Leveraged Buyouts and Fraudulent Transfers

In recent years leveraged buyouts have become more common in the business world despite opposition from courts. Although leveraged buyouts are not per se fraudulent, creditors may look to fraudulent transfer law to avoid the transfer made by a corporation if it fails to pay its debts.

In simplest terms, a leveraged buyout is a transaction in which the purchase of shares of in a corporation is financed by the corporation itself or secured by the assets of the corporation. In essence, the corporation makes available its own funds or other assets to enable the buyer to finance the purchase of its shares. The expectation is that the corporate assets will be restored over time from future profits that the buyer will make from the operation of the corporation’s business.

Leveraged Buyouts Structures

Leveraged buyouts are structured in many different ways. One method is for the corporation to allow the buyer to use its unencumbered assets to secure the purchase price of the shares.

The seller may give the buyer credit for the price of the shares and secures this credit by having the corporation grant a security interest in its assets. However, if the business does not produce large enough profits, the debt will not be repaid, and the assets will be foreclosed upon. The risk of failure is borne not only by the corporation, but also by its unsecured creditors who have lost the protection of recourse to unencumbered assets.

Purpose of a Leveraged Buyout

Some people view leveraged buyouts as serving useful purposes, such as facilitation of changes in corporate management, the promotion of efficiency, and the enhancement of investment opportunities.

Yet, others feel that leveraged buyouts are manipulative devices that result in the plunder of corporate assets and the imposition of crippling debt on a formerly viable corporation. Thus, fraudulent transfer law can serve the useful purpose of shifting risk of the corporation’s failure from the creditors to the parties who were responsible for the arrangements.

Many times it is necessary to consult with an attorney if your company or business is facing financial difficulty.  If you need help with corporate reorganization, consult with Lanigan and Lanigan, P.L., Attorneys Eric and Roddy Lanigan can help your company resolve the financial and legal challenges that occur with corporate reorganizations like leveraged buyouts.