It is unfortunate that credit unions often must deal withinsolvent debtors and guarantors. Insolvency of a credit party canleave a creditor in an unanticipated position; namely, with no lienor with an unenforceable guaranty. Section 548 of the U.S.Bankruptcy Code establishes the law of “fraudulent conveyances” andempowers a bankruptcy trustee or a debtor in possession to void orcancel certain security interests or guarantys that:

(i) were made or incurred when the grantor of the lien or guarantor wasinsolvent, or

(ii) that rendered the grantor of the lien or guarantor insolvent,or

(iii) left the grantor of the lien or guarantor with unreasonably smallcapital, or

(iv) left the grantor of the lien or guarantor unable to pay itsobligations as they matured, and

(v) were made or incurred for less than reasonably equivalentvalue.

A credit union must assess whether a credit party under the loanis insolvent or will be rendered insolvent by reason of the loan;or will be left with unreasonably small capital; or will be unableto pay its obligations as they mature.

In addition to evaluating a credit party's credit worthiness, acredit union must also determine whether the credit party receivedsomething meaningful in exchange for its guaranty or pledge ofassets. If not, the guaranty or pledge could be deemed void orvoidable. The risk of fraudulent conveyances can becomeparticularly acute in loans to a consolidated group of companies,particularly where parties pledging assets or guaranteeing the loanare not receiving loan proceeds.

When evaluating and monitoring credit extended to a parentcompany and its subsidiaries, many lenders often focus solely onthe consolidated financial statement of the credit parties. Theyfail to evaluate and monitor the credit worthiness of eachindividual credit party.

Because of the concern of fraudulent conveyances, this approachis inherently flawed. Credit unions should evaluate all the factswhen making these types of loans in order to mitigate thefraudulent conveyance risks.

One approach to monitoring solvency is to require updated andaudited financial statements for each of the credit parties. Thiswould allow the credit union to monitor the solvency of each party,reserving the right to refuse to lend additional amounts if anycritical repayment source is not sufficiently solvent.

In short, there is no substitute for careful monitoring of thefinancial status of each credit party on astand-alone basis. Simply relying on the financial strength of theconsolidated group of credit parties can lead to problems down theroad.

As long as credit unions enter into loan transactions with theireyes open and with an understanding of the fraudulent conveyancerisks, loans can be analyzed and structured to at least mitigatethe chance that guaranties or collateral pledges could be avoidedin the event of the insolvency of an obligor.

Alfred “Ran”Randolph Jr. is an attorney with Kaufman & Canoles inNorfolk, Va.