Fraudulent Transfers and Fraudulent Conveyances Explained
Before we get into this extensive section on fraudulent conveyance, I want you to understand the bottom line. If you are already in deep trouble you can’t practice self-help, you’ll need expert help. This website and lesson is meant to provide you a solution BEFORE you are upside-down.
The following discussions, which may scare you to death, are NOT an issue if you do your plan BEFORE trouble arises.
If you are currently in trouble, you’ll need to hire an expert. For more information on what to do if you are in trouble, email me at email@example.com and I will help you figure out what to do.
What is a fraudulent conveyance?
All of the sets of domestic fraudulent conveyance laws, under which a transfer to an asset protection trust might be analyzed, have one thing in common. Every transfer with the “actual intent” to delay, hinder or defraud creditors is subject to attack, even if the creditor is a future unanticipated creditor at the time of the transfer.
There are no cases directly on point. Although, some authority exists for the proposition that a transfer to a single purpose trust, designed to protect assets from future unanticipated creditors, is permissible.
For any creditor to successfully attack debtor transfers, they must prove the transaction was fraudulent - that it hinders or delays their rights as a creditor to reach the debtor’s property.
In their effort to categorize the transfer as fraudulent, the creditor will rely upon either the Uniform Fraudulent Conveyance Act (UFCA) or theUniform Fraudulent Transfers Act (UFTA). The two laws are nearly identical and can be discussed as one.
Fraudulent transfers fall within two categories: Fraud-in-law or constructive fraud.
Fraud-in-fact or actual fraud.
Fraud-in-law occurs when: there is a gift or sale of the debtor’s property, and it was for less than fair market value, and took place in the face of a known liability and the transfer rendered the debtor insolvent or unable to pay the creditor.
Each element must exist for there to be practical fraud or fraud-in law. But there is no need to prove that the debtor actually planned to defraud the creditor. As I’ve already mentioned, the transfer may even have been done before the debtor knew of a claim.
The fact that the creditor had the right to make claim is sufficient to set aside a later transfer that renders the debtor insolvent and unable to satisfy the claim.
The theory is that assets owned by an insolvent debtor gainfully belong to his creditors. When the debtor, however innocently, transfers property without receiving, in exchange, assets of roughly comparable value, the debtor’s creditors can recover the transferred property.
This is true even without proof that the transfer intended to dispossess creditors of the assets when the transfer was made. A fraudulent transfer occurs even if the debtor had charitable motives when transferring the property.
Two questions must then be answered:
- (1) What determines fair consideration (exchange of value or money) fair value adequate to make a transfer non-fraudulent?
- (2) When does a debtor become “insolvent” under the fraudulent transfer laws?
Fair consideration or the fair value of the property is what a reasonably sensible seller would be able to sell the asset for, using commercially reasonable methods.
This doesn’t mean the price must equal the precise fair market value. In the case of a home or other real estate, a payment of at least 70% of the actual market value is sufficient consideration.
The law recognizes that some belongings are difficult to market under distress conditions, but publicly listed securities can be sold for a known price any business day.
If a debtor sells securities for considerably less, the courts can conclude there was no fair consideration.
When less than fair value is paid, the transferee can be required to return the property, but only upon the repayment of what he paid.
Otherwise, the debtor may be required to pay the difference between what was paid and the actual fair value of the asset as determined by the court.
A transferee is protected if he acts in good faith without knowledge of fraudulent Intent and pays fair value. This fair value does not have to be money. It can be the exchange of other property or even services. The court will closely examine the services rendered to ascertain it was worth its claimed value.
Consideration, however, cannot be for future services, but must be for services previously or concurrently rendered. The second question is when does a debtor become “insolvent”?
Recall that a conveyance is not fraudulent if the debtor was left with sufficient other assets to satisfy creditor claims.
The law says you are “insolvent“ if the market value of your total property is less than the amount necessary to pay your apparent liability on your existing debts as they become fixed and due. Liabilities include all your debts whether now due or due at a future date, contingent or non-contingent, disputed or undisputed.
