As a business descends into financial distress, it commonly enters into discussions with its creditors concerning a viable path forward to stave off a bankruptcy filing or liquidation. Either as the first step in a series of agreements or as part and parcel of a larger out-of-court restructuring, creditors often agree to forbear from pursuing collection remedies against the company or the collateral for a period. In return, the company may transfer money or property to the creditors—transfers that may or may not reduce the company's obligations—or incur additional debt. If, in a subsequent bankruptcy proceeding, the estate representative sues a given creditor for a fraudulent transfer based on the receipt of the money or property or a fraudulent incurrence of the additional obligation, then the creditor may well defend by claiming that the forbearance provided "value" to the debtor. Perhaps in conjunction with other benefits received by the debtor, the creditor will argue that it gave "reasonably equivalent value" and thus may defeat the fraudulent transfer action. In the resolution to that litigation, the creditor's liability may turn on whether and to what extent a court ascribes value to the forbearance. Below we discuss the legal and financial framework for addressing that question.
The Legal Introduction
Section 548(a)(1)(B) of the Bankruptcy Code—the constructive fraudulent transfer section—states in relevant part that a
trustee may avoid any transfer…of an interest of the debtor in property, or any obligation…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…received less than a reasonably equivalent value in exchange for such transfer or obligation and…was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation….1
Section 548(d)(2) defines value as "property, or satisfaction or securing of a present or antecedent debt of the debtor, but does not include an unperformed promise to furnish support to the debtor or to a relative of the debtor." "Value has been defined as that which provides an economic benefit, either direct or indirect, to the debtor."2 However, whether the value provided in a given case rises to the level of "reasonably equivalent value" requires a more searching inquiry. "There is no fixed mathematical formula for determining reasonably equivalent value; rather, the determination depends on all the facts of each case."3
Courts have routinely recognized that forbearance can comprise a component of reasonably equivalent value with respect to a fraudulent transfer analysis.4 Two relatively recent cases, however, show that courts at times reach a summary conclusion with respect to valuing forbearance without readily providing significant detail around the attendant calculations. These decisions demonstrate that forbearance provides legitimate benefits to the debtor, but they do not necessarily illuminate the path for parties that may face the issue in the next case.
In In re Positive Health Management, the debtor operated a pain management clinic in a building over which First National Bank held a security interest.5 The debtor, however, was not directly obligated on the mortgage debt to the bank; rather, the bank had a contractual relationship with a different entity.6 Nevertheless, the debtor made prepetition transfers directly to the bank, which then did not pursue foreclosure or other collection efforts against the property.7 After the debtor filed for bankruptcy, the Chapter 7 trustee sued the bank to avoid the payments as fraudulent transfers.8
After a trial to the bankruptcy court, the trustee argued to the district court that the bank had received $367,681.35 in prepetition payments, but the fair market rental value of the premises was only $253,333.33.9 Thus, the bank only "gave value" to the extent of the rental value, and the difference between the payments and the rental value—the difference was $114,348.02—should be avoided as a fraudulent transfer. The court disagreed, finding that the record at trial showed that the debtor had received value for the use of the building—that is, the rental value—and additional value in the form of the bank's forbearance from foreclosing on the property.10 That forbearance allowed the debtor "to engage in ongoing business operations to generate continued cash flow."11 Thus, while the court did not provide a detailed analysis, it necessarily concluded that the forbearance provided reasonably equivalent value to offset the $114,348.02 in payments above and beyond the rental value.
In In re Propex, the debtor had entered into a prepetition secured credit agreement with various lenders.12 Thereafter, on Jan. 26, 2007, the parties amended the credit agreement by waiving the debtor's obligations to comply with certain financial covenants for the fourth quarter of 2006 and relaxing the covenants for 2007 and the first quarter of 2008.13 In exchange, (i) the debtor made a $20 million payment, and (ii) the interest rate on the credit facility was increased.14 After the debtor filed for bankruptcy, the committee brought suit alleging that the amendment was a fraudulent transfer because the debtor received less than fair consideration for the cash payment and interest rate increase.15
On a motion to dismiss, the court quickly concluded that the debtor had received reasonably equivalent value as a matter of law with respect to the $20 million cash payment because that payment satisfied antecedent debt on a dollar for dollar basis.16 That conclusion is clearly correct as an application of black letter law. But the court also had to consider the other aspect of the transaction—the interest rate increase.
With respect to the interest rate increase, the court found that the waiver of the financial covenants for the fourth quarter of 2006 and the relaxing of the covenants for the next five quarters constituted reasonably equivalent value as a matter of law for the increase in interest rate.17 The committee argued that the waiver and covenant relaxation had no value, as there was no chance that the debtor could comply with the financial covenants (even as modified).18 The court disagreed:
[T]he lenders could have declared Propex in default, demanded immediate payment on all its obligations, and pursued all the remedies available to them by virtue of the default. By agreeing to forbear and to relax the financial covenants, the lenders gave Propex "'breathing room'—an opportunity to avoid default, to facilitate its rehabilitation, and to avoid bankruptcy." The court holds that that opportunity constitutes reasonably equivalent value for the interest rate increase as a matter of law, irrespective of the fact that "[t]he 'breathing room' turned out to be short-lived."19
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