Bankruptcy Litigation Update: Determining Adequate Capital

A transfer (or obligation) can be challenged as an actual fraudulent transfer, which requires evidence that the transferor intended to “hinder, delay or defraud” its creditors. Alternatively, a plaintiff can challenge the transfer (or obligation) as a constructive fraudulent transfer, which requires evidence that: 1) the debtor made a transfer or incurred an obligation in exchange for less than reasonably equivalent value; and 2) was either: (a) insolvent on the date of the transfer or became insolvent thereby; (b) “engaged in business or a transaction, or was about to engage in a business or transaction, for which any property remaining with the debtor was an unreasonably small capital;” or (c) “intended to incur, or believed that it would incur, debts that would be beyond the transferee's ability to pay as they matured.” See 11 U.S.C. § 548(a)(1)(B).

This article focuses on the concept of “unreasonably small capital,” which is not defined in the Bankruptcy Code or applicable state statutes. Consequently, the determination of adequate capital is fact-intensive and fertile grounds for litigation. We have divided into two parts: first, a summary of the general standards used by courts for determining adequate capital, and second, a summary of two recent circuit court decisions addressing adequate capital.