Consumer Law

Fraudulent Transfers

Fraudulent Transfers

The trustee is given the power to set aside or "avoid" certain transfers of the debtor's assets out of the estate that unfairly place assets beyond the reach of creditors. Such a transfer of the debtor's assets to a third party, with the intent to prevent creditors from reaching the assets to satisfy their claims, is called a fraudulent conveyance or transfer. As a general rule, the power to avoid transfers is effective against transfers made within 90 days prior to the filing of the bankruptcy petition. If the transfers involved insiders, which include relatives, general partners, directors, or officers of the debtor, the trustee or debtor in possession may cancel such transfers if they were made up to one year prior to the bankruptcy filing.

The debtor must disclose and the trustee may avoid those transfers made within one year of the bankruptcy filing by which the debtor intended to hinder, delay, or defraud a creditor, or if the debtor received less than reasonably equivalent value and (1) the debtor was insolvent at the time of the transfer or immediately after the transfer, (2) the debtor's operation was under-capitalized after the transaction, or (3) the debtor knew that he or she would incur debts beyond his or her capacity to repay.

Purpose and Intent Behind Transfer or Conversion

Not all transfers or conversions which move assets beyond a creditor's reach are fraudulent and subject to reversal. Whether or not a transfer is intended to hinder, delay, or defraud creditors depends on the debtor's purpose and his intent behind the transfer or conversion. To ascertain the debtor's purpose and intent of a property transfer courts look to factors that are often indicative of intent to avoid creditor claims. For example, a court will examine whether any particular transfer was made to a debtor's family member, whether a transfer was concealed, whether the debtor retained effective use or control over the property transferred, and whether the transfer rendered the debtor insolvent. These factors suggest that a transfer was fraudulent and should be set aside.

Defenses to Conveyance of Assets

A debtor can show many legitimate reasons to convey assets other than avoiding creditors. People have a constitutional right to control or transfer their property until such time as a judgment creditor obtains a legal interest in the property, which is why the applicable statutes do not prohibit or make illegal fraudulent conveyances. A court cannot increase the amount of the judgment damages already awarded against a debtor based on a debtor's fraudulent conveyance.

Actual and Constuctive Fraud

There are two types of fraudulent transfers in bankruptcy law. The first, actual fraud, involves the intent to defraud creditors, the other, sometimes called constructive fraud, involves a transfer, which is made in exchange for grossly inadequate consideration.

Actual fraud is committed when:

  • A transfer is made within one year before the date of the filing of a bankruptcy petition
  • The tranfer is made with the intent to hinder or defraud a creditor

Actual fraud requires proof of intent from the person challenging the transfer. Courts have set forth circumstances that indicate the intent to defraud, such as actual or threatened litigation against the debtor, a retention of possession or control of the property, transfer of substantially all the debtor's assets, transfer to a newly created corporation, and a special relationship with the person to whom the property is transferred.

Constructive fraud also requires two conditions:

  • In exchange for the transfer, the debtor received less than the reasonably equivalent value and
  • The debtor is unable to pay debts either at the time the transfer was made or as a result of the transfer itself.

In this case, intent need not be proven rather the focus of the inquiry rests on whether the debtor received reasonably equivalent value. Although the trustee of the estate must prove that reasonably equivalent value has not been given, there is no formula for determining reasonably equivalent value. Courts will look at all the circumstances surrounding a transaction to determine whether the exchange looks even. Some of the factors courts have considered in making a determination are whether the sale was for fair market value, whether the transaction was made in good faith in the ordinary course of business by parties of independent interests, the competitiveness of bids for the property, and the net effect on the debtor's estate with respect to funds available to unsecured creditors. Generally, for an exchange to be considered legitimate, value does not have to be received directly by the debtor, but may exist in the form of additional business opportunities made available through new lines of credit or new affiliations created by the transfer. However, transfers made solely for the benefit of third parties are not reasonably equivalent value.

Timing of the Transfer

The timing of the transfer is important in determining whether the transfer will stand or not. Only those transfers completed or "perfected" within a year of the filing of the petition for bankruptcy may be reversed. The transfer of certain types of property requires more than one step to complete the transaction. In the case of real estate, for example, the transfer is not complete until a deed is officially recorded.

Recovering the Property

Once a transfer has been deemed fraudulent, the trustee may recover the property, or the value of the property, and make it part of the bankruptcy estate. They may do so from either the immediate recipient or from anyone else to whom the property was subsequently transferred. One exception to this general rule is when there is a "bona fide purchaser." A bona fide purchaser is one who acted in good faith to purchase the property without notice of the outstanding rights of others to the property. The bona fide purchaser may retain the property. Another exception is made in a case where valuable improvements to the property have been made. In this case, those that made the improvements to the property are given a lien on the property, securing the improvements they made. Finally, if the law places no other restrictions on the transfer, and the property was purchased for some value in good faith, in other words, with no knowledge of the fraudulent intent, the person receiving the transferred property may be allowed to retain the property or regain the value they paid for it in the settling of the estate.

Temporary Restraining Orders and Preliminary Injunctions

Creditors who suspect the fraudulent transfer of property may be able to obtain a temporary restraining order and preliminary injunction to prevent the transfer before it occurs.

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