Fraudulent Transfers in Bankruptcy

A client recently asked me to explain “fraudulent transfers” to her.  I was a bit surprised to have a client ask me about them, not because they are in any way unusual, nor are they something I don’t talk about often.  In fact they are very common and I talk about them with my clients quite often.  However, clients rarely ever specifically ask about them, because most client’s aren’t really familiar with the concept. Fraudulent transfers typically come up in one of two ways, (1) my interview and investigation uncovers them, or (2) a client just asks me if they can protect some of their assets by giving them away to a family member or close friend for “safe keeping”.

DEFINITION

So what is a fraudulent transfer exactly?  A fraudulent transfer is one several types of transfers that a Trustee in bankruptcy can recover for the benefit of creditors.  Specifically, the United States Bankruptcy Code defines a fraudulent transfer in a couple of distinct ways.  The first is an “Intentional Fraudulent Transfer, which is a transfer of an asset made with “actual intent to hinder, delay or defraud” any creditor. See Bankruptcy Code § 548(a)(1)(a).  This definition neatly covers the client asking if they can protect some asset (such as her Mercedes) by giving it to her uncle.

The second definition is a bit more nuanced that the previous.  A “Constructive Fraudulent Transfer” includes any transfer that was made for less than a reasonably equivalent value, at a time when the debtor was insolvent or where the debtor became insolvent as a result of the transfer.  See Bankruptcy Code § 548(a)(1)(B)(ii)(I). This second type of fraudulent transfer is actually far more common, and usually is the type of transfer that I uncover as the result of my questions.  It is important to note that in these types of transfers no one is accusing the debtor of doing anything illicit or immoral, and despite the term there is no accusation of fraud.  Very often the transfer is made for otherwise legitimate purposes, such as a parent deeding a house to her children as part of an estate plan.

Nonetheless, this type of transfer is reversible by the Trustee in bankruptcy.

STATUTE OF LIMITATIONS (OR “LOOKBACK PERIOD”)

Under the Bankruptcy Code, a Fraudulent transfer, be it intentional or constructive, is recoverable by the Chapter 7 Trustee to the extent that the transfer occurred two years prior to the filing of the petition in bankruptcy. See Bankruptcy Code § 548(a)(1).  However, the Bankruptcy Code also allows a Trustee to recover transfers pursuant to applicable state law.  See Bankruptcy Code § 544(b).  Massachusetts, like many other states, has enacted the Uniform Fraudulent Transfers Act, which allows a creditor to recover a fraudulent transfer (and the definitions are substantially similar here), for up to four years. In bankruptcy, the Trustee can stand in the shoes of any creditor, and can therefore recover a fraudulent transfer made up to four years prior to the commencement of the bankruptcy case.

TRUSTEE POWERS

As I’ve said, the Trustee has the power to reverse (or “avoid”) a transfer that falls under the definition and time requirements under either the Bankruptcy Code or applicable state law.  But how does the Trustee avoid the transfer?  Simply put the Trustee files a lawsuit in the bankruptcy court (called an “Adversary Proceeding”) and names the person who received the transfer as the defendant.  So in our example where the parent, for estate planning purposes, executes a deed on her home to her four children and receives no value in return, the Trustee would name each of the four children.  The Trustee would then seek to unwind the transfer from a legal perspective and either force the turnover of the property itself (which he could then sell), or would seek a money judgment for the value of the transfer.  The parent hoping to make her estate less complicated, now is faced with losing her home, or, in the alternative, forcing her children to essentially purchase the house from the bankruptcy estate (either through a money judgment or by literally purchasing the home at the bankruptcy estate sale), in order to allow the debtor parent to stay in her home.

IMPACT ON DISCHARGE

As if losing the property was not a bad enough outcome, there in some cases the debtor herself might lose her discharge.  While this is not a likely outcome in a purely Constructive Fraudulent Transfer Case, the standard for proving an Intentional Fraudulent Transfer is precisely the same as the facts necessary to deny a debtor her discharge under Bankruptcy Code § 727.  Specifically, § 727(a)(2) states that the Court shall deny a debtor a discharge where “the debtor, with intent to hinder, delay or defraud a creditor… has transferred … property of the debtor within one year before the date of filing the petition.”

In other words, an intentional fraudulent transfer that occurs within one year prior to commencing a bankruptcy case will lead not only to a loss of the property, but also to a denial of the debtor’s discharge.  In the example of our debtor putting title to her Mercedes into her uncle’s name, she would not only lose the Mercedes, but would also still owe all her debts even after her bankruptcy was complete.

CONCLUSION

Fraudulent transfers are just one type of pre-petition transfer that can be problematic for debtors and their family members.   Fully disclosing all transfers of property to your attorney can help to avoid a nightmare scenarios for you and your loved ones.  If you are contemplating bankruptcy be certain to consult with an experienced bankruptcy attorney.  If you are contemplating bankruptcy, or if someone has transferred property to you who is now considering bankruptcy or in bankruptcy, call the Law Offices of James Wingfield at 508-797-0200 to schedule a consultation today.