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JOURNALIssues and Information for the Professional Today in the United States, every state matured (sometimes referred Chapter 11 - has its own fraudulent conveyance law, to as “constructive fraud”). which is applicable outside of bankruptcy Avoidance actions must be commenced “101” as well as in bankruptcy. In addition, the under ¤548 before the later of two years Bankruptcy Code contains its own after the entry of the order for relief (the fraudulent conveyance law, codified in date of the bankruptcy filing in voluntary The ’s Power ¤548 of the Code, which applies only in cases) or one year after a trustee is bankruptcy cases. The Uniform Fraudulent appointed, if the appointment occurs Transfer Act (UFTA) is the applicable before the expiration for the original two- to Avoid Fraudulent state fraudulent conveyance law of all but year period. about five states. New York is the most Bankruptcy Rule 7001(2) requires the Transfers important exception. The UFTA in many plaintiff to bring a fraudulent transfer avoidance cause of action as an adversary Contributing Editors: respects parallels Code ¤548, although the proceeding. The plaintiff has the burden Prof. John D. Ayer two are not identical. The remaining five of making a prima facie case. Insolvency University of California at Davis; Chico, Calif. states retain the old Uniform Fraudulent must be proven by the plaintiff; unlike in [email protected] Conveyance Act (UFCA). The trustee or DIP essentially must a preference action, insolvency is not Michael L. Bernstein show the following elements in a fraudulent presumed. The standard of proof is a Arnold & Porter LLP; Washington, D.C. conveyance action under ¤548: preponderance of the evidence; intent to [email protected] A transfer, either voluntary or defraud, however, must be proven by Jonathan Friedland involuntary, of the ’s clear and convincing evidence. Kirkland & Ellis LLP, Chicago or an interest therein (including the Actual Intent vs. Reasonably [email protected] incurring of an obligation by the debtor); Equivalent Value Editors’ Note: Bankruptcy law gives a 1. made (or incurred) within As indicated above, the trustee has the bankruptcy trustee or debtor-in-possession one year before the date of ability to avoid two different kinds of (DIP) the power to avoid certain transfers the filing of the bankruptcy transfers: (1) transfers made with actual fraud and transactions that took place before the petition, and either (under ¤548(a)(1)(A)), or (2) transfers that bankruptcy. The most common avoidance (a) made (or incurred) with involve constructive fraud (¤548(a) (1)(B)). powers are (1) the power to avoid prefer- actual intent to hinder, The distinction between the two is important. ences, (2) the power to avoid fraudulent delay or defraud a It is important in practice, because the prima conveyances and (3) the trustee’s “strong- of the debtor (sometimes facie showing required for each type of case arm” power. Last month’s column focused on referred to as “actual is different. It is important in principle the trustee’s ability to avoid preferences. This fraud”), or because it exhibits the different policies that month’s column focuses on the trustee’s (b) for which the debtor underlie fraudulent transfer law. power to avoid fraudulent conveyances and received less than reason- The trustee is free to proceed under “strong-arm” powers. ably equivalent value, and either prong of the fraudulent conveyance law. Thus, if the trustee can show insolvency raudulent transfer law is old. The (i) the debtor was insolvent and less-than-reasonably equivalent value, precursor to our modern fraudulent when the transfer was made then he doesn’t have to show actual intent. conveyances law dates back to the (or obligation incurred) or F For example, if the debtor gives away any of Statute of Elizabeth, enacted in England in was rendered insolvent his property while he is insolvent, the trustee the 16th Century. It was designed to protect hereby, or (ii) the debtor may avoid the transfer without any showing against that would thwart was engaged (or was about of intent. Alternatively, if the trustee can collection efforts by giving away their to become engaged) in a show that the debtor intended to hinder, property with the hopes of having it business for which the delay or defraud, then he may avoid the reconveyed after discouraged creditors gave debtor’s remaining property transaction without any showing as to up on collecting their claim. Case law represented an unreason- solvency. history dating back to the 17th Century ably small capital, or (iii) the The trustee is perfectly free to “plead in continues to be relevant. Indeed, current debtor intended to incur (or the alternative,” and there are cases where the statutes can best be understood as believed he or she would two classes overlap: A debtor who gives crystallizing a lot of this long case-law incur) debts beyond his or away property while insolvent may well history. her ability to repay as they have the intent to hinder, delay or defraud The American Bankruptcy Institute 44 Canal Center Plaza, Suite 404, Alexandria, VA 22314-1592 • 703 739 0800 creditors. Moreover, there may be a fine line 9. the debtor was insolvent or became Another important exception relates to between “intend[ing] to incur debts beyond insolvent shortly after the transfer was the case of charitable contributions. A his ability to pay” and “actual intent to made or the obligation was incurred; charitable contribution would seem to be a hinder, delay or defraud” a creditor. 