Cross-Stream Guaranty Found To Be Fraudulent Conveyance

Intercorporate guarantees are common practice for most commercial lenders. Intercorporate guarantees fall into three types: Up-stream guarantees (the subsidiary guaranties the parent's debt); down-stream guarantees (the parent guaranties the subsidiary's debt); and cross-stream (the brother corporation guaranties the sister's debt). A recent decision from the 7th Circuit Court of Appeals serves as a reminder of the potential pitfall of this common practice.

Relying on case law, the trustee in In re Image Worldwide, Ltd. sought to avoid a cross-stream guaranty as a fraudulent transfer in violation of the Uniform Fraudulent Transfer Act. Worldwide guaranteed the repayment of its affiliate's loan balance to the Bank. Because the Bank stipulated that the transaction rendered Worldwide insolvent, the only issue was whether Worldwide, as a guarantor, received reasonably equivalent value for its guaranty.

The Bankruptcy Court determined that a loan for the benefit of an affiliate is not regarded as fair consideration to the sister corporation. The Seventh Circuit rejected this narrow interpretation and stated that in analyzing whether the debtor received reasonably equivalent value, courts should look to whether the guarantor received indirect benefits from the guaranty. The Court also noted that reasonably equivalent value for the purposes of the fraudulent transfers law is something more than consideration to support the contract. While the Bank's agreement to forbear from further collection activities was probably sufficient consideration for the guaranty, that did not mean that the guarantor corporation received reasonably equivalent value.

Image Worldwide should serve as a reminder to lenders that intercorporate guarantees are often subject to attack, but also that indirect benefits to a guarantor may be considered in determining reasonably equivalent value. In particular, in the context of cross-stream guarantys, the court may find reasonably equivalent value when the transaction strengthens the viability of the corporate group.