FRAUDULENT TRANSFERS INTRODUCTION

Fraudulent Transfer Law is talked around a lot in asset protection planning, but it is rarely addressed head-on. The purpose of this section is to explain the basics of Fraudulent Transfer Law (also known as Fraudulent Conveyance Law,) so that when you hear the phrase you will better understand how important it is.

Basically, a Fraudulent Transfer (a/k/a "Fraudulent Conveyance") is a transfer that a debtor makes for the purpose of defeating a creditor's collection efforts against the debtor. This typically happens when, say, a debtor attempts to "sell" everything to his wife, cousin or business partner for $500 to keep his stuff out of the hands of his creditors. If the court figures out that the transaction is a sham to defeat the creditor, the court will set aside the transaction and make the person holding the assets give them to the creditor.

The modern law relating to fraudulent transfers derives from a case decided by the late Lord Coke in 1601, see, e.g., Twyne's Case, 3 Coke 80b, 76 Eng.Rep. 809 (Star Chamber 1601), and the law really hasn't changed that much over the course of the last 400 years.

Quite simply, Fraudulent Transfer Law is this: You can't do anything which would impair the rights of your unsecured creditors. If you do then the courts will simply ignore what you have done and assist your creditor in recovering the assets you transferred.

Gifts and Donations

Fraudulent Transfer Law is primarily aimed at people who try to make gifts to other people to avoid their creditors. These gifts are invariably to family or friends, and the real purpose is almost always that the person will get his assets back at some point in the future after the creditor is no longer a problem.

The unexpressed rationale is that the gift was only made to keep creditors from getting it, and the gift will either be controlled by the person who made the gift, or they will get it back after the creditors go away. So right off the bat there is a control test: If you have made a gift to keep it away from creditors, but you really still control it, the gift will be a fraudulent transfer.

Another unexpressed rationale is that you shouldn't be making gifts if you are broke (if you are broke you should be receiving gifts!). So there is also an "insolvency test": If you have made a gift while you are insolvent, the gift will be a fraudulent transfer.

Finally, you shouldn't be doing anything which would lessen your creditor's rights. So there is an "actual intent test": If you make a gift with the actual intent of keeping it away from your creditors, the gift will be a fraudulent transfer. This is why you should never call an asset protection plan an asset protection plan, and why you should incorporate other planning into the plan. Call it anything else -- a tax plan, an estate plan, whatever -- just not an asset protection plan.

Well, you say, I'm sure not going to admit that my intention was to keep it away from my creditors. This argument does not protect the gift, it just makes it a little harder to prove, because fraudulent transfers can be proved by circumstantial evidence. And this is why you need to have you plan formed by a licensed attorney who has been in court, and knows what sort of evidence to look out for. The Courts have developed a number of criteria that they look to in order to determine what your real intent was (even though you won't admit it.) These criteria are called "the badges of fraud." We won't go into all of them here but they include such obvious items as whether the transfer was made at "arm's length" (to someone other than a family member or friend",) whether you received fair consideration for the asset you transferred, and whether you made the transfer after you knew you were going to have a creditor problem. These are things that suggest that you had the wrong motive at the time of the transfer.

How Do You Avoid Fraudulent Transfers?

The safest way to avoid fraudulent transfers is make sure that all transactions are at least close to being "for fair or comparable value." While "for value" transactions can still be set aside as a fraudulent conveyance, it is very, very hard for a creditor to prove.

Another factor is that the transaction must have economic substance. A transaction which does not have economic substance is likely to be deemed a fraudulent transfer, but a transaction which makes good economic sense under the circumstances is going to be very, very difficult for a creditor to defeat.

While a conveyance for value will not guarantee that the transfer will stand up, see, e.g., Cioli v. Kenourgios, 59 Cal.App. 690, 211 P. 838 (1922) (debtor's sale of all assets and shipment of proceeds out of the country held to be fraudulent conveyance notwithstanding "fair value"), if a transfer is for equal or near-equal consideration then you have a much, much higher chance that the transfer will not be deemed to be a fraudulent transfer, see, e.g., Bank of Sun Prairie v. Hovig, 218 F.Supp. 769 (W.D.Ark. 1963); Lumpkin v. McPhee, 59 N.M. 442, 286 P.2d 299 (1955); Weigel v. Wood, 355 Mo. 11, 194 S.W.2d 40 (1946); Wareheim v. Bayliss, 149 Md. 103, 131 A. 27 (1925).

When Transfers Are Made

The timing of the transfer is often critical to the determination of whether a particular transfer amounts to a fraudulent conveyance.

It will be very difficult to prove that any transfer which was made before any claims were known or reasonably suspected was a fraudulent transfer. By like token, it can be assumed that any gifts made after bankruptcy is filed are fraudulent transfers, and even for-value transfers will typically have to be approved in advance by the bankruptcy court.

Between these two extremes, it is possible to take reasonable but adverse positions as to whether or not a transfer was fraudulent in nature. These positions can be taken with increasing or decreasing comfort, depending upon the progress of the litigation.