Fraudulent conveyance
Encyclopedia
A fraudulent conveyance, or 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. There are two kinds of fraudulent transfer--"actual fraud" and "constructive fraud."
"Actual fraud" typically involves a debtor who as part of an asset protection scheme
donates his asset
s, usually to an "insider", and leaves himself nothing to pay his creditors. "Constructive fraud" does not relate to fraudulent intent, but rather to the underlying economics of the transaction, if it took place for less than reasonably equivalent value at a time when the debtor was in a distressed financial condition. For example, where the debtor 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
). In a successful suit, 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.
Although fraudulent transfer law originally evolved in the context of a relatively simple agrarian economy, it is now widely used to challenge complex modern financial transactions such as leveraged buyouts.
The most factually complex aspect of fraudulent transfer law is often evaluating the financial condition of the debtor at a particular point in the past. Courts and scholars have recently developed market-based approaches to try to make this analysis simpler, more consistent across cases, and more predictable.
, fraudulent conveyances or transfers are governed by two sets of laws that are generally consistent. The first is the Uniform Fraudulent Transfer Act ("UFTA") that has been adopted by all but a handful of the states. The second is found in the federal Bankruptcy Code.
The UFTA and the Bankruptcy Code both provide that a transfer made by a debtor is fraudulent as to a creditor if the debtor made the transfer with the "actual intention to hinder, delay or defraud" any creditor of the debtor. Regarding the modifier "any" (creditor), Jacob Stein
, author of textbooks on asset protection, divides the creditors into three classes: present, future and future potential creditors. While UFTA applies clearly to present creditors, the distinction between a future creditor and a future potential creditor is not as clear. The UFTA is commonly held to apply only to future creditors and not to future potential creditors (those whose claim arises after the transfer, but there was no foreseeable connection between the creditor and the debtor at the time of the transfer).
There are two kinds of fraudulent transfer. The archetypal 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. 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 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. Unlike the intentional fraudulent transfer, no intention to defraud is necessary.
The Bankruptcy Code authorizes a bankruptcy trustee to recover the property transferred fraudulently for the benefit of all of the creditors of the debtor if the transfer took place within the relevant time frame. 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. Creditors may also pursue remedies under the UFTA without the necessity of a bankruptcy.
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.
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 LBOs are fraudulent transfers, a red flag is raised when, after an LBO, the company then cannot pay its creditors.
U.S. courts and scholars have recently developed market-based approaches to try to streamline the analysis of constructive fraud.
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 preference
s or fraudulent transfers by the debtor prior to a seizure of assets or a bankruptcy
.
Civil law (common law)
Civil law, as opposed to criminal law, is the branch of law dealing with disputes between individuals or organizations, in which compensation may be awarded to the victim...
cause of action. It arises in debtor
Debtor
A debtor is an entity that owes a debt to someone else. The entity may be an individual, a firm, a government, a company or other legal person. The counterparty is called a creditor...
/creditor
Creditor
A creditor is a party that has a claim to the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property or service to the second party under the assumption that the second party will return an equivalent property or...
relations, particularly with reference to insolvent debtors. The cause of action is typically brought by creditors or by bankruptcy
Bankruptcy
Bankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
trustees. There are two kinds of fraudulent transfer--"actual fraud" and "constructive fraud."
"Actual fraud" typically involves a debtor who as part of an asset protection scheme
Asset protection
Asset protection is a set of legal techniques and a body of statutory and common law dealing with protecting assets of individuals and business entities from civil money judgments...
donates his asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
s, usually to an "insider", and leaves himself nothing to pay his creditors. "Constructive fraud" does not relate to fraudulent intent, but rather to the underlying economics of the transaction, if it took place for less than reasonably equivalent value at a time when the debtor was in a distressed financial condition. For example, where the debtor 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
Unfair preference
An unfair preference is a legal term arising in bankruptcy law where a person or company transfers assets or pays a debt to a creditor shortly before going into bankruptcy, that payment or transfer can be set aside on the application of the liquidator or trustee in bankruptcy as an unfair...
(see generally, wrongful trading
Wrongful trading
Wrongful trading is a type of civil wrong found in UK insolvency law, under s 214 Insolvency Act 1986. It was introduced to enable contributions to be obtained for the benefit of creditors from those responsible for mismanagement of the insolvent company....
). In a successful suit, the plaintiff
Plaintiff
A plaintiff , also known as a claimant or complainant, is the term used in some jurisdictions for the party who initiates a lawsuit before a court...
is entitled to recover the property
Property
Property is any physical or intangible entity that is owned by a person or jointly by a group of people or a legal entity like a corporation...
transferred or its value from the transferee who has received a gift of the debtor's assets.
Although fraudulent transfer law originally evolved in the context of a relatively simple agrarian economy, it is now widely used to challenge complex modern financial transactions such as leveraged buyouts.
The most factually complex aspect of fraudulent transfer law is often evaluating the financial condition of the debtor at a particular point in the past. Courts and scholars have recently developed market-based approaches to try to make this analysis simpler, more consistent across cases, and more predictable.
United Kingdom
- Fraudulent Conveyances Act 1571Fraudulent Conveyances Act 1571Fraudulent Conveyances Act 1571 was an Act of Parliament in England, which laid the foundations for fraudulent transactions to be unwound when a person had gone insolvent or bankrupt...