The important point to bear in mind is that you cannot transfer assets for less than fair consideration when your remaining assets will not cover your apparent liabilities as they fall due.
In short, the law does not prevent you from making valid gifts of your property, as long as you stay adequately funded to fully pay those debts, you can reasonably anticipate as due and payable in the future.
When you transfer property without fair consideration and the transfer makes your liabilities exceed your assets, the courts automatically infer the transfer was made with fraudulent intent.
However, creditors cannot easily prove your state of mind or compel you to confess fraudulent intent. They are left with the burden to prove fraudulent intent through circumstances or factors that tend to prove intent.
Such factors include the relationship between transfer or and transferee, whether the transfer was for all or only a small part of the debtors’ assets; whether the transfer was concealed, or whether the transfer or had knowledge of the claim or possible claim.
Again, these factors only suppose fraudulent intent. They do not create the presupposition of fraud. Often, the transfer can be effectively explained away as an attempt to accomplish justifiable estate planning, investment, or business objectives.
The court may then uphold the transfer as appropriate even though its ultimate effect was to hinder, or delay, creditors claims.
It is easier for a creditor to recover under a claim of constructive fraud, or fraud-in-fact because the creditor can then ignore the issue of intent. Here the creditor need only show the claim existed(whether known or not), the transfer was for too little consideration, and the transfer rendered the debtor too insolvent to cover the creditor’s claim.
It’s difficult to understand fraudulent conveyances in conceptual terms, so let's look at a few case examples to demonstrate transfers that may be viewed as fraudulent, and others that are valid:
You acquire a business loan of $750,000. While the note was in good standing, you make a gift of virtually all your assets to various family members. A year later, your business fails and the bank looks to recover on your guarantee. Would a court find the gifts to be a fraudulent transfer and order them set aside? Probably not.
(1) There was no consideration, nothing received in exchange because the assets were gifted.
(2) The transfer did render you insolvent since your business failed and you were left with too few assets to pay the bank note.
Now the third issue – was the bank note guarantee a probable liability? It was a possible liability, but that doesn’t make it a probable liability. Lawyers here would focus on whether you could reasonably predict the failure of your business and the need to pay on your guarantee.
The bank’s attorney would point to all the signs of business decline to show the likelihood of liability. Your attorney would take the reverse position, and he would probably succeed, but that’s far from an exact statement because no exact statement can be made.
As with so many areas of law, the final determination is one-sided. For this reason, you cannot expect your legal representative to ever guarantee your assets are safe. Your lawyer will, as an alternative, give you a qualified “practically” or “probably” safe, or those they are the safest they can possibly be under the conditions.
Buck lives in Texas. He transferred his home to his brother as trustee in trust for Buck’s minor children. Homes inTexas are homesteaded and therefore exempt from creditor claim. At the time of transfer, Buck had a $200,000 lawsuit against him from a rodeo incident where one of his bulls mauled a competitor. Buck has no other assets to satisfy the claim. This would not be a fraudulent conveyance because creditors had no right to the home to begin with since it was homesteaded. This example exemplifies the point that creditors cannot declare a fraudulent conveyance unless their right to the asset had been hindered.
Assume that Buck owned $300,000 worth of nonexempt assets, and in the face of several lawsuits acquired exempt property with the $300,000.This is a more difficult case.
Most courts hold that it is not a fraudulent transfer because there is a fair value exchange-even though the replacement asset is beyond the reach of creditors.
This rein forces the soundness of an asset protection plan that exchanges non-exempt assets for exempt assets. However, not all courts agree this approach is legitimate. Decisions vary between courts.
This stresses still another complexity in asset protection planning court rulings do vary; in fact, the same court may change its own position on an issue over time. This adds to the uncertainty whether your asset protection plan is totally safe.
At the least, it requires your attorney to thoroughly research recent cases in your state to more accurately predict how the court will view your transfers, should they be challenged.
Suppose John transferred title to his home (nonexempt)to his new bride, (20 years his junior) who, in return, promised to care for him in his later years. What would happen if he later went bankrupt?
The bankruptcy court could overturn this transfer if the transfer took place after the debts were incurred. Because the liabilities existed at the time, the transfer would most likely be set aside as fraudulent. Why?
