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Today in the United States, every statehas its own fraudulent conveyance law,which is applicable outside of bankruptcyas well as in bankruptcy. In addition, theBankruptcy Code contains its ownfraudulent conveyance law, codified in§548 of the Code, which applies only inbankruptcy cases. The Uniform FraudulentTransfer Act (UFTA) is the applicablestate fraudulent conveyance law of all butabout five states. New York is the mostimportant exception. The UFTA in manyrespects parallels Code §548, although thetwo are not identical. The remaining fivestates retain the old Uniform FraudulentConveyance Act (UFCA).
The trustee or DIP essentially mustshow the following elements in a fraudulentconveyance action under §548:
A transfer, either voluntary orinvoluntary, of the debtor’s propertyor an interest therein (including theincurring of an obligation by thedebtor);
1. made (or incurred) withinone year before the date ofthe filing of the bankruptcypetition, and either(a) made (or incurred) withactual intent to hinder,delay or defraud a creditorof the debtor (sometimesreferred to as “actualfraud”), or(b) for which the debtorreceived less than reason-ably equivalent value, and(i) the debtor was insolventwhen the transfer was made(or obligation incurred) orwas rendered insolventhereby, or (ii) the debtorwas engaged (or was aboutto become engaged) in abusiness for which thedebtor’s remaining propertyrepresented an unreason-ably small capital, or (iii) thedebtor intended to incur (orbelieved he or she wouldincur) debts beyond his orher ability to repay as they
JOURNALIssues and Information for the Insolvency Professional
The American Bankruptcy Institute 44 Canal Center Plaza, Suite 404, Alexandria, VA 22314-1592 • 703 739 0800
The Trustee’s Powerto Avoid FraudulentTransfers
Contributing Editors:Prof. John D. Ayer
University of California at Davis; Chico, [email protected]
Michael L. BernsteinArnold & Porter LLP; Washington, D.C.
Jonathan FriedlandKirkland & Ellis LLP, Chicago
Editors’ Note: Bankruptcy law gives abankruptcy trustee or debtor-in-possession(DIP) the power to avoid certain transfersand transactions that took place before thebankruptcy. The most common avoidancepowers are (1) the power to avoid prefer-ences, (2) the power to avoid fraudulentconveyances and (3) the trustee’s “strong-arm” power. Last month’s column focused onthe trustee’s ability to avoid preferences. Thismonth’s column focuses on the trustee’spower to avoid fraudulent conveyances and“strong-arm” powers.
Fraudulent transfer law is old. Theprecursor to our modern fraudulentconveyances law dates back to the
Statute of Elizabeth, enacted in England inthe 16th Century. It was designed to protectcreditors against debtors that would thwartcollection efforts by giving away theirproperty with the hopes of having itreconveyed after discouraged creditors gaveup on collecting their claim. Case lawhistory dating back to the 17th Centurycontinues to be relevant. Indeed, currentstatutes can best be understood ascrystallizing a lot of this long case-lawhistory.
matured (sometimes referredto as “constructive fraud”).
Avoidance actions must be commencedunder §548 before the later of two yearsafter the entry of the order for relief (thedate of the bankruptcy filing in voluntarycases) or one year after a trustee isappointed, if the appointment occursbefore the expiration for the original two-year period.
Bankruptcy Rule 7001(2) requires theplaintiff to bring a fraudulent transferavoidance cause of action as an adversaryproceeding. The plaintiff has the burdenof making a prima facie case. Insolvencymust be proven by the plaintiff; unlike ina preference action, insolvency is notpresumed. The standard of proof is apreponderance of the evidence; intent todefraud, however, must be proven byclear and convincing evidence.
Actual Intent vs. ReasonablyEquivalent Value
As indicated above, the trustee has theability to avoid two different kinds oftransfers: (1) transfers made with actual fraud(under §548(a)(1)(A)), or (2) transfers thatinvolve constructive fraud (§548(a) (1)(B)).The distinction between the two is important.It is important in practice, because the primafacie showing required for each type of caseis different. It is important in principlebecause it exhibits the different policies thatunderlie fraudulent transfer law.
The trustee is free to proceed undereither prong of the fraudulent conveyancelaw. Thus, if the trustee can show insolvencyand less-than-reasonably equivalent value,then he doesn’t have to show actual intent.For example, if the debtor gives away any ofhis property while he is insolvent, the trusteemay avoid the transfer without any showingof intent. Alternatively, if the trustee canshow that the debtor intended to hinder,delay or defraud, then he may avoid thetransaction without any showing as tosolvency.
The trustee is perfectly free to “plead inthe alternative,” and there are cases where thetwo classes overlap: A debtor who givesaway property while insolvent may wellhave the intent to hinder, delay or defraud
A M E R I C A N B A N K R U P T C Y I N S T I T U T E
Chapter 11 - “101”
The American Bankruptcy Institute 44 Canal Center Plaza, Suite 404, Alexandria, VA 22314-1592 • 703 739 0800
creditors. Moreover, there may be a fine linebetween “intend[ing] to incur debts beyondhis ability to pay” and “actual intent tohinder, delay or defraud” a creditor.
What Is a Transfer?So far, we have spoken of “transfers,” but
we have not defined transfers. Of course, aconveyance of real or personal property canbe a “transfer,” and that is the most commoncase. For example, a deed to real property or apayment of cash is a “transfer.” But there areless obvious sorts of “transfers” as well. Forexample, the granting of a release or waivingof claims may be a transfer. Terminating alicense could be a “transfer.” And somecourts have held that making a tax electionthat results in a loss of valuable tax attributesconstitutes a transfer. Thus, it makes sense tothink broadly when considering what mayconstitute a transfer for purposes of fraudulentconveyance analysis—anything that results ina loss of value to the transferor, whetherintentionally or not, may qualify.
