In a bankruptcy proceeding, a trustee may avoid transfers made, or obligations incurred, by the debtor during the two years prior to the filing date, if the transfer or obligation was actually or constructively fraudulent. 11 U.S.C. § 548(a). The Ninth Circuit recently considered whether a transfer made to pay a purported debt was constructively fraudulent, finding that the Bankruptcy Code requires courts to apply state law. In re Fitness Holdings International, Inc., No. 11-56677, slip op. (9th Cir., Apr. 30, 2013). The court articulated a procedure for evaluating a purported debt, and it held that courts have the authority to recharacterize a debt under certain circumstances.
The debtor, Fitness Holdings International (FHI), signed multiple promissory notes to its sole shareholder, Hancock Park (HP), in exchange for over $24 million in funding from 2003 to 2006. The company also received about $12 million in loans from Pacific Western Bank (PWB) in 2004, secured by FHI’s assets and guaranteed by HP. In June 2007, FHI refinanced its loans with PWB, which included favorable repayment terms and a release of HP from its guarantee. From the funds received in the refinance, FHI made a $12 million payment to HP to pay off its unsecured promissory notes. Despite these efforts, FHI filed for Chapter 11 bankruptcy in October 2008. Continue reading