- Insolvency Act 1986Insolvency Act 1986The Insolvency Act 1986 is an Act of the Parliament of the United Kingdom that provides the legal platform for all matters relating to personal and corporate insolvency in the UK.-History:...
section 423
United States
In Anglo-American law, the doctrine of Fraudulent Conveyance traces its origins back to Twyne's Case, in which an English farmer attempted to defraud his creditors by selling his sheep to a man named Twyne, while remaining in possession of the sheep, marking and shearing them. In the United StatesUnited States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
, fraudulent conveyances or transfers are governed by two sets of laws that are generally consistent. The first is the Uniform Fraudulent Transfer Act ("UFTA") that has been adopted by all but a handful of the states. The second is found in the federal Bankruptcy Code.
The UFTA and the Bankruptcy Code both provide that a transfer made by a debtor is fraudulent as to a creditor if the debtor made the transfer with the "actual intention to hinder, delay or defraud" any creditor of the debtor. Regarding the modifier "any" (creditor), Jacob Stein
Jacob Stein
Jacob Stein is a California attorney and an authority on the subject of asset protection. His textbooks on asset protection are used by Lorman Education Services, National Business Institute, California CPA Society, and the California CPA Education Foundation...
, author of textbooks on asset protection, divides the creditors into three classes: present, future and future potential creditors. While UFTA applies clearly to present creditors, the distinction between a future creditor and a future potential creditor is not as clear. The UFTA is commonly held to apply only to future creditors and not to future potential creditors (those whose claim arises after the transfer, but there was no foreseeable connection between the creditor and the debtor at the time of the transfer).
There are two kinds of fraudulent transfer. The archetypal 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. 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 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. Unlike the intentional fraudulent transfer, no intention to defraud is necessary.
The Bankruptcy Code authorizes a bankruptcy trustee to recover the property transferred fraudulently for the benefit of all of the creditors of the debtor if the transfer took place within the relevant time frame. 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. Creditors may also pursue remedies under the UFTA without the necessity of a bankruptcy.
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
Probate
Probate is the legal process of administering the estate of a deceased person by resolving all claims and distributing the deceased person's property under the valid will. A probate court decides the validity of a testator's will...
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
Petition
A petition is a request to do something, most commonly addressed to a government official or public entity. Petitions to a deity are a form of prayer....
without recognizing the problem, they are unable to exempt the home from administration by the trustee
Trustee
Trustee is a legal term which, in its broadest sense, can refer to any person who holds property, authority, or a position of trust or responsibility for the benefit of another...
. 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
Good faith
In philosophy, the concept of Good faith—Latin bona fides “good faith”, bona fide “in good faith”—denotes sincere, honest intention or belief, regardless of the outcome of an action; the opposed concepts are bad faith, mala fides and perfidy...
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.
Often fraudulent transfers occur in connection with leveraged buyouts (LBOs), where the management
Management
Management in all business and organizational activities is the act of getting people together to accomplish desired goals and objectives using available resources efficiently and effectively...
/owners of a failing corporation
Corporation
A corporation is created under the laws of a state as a separate legal entity that has privileges and liabilities that are distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business. Early corporations were established by charter...
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 LBOs are fraudulent transfers, a red flag is raised when, after an LBO, the company then cannot pay its creditors.
U.S. courts and scholars have recently developed market-based approaches to try to streamline the analysis of constructive fraud.
Switzerland
Under SwissSwitzerland
Switzerland name of one of the Swiss cantons. ; ; ; or ), in its full name the Swiss Confederation , is a federal republic consisting of 26 cantons, with Bern as the seat of the federal authorities. The country is situated in Western Europe,Or Central Europe depending on the definition....
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 preference
Unfair preference
An unfair preference is a legal term arising in bankruptcy law where a person or company transfers assets or pays a debt to a creditor shortly before going into bankruptcy, that payment or transfer can be set aside on the application of the liquidator or trustee in bankruptcy as an unfair...
s or fraudulent transfers by the debtor prior to a seizure of assets or a bankruptcy
Bankruptcy
Bankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
.
See also
- UK insolvency lawUK insolvency lawUnited Kingdom insolvency law deals with the insolvency of firms and individuals in the United Kingdom. The important statutes are the Insolvency Act 1986, as amended by the Enterprise Act 2002, as well as the Company Director Disqualification Act 1986 and the Companies Act 2006.Insolvency is a...
- Fraudulent Conveyances Act 1571Fraudulent Conveyances Act 1571Fraudulent Conveyances Act 1571 was an Act of Parliament in England, which laid the foundations for fraudulent transactions to be unwound when a person had gone insolvent or bankrupt...
- Bayou Hedge Fund GroupBayou Hedge Fund GroupThe Bayou Hedge Fund Group was a group of companies and hedge funds founded by Samuel Israel III in 1996. Approximately $450m was raised by the group from investors. Its investors were defrauded from the start with funds being misappropriated for personal use...
- Bernard MadoffBernard MadoffBernard Lawrence "Bernie" Madoff is a former American businessman, stockbroker, investment advisor, and financier. He is the former non-executive chairman of the NASDAQ stock market, and the admitted operator of a Ponzi scheme that is considered to be the largest financial fraud in U.S...
External links
- Fraudulent conveyance (Actio Pauliana) under Dutch and Belgium law (Article in Dutch language Wikipedia)