Fraudulent Transfer Claims Against Business Buyers

When Can a Seller’s Creditors Undo the Sale of a Business?

A seller’s creditor can void the sale of a business under Minnesota law if the seller sold to defraud creditors, called actual fraud, or sold for less than reasonably equivalent value while in financial trouble, called constructive fraud. A third rule reaches some sales to insiders.

The actual-fraud rule is in Minn. Stat. § 513.44(a)(1): a transfer is voidable if the debtor made it “with actual intent to hinder, delay, or defraud any creditor of the debtor.” The intent this rule asks about is the seller’s, because the seller is the “debtor” in the statute. The buyer’s own good faith enters through the defense covered in the next sections.

The constructive-fraud rules need no proof of intent. The Minnesota Supreme Court described them as provisions that “allow a creditor to void a transfer without proving that the debtor intended to defraud a creditor” in Citizens State Bank Norwood Young America v. Brown, 849 N.W.2d 55 (Minn. 2014). Under § 513.44(a)(2), a sale is voidable if the seller sold “without receiving a reasonably equivalent value in exchange for the transfer or obligation” and one of two conditions was true:

1. The seller “was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction.”
2. The seller “intended to incur, or believed or reasonably should have believed that the debtor would incur, debts beyond the debtor’s ability to pay as they became due.”

A separate rule in Minn. Stat. § 513.45(a) protects creditors whose claims existed before the sale. It makes a sale voidable if the seller received less than reasonably equivalent value and “the debtor was insolvent at that time or the debtor became insolvent as a result of the transfer or obligation.” Section 513.45(b) adds the insider rule for those same earlier creditors: “A transfer made by a debtor is voidable as to a creditor whose claim arose before the transfer was made if the transfer was made to an insider for an antecedent debt, the debtor was insolvent at that time, and the insider had reasonable cause to believe that the debtor was insolvent.”

Two features of the act widen a buyer’s exposure. Section 513.44 reaches a creditor “whether the creditor’s claim arose before or after the transfer was made,” so a later creditor of the seller can sue too. Insolvency has a statutory test in Minn. Stat. § 513.42: a debtor is insolvent “if, at a fair valuation, the sum of the debtor’s debts is greater than the sum of the debtor’s assets,” and a debtor “generally not paying the debtor’s debts as they become due other than as a result of a bona fide dispute is presumed to be insolvent.” The Minnesota Uniform Voidable Transactions Act page covers the rest of the act’s structure.

What Are the Badges of Fraud in a Business Sale?

Badges of fraud are the circumstances a court may weigh to decide whether a seller meant to defraud its creditors. Minnesota lists eleven in Minn. Stat. § 513.44(b), and a court may weigh other facts as well, because the list is introduced with “consideration may be given, among other factors, to whether.”

Courts rely on these factors because direct proof is scarce. In Brown, the Minnesota Supreme Court explained that “the intent to defraud creditors is rarely susceptible of direct proof,” so courts “continue to rely on” badges of fraud “to determine whether a transfer is fraudulent.” The badges that fit the facts of a business sale include whether:

• “the transfer or obligation was to an insider” (a buyer related to the seller’s directors, officers, or controlling owners can be one);
• “the debtor retained possession or control of the property transferred after the transfer”;
• “before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit”;
• “the transfer was of substantially all the debtor’s assets” (a sale of the whole business may meet this one on its face);
• “the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred”;
• “the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred”; and
• “the debtor transferred the essential assets of the business to a lienor that transferred the assets to an insider of the debtor.”

One badge does not decide the case. In Brown, the court said “The presence of a single badge of fraud may, but does not necessarily, prove fraudulent intent,” while “The presence of several badges of fraud, however, creates an inference of fraud that requires clear evidence of a legitimate purpose to rebut.” Applying the act’s pre-2015 text, the court affirmed setting aside transfers a debtor made in a divorce to his former wife, who still lived with him, where six of the eleven badges were established. That case involved transfers between spouses, but the method applies to any sale.

For a buyer, the practical point is the legitimate purpose. I suggest building that record before closing: a written business reason for the sale, a price tested against an outside valuation, and a closing statement showing the seller’s creditors paid from the proceeds. Once several badges appear, Brown requires clear evidence of a legitimate purpose to rebut the inference, and those documents are that evidence.

How Does a Buyer’s Good Faith and Fair Price Protect the Purchase?

