Husband was in the agriculture business in North Carolina, and owned and operated several companies, including Tanglewood Farms, Inc., which operated a granary.
In 2008, Husband arranged for a loan from a unrelated Lender in the amount of $600,000 and both Husband and his Wife individually, plus Tanglewood, executed a Promissory Note to the Lender. To secure repayment, Husband, Wife and Tanglewood gave the Lender a security interest in 113,208 corn bushels. The loan proceeds were deposited into the personal bank account of Husband and Wife, who then tendered back $50,000 to Tanglewood.
A couple of years later, things had not worked out financially, and so Husband and Wife voluntarily filed for Chapter 11 bankruptcy protection, and Tanglewood was also voluntarily placed into a Chapter 11 proceeding. A year later, Tanglewood's bankruptcy was converted to a Chapter 7, and a Trustee was appointed for Tanglewood. Eventually, it came out that the bushels of corn had been sold by Husband without the proceeds going to the Lender, who was left unsecured.
Among his other activities, the Trustee filed an adversary action against the Lender, seeking to set aside the Promissory Note and Security Agreement as to Tanglewood, on the basis that the transaction was a fraudulent transfer and therefore avoidable. The Lender moved to dismiss the adversary action, leading to this Opinion.
The issue was whether the $50,000 that Tanglewood received was worth it signing off on the $600,000 promissory note -- in fraudulent transfer parlance, whether the $50,000 constituted "reasonably equivalent value" for the $600,000 loan.
Section 548 of the Bankruptcy Code governs fraudulent transfers, and one of the key elements is that a party challenging a transfer (here, the Trustee) to prove that the transferred was not for "reasonably equivalent value", which is the identical phrase used in the Uniform Fraudulent Transfer Act outside of Bankruptcy.
In looking at value in a fraudulent transfer case, the focus is on what the debtor received that would similar value to creditors, what is known as "utility creditors".
For example, let's say that Bob sells his car to Jim. The car is worth $15,000 and, because Bob likes chocolate ice cream, Jim has $15,000 worth of chocolate ice cream delivered to Bob's house. In such a case, the chocolate ice cream would be of little value to creditors as opposed to the car (which creditors could readily sell for cash), and thus there would be no "value" from a fraudulent transfer viewpoint.
The issue of value is thus seen through the eyes of creditors, not the transferee. This is commensurate with the purpose of the fraudulent transfer laws which is to preserve the assets of the debtor for the benefit of unsecured creditors.
Here, the Lender protested that because the Lender had given up $600,000 (albeit $550,000 was retained by Husband and Wife personally) in exchange for a $600,000 promissory note from Tanglewood, that "reasonably equivalent value" was precisely satisfied -- $600,000 in cash for a $600,000 note.
The problem was, of course, that from the viewpoint of the Tanglewood as the debtor, it only received back $50,000 cash in exchange for giving a $600,000 promissory note, and that was not only a raw deal from its perspective, but nothing even close to "reasonably equivalent value".
And that is exactly how the Court ruled, and denied the Lender's Motion to Dismiss on essentially that basis.
Where this trips up planners is that they will often presume that because an asset received back by a debtor has the same tax value as what the debtor gave up, there could be no fraudulent transfer. This philosophy blissfully ignores the "utility to creditors" methodology of measuring value which is mandated by the fraudulent transfer laws.
In asset protection planning, it has become dogma that if a debtor exchanges liquid assets for an interest in a Limited Liability Company or Limited Partnership, the exchange will be for "reasonably equivalent value" and thus not challengeable as a fraudulent transfer.
English: ESPN College GameDay's Lee Corso in Lincoln, Nebraska: home of the Nebraska Cornhuskers... [+]
But as legendary football commentator Lee Corso would say, "Not so fast, my friend!" An interest in an LLC or LP is restricted so that it is not freely alienable -- in English, it cannot be easily sold, and might not be liquid at all if the other members or partners do not agree. Plus, as opposed to cash or other typical financial assets, an LLC or LP interest cannot be levied upon but instead is subject to an archaic "charging order" procedure that results in only a lien being placed on the debtor/member's economic right to distributions from the LLC or LP. Such usually does not constitute "reasonably equivalent value", since from the viewpoint of the creditor what was received by the debtor does not have the same utility (read: ability to liquidate for about the same price) as what the debtor put into the entity in exchange for the LLC or LP interest.
Nonetheless, the myth of the "for value" exchange of a vulnerable asset for an LLC or LP interest persists in asset protection marketing (which, by the way, has scarcely little to do with real-world asset protection planning.
The other place one sees asset protection schemes come a'cropper in this context involves sham loans, where a debtor has attempted to encumber some asset with a lien or mortgage -- but nothing was ever actually received back in consideration that would be of any utility to creditors. These liens can annoy creditors it is true, but they can also quickly put a debtor on the judge's wrong side when the bogus lien is exposed.
Cite As:
In re Tanglewood Farms, Inc., 2013 WL 692975 (Bk.E.D.N.C., Feb. 26, 2013). http://goo.gl/J2s7F
This article at http://onforb.es/14j5uK4 and http://goo.gl/lzSNe
