## Facts

- Crescent Food Company, a California food distributor, was formerly a wholly owned subsidiary of The Federal Company.
- In May 1982, Federal sold Crescent to an acquisition vehicle formed by Crescent’s management in a leveraged buyout (LBO).
- Management contributed about $85,000 in equity; the remainder of the purchase structure relied largely on debt incurred in connection with the transaction.
- Before the sale, Crescent owed Federal about $7.25 million on an intercompany loan.
- At closing, Crescent repaid the $7.25 million to Federal using proceeds of a new loan from General Electric Credit Corporation (GECC), substituting third-party secured debt for the prior insider debt while Federal received cash.
- In November 1982, GECC extended an additional $2.5 million loan to Crescent.
- After the LBO, Crescent’s liquidity deteriorated due to tightened supplier credit, competitive pressure on customer terms, a labor strike, and customer failures.
- By October 1983, Crescent made a general assignment for the benefit of creditors to Credit Managers Association of Southern California (CMA), which sued Federal to recover or avoid transfers connected to the LBO.

## Issues

1. Whether Crescent’s debt-funded repayment of Federal in the LBO was a fraudulent conveyance under California’s Uniform Fraudulent Conveyance Act standards, including “unreasonably small capital.”
2. Whether the LBO-related payments to or for the benefit of Federal constituted an unlawful shareholder distribution under California corporate law.
3. Whether CMA, as assignee for the benefit of creditors, had standing to pursue fraudulent conveyance and unlawful distribution theories.

## Decision

- The court held that an LBO is not per se a fraudulent conveyance, but it is subject to avoidance where it leaves the debtor with unreasonably small capital or an inability to meet obligations.
- The court determined that Crescent’s debt-funded payoff to Federal could be avoided under fraudulent conveyance principles based on capital adequacy and cash-flow evidence, notwithstanding lender participation and management’s equity investment.
- The court treated the transfer of value to Federal, financed by increased leverage at the operating-company level, as capable of constituting an unlawful shareholder distribution if statutory capital/insolvency limits were violated.
- The court rejected Federal’s standing objection and held CMA, as assignee for the benefit of creditors, could assert claims available to Crescent and its creditors, including fraudulent conveyance and unlawful distribution claims.

## Legal Principles

- A leveraged buyout may be challenged as a fraudulent conveyance when the acquired company incurs obligations or makes transfers that leave it with “unreasonably small capital” for its business and foreseeable risks, even if balance-sheet solvency appears arguable at closing.
- Capital adequacy for fraudulent conveyance purposes is a forward-looking inquiry that focuses on realistic cash-flow capacity and the debtor’s ability to withstand reasonably foreseeable business pressures.
- Participation by a sophisticated lender and insider equity contributions are probative but not conclusive on the question of adequate capitalization and do not bar fraudulent conveyance relief.
- Payments to a shareholder or former shareholder that are effectively funded through operating-company borrowing may be treated as distributions subject to corporate-law limits tied to insolvency and impairment of capital.
- An assignee for the benefit of creditors succeeds to relevant rights of the assignor and creditors and may pursue creditor-protective remedies such as fraudulent conveyance and unlawful distribution claims.

## Conclusion

The court permitted creditor-side avoidance and recovery theories against a former parent in an LBO where the operating company borrowed to cash out the seller, holding that the legality turned on post-transaction capital adequacy and statutory creditor protections, and that an assignee for the benefit of creditors had standing to assert those claims.


Credit Managers Ass’n of S. Cal. v. Fed. Co., 629 F. Supp. 175 (C.D. Cal. 1985)