In a leveraged transaction, the “target” company carries significantly greater debt following the transaction than the company had prior to the deal. Should the company later find its operating income insufficient to pay its increased obligations, financial distress may result. In such circumstances, a court may determine that the original transaction was a “fraudulent conveyance” or a “fraudulent transfer of assets.”
The downside for participants in the transaction can be substantial. If a judge determines that financial distress was preceded by a fraudulent conveyance, the company’s secured lenders can lose their security interest and shareholders who sold their stock in the original transaction might have to return proceeds. Directors may even face personal liability.
A solvency opinion, issued at the time of the leveraged transaction should be determined if the company has a reasonable capital base and address its ability to pay future obligations.