A fraudulent conveyance, also called a fraudulent transfer, is a transaction where one party (“Transferor”) gives or sells for less than full value an asset to another party (“Transferee”), leaving the Transferor without sufficient assets to pay his obligations. An example of a fraudulent transfer is an individual gift all his assets to a close friend in order not to pay his debts. Although historically a fraudulent transfer required a transfer to be made in bad faith, under modern law a good-faith transfer can still constitute a fraudulent conveyance. Simply put, a transaction is a fraudulent conveyance if the transfer is not made for reasonably equivalent value and the debtor was insolvent (meaning, not able to pay his debts as they came due), rendered insolvent by the transaction, or intended to defraud, delay, or hinder a creditor’s attempts to collect on a debt.
Fraudulent transfers are governed by two separate bodies of law:
- state fraudulent transfer law, which generally follow the Uniform Fraudulent Transfer Act (“UFTA”) or the Uniform Fraudulent Conveyance Act (“UFCA”) and
- Section 548 of the federal Bankruptcy Code (11 U.S.C. 548).
Although fraudulent conveyance claims are most commonly asserted by creditors and bankruptcy trustees in bankruptcy proceedings, nothing in the law limits fraudulent conveyance claims to bankruptcy proceedings. If a transfer violates the UFTA or UFCA, creditors can and often do pursue fraudulent transfer claims outside of bankruptcy.
Determining a Transfer or Sale is a Fraudulent Conveyance Under State Law
Under the UFTA, which is the law in the majority of states, determining whether or not a transfer is a fraudulent conveyance involves four separate questions. If the answer to any of the four questions is yes, the transfer is a fraudulent conveyance. The questions are:
- Was the transfer made with the actual intent to hinder, delay, or defraud a current or future creditor’s attempt to collect? If the answer is yes, the conveyance is an intentional fraudulent conveyance and the creditor prevails under UFTA Section 4(a)(1). A creditor must establish that the Transferor actually intended to hinder, delay or defraud by a preponderance of the evidence as opposed to the criminal standard of proof of beyond a reasonable doubt. Under Section 4(b) of the UFTA, facts that indicate actual intent include, but are not limited to: Transferor retaining possession or control after the transfer, concealing the transfer, and the transfer including all or almost all of the Transferor’s assets.
- Did the Transferor fail to receive reasonably equivalent value for the transfer under circumstances indicating a heightened likelihood of fraudulent intent? If yes, the conveyance is fraudulent as to present and future creditors under UFTA Section 4(a)(2). The “circumstances indicating a heightened likelihood of fraudulent intent” prong of this requirement is satisfied if either: (1) the Transferor intended to incur, believed he would incur, or should have believed he would incur debts beyond his ability to pay them OR (2) the Transferor engaged in or was about to engage in a transaction or action where the remaining assets are unreasonable small. For example, a subsidiary company which transfers all its assets to a parent company immediately before engaging in a highly dangerous activity for which it is likely to be held liable for harm to others will be considered to have fraudulently transferred the assets to the parent company.
- Was a transfer made without receiving reasonably equivalent value by a Transferor who was insolvent EITHER before the transfer or as a result of the fraudulent transfer? If yes, the transfer is a fraudulent transfer under UFTA Section 5(a), but only persons who were already creditors at the time the transfer occurred can collect. If a transfer is for reasonably equivalent value, the transfer is NOT fraudulent under Section 5(a). If the Transferor is solvent when the transfer is made and the transfer does not cause the Transferor to become insolvent, the transfer is not fraudulent under Section 5(a).
- Was the transfer a payment of an existing debt by an insolvent Transferor to an insider who had reasonable cause to believe the debtor was insolvent? An “insider” is a person with special knowledge of a company’s finances; such as an officer, director, shareholder or key employee. If yes, the transfer is fraudulent under UFTA Section 5(b), but only persons who were already creditors at the time the transfer occurred can collect.
Determining Whether a Transfer is a Fraudulent Conveyance Under Bankruptcy Law
The Bankruptcy Code authorizes the bankruptcy trustee to rescind (known as “avoiding”) six separate types of transactions as impermissible fraudulent conveyances. These transactions are:
- Any transfer that could be avoided by ANY unsecured creditor as a fraudulent conveyance under state law. To determine if this section applies, perform the analysis discussed above.
- Transfers made less than two years before the Transferor files for bankruptcy AND made with the actual intent to hinder, delay, or defraud any and/or all creditors.
- Transfers in which the Debtor receives less than a reasonably equivalent value, which are made less than two years before the Transferor files for bankruptcy which leave the Transferor insolvent or lead to the Transferor’s eventual insolvency.
- Transfers in which the Debtor receives less than a reasonably equivalent value, which are made less than two years before the Transferor files for bankruptcy if the Transferor believed the Transferor would be unable to pay his/its debts.
- Transfers in which the Debtor receives less than a reasonably equivalent value, which are made less than two years before the Transferor files for bankruptcy if the transfer is made to or for the benefit of an insider and the transfer is not made in the ordinary course of business.
- Transfers in which the Debtor receives less than a reasonably equivalent value, which are made less than two years before the Transferor files for bankruptcy if the transfer leaves the Transferor with unreasonably small capital for the business in which the Transferor is engaged.
Consequences of a Transfer Being a Fraudulent Conveyance
If a creditor succeeds in establishing that a transfer was a fraudulent conveyance under the UFTA or UFCA outside of bankruptcy, the creditor is entitled to recover for the Transferor the fraudulently transferred property from the Transferee. The creditor can then pursue the Transferor for that asset. If a bankruptcy establishes that a conveyance was fraudulent under any of the UFTA, UFCA or the Federal Bankruptcy Code, the Transferee must return the transferred property the Transferor’s estate. Under the Bankruptcy Code, if the Transferee gave value in good faith in exchange for the conveyed property, the Transferee can keep the property up to the amount of value given. 11 U.S.C. Section 548(a)(1)(C).
Section 7 of the UFTA provides a variety of additional remedies successful creditor can seek. Among these are: injunctions against further transfers by the Transferor, appointment of a receiver to take control of the asset from the Transferee, and a constructive trust over the fraudulently transferred property and/or any proceeds from the property.
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