A buyer that took the business “in good faith and for a reasonably equivalent value given the debtor” defeats the creditor’s actual-fraud claim under Minn. Stat. § 513.48(a). Even when a sale is voidable, a good-faith buyer keeps a lien or a credit for the value it gave the seller.

The defense belongs to the buyer, and so does the burden. The Minnesota Supreme Court addressed the defense in Finn v. Alliance Bank, 860 N.W.2d 638 (Minn. 2015). It explained that once a creditor proves fraudulent intent, “the transferee may still defeat liability by establishing the affirmative defense in Minn. Stat. § 513.48.” The court added that transferees “carry the burden to plead and prove the affirmative defense.” The current statute says the same thing: “A party that seeks to invoke paragraph (a), (d), (e), or (f) has the burden of proving the applicability of that subsection.”

The defense has two parts, and the buyer needs both: good faith and reasonably equivalent value. The act does not define good faith; its definitions section, Minn. Stat. § 513.41, has no entry for it. Because the buyer carries the burden, I suggest keeping the file that shows what the buyer knew and checked before closing. That file should include the lien and litigation searches, the seller’s financial statements, the valuation, and the closing statement showing where the money went, because those records are the buyer’s proof.

A buyer whose sale is set aside still has a fallback. Under § 513.48(d), “a good faith transferee or obligee is entitled, to the extent of the value given the debtor for the transfer or obligation,” to one of three protections:

1. “a lien on or a right to retain an interest in the asset transferred”;
2. enforcement of an obligation incurred; or
3. “a reduction in the amount of the liability on the judgment.”

That protection is measured by what the buyer actually gave the seller, because the statute limits it “to the extent of the value given the debtor.”

What Counts as Reasonably Equivalent Value for a Business?

Reasonably equivalent value compares what the seller received with what the seller gave up. It decides both the constructive-fraud claims and the second half of the buyer’s defense, so the price and the form of payment both matter.

The act defines value in Minn. Stat. § 513.43(a): “Value is given for a transfer or an obligation if, in exchange for the transfer or obligation, property is transferred or an antecedent debt is secured or satisfied, but value does not include an unperformed promise made otherwise than in the ordinary course of the promisor’s business to furnish support to the debtor or another person.” Paying off the seller’s lender at closing satisfies a debt the seller already owed, which that definition counts as value. In Finn, the court held that “any legally enforceable right to payment against the debtor is sufficient to qualify as an antecedent debt.” It treated the satisfaction of that kind of debt as value under the act.

The value must reach the seller. Section 513.48(a) protects a buyer that gave value “given the debtor,” and in an asset sale the debtor is the selling company, not its owners. When part of the price goes to the owners personally through a consulting agreement or a noncompete payment, I suggest pricing those side payments at what the services are worth, because only the value given to the selling company counts toward the defense. Whether a seller’s noncompete is enforceable is a separate question under Minn. Stat. § 181.988, subd. 2(b)(1), which covers a covenant “agreed upon during the sale of a business.”

The same test applies when the main asset is intellectual property. The act’s definition of “transfer” in § 513.41 includes a “license,” so a license of the seller’s software or brand is tested for value the same way a sale is.

What Can a Creditor Recover From the Buyer?

A creditor that wins can have the sale undone “to the extent necessary to satisfy the creditor’s claim” under § 513.47(a)(1), or take a money judgment against the buyer for the lesser of the asset’s value or the claim. A good-faith buyer is entitled, to the extent of the value given the seller, to “a reduction in the amount of the liability on the judgment.” The creditor must first prove its claim by a preponderance of the evidence under Minn. Stat. § 513.44(c).

The remedies in Minn. Stat. § 513.47 can reach the buyer’s business while the case is pending, not only after judgment. They include:

• “an attachment or other provisional remedy against the asset transferred or other property of the transferee if available under applicable law”;
• “an injunction against further disposition by the debtor or a transferee, or both, of the asset transferred or of other property”; and
• “appointment of a receiver to take charge of the asset transferred or of other property of the transferee.”

Taking the asset itself requires a court order. Under § 513.47(b), a creditor with a judgment against the seller, “if the court so orders, may levy execution on the asset transferred or its proceeds.”

A money judgment against the buyer has two limits in Minn. Stat. § 513.48(b). The creditor “may recover judgment for the value of the asset transferred, as adjusted under paragraph (c), or the amount necessary to satisfy the creditor’s claim, whichever is less.” The judgment runs against “the first transferee of the asset or the person for whose benefit the transfer was made,” which is the buyer in a direct purchase.

