Fraudulent Transfer Issues In Asset Protection

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Volume I, Number 5 – December 1992

© Donlevy-Rosen & Rosen, P.A.

FRAUDULENT TRANSFER ISSUES IN ASSET PROTECTION:

What You Need To Know

BACKGROUND. It is often said that the key to effective asset protection is ADVANCE PLANNING. This truism is repeatedly emphasized, because of the “fraudulent transfer” laws. Fraudulent transfer laws in one form or another are in effect in every state and civilized jurisdiction in the world. A fraudulent transfer is generally defined as a transfer of property made with the intent to hinder, delay, or defraud a creditor. Gifts and below-market sales are by far the most common transactions which may be characterized as fraudulent transfers.

EFFECT. In general, if a property transfer is determined by a court to constitute a fraudulent transfer, the court will set the transfer aside – as if it had never been made. This effectively places the transferred property back in the debtor-transferor’s hands, and makes it available to satisfy the claims of his creditors. In addition, criminal sanctions may be imposed, and/or a discharge in bankruptcy may be denied if a bankruptcy court determines that fraudulent transfers have been made. Criminal sanctions may also be imposed under the laws of some states, and under federal law where the RTC or the FDIC is the creditor.

apn1-5HOW A FRAUDULENT TRANSFER IS DETERMINED.A transfer is fraudulent as to present and subsequent creditors if it is made with the actual intent to hinder, delay, or defraud a creditor of the transferor. In addition to actual intent, a transfer is also fraudulent: (1) if the transferor was insolvent at the time of the transfer, or the transfer rendered him so, or (2) where the transferor did not receive equivalent value for the property transferred (which would encompass any gift or below-market sale) and the transferor: (a) was engaging or about to engage in a business or transaction for which the transferor’s remaining assets were unreasonably small in relation to the business or the transaction, or (b) intended to incur, or believed or reasonably should have believed that he would incur, debts beyond his ability to pay as they became due.

Actual intent is typically proven in two ways: (1) by the transferor’s own statements, to the effect that the transfer in question was made to avoid paying the creditor, and (2) through an examination of the facts and circumstances surrounding the transfer for “badges of fraud”. Eleven factors – or badges of fraud – are listed in the Uniform Fraudulent Transfers Act which may be considered by the court in making its determination. The one most frequently encountered is a transfer made shortly after a transferor has been sued or threatened with suit. A typical example of a fraudulent transfer would be where a person is served with a complaint naming him as a defendant in a lawsuit. Shortly thereafter, he makes gifts to his wife and children rendering him unable to satisfy the judgment ultimately won by his creditor. The creditor would be able to have the gifts set aside, making the transferred assets available to satisfy his claim.

SOLVENCY ISSUES. The solvency of the transferor before and after the transfer is a key factor, and one which goes a long way in diminishing the fraudulent transfer issue in a particular case. For this reason, a thorough review of the transferor’s solvency is in order in connection with any asset protection program. How is solvency defined for this purpose? In most jurisdictions, a person is considered solvent if the fair market value of his assets exceeds his liabilities at the relevant time. Here’s where things can get a bit sticky for those unfamiliar with the law: In measuring the value of the transferor’s assets for this purpose, property exempt under the law from the claims of creditors isnot counted. For example, the personal residence of a Florida resident (his homestead) would not be included in determining whether a Florida transferor was solvent at the time of a property transfer. In some states (but not in Florida), liabilities secured by exempt assets are counted, even though the asset is not, thereby creating a potential “insolvency” trap for the unwary. A second test of solvency – many jurisdictions apply both on an either/or basis – is whether the transferor is paying his debts as they become due. If not, he is presumed insolvent.

THE SOLVENT TRANSFEROR. How can a solvent transferor avoid having his gift-type transfers characterized as fraudulent transfers? Since his intent will be inferred from the facts and circumstances surrounding the transfer, and solvency is but one of such facts and circumstances, it is essential that the transferor have a significant non asset protection motive for his transfer, such as estate planning. Asset protection planning should, therefore, be undertaken in an estate planning or other business planning context, because even though the transferor’s solvency at the time of (and following) the transfer will substantially mitigate the fraudulent transfer issue, the other surrounding facts should also indicate that he had a valid reason – other than asset protection – for the transfer. For example, family limited partnerships and trusts have long been used in an estate planning context for various purposes; it just so happens, however, that substantial asset protection is also afforded by their proper use.

CREDITORS. The fraudulent transfer rules exist to protect the present and future creditors of a transferor. A creditor is a person who has a claim. A claim includes, among other things, contingent, equitable, and unliquidated rights to payment. Thus, a shareholder’s guarantee of his corporation’s debt would render the corporation’s creditor on that debt the shareholder’s creditor, and the guaranteed corporate debt would be included in determining the shareholder’s solvency for these purposes.

If future creditors are protected, how can one ever protect his assets? While the law on this subject varies from one jurisdiction to another, the courts have distinguished between attempts to defraudspecific future creditors – which will not succeed, and protecting oneself from indeterminate future “potential” creditors. Absent proof of actual intent, courts have held that one can effectively protect himself against future potential creditors, provided a transfer is made sufficiently in advance of a potential future creditor problem. Put another way, planning for one’s future well being is not prohibited by the fraudulent transfer laws, and ADVANCE PLANNING IS ESSENTIAL.

SUMMARY. Do all of these rules mean that planning is precluded in the face of an impending lawsuit or other creditor problem? Not necessarily. Certainly, the available planning options are significantly narrowed in the face of a substantial creditor threat, but, depending upon the circumstances, some avenues may still be open. Qualified legal counsel is essential in such situations.

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