Voidable Transactions: Fair Consideration and Insiders

The concept of “reasonably equivalent value” is prevalent in almost every voidable transaction claim. In a way, it’s a very simple concept: Let’s say you give someone a computer that’s worth $1,000, and you only charge them $10 for it. The $10 would not be considered “equivalent” consideration, since you have only received 1% of the value of the computer.

As you can imagine, most of the time the claim is not as clear, so courts look at two factors to determine whether a party received fair consideration in a transaction:

1. Fair Value: This is the fair salable value of an asset. The lack of reasonably equivalent value is very clear when property is transferred and no one pays for it (or pays very little compared to the value of the property).

2. Good Faith: This goes to the intentions of all parties in the transaction. Good faith becomes a major issue when a corporate debtor transfers assets to individuals or entities whom the court recognizes as “insiders.”

An insider is someone who has control or influence over a transaction, even though the transaction may otherwise be fair and in good faith. When an insider is involved in a transaction with a corporate debtor, the transaction lacks good faith as a matter of law, and therefore cannot be for fair consideration. Insiders typically include the owners, officers, board members, family members of the owners, or affiliated companies of the corporate debtor, although courts can find other classes of people to be insiders.

The easy way to consider insiders and fair consideration is this: debtors cannot prefer themselves, or the individuals close to them, over others. If they do, a creditor will likely have a straightforward claim for a voidable transaction against the corporation and its insiders for any assets transferred by the corporation.

Corporations in the midst of litigation can inadvertently commit a voidable transaction while running their businesses as usual. For example, they may repay loans to shareholders, or transfer money to an affiliated company in need of cash. Transactions that previously would be considered in the ‘ordinary course of business’ now could expose affiliated entities, shareholders, or other insiders to liability. We explore inadvertent voidable transactions in more detail in the next article.

Ultimately, debtors must be aware that when they engage in transactions with insiders, courts can closely scrutinize those transactions and hold non-debtors liable for voidable transaction. Even though the transaction may seem fair to the debtor, a creditor can often attack insider transactions as a way to collect the debt.

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NOTE: This post has been updated to reflect the Uniform Voidable Transaction Act, which came into effect Apr. 3, 2020.