A business owner wants to protect the business’s assets, mostly cash, from a creditor that is suing the business. He wants to transfer the business’s cash to himself, the owner, but is concerned that the transfer may look like a fraudulent conveyance from the business to himself. So, he has the business loan him the cash and he executes a promissory note to the business with liberal repayment terms. That way, the business has received value for the money but the note would be difficult to collect by the business’s judgment creditors.
This strategy failed before a California bankruptcy court and the Court of Appeals in a recent case. A debtor borrowed money from his debtor business for purported business purposes. The court found that the real purpose of the loan was to withdraw money from the business to defraud the business creditors. The repayment terms were not commercially reasonable, and terms in the note made collection of the note difficult by the lender business or its creditors who could levy on the note. Repayment was liberal and payments deferred.
When a debtor business loans non-exempt assets to its owners the value of the promissory note must be reasonably equivalent to the money lent. Otherwise, a court will see through this transaction between insiders and undo the entire transaction as a fraudulent conveyance. The business’s creditors then can seek recovery from the owner personally for the money received from the business.