Protecting All Corporate Stakeholders: Fraudulent Transfer Law as a Check on Corporate Distributions

Delaware Journal of Corporate Law, 2019

Posted: 19 Jun 2019

See all articles by Irina Fox

Irina Fox

Creighton University School of Law; U.S. Federal Courts; Latham & Watkins LLP

Date Written: April 1, 2019

Abstract

Debt-funded dividends is a recent aggressive practice that is a product of post-recession low interest rates. On numerous occasions, private-equity funds have forced the companies they invest in to borrow substantial sums of money to pay out a dividend. The companies that pay such dividends precipitously experience adverse consequences. With not enough cash to satisfy their operational needs and debt obligations, the companies’ credit ratings get downgraded. Liquidity issues cause these companies to quickly spiral into bankruptcy, in some instances resulting in liquidation. Depletion of corporate resources to pay dividends reverses the order of claim and interest repayment, putting shareholders ahead of creditors. An examination of the aggressive and risky strategy of financing dividends with borrowed funds reveals the need to reconcile state statutes imposing limitations on distributions with the standard that applies in fraudulent transfer actions. In addition to the current legal capital and insolvency limitations imposed by corporate law, statutes restricting dividends should specifically incorporate fraudulent transfer standards: dividends must be made unlawful if their distribution would violate fraudulent transfer laws. State-law restrictions on dividends have over the years ceased to serve their original purpose of protecting creditors. Several jurisdictions including Delaware apply lax standards for dividend authorization, allowing directors significant latitude in determining the corporation’s financial condition. Even modern statutes that test insolvency as an inability to pay debts when due in addition to a pure balance sheet calculation are inadequate and inconsistent with fraudulent transfer laws. Thus, directors often evade liability for authorizing dividends even if these dividends turn out to be fraudulent transfers. Yet, shareholder recipients of dividends may be defendants in future avoidance actions which allow creditors to recover the full amount of the payout. This Article argues that incorporation of fraudulent transfer standards into corporate-law statutes would provide uniformity and encourage careful decision-making by the board based on a diligent determination of solvency. Imposing liability on directors for authorizing fraudulent transfers would also foster responsible borrowing and entice the board to consider more productive alternatives.

Keywords: debt-funded dividends, leverage, recapitalization, fraudulent transfer, dividend, distribution, impairment of capital, insolvency

JEL Classification: K22

Suggested Citation

Fox, Irina, Protecting All Corporate Stakeholders: Fraudulent Transfer Law as a Check on Corporate Distributions (April 1, 2019). Delaware Journal of Corporate Law, 2019, Available at SSRN: https://ssrn.com/abstract=3402255

Irina Fox (Contact Author)

Creighton University School of Law ( email )

2500 California Plaza
Omaha, NE 68178

U.S. Federal Courts ( email )

500 Poydras Street, Room C-151
New Orleans, LA 70130
United States

Latham & Watkins LLP ( email )

505 Montgomery Streest
Suite 2000
San Francisco, CA 941116
United States

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