In fact, the Code’s definition is moreextensive than just transfers. It says thetrustee “may avoid any transfer of an interestof the debtor in property.” But then it addsthe phrase “or any obligation incurred.” So apromise to transfer money or property maybe avoidable, just as much as a transfer itself.Proving Intent
It is usually difficult to find good, non-circumstantial evidence of “actual intent tohinder, delay or defraud.” People do not tendto admit such “evil” intent, and other “hardevidence” of intent is hard to come by.Recognizing this, the UFTA includes a listof conditions or events that are suggestive offraudulent intent. These are referred to as“badges of fraud.” UFTA §4(b) providesthat “in determining actual intent undersubsection (a)(1), consideration may begiven, among other factors, to whether:”
1. the transfer or obligation was to aninsider;2. the debtor retained possession orcontrol of the property transferred afterthe transfer;3. the transfer or obligation wasdisclosed or concealed;4. before the transfer was made orobligation was incurred, the debtor hadbeen sued or threatened with suit;5. the transfer was of substantially all thedebtor’s assets;6. the debtor absconded;7. the debtor removed or concealedassets;8. the value of the considerationreceived by the debtor was reasonablyequivalent to the value of the assettransferred or the amount of theobligation incurred;
9. the debtor was insolvent or becameinsolvent shortly after the transfer wasmade or the obligation was incurred;10. the transfer occurred shortly beforeor shortly after a substantial debt wasincurred; and11. the debtor transferred the essentialassets of the business to a lienor whotransferred the assets to an insider of thedebtor.
And while these factors are not specificallyincluded in §548, many judges considerthem in fraudulent transfer actions under theBankruptcy Code, as well as under theUFTA. The “badges of fraud” point to animportant conceptual difficulty in fraudulenttransfer law, which is: We are talking about“actual” intent. Yet by including the badgesof fraud, the drafters implicitly concede thatwe rarely know the transferor’s actualintent; in most cases, the best we can do is toinfer the transferor’s intent from someoutward signs.
Good-faith Transferees and Charitable Contributions
A transferee who deals at arm’s lengthwith his transferor may be protected by a“good-faith transferee rule.” Specifically,§548(c) provides that a transferee, who takesfor value and in good faith, has a lien on theproperty transferred (or may retain propertytransferred) to the extent of the value hegave for the transfer. For example, a good-faith purchaser buys a house for $300,000.The seller then files bankruptcy and sues thebuyer under §548 to avoid the sale as afraudulent conveyance, arguing that theseller was insolvent at the time of the saleand that the house was actually worth $1million. The transaction will be avoided,since the seller did not receive reasonablyequivalent value, but the buyer will retain alien on the house, after it is reconveyed tothe seller’s estate, to secure its $300,000purchase price. (If the buyer madeimprovements to the house before hereconveyed it, he may also have a lien tosecure the value of the improvements hemade, pursuant to §550(e)).
Good faith requires an arm’s-lengthtransaction and the following three factors:
1. a belief in the propriety of the actionsin question;2. no intent to unconscionably disad-vantage others; and3. no intent to, or awareness that, theactivities in question will hinder, delayor defraud others.
Lienors and obligees, as well as good-faithpurchasers, may be protected under thisdefense. Knowledge of the transferor’sinsolvency may prevent an assertion of good faith.
Another important exception relates tothe case of charitable contributions. Acharitable contribution would seem to be agift, and if the debtor makes the charitablecontribution while insolvent, you might thinkit would be avoidable under the “constructivefraud” rule. This is not necessarily so per§548(a)(2), which insulates certain charitablecontributions from fraudulent transfer attack.But note that it does not exempt charitablecontributions made with actual intent tohinder, delay or defraud creditors.
“Strong-arm” Avoidance Under §544(b)
Aside from §548, there is a whollyseparate line of attack for the trustee trying toavoid a fraudulent transfer. This is §544(b) ofthe Code, which provides that the trusteemay avoid a transfer “that is voidable underapplicable law by a creditor holding anunsecured claim.” This means that the trusteemay look to non-bankruptcy law (usually“state” law) and deploy any avoiding powerthat he finds there. The most common use of§544(b) is to give the trustee a right of actionunder state fraudulent transfer law, theUFTA or UFCA. These are most oftenuseful to the trustee (or DIP) because of thelonger reach-back period available understate law. As noted above, under §548 atrustee may avoid a fraudulent transfer only ifit took place within one year prior to thepetition date. However, depending on thestate, the reach-back period under state lawmay be from two to six years.
There are occasionally other uses that atrustee can make of state fraudulentconveyance law—claims that exist understate law but not under §548. For example,under the UFTA a transfer by an insolventdebtor to an insider who knew of theinsolvency, on account of a debt owed to theinsider, may be avoidable, even though itwould (absent actual fraud) not be avoidableunder §548 because, under §548, “value”includes the satisfaction of an antecedentdebt. This case may not come up every day,but it illustrates an important point: Whenconsidering a fraudulent conveyance action,the trustee (or DIP) should review theapplicable state statute to determine whatclaims may be available. ■
Reprinted with permission from the ABIJournal, Vol. XXIII, No. 4, May 2004.
The American Bankruptcy Institute is amulti-disciplinary, non-partisan orga-nization devoted to bankruptcy issues.ABI has more than 10,000 members,representing all facets of the insolvencyfield. For more information, visit ABIWorld at www.abiworld.org.
