Making Fraudulent Transfer Law More Predictable

Abstract

The methods that bankruptcy courts have traditionally used to adjudicate fraudulent transfer claims have at times led to inconsistent, unpredictable, and inadvertently biased outcomes. However, recent legal and financial innovations may aid bankruptcy courts in assessing fraudulent transfer claims in large business bankruptcies. These innovations have the potential to diminish the importance of experts, increase consistency and predictability in fraudulent transfer law, de-bias and simplify judicial decision-making, and reduce the cost of capital for ex-ante value-creating leveraging transactions while deterring imprudent excess leverage.

Specifically, this chapter discusses the shift by bankruptcy courts toward market-implied probabilities of default and the growing sophistication of courts in applying these methods for purposes of solvency analysis. This new market-centered paradigm — coupled with recent innovations in the financial markets and finance theory — can enable fraudulent transfer law to more effectively achieve its historical policy objectives.

Although this chapter focuses on fraudulent transfer law, its potential applications are much broader. Market-implied probabilities of default can assist courts in deciding any controversy that requires a judicial determination of corporate solvency, whether the controversy pertains to fraudulent transfer, preference, or corporate directors’ duties. Market-implied probabilities of default can be calculated from any debt instrument that is traded in a liquid and reasonably informed market and for which a yield to maturity can be calculated, whether the instrument is a credit default swap, a corporate bond, or a bank loan. The applications are diverse and the ramifications are potentially vast.

This is a draft chapter that has been accepted for publication by Edward Elgar Publishing in the forthcoming Corporate Bankruptcy Handbook edited by Barry Adler due to be published in 2016.

Keywords: Solvency, Adequate Capitalization, Fraudulent Transfer, Fraudulent Conveyance, Voidable Transactions, Preference, Insolvent, Solvent, Default, Bankruptcy, Credit Default Swap, Corporate Bond Spread, Probability of Default, Recovery Rate, Credit Spread, Distress, Chapter 11, leverage, expert witness

JEL Classification: G33, K20, K4, K41, K42, A1, A11, B23, B41, C53, C78, D4, D8, D81, D84, D83, E37, E4, E43, E44, E47