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Fraudulent Conveyances & Hidden Landmines

One of the key elements of a successful asset protection plan is not having a transfer of property pursuant to that plan be deemed by a court to be a "fraudulent conveyance". If held to be a fraudulent conveyance, the transfer can be undone and, if the transferor has sought relief in bankruptcy, he may be denied a discharge. Depending on applicable state law, the transferor may also be subject to a wide range of remedies and friends, family and advisors who 'aid and abet' the transfer could be brought into litigation and in some cases be charged with civil conspiracy.

Fraudulent conveyances can be either (1) intentionally fraudulent or (2) constructively fraudulent.

Intentionally Fraudulent Conveyances. Both the Bankruptcy Code, a Federal Law, and Uniform Fraudulent Conveyance Acts ("UFC Acts"), adopted by Idaho and many other states[1], provide that a transfer made by a debtor is fraudulent if made with the "actual intention to hinder, delay or defraud"[2] any creditor of the debtor within: (a) 2 years prior to filing a petition in bankruptcy[3], and (b) four years under most (but not all) state UFC Acts prior to a creditor bringing an action under the applicable UFC Act (the "reach back period"). The reach back period is typically 1 year if the transfer is made to an insider.[4]

Because "intent to hinder, delay or defraud" is not easy to prove, courts rely on "badges of fraud" to prove intent. The "badges of fraud" include consideration as to whether:

  1. The transfer or obligation was to an insider;
  2. The debtor retained possession or control of the property transferred after the transfer;
  3. The transfer or obligation was disclosed or concealed;
  4. Before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit;
  5. The transfer was of substantially all the debtor's assets;
  6. The debtor absconded with the proceeds of the transfer after their receipt;
  7. The debtor removed or concealed assets;
  8. The value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred;
  9. The debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred;
  10. The transfer occurred shortly before or shortly after a substantial debt was incurred; and
  11. The debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.[5]

"Badges of fraud" give courts wide latitude to dissect transactions to consider motive, secrecy, timing relative to a claim and insolvency, and whether the debtor received "reasonably equivalent value" among other factors. If confronted with such a claim, the debtor is in a stronger position (although not assured) to defend against such a claim, if he/she can show that the transfer was made in good faith (e.g., as part of ordinary business or estate planning plan), was not concealed, and was made at a good distance in time prior to any debt or claim being incurred or insolvency being suffered.

Constructive Fraudulent Conveyance. In constructive fraudulent conveyance cases, intent is irrelevant. The analysis focuses on whether the debtor:

  • received reasonably equivalent value in exchange for the transfer or obligation, and
  • was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or
  • intended to incur, or believed or reasonably should have believed that he or she would incur, debts beyond his or her ability to pay as they became due.[6]

Because of the reach back periods applicable to fraudulent conveyances and because intent is irrelevant, a wide variety of transfers may be alleged to be fraudulent. Examples include transfers to retirement accounts and 529 educational plans, gifts to family members including spouses, and transfers into irrevocable trusts, and payment of education and medical expenses if the transferor did not have a legal obligation to provide the same.

In general, assertions of fraudulent conveyance can usually be defended against if the transferee received "reasonably equivalent value" in exchange for the transfer. Unfortunately, "reasonably equivalent value" is not defined in the Bankruptcy Code or UFC Acts. This has resulted in a great deal of case law with widely varying outcomes depending on the specific facts of the cases and the jurisdiction in which the creditor's claim was brought.

As attorneys our objective is to enable our clients to not only protect their assets, but to also stay on the right side of the law. The threat of an action for fraudulent conveyance is very real and should be taken seriously by anyone desiring to mitigate the risk of creditors' claims. We work with our clients to understand the risks of taking various actions and develop a life long plan that is reasonable, defensible, and woven into the fabric of their overall estate, retirement, and business planning.

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