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If you didn’t think the situation at Enron Corp. could get any uglier, think again. Bankruptcy experts now say that revelations that Enron management may have concealed damaging information about its maze of partnerships leaves the bankrupt energy giant open to allegations of fraudulent conveyance. Disgruntled creditors are expected to turn to a rarely used “intent-to-defraud” clause in the U.S. Bankruptcy Code to seek the recovery of assets that may have been transferred from Enron to its partnerships in off-balance-sheet transactions. Enron capitalized the partnerships with its stock in return for promissory notes, thus using them as financing vehicles. But that stock doesn’t carry the value it once did. Enron also used the partnerships to conceal losses while management continued to tout the company’s performance and ultimately, hype its stock. Fraudulent conveyance involves the pre-bankruptcy transfer of assets for less than their fair equivalent value. Creditors typically seek to return those assets to the debtor’s estate for ultimate recovery. “Enron certainly has a clear potential for fraudulent conveyance since Enron executives themselves have said they established these partnerships in order for loans not to be revealed on their books,” said Elizabeth Warren, Leo Gottlieb professor of law at Harvard Law School. “Creditors could well turn to the ‘intent to defraud’ clause in fraudulent conveyance law that is very rare, and that’s what makes it a scandal when it happens.” While fraudulent conveyance often downplays debtor intent by honing in on the estimated “fair value” recovery of pre-Chapter 11 transfers, creditors could turn to Enron’s alleged intent to hide asset transfers to its off-balance sheet partnerships when they seek to bolster their recovery. “It seems to me that those partnerships come under the fraudulent conveyance clause of ‘actual intent to hinder, delay or defraud a creditor,’” added a New York bankruptcy partner who spoke on condition of anonymity. “I’m assuming that Enron made investments in those partnerships and creditors will surely look to that clause to try and bring those assets back into the estate for distribution.” The key word is “or,” in the “intent to hinder, delay or defraud a creditor” clause, the partner stressed, because it gives creditors that much more grist to use when they seek eventual recovery if Enron emerges from Chapter 11. Warren agrees. “The big question in Enron is how value disappeared before the bankruptcy filing,” she noted. “Fraudulent conveyance law gives courts an opportunity to scrutinize pre-bankruptcy transactions that may have been designed to drain assets out of the company. “The filing is still in its early stages, however, and we’ll just have to wait for the documents to see how the partnerships were structured and what assets may have been transferred before we know whether fraudulent conveyance will surface down the road,” Warren said. The key to fraudulent conveyance is what assets the creditors might recover. Creditors might find it difficult to uncover any asset value that they could then try to transfer back to Enron as part of any reorganization plan’s distribution, said Martin Zohn, bankruptcy partner in Los Angeles at Proskauer Rose. “Many of those partnerships melted down faster than Enron, and if it turns out that Enron misrepresented creditors, then it could turn out to be actual fraud and not fraudulent conveyance,” he said. The situation got worse when the value of the stock that Enron used to capitalize the partnerships started to tank. “Enron just had to keep feeding the monster once its shares starting falling and it became a case of a snake eating its own tail,” Zohn said. “The value of the partnerships may have evaporated with the falling stock price.” While Zohn thinks creditors might find it easier to rely on the fair-value standard to convince a judge that a third-party benefited from an asset transfer, the likelihood is that creditors will turn to several different facets of the bankruptcy code to bolster any allegations of fraudulent conveyance. Creditors would then be required to show that a third party benefited from the asset transfer to prove fraudulent conveyance. “There are several quivers in the bow and creditors could first turn to constructive fraudulent conveyance because it’s a lot easier under the law to convince a judge that management was sloppy or careless rather than bad people,” Zohn said. “They could then turn to the intent clause but would have to prove that an actual transfer took place to a third party and that the party benefited from the transfer.” Warren, however, countered that the intent clause should be enough to show fraudulent conveyance. She also believes potential recovery for creditors might come from any benefits passed along to Enron managers or directors — such as stock market gains — that would then be folded back into the estate for creditor distribution. “The intent clause is hard to prove in most fraudulent conveyance cases, but it clearly becomes much easier to prove fraudulent intent when Enron’s executives said they designed the partnerships so that loans would not be revealed on its books,” Warren said. “Then it doesn’t matter whether there’s fair equivalent value or not.” Copyright (c)2002 TDD, LLC. All rights reserved.

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