Bankruptcy Solvency and Fraudulent Transfer Analysis: What Trustees and Creditors' Counsel Should Know

Solvency isn't a single balance-sheet number: the work of a bankruptcy forensic accountant means weighing fair value of assets against liabilities, ability to pay debts as they come due, and adequate capital together -- while preference and fraudulent-transfer questions start with establishing what "normal" looked like before trouble began.

Solvency sounds like a yes-or-no question. In practice, it's rarely that simple -- and reducing it to one number is one of the more common ways a solvency analysis goes wrong before it even gets challenged.

A real matter: testing whether a company could survive

One matter that comes to mind is a company that brought me in when bankruptcy was a very real possibility. They were already insolvent, so the question wasn't whether they had a problem -- we knew we had a problem. The question was whether the business could actually survive it.

I started with the balance sheet, but a balance sheet is only the beginning of a solvency analysis. In a formal solvency analysis, you may need to consider the fair value of assets compared with liabilities, the company's ability to pay debts as they come due, and whether it has adequate capital to continue operating.

I was looking at the underlying accounting records, bank activity, accounts receivable and payable, debt obligations, payroll and staffing costs, operating expenses, and the company's actual and projected cash flow -- plus which expenses could realistically be reduced and how quickly those changes would affect cash. Book value isn't necessarily the same as fair value, and contingent or unrecorded obligations can matter too.

This was a very hands-on restructuring, with cash-flow expectations updated frequently as circumstances changed. The survival plan ultimately included scaling back operations, reducing staff, moving to a less expensive location, and negotiating directly with creditors. I also pressure-tested the projections: if revenue came in below expectations, collections slowed down, or an anticipated cost reduction didn't happen, could the company still meet its obligations? That sensitivity analysis is an important part of evaluating a company's ability to service its obligations under different operating conditions.

Ultimately, the company remained technically insolvent, but insolvent didn't necessarily mean unsalvageable. They avoided a bankruptcy filing by making difficult operating changes and negotiating their debts directly with creditors. Most of this experience has been on the restructuring and pre-bankruptcy side rather than coming in afterward to provide a retrospective solvency opinion for litigation -- but that week-to-week view of what insolvency actually looks like translates directly to bankruptcy litigation and solvency disputes. (It's the same ground covered from the recovery side in our post on building a post-bankruptcy recovery plan.)

Preference payment or ordinary course? Start with what "normal" looked like

The first thing I check when testing for a preference payment is what normal looked like before anyone was worried about bankruptcy. Give me the invoices, payment history, A/P detail, and bank records. I compare the challenged payment with how that creditor was historically paid: Was the timing different? Was the amount unusual? Did the payment method change? Was there suddenly increased collection pressure? Those kinds of changes can matter in an ordinary-course analysis.

Then, of course, I'm looking at whether the transaction meets the underlying elements of a preference in the first place. Section 547 looks at things like whether the transfer was on account of an antecedent debt, made while the debtor was insolvent, and made within the applicable prepetition period. Show me normal first. Then show me what changed. That's usually where the interesting part starts.

Fraudulent transfer: looking past how a transaction was recorded

I haven't personally been retained on a fraudulent transfer matter yet, so I'd be careful about pretending I have a case example. But from the forensic accounting perspective, the interesting question is whether a transaction actually delivered value equivalent to what left the company. I'd want to understand what was transferred, what the company received in return, how that value was established, and what the underlying records show about the substance of the transaction.

That's really where forensic accounting comes in. The books might tell you how somebody recorded a transaction. The job is to figure out the economic reality behind it -- an area of bankruptcy litigation worth doing more of.

The balance sheet isn't the whole test

I don't think trustees or creditors' attorneys misunderstand solvency so much as I think it sometimes gets reduced to one number when it's much more nuanced than that. Under the Bankruptcy Code's definition for most entities, the balance-sheet test isn't simply pulling up the balance sheet and checking whether equity is negative -- it compares debts with the debtor's property at fair valuation. Book value and the value relevant to a solvency analysis aren't necessarily the same thing.

Then there are other financial-condition questions that can matter depending on what's being analyzed, like whether the company could pay its debts as they came due or whether it had adequate capital. Those concepts show up in different provisions and contexts, so you have to understand which legal test counsel is asking you to analyze before you start crunching numbers. That means not accepting the balance sheet at face value -- understanding what the assets were actually worth at the relevant date, what liabilities existed, what obligations may not be obvious from the face of the financial statements, and what was happening with the company's liquidity and cash flow. A company can have assets and still have a cash problem. It can also be paying its bills while having a solvency problem. Those aren't the same analysis. If determining solvency were as easy as printing a balance sheet, nobody would need to hire a forensic accountant for it.

Tracing commingled funds

I haven't had a matter specifically labeled an alter-ego investigation yet, but I've done plenty of tracing involving commingled funds. The approach is to get underneath the accounting records and reconstruct the actual movement of money -- comparing bank activity to the general ledger, looking at transfers between accounts and entities, owner transactions, personal versus business expenditures, and whether there's documentation supporting the stated purpose of those transactions. How a transaction is recorded and what actually happened with the money are not always the same thing. That's where the forensic work starts: follow the money first, and let counsel determine what those findings mean legally. Commingled funds don't scare me. They just mean I need a bigger spreadsheet.

What makes an analysis hold up against a defense expert

I try to make the defense expert's job as boring as possible. That means no mystery numbers, no unsupported assumptions, and no "because that's what management told me" holding up a multimillion-dollar conclusion. Every material number should have a source. Every major assumption should have a reason. And if there's judgment involved, I want to understand how sensitive my conclusion is to that judgment.

That matters because the evidence supporting solvency can become the battleground itself -- courts have scrutinized things like book values, comparable companies, transaction dates, and whether valuation evidence actually supports the debtor's value on the relevant date. Then I basically rebut my own report before anyone else gets it. If opposing counsel finds a hole in the analysis, I want it to be because they worked really hard, not because I left the door open for them.

Key Takeaways

• A formal solvency analysis weighs fair value of assets against liabilities, ability to pay debts as they come due, and adequate capital -- not just book equity.
• Testing a preference payment starts with establishing the creditor's ordinary payment history, then flagging what changed.
• Fraudulent transfer analysis asks whether a transaction delivered real value, not just how it was recorded.
• Tracing commingled funds means reconstructing actual cash movement against the books, not trusting how transactions were labeled.
• A solvency or preference analysis holds up best when every number and assumption has a documented source.

If you're a trustee or creditors' counsel who needs a solvency, preference, or tracing analysis that holds up under scrutiny, let's talk.