Fraudulent Transfers Revisited


Volume IV, Number 4 – October/November 1995 

© Donlevy-Rosen & Rosen, P.A.


Let’s Take Another Look

INTRODUCTION. For years now we have stressed the importance of implementing asset protection strategies before any type of claim or threat of litigation arises. Why is advance planning continuously emphasized? Because once a claim arises, one or more of the various fraudulent transfer laws would likely negate any protective planning you undertake at that time, thereby diminishing your asset protection options, and very often eliminating them entirely (and, in some cases, causing other more serious problems). Do you want to be the one to box yourself into a corner by delaying your planning until a claim against you arises?

BACKGROUND.. Fraudulent transfer laws have been a part of our legal system for over 400 years. These laws typically function to undo a transfer which is determined by a court to be a fraudulent transfer, although some such laws do impose other sanctions. When a transaction is “undone”, the transferred property is essentially put back in the debtor’s hands, and thus becomes available to satisfy the creditor’s claim. Other consequences of a fraudulent transfer can include the denial of a discharge in bankruptcy, and criminal prosecution for: defrauding the bankruptcy court, placing assets beyond the reach of the RTC or FDIC, or impeding the Internal Revenue Service’s ability to administer the tax laws.

WHAT IS A FRAUDULENT TRANSFER? In lay terms, a fraudulent transfer is a transfer of an asset (or incurring an obligation) with the actual intent to hinder, delay, or defeat a creditor’s claim, and, regardless of intent, making a transfer while insolvent or which renders the transferor insolvent. Actual intent is proven in two ways: By the transferor’s own statements, such as: “I knew Mr. X was going to sue me, so I gave the brokerage account to my wife”, or, more commonly, by a review of the other factors surrounding the transfer. Over the last several hundred years, the court cases have identified a list of factors, sometimes referred to as “badges of fraud”, which may be taken into consideration in determining a transferor’s intent. These factors include, among others: being sued or threatened with suit before the transfer, removing and concealing assets, concealing the transfer, transferring substantially all of the debtor’s assets, and whether the transfer or was insolvent at the time of the transferor became insolvent shortly after the transfer was made. How does this translate into real life? You’ve been called by a person who says that he has a claim against you for one reason or another (no suit has been filed). You remember the person, and even though you think he has no basis to make a claim against you, you decide to play it safe, and make “gifts” of your assets to your spouse and children. If the claimant is successful and obtains a judgment against you which he can’t collect, the transfers will likely be held to be a fraudulent transfer by the court unlesssignificant non asset protection motives can be proven for the transfer (remember – it’s a question of intent).

ARE ALL CREDITORS COVERED BY THE LAW?. First, who is a “creditor”? 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, even though the claim is contingent – it only exists if the corporation doesn’t pay the debt.

The fraudulent transfer rules exist to protect a creditor whose “claim arose before or after the transfer was made..“. A literal interpretation of the quoted language might lead one to conclude that you’re always open to a claim that a transfer was fraudulent, regardless of how long after the transfer the creditor’s claim arose. Fortunately, the court cases have been somewhat more realistic in applying the law. Who is meant to be covered as a creditor whose claim arose “after the transfer”? It is not a creditor who would be included in one’s general concern regarding untoward future events – a concern held by many of us. Although the fraudulent transfer laws vary somewhat among the jurisdictions, the courts have held that a person can protect himself from indeterminate future “potential” creditors – remember advance planning?

HOW TO AVOID THE PROBLEM. Ideally, transfers should be made when you have no creditors, and in many cases this is possible. Unfortunately, in many cases it is not possible. So what can be done? A review of the fraudulent transfer cases reveals that although many factors may be considered by the court in determining the transferor’s intent, the most important factor is the transferor’s solvency before and after the transfer. By definition in the law, solvency means that the value of your assets exceeds the value of your liabilities, and that you are paying your debts as they become due. Add to the solvency factor an appropriate context for the transfer from which a non asset protection motive can be inferred, such as estate planning, and a relatively strong foundation has been laid for the transfer to withstand attack. In summary, the transfer should make sense (for a non asset protection reason), and you must be solvent before and after the transfer. Before you begin making transfers, you should know that the value of assets which are exempt from creditors’ claims under state law (and the liabilities encumbering them) are not counted in determining a person’s solvency. Thus, for example, a Florida or Texas resident could not count the value of his personal residence, since it is exempt from creditor’s claims in each of those states.

CONCLUSION. Does the foregoing discussion mean that once a claim arises you should meekly throw yourself upon the creditor’s mercy? Not necessarily, but it will most likely mean that you have fewer options open to you, if any. Why place yourself in that position? Advance planning is essential if you want all the planning options to be available to you.

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