BY MICHAEL KLEIN, ESQ. & JANET DEAN GERTZ, ESQ., COOLEY LLP
Recoveries from fraudulent conveyance lawsuits can be a significant source of recovery
for creditors of bankruptcy estates.
Because a plaintiff seeking to avoid a
prepetition transfer as constructively
fraudulent must demonstrate that the
debtor was insolvent or inadequately
capitalized at the time of the challenged
transfer, valuation analyses that support
allegations of insolvency are critical.
A recent opinion issued by the U.S.
Bankruptcy Court for the Southern
District of New York in Adelphia
Recovery Trust v. FPL Group, Inc.
(In re Adelphia Communs. Corp.), Adv.
Pro. No. 04-03295, 2014 Bankr. LEXIS
2011 (Bankr. S.D.N. Y. May 6, 2014),
demonstrates how accounting and
other forms of corporate fraud can
impact these analyses. In re Adlphia
Communications Corp. was a Chapter 11
case precipitated by a massive fraud
perpetrated by the debtor’s management,
Valuation is by nature more art than
a science, and testifying experts and
finders of fact are free to use any
number of methods to determine
solvency on a case by case basis.
The existence of fraud can
significantly affect valuations based on
a balance sheet analysis. The Adelphia
opinion demonstrates that when a
company’s historical financial records
are fraudulent or suspect, the best
method for proving solvency is through
evidence of market comparables, as
opposed to use of the more traditionally
favored discounted cash flow method.
In Adelphia, a trust established under the
cable television operator’s Chapter 11
plan was vested with a $150 million
fraudulent transfer claim against
defendants FPL Group Inc. and its affiliate
Mayberry Investments Inc. arising from a
prepetition stock repurchase transaction
that was consummated by the debtor
for the benefit of former management.
The repurchase occurred a mere three
months before the company borrowed
more than $3 billion, a transaction
that the court described as having “a
crushing effect on Adelphia’s solvency.”
A threshold question addressed by the
court was the precise date on which
Adelpia’s solvency should be tested. The
trust argued that the stock repurchase
encompassed a series of transactions,
including (i) the stock repurchase
itself, through which Adelphia paid
$150 million for the repurchase of its
own stock, and (ii) a subsequent stock
redemption more than eight months
later in which Adelphia affiliate Olympus
Communications L.P. made a second
purchase from FPL Group, redeeming
FPL's interest in a joint venture
partnership between Olympus and FPL.
Given the profound impact on the
company’s solvency of Adelphia’s entry
into the $3 billion facility during the
period between these two stock deals, the