Value is measured at the time of the transfer, which the timing rule covered below can place after the closing date. Under § 513.48(c), the judgment “must be for an amount equal to the value of the asset at the time of the transfer, subject to adjustment as the equities may require.” Under § 513.48(g)(4), “A party that seeks adjustment under paragraph (c) has the burden of proving the adjustment.”

What Changes if the Seller Files Bankruptcy?

If the seller files bankruptcy, the bankruptcy trustee can bring the same challenge, under the state law that governs the transfer or under the federal Bankruptcy Code. Under the federal rule, a buyer who took for value and in good faith keeps a lien or interest to the extent it gave value to the seller.

The trustee has two routes. Under 11 U.S.C. § 544(b)(1), “the trustee may avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim that is allowable under section 502 of this title.” That route uses “applicable law,” and under § 513.485(b) that is “the local law of the jurisdiction in which the debtor is located when the transfer is made or the obligation is incurred” for a claim of this kind. The federal rule in 11 U.S.C. § 548(a)(1) covers transfers made within a set period before the bankruptcy filing, on grounds that track the Minnesota rules: actual intent to defraud, or less than reasonably equivalent value combined with financial distress.

The federal protection for buyers mirrors Minnesota’s. Under § 548(c), “a transferee or obligee of such a transfer or obligation that takes for value and in good faith has a lien on or may retain any interest transferred or may enforce any obligation incurred, as the case may be, to the extent that such transferee or obligee gave value to the debtor in exchange for such transfer or obligation.”

Recovery runs against the first buyer. Under 11 U.S.C. § 550(a), the trustee may recover “the property transferred, or, if the court so orders, the value of such property,” from “the initial transferee of such transfer or the entity for whose benefit such transfer was made.” A later transferee is protected if it took “for value, including satisfaction or securing of a present or antecedent debt, in good faith, and without knowledge of the voidability of the transfer avoided” (§ 550(b)). A good-faith buyer that improved the property has a lien under § 550(e) that secures the lesser of “the cost, to such transferee, of any improvement made after the transfer, less the amount of any profit realized by or accruing to such transferee from such property” and the increase in value the improvement produced. Payments a failing seller made to particular creditors shortly before filing are tested under a different rule, the bankruptcy preference period.

How Long Can a Creditor Wait to Challenge the Sale?

No fixed date after closing ends the risk of an actual-fraud claim, because that claim does not accrue until the creditor discovers the fraud or, by reasonable diligence, should have discovered it. The buyer’s exposure runs from that point, not from the closing date.

In Finn, the Minnesota Supreme Court treated an actual-fraud claim under the act as one “for relief on the ground of fraud” under Minn. Stat. § 541.05, subd. 1(6). That provision says that the cause of action “shall not be deemed to have accrued until the discovery by the aggrieved party of the facts constituting the fraud.” In Toombs v. Daniels, 361 N.W.2d 801 (Minn. 1985), the Minnesota Supreme Court said the period under that provision “begins to run when the facts constituting fraud were discovered or, by reasonable diligence, should have been discovered.” In Finn, the court decided only the actual-fraud question. It said, “We express no opinion on the statute of limitations applicable to constructive-fraud claims.” The limitations period itself is set in § 541.05, and its current text controls any date calculation.

The act also decides when a sale counts as made, and that date can move. Under Minn. Stat. § 513.46, if the law lets a transfer be perfected and “the transfer is not so perfected before the commencement of an action for relief under sections 513.41 to 513.51, the transfer is deemed made immediately before the commencement of the action.” For real property other than a fixture, a transfer is perfected when a later good-faith purchaser from the seller can no longer take ahead of the buyer. I suggest recording deeds and completing any other perfection step promptly after closing, because an unperfected transfer is treated as made immediately before the creditor’s lawsuit, not on the closing date.

What Can a Buyer Do if the Seller Defrauded the Buyer?

A buyer the seller defrauded is itself a creditor of the seller, so the same act can help the buyer reach sale proceeds the seller moved out of reach. The buyer’s claim qualifies before any judgment and even while the seller disputes it.

The definitions make this work. Under Minn. Stat. § 513.41, a “claim” is “a right to payment, whether or not the right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured,” and “creditor” means “a person that has a claim.” A buyer with a fraud or breach-of-warranty claim against the seller fits both definitions. If the seller then sends the purchase price to family members or a new company, the buyer can bring the claims described above against those transfers, because § 513.44 protects a creditor “whether the creditor’s claim arose before or after the transfer was made.”