10. the transfer occurred shortly before gift, and if the debtor makes the charitable or shortly after a substantial debt was contribution while insolvent, you might think What Is a Transfer? incurred; and it would be avoidable under the “constructive So far, we have spoken of “transfers,” but 11. the debtor transferred the essential fraud” rule. This is not necessarily so per we have not defined transfers. Of course, a assets of the business to a lienor who ¤548(a)(2), which insulates certain charitable conveyance of real or personal property can transferred the assets to an insider of the contributions from fraudulent transfer attack. be a “transfer,” and that is the most common debtor. But note that it does not exempt charitable case. For example, a deed to real property or a And while these factors are not specifically contributions made with actual intent to payment of cash is a “transfer.” But there are included in ¤548, many judges consider hinder, delay or defraud creditors. less obvious sorts of “transfers” as well. For them in fraudulent transfer actions under the example, the granting of a release or waiving Bankruptcy Code, as well as under the “Strong-arm” Avoidance of claims may be a transfer. Terminating a UFTA. The “badges of fraud” point to an Under §544(b) license could be a “transfer.” And some important conceptual difficulty in fraudulent Aside from ¤548, there is a wholly courts have held that making a tax election transfer law, which is: We are talking about separate line of attack for the trustee trying to that results in a loss of valuable tax attributes “actual” intent. Yet by including the badges avoid a fraudulent transfer. This is ¤544(b) of constitutes a transfer. Thus, it makes sense to of fraud, the drafters implicitly concede that the Code, which provides that the trustee think broadly when considering what may we rarely know the transferor’s actual may avoid a transfer “that is voidable under constitute a transfer for purposes of fraudulent intent; in most cases, the best we can do is to applicable law by a creditor holding an conveyance analysis—anything that results in infer the transferor’s intent from some unsecured claim.” This means that the trustee a loss of value to the transferor, whether outward signs. may look to non-bankruptcy law (usually intentionally or not, may qualify. “state” law) and deploy any avoiding power In fact, the Code’s definition is more Good-faith Transferees that he finds there. The most common use of extensive than just transfers. It says the and Charitable Contributions ¤544(b) is to give the trustee a right of action trustee “may avoid any transfer of an interest A transferee who deals at arm’s length under state fraudulent transfer law, the of the debtor in property.” But then it adds with his transferor may be protected by a UFTA or UFCA. These are most often the phrase “or any obligation incurred.” So a “good-faith transferee rule.” Specifically, useful to the trustee (or DIP) because of the promise to transfer money or property may ¤548(c) provides that a transferee, who takes longer reach-back period available under be avoidable, just as much as a transfer itself. for value and in good faith, has a on the state law. As noted above, under ¤548 a Proving Intent property transferred (or may retain property trustee may avoid a fraudulent transfer only if It is usually difficult to find good, non- transferred) to the extent of the value he it took place within one year prior to the circumstantial evidence of “actual intent to gave for the transfer. For example, a good- petition date. However, depending on the hinder, delay or defraud.” People do not tend faith purchaser buys a house for $300,000. state, the reach-back period under state law to admit such “evil” intent, and other “hard The seller then files bankruptcy and sues the may be from two to six years. evidence” of intent is hard to come by. buyer under ¤548 to avoid the sale as a There are occasionally other uses that a Recognizing this, the UFTA includes a list fraudulent conveyance, arguing that the trustee can make of state fraudulent of conditions or events that are suggestive of seller was insolvent at the time of the sale conveyance law—claims that exist under fraudulent intent. These are referred to as and that the house was actually worth $1 state law but not under ¤548. For example, “badges of fraud.” UFTA §4(b) provides million. The transaction will be avoided, under the UFTA a transfer by an insolvent that “in determining actual intent under since the seller did not receive reasonably debtor to an insider who knew of the subsection (a)(1), consideration may be equivalent value, but the buyer will retain a insolvency, on account of a debt owed to the given, among other factors, to whether:” lien on the house, after it is reconveyed to insider, may be avoidable, even though it 1. the transfer or obligation was to an the seller’s estate, to secure its $300,000 would (absent actual fraud) not be avoidable insider; purchase price. (If the buyer made under §548 because, under §548, “value” 2. the debtor retained possession or improvements to the house before he includes the satisfaction of an antecedent control of the property transferred after reconveyed it, he may also have a lien to debt. This case may not come up every day, the transfer; secure the value of the improvements he but it illustrates an important point: When 3. the transfer or obligation was made, pursuant to ¤550(e)). considering a fraudulent conveyance action, disclosed or concealed; Good faith requires an arm’s-length the trustee (or DIP) should review the 4. before the transfer was made or transaction and the following three factors: applicable state statute to determine what obligation was incurred, the debtor had 1. a belief in the propriety of the actions claims may be available. ■ been sued or threatened with suit; in question; 5. the transfer was of substantially all the 2. no intent to unconscionably disad- Reprinted with permission from the ABI debtor’s assets; vantage others; and Journal, Vol. XXIII, No. 4, May 2004. 6. the debtor absconded; 3. no intent to, or awareness that, the 7. the debtor removed or concealed activities in question will hinder, delay The American Bankruptcy Institute is a assets; or defraud others. multi-disciplinary, non-partisan orga- 8. the value of the consideration Lienors and obligees, as well as good-faith nization devoted to bankruptcy issues. received by the debtor was reasonably purchasers, may be protected under this ABI has more than 10,000 members, equivalent to the value of the asset defense. Knowledge of the transferor’s representing all facets of the insolvency transferred or the amount of the insolvency may prevent an assertion of field. For more information, visit ABI obligation incurred; good faith. World at www.abiworld.org. The American Bankruptcy Institute 44 Canal Center Plaza, Suite 404, Alexandria, VA 22314-1592 • 703 739 0800