22.6.5 How should complex capital withdrawals by shareholders comprising a complex of closely related legal transactions be regulated?

Finally, this leads to the question regarding the standardization of capital withdrawals by shareholders consisting of complex, closely related (legal) transactions, in particular leveraged buyouts. As indicated before, a leveraged buyout generally consists of an extensive capital withdrawal, without necessarily using the formal distribution possibilities. For example, the actual withdrawal may be in the fact that the target company furnishes an unsecured loan to a marginally capitalized acquisition vehicle, which immediately uses the means acquired in this way to pay the purchase price of the shares. In the event that the unsecured creditors of the company are exposed to unreasonable risks by the LBO, Section 2:216 (3) DCC does not offer any help. Even if the capital withdrawal did have the form of a formal dividend distribution or repurchase of shares, the target company’s trustee in bankruptcy can do little with Section 2:216 (3) DCC or the fraudulent transfer in bankruptcy law. After all, the capital was formally withdrawn from the target by the acquisition company; as a rule, the latter company does not offer any recourse.

In the United States, LBOs and other complex transactions with shareholders are nevertheless principally regulated by the insolvency law doctrine of fraudulent transfer law. The fact that this doctrine, which is based on a two-party relationship, managed to capture an important role in the regulation of LBOs is primarily due to the willingness of American judges to ‘consolidate’ the LBO for the application of the doctrine: the judge assesses the LBO as if one transfer by the target company to the selling shareholders was involved. This is an attractive approach, because it takes into account the net effect of the entire transaction and puts the contents above the form. Nevertheless, this approach leads to difficult questions and new problems. How should the multistep transaction be qualified for the application of the fraudulent transfer rules? Exactly what are the consequences of impairing the entire transaction? Is it reasonable that only the shareholders who alienated their shares in the scope of the LBO are required to repay the funds they received or should the buyer of the shares, who effectuated an important part of the LBO, also be liable under certain circumstances? Finally, is it reasonable that the bank that was closely involved in setting up the new financial structure shares in the proceeds of the fraudulent transfer claim? Because the consequence of successfully invoking the fraudulent transfer rules is quite absolute (nullification), the application of this doctrine to complex transactions offers the judge insufficient discretion to take the specific circumstances of the case into account in the ex post assessment of the financing structure, in particular if more than two parties were involved in the transaction. I believe that this problem would equally occur in a ‘consolidated’ application of the Dutch fraudulent transfer in bankruptcy law to complex capital withdrawals by shareholders.

I feel that the doctrine of the wrongful act is more suitable for assessing the acts of shareholders in an LBO. The flexibility of the wrongful act standard offers more room to standardize complex capital withdrawals subject to all relevant factors and circumstances of the specific case and makes it possible to place the substantive contents of the transaction above its formal structure. In my view, the primary issue in this assessment is the question regarding whether the company’s financial resilience after the LBO was sufficient to bear the reasonably foreseeable risks. Was the LBO based on reasonable, realistic forecasts that offered sufficient room for setbacks? In the event that the LBO took unreasonable risks, can the selling shareholders and the new (purchasing) shareholders be liable to pay compensation to the collective creditors?1 I believe that liability of the selling shareholder is not precluded by the fact that formally, the withdrawals from the capital of the company only occurred after the shares were transferred to the purchasing shareholder. The selling shareholders act wrongfully if they were aware of the fact that the purchase price would be financed by withdrawals from the company’s capital, and seriously had to allow for a deficit as a result. Generally, the purchasing shareholder is formally a marginally capitalized acquisition company, but is, in fact, the underlying investor. In practice, this investor is quite frequently the architect of the financing structure and often has a leading role in realizing the financing, such as in the negotiations with the financing bank. In my opinion, the fact that it is not the underlying investor itself, but an acquisition company that he incorporated for the LBO that acquires the shares in the target company should not preclude his liability without reservation. As a rule, the acquisition company can be designated as an undercapitalized company that is fully controlled by the investor, so that it is possible to ‘pierce the corporate veil’ to the underlying investor; the latter is acting wrongfully by creating an inadequate financial structure, while he should seriously allow for a shortfall.