Fraudulent conveyance

A fraudulent conveyance, also "fraudulent transfer" is a civil cause of action. It arises in debtor/creditor relations, particularly with reference to insolvent debtors. The cause of action is typically brought by creditors or by bankruptcy trustees. The usual fact situation involves a debtor who donates his assets, usually to an "insider", and leaves himself nothing to pay his creditors as part of an asset protection scheme. However, it is not uncommon to see fraudulent conveyance applications in relation to "bona fides" transfers, where the bankrupt has simply been more generous than they should have or, in business transactions, the business should have ceased trading earlier to avoid giving certain business creditors an unfair preference (see generally, "wrongful trading"). If prosecuted successfully, the plaintiff is entitled to recover the property transferred or its value from the transferee who has received a gift of the debtor's assets.

There is an old equitable maxim: "One must be just, before one is generous."

In individual jurisdictions

United States

In the United States, fraudulent conveyances or transfers [The term "fraudulent conveyance" is included within the more general term "fraudulent transfer", as a "conveyance" is more descriptive of the transfer of title to real property. "Fraudulent transfer", however, includes all types of property and in the U.S., both are generally all governed by the same law. Therefore, the "transfer" will be used for the remainder of this section.] are governed by two sets of laws that are generally consistent. The first is the Uniform Fraudulent Transfer Act [Promulgated by the National Conference of Commissioners on Uniform State Laws (NCCUSL) in 1984] ("UFTA") that has been adopted by all but a handful of the states. [As of June, 2005, 43 states and the District of Columbia had adopted it. See NCCUSL website, http://www.nccusl.org. A complete copy can be found there or at http://www.stcl.edu/rosin/ufta84.pdf] The second is found in the federal Bankruptcy Code. [11 USC § 548. Much of the language of this section was adopted from the Uniform Fraudulent Conveyance Act, which is the predecessor of the UFTA.]

There are two kinds of fraudulent transfer. The archetypical example is the intentional fraudulent transfer. This is a transfer of property made by a debtor with intent to defraud, hinder, or delay his or her creditors. [11 USC § 548(1); UFTA § 4(a)(1).] The second is a constructive fraudulent transfer. Generally, this occurs when a debtor transfers property without receiving "reasonably equivalent value" in exchange for the transfer if the debtor is insolvent [Under the Bankruptcy Code, insolvency exists when the sum of the debtor's debts exceeds the fair value of the debtor's property, with some exceptions. It is a balance sheet test. 11 USC § 101(32)] at the time of the transfer or becomes insolvent or is left with unreasonably small capital to continue in business as a result of the transfer. [11 USC § 548(2); UFTA § 4(a)(2).] Unlike the intentional fraudulent transfer, no intention to defraud is necessary.

The Bankruptcy Code authorizes a bankruptcy trustee to recover the property transferred fraudulently [This is done through the mechanism of avoidance of the transfer. 11 USC § 548.] for the benefit of all of the creditors of the debtor [11 USC § 551] if the transfer took place within the relevant time frame. [Within two years prior to the filing of bankruptcy - 11 USC § 548(a)] The transfer may also be recovered by a bankruptcy trustee under the UFTA too, if the state in which the transfer took place has adopted it and the transfer took place within its relevant time period. [11 USC § 544(b) allows trustees to employ applicable state law to recover fraudulent transfers. The time period under the UFTA is in most cases four years before action is brought to recover. - UFTA § 9.] Creditors may also pursue remedies under the UFTA without the necessity of a bankruptcy. [UFTA § 7.] Because this second type of transfer does not necessarily involve any actual wrongdoing, it is a common trap into which honest, but unwary debtors fall when filing a bankruptcy petition without an attorney. Particularly devastating and not uncommon is the situation in which an adult child takes title to the parents' home as a self-help probate measure (in order to avoid any confusion about who owns the home when the parents die and to avoid losing the home to a perceived threat from the state). Later, when the parents file a bankruptcy petition without recognizing the problem, they are unable to exempt the home from administration by the trustee. Unless they are able to pay the trustee an amount equal to the greater of the equity in the home or the sum of their debts (either directly to the Chapter 7 trustee or in payments to a Chapter 13 trustee,) the trustee will sell their home to pay the creditors. Ironically, in many cases, the parents would have been able to exempt the home and carry it safely through a bankruptcy if they had retained title or had recovered title before filing.

Even "good faith purchasers" of property who are the recipients of fraudulent transfers are only partially protected by the law in the U.S. Under the Bankruptcy Code, they get to keep the transfer to the extent of the value they gave for it, which means that they may lose much of the benefit of their bargain even though they have no knowledge that the transfer to them is fraudulent. [See, "Gill v. Maddalena", 176 B.R. 551, 555, 558 (Bankr.C.D.Cal. 1994) (citing 11 USC § 548(c))]

Often fraudulent transfers occur in connection with leveraged buyouts (LBOs), where the management/owners of a failing corporation will cause the corporation to borrow on its assets and use the loan proceeds to purchase the management/owner's stock at highly inflated prices. The creditors of the corporation will then often have little or no unencumbered assets left upon which to collect their debts. LBOs can be either intentional or constructive fraudulent transfers, or both, depending on how obviously the corporation is financially impaired when the transaction is completed.

Although not all leveraged buy outs LBOs are fraudulent transfers, a red flag is raised when, after an LBO, the company then cannot pay its creditors. [ See, for example, "Murphy v. Meritor Savings Bank", 126 B.R. 370, 393, 413 (Bankr. D. Mass. 1991), in which an LBO left the corporation with insufficient cash to operate for longer than 10 days.]

witzerland

Under Swiss law, creditors who hold a certificate of unpaid debts against the debtor, or creditors in a bankruptcy, may file suit against third parties who have benefited from unfair preferences or fraudulent transfers by the debtor prior to a seizure of assets or a bankruptcy.

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