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Creditors may prove fraudulent intent in divisive mergers

On Behalf of | Sep 20, 2021 | B2B Commercial Law, B2B Commercial Litigation |

The Texas Business Organizations Code permits companies to engage in a divisive merger. As reported by CNBC, a business may choose to attempt a divisive merger as a prelude to filing for bankruptcy protection and limiting its responsibility to pay liabilities. The approach is sometimes referred to as a “Texas Two-Step.”

If a company faces litigation, for example, it may consider using a divisive merger to separate its assets into one entity and its legal liabilities into another. A bankruptcy petition filed by the entity holding the liabilities may then help stop creditors’ lawsuits from moving forward.

Texas businesses may legally engage in a divisive merger

Because Texas statutes do not recognize an actual transfer during a divisive merger, the transaction may not classify as a fraudulent transfer. If, however, a creditor provides proof of intent that a debtor used a merger specifically to evade financial liabilities, a Texas court may void the transaction.

Under the Texas Business and Commerce Code’s Chapter 24, the responsibility in a lawsuit rests with the plaintiff to provide evidence that a debtor intentionally transferred or removed assets to defraud creditors.

How creditors may raise allegations of a fraudulent transaction

Fraudulent intent may arise when a debtor engages in a divisive merger immediately after a creditor pursues legal action, according to the Texas Uniform Fraudulent Transfer Act. Creditors have four years to pursue their claims before the statute of limitations runs out, as noted by Credit.com.

A Texas company may divide its assets and liabilities into several entities through a divisive merger. The law recognizes these transactions when business owners do not intend to conceal or hide assets from their creditors. A creditor, however, may choose to pursue legal action against a debtor with proof that the divisive merger reflects fraudulent intent.