September 17, 2014 Articles

Young Lawyer Focus: Determining Insolvency and the Balance Sheet Test

Careful consideration must be given to many factors before interpreting this test's results.

By Jeffrey L. Baliban

Section 548 of the U.S. Bankruptcy Code discusses a trustee’s powers to avoid transfers of assets out of a company and repatriate them to the debtor’s estate when such a transfer of assets was fraudulent—either actually (i.e., with intent to hinder, delay, or defraud creditors) or constructively. Regarding constructively fraudulent transfers, a trustee must show that such transfers were made when the debtor was insolvent—or became insolvent as a result of the transfer—and that reasonably equivalent value was not received in exchange. (See my article in the Winter 2012 issue of this newsletter, “Measuring Reasonably Equivalent Value.”) Given that the concept of economic insolvency cannot be captured by any simple bright-line test, much time can be spent litigating whether the debtor was insolvent at the time of the transfer or was rendered insolvent as a result thereof.

Section 548 outlines three characteristics of insolvency, each of which gives rise to a specific test to determine the extent to which such characteristics existed at the time of the transfer. In this article, I focus on what is known as the balance sheet test. Note that while I will be dealing with the other two solvency tests in future submissions, discussing the balance sheet test first should not be taken to mean that it is primary, best, or somehow more able to identify insolvency. The other two tests—the ability-to-pay test and the capital adequacy test—analyze different aspects of financial capability. While these test names may sound self-explanatory, application of these tests is anything but mechanical, and careful consideration must be given to many factors before interpreting their results. However, the other tests provide for a confluence of insolvency indicia because a finding of insolvency under any one test does not ensure such a finding under all three. Multiple solvency tests, therefore, provide for a more reliable finding in terms of whether or not a firm was insolvent at the time of the asset transfer or rendered insolvent as a result  of it.

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