Side-Stepping Exposure to Bankruptcy Litigation: Fraudulent Transfers and Centralized Cash Management Systems

By Giaimo, Christopher; Workman, Donald et al. | Business Credit, May 2014 | Go to article overview

Side-Stepping Exposure to Bankruptcy Litigation: Fraudulent Transfers and Centralized Cash Management Systems


Giaimo, Christopher, Workman, Donald, Kessler, Dena, Business Credit


Account managers may consider receiving payments from a customer as an unequivocal victory, but they might want to take a closer look at who is actually making the payment before celebrating too much. A careful analysis may avoid being drawn in to what is a growing trend in large Chapter 11 bankruptcy cases: fraudulent transfer claims related to centralized cash management systems. By receiving payments from an entity different from the one it contracted with, a vendor may be exposing itself to fraudulent transfer liability. While courts are still sorting through these issues, creditors can try to avoid this headache by understanding the issues involved and taking certain preventative measures.

Fraudulent Transfer Actions: What Are They?

A debtor can try to recover certain transfers of assets it made shortly before filing for bankruptcy, including those deemed a "fraudulent transfer." Of the two kinds of fraudulent transfers--"actually fraudulent" and "constructively fraudulent"--corporate debtors more often pursue transfers under the theory that they are constructively fraudulent. Constructive fraud is found where the debtor received less than "reasonably equivalent value" in exchange for the transfer and the debtor:

(1) was rendered insolvent as a result of the transfer;

(2) was engaged in or about to engage in a business or transaction for which the debtor's remaining assets after the transfer were unreasonably small in relation to its business; or

(3) believed or should have reasonably believed that after the transfer it would incur debts beyond its ability to pay them as they became due.

For example, if a company transfers its only asset, a piece of land worth $50 million, to a creditor to satisfy a debt of $500,000 and the company soon files for bankruptcy, the debtor may recover the land on the basis that it did not receive reasonably equivalent value.

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A debtor can recover fraudulent transfers that occurred two years before filing for bankruptcy, and sometimes longer depending on the relevant states fraudulent transfer law.

Centralized Cash Management Systems and How They Relate to Fraudulent Transfers

Though not exclusively, most centralized cash management systems (CMS) are used by complex corporate entities that have multiple divisions and subsidiaries, and are generally structured with a parent holding company and operating subsidiaries. While the exact arrangements may vary, the basic concept is simple: the operating subsidiaries do not maintain individual bank accounts, but rather "upstream" cash to the parent corporation. The parent corporation pools cash from all of its operating subsidiaries and uses those pooled funds to pay expenses for the operating subsidiaries, including payments to third-party vendors that contract with the subsidiary rather than the parent, and provide goods and services directly to the subsidiary and not to the parent. Even though the cash is generated by the subsidiary, once a subsidiary upstreams its cash to the parent, that money belongs to the parent. The parent may not be legally obligated to pay the subsidiaries' expenses, but the system benefits the parent and the subsidiaries by reducing administrative costs and providing the parent flexibility by allowing it to allocate cash where needed.

For example, Vendor V may have a contract with Subsidiary S to provide S software for S's operations. S is a wholly owned subsidiary of Parent P and all of S's cash is upstreamed to P, which is simply a holding company with no independent operations. P is not a party to the software agreement between S and V, and P is not obligated to pay S's bills, but it does so for its own administrative ease. P cuts a check to V to pay for the software it provided to S even though: (1) P does not use the software V provided; and (2) P was not obligated to pay S's software expenses. …

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