Fraudulent conveyances

A defunct New York based hedge fund named Manhattan Investment entered chapter 11 protection seven years ago.

Earlier this year, in a surprise move, a bankruptcy court judge ruled that giant brokerage firm Bear Stearns -- which was the "prime broker" for Manhattan -- might be on the hook for $121.5 million in money that this particular client transferred thereto shortly before the collapse. Bear with me whilst I try to explain this to myself.

There's a large and convoluted body of precedent and principles that deal with pre-bankruptcy transfers. There's good intuitive reason for concern. After all, think of this on a Mayberry Scale. Suppose Floyd's Barber Shop (or FBS Inc.) has fallen on hard times. Too many of the men of Mayberry have gone bald, or have gotten into the habit of going to Raleigh to get their hair cut in fashionable styles, and poor Floyd just can't make ends meet.

He has lots of creditors, but we'll focus on two, the North Carolina Scissor Sales Co. (NCSS) and the Greater Mayberry Hair Tonic Supplier (GMHTS).

The folks at GMHTS have always been buddies with Floyd. They've hung out together out in front of the sheriff's office and all that. But Floyd hardly knows the NCSS at all. They're just the name of the invoice to him.

So what does he do when he is facing insolvency? If he declares bankruptcy, then his barbershop as an "estate" is protected from all creditors until the court-appointed trustee can come up with a plan for who gets what. The strangers at the NCSS and Floyd's buddies at the GMHTS will be on an even basis here.

Suppose that he doesn't like that idea. Giving in to a natural human temptation, he might make a large payment -- all the cash he has left in the register, against the GMHTS bill. Then declare bankruptcy the following day.

The NCSS will naturally be unhappy when they discover this. Floyd isn't allowed to do that. The Trustee may seek to "avoid" that conveyance -- in other words, get the money back from the scissors' salesmen and put it back into the barbershop's cash register until a general plan is developed, wherein of course the NCSS and the GMHTS will be treated equally.

Which conveyances are avoidable and which aren't? Ah, there's the rub. The $121.5 million question for Bear Stearns just now.