The early remedies in § 513.47 matter here, because a seller can move transferred money again before any judgment. A buyer may ask for “an injunction against further disposition by the debtor or a transferee, or both, of the asset transferred or of other property,” along with attachment where available. If the seller has filed bankruptcy, the petition “operates as a stay, applicable to all entities, of . . . the commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case” under 11 U.S.C. § 362(a)(1). The act also keeps the general law of fraud in play: under Minn. Stat. § 513.50, “Unless displaced by the provisions of sections 513.41 to 513.51, the principles of law and equity, including . . . fraud, misrepresentation, duress, coercion, mistake, insolvency, or other validating or invalidating cause, supplement its provisions.”

The buyer’s underlying claim against the seller is its own lawsuit, which may be a fraudulent misrepresentation claim. I suggest checking the purchase agreement first, because indemnity, escrow, and holdback terms may give the buyer a faster path to money than a lawsuit against the seller.

What Other Seller Debts Can Follow the Business?

Apart from a fraudulent-transfer claim, a buyer can become liable for some of the seller’s debts directly. Two Minnesota statutes address this: the corporate asset-transfer statute and the tax successor statute.

When a Minnesota corporation transfers its assets, Minn. Stat. § 302A.661, subd. 4 provides: “The transferee is liable for the debts, obligations, and liabilities of the transferor only to the extent provided in the contract or agreement between the transferee and the transferor or to the extent provided by this chapter or other statutes of this state.” The rules for other sellers and other liabilities are covered in successor liability in a Minnesota asset sale.

Unpaid state taxes are one of those other statutes. Under Minn. Stat. § 270C.57, the “tax” covered “means sales, withholding, and any tax imposed by chapter 296A.” A “transfer in bulk” is “a transfer, other than in the ordinary course of the transferor’s trade or business, of more than one-half of all the property of a business at all locations combined.” When a business makes that kind of transfer and “an enforceable lien for unpaid taxes has been filed against the business by the commissioner,” the statute provides that “at least 20 days before taking possession of the assets or paying the purchase price, the successor shall notify the commissioner of the transfer and the terms and conditions related to it.” The statute adds timing rules for a lien filed after the purchase agreement is signed. Skipping the notice has a direct cost: “If the successor fails to give the notice required in paragraph (a), the successor is liable for any unpaid taxes, interest, and penalties due from the transferring business to the extent of the purchase price.” For a related buyer the measure can change. If the commissioner “determines that a transfer was not at arm’s length or was a gift, the successor’s liability under this section equals the value of the assets transferred,” and between related parties “a rebuttable presumption arises that the transaction is not at arm’s length” under the statute’s definitions. The statute adds: “For purposes of imposing the liability, the value of the property transferred is presumed, subject to rebuttal, to equal the unpaid taxes, interest, and penalties of the transferring business.” The statute then addresses a buyer who gives notice. If the commissioner responds “within 20 days after receipt of the notice” that other liabilities exist, “the successor is, in addition to being liable for the amounts included on the lien, liable for all other uncontested taxes, interest, and penalties as stated in the commissioner’s notice from the transferring business to the extent of the purchase price if the successor pays the purchase price or takes possession of the assets without withholding and remitting the liability to the commissioner.” A buyer who follows the notice process gets a limit on later assessments: “A successor who complies with the requirements of paragraphs (a) and (b) is not liable for any assessments of taxes of the transferring business made after the commissioner provides notice to the successor under paragraph (b), except for taxes assessed on returns filed to comply with the notice.” I suggest running a state tax lien search before closing, because the notice duty turns on whether that lien has been filed. The bulk-sale rules page covers the transfer-in-bulk side of a purchase.

Next Steps for a Buyer Facing a Fraudulent Transfer Claim

I suggest starting with the records that prove the defense in § 513.48(a), because the buyer carries the burden of proving it. Those records include the purchase agreement, the closing statement and lien payoff letters, the valuation, the lien and litigation searches run before closing, and the dates each deed or filing was recorded. Those documents go to three of the questions the act turns on: whether the seller received reasonably equivalent value, whether the buyer acted in good faith, and when the transfer was made. If the seller misled you, the same act may let you reach the sale proceeds.

More on creditor and collection matters is on the practice page. If you would like to know whether a creditor’s challenge can reach the business you bought, or whether you can reach a seller’s transferred proceeds, email [email protected] with a short description of the sale and the claim. I will run an intake and conflict check before you send any confidential documents.