Mercury’s outstanding obligations to the lender.  As of the commencement of the fraudulent transfer proceeding, $2,515,996 of the purchase price was outstanding.
At trial, the parties agreed Mercury was insolvent on the date of the stock sale.  At issue was whether Mercury received reasonably equivalent value for the stock.  Mercury asserted that the Court should consider only the contract price and the value of the property, excluding evidence of good faith and arm’s length dealing.  FNF, however, contended that it proceeded in good faith, and the price was fair under the facts and circumstances surrounding the sale.
Bankruptcy Court’s Decision
The court found that a transferee’s good faith is not a requirement for establishing reasonably equivalent value, but can be considered as a component of the total circumstances surrounding a transaction for purposes of addressing reasonably equivalent value.  The court held that the mere fact that a transferee knows the debtor is distressed and wants to sell property immediately does not necessarily lead to a bright-line rule that good faith is lacking.  The arguably below-market price Mercury received for the sale of stock in certain of its subsidiaries was caused by management’s unwarranted “panic,” and not by FNF’s “coercion and sharp dealing.”  Mercury’s panic-induced desire for a quick sale at a discounted price did not remove the transaction from “the realm of fair market value,” and it received benefits from the immediate sale.
In its decision, the court questioned why experienced business people would have acted on the mistaken beliefs held by management rather than engaging in due diligence to obtain more accurate information.  For example, management could have verified what funds were available after the sweep—there was some evidence indicating management should have known that available funds were on deposit in accounts not affected by the lender’s sweep.  Mercury chose to proceed on an expedited basis, either ignoring information it had or knowing it had inadequate information.  Nonetheless, management’s panic was not the result of FNF’s actions and, importantly, Mercury came up with the $5 million purchase price – a substantial discount it offered to induce FNF to complete a quick sale.
The bankruptcy court noted that there might be circumstances where a purchaser’s knowledge of a debtor’s financial distress or insolvency might prevent a finding of good faith, but the facts and circumstances of this case supported “a finding of a willing seller offering to sell a valuable asset as a discount to get to a quick closing, and a buyer willing to forego a more typical, protracted ‘due diligence’ process to receive the valuable asset at a discounted price.”  In light of this, and having found that the debtor received value in exchange for the transfer, the court concluded that the transfer could not be avoided under section 548 of the Bankruptcy Code.
Conclusion
The Mercury Companies decision should provide some comfort to investors seeking to purchase assets from a would-be debtor.  Where the circumstances require it, a court may find “reasonably equivalent value,” even where under a different set of facts, the results might not be the same.