Because the consideration anticipated future services rather services that had been previously or concurrently furnished. This form of consideration is not sufficient.
Now, if John had no debts at the time of the transfer, the property could not have recovered by later creditors. They could not logically dispute the transfer was to defraud, hinder or delay their efforts to the property when they were not even creditors at the time. These cases give you only a glimpse of some of the possible situations, but they hopefully provided you with a general idea of fraudulent and non-fraudulent transfers.
The bottom line with actual fraud cases is this: your creditor must prove you actually intended to hinder, delay, or defraud your creditors. Historically, because of the difficulty in proving actual subjective intent to defraud a creditor, common law courts have pointed to“badges” of fraud as evidence of the settler’s subjective intent.
Any asset protection planner should be familiar with these “badges” and should document any transfer to minimize these factors. The badges identified by the Uniform Fraudulent Transfer Act, which may be utilized to infer actual subjective intent, are whether or not Fraudulent transfer law provides remedies for creditors (people or businesses to whom money is owed) who find that their debtors(people or businesses who owe money) are unfairly transferring assets beyond creditors’ reach.
It is thus a limitation on debtors’ freedom of contract and of disposition. Current law can be traced to a 1571 English statute.
Other badges of Fraudulent Transfers
In particular, fraudulent transfer law allows creditors to avoid transfers of property or obligations incurred to the extent these transactions are made either with the intent to hinder, delay or defraud creditors (the words of the original 1571 statute), or are made for less than reasonably equivalent value and leave the transfer or are in a precarious financial state.
Remember, a classic fraudulent transfer occurs if a person, when pressed by creditors and in an effort to avoid collection activity, transfers his or her car or home to relatives for little or no consideration.
Under the Act, a creditor of the person transferring the car or home would have the ability to ignore this change of title and could sue the relative for the value of the car or home. Similarly, a gift of property or money made when the transfer or is insolvent (that is, does not have enough assets to satisfy all creditor claims) is also a fraudulent transfer. This is but one instance of the maxim that one must be “just before being generous.”
1. The transfer or obligation was to an insider;
2. The debtor kept possession or control of the property transferred after the transfer;
3. The transfer or obligation was disclosed or concealed;
4. Before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit;
5. The transfer was of substantially all of the debtor’s assets;
6. The debtor left suddenly, fled, absconded;
7. The debtor removed or concealed assets;
8. The value or the consideration received by the debtor was a reasonable equivalent to the value of the asset transferred or the amount of the obligation incurred;
9. The debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred;
10. The transfer occurred shortly before or shortly after a substantial debt was incurred;
11. The debtor transferred the essential assets of the business to a lien or who transferred the assets to an insider of the debtor.
In addition to minimizing these “badges,” a careful plan should emphasize the other business justifications for the settlement of a foreign trust.
Provided a trust is properly crafted and careful settlement procedures are followed, the issue of whether or not a trust formed with the sole purpose of protecting assets from creditors is per se fraudulent should never come up; because any carefully conceived plan will document substantial and independent business justifications for the trust.
Careful justification of the independent business reasons for the foreign trust should make it difficult for a distressed creditor to effectively argue that a transfer, that was not fraudulent under any objective criteria, was nevertheless fraudulent because of the transfer or harbored some internal, biased, actual fraudulent intent.
The use of a family limited partnership is a popular way to turn attractive assets (i.e. an apartment house) into unattractive assets. It is also a technique whereby the asset protection trust may indirectly own U.S. situs assets (situs means location).
The asset becomes unattractive to a creditor because, by placing the apartment house into the limited partnership, the judgment creditor’s remedy changes. The judgment creditor cannot execute directly upon the apartment house and force its sale.
Instead, the remedy is outlined by the Uniform Limited Partnership Act which provides that “On application to a court... by a judgment creditor, the court may charge the partnership interest of the partner with payment of the judgment... the judgment creditor has only the rights of an assignee of the partnership interest.”
This act also provides that “an assignment entitles the assignee to receive... only the distribution to which the assignor would be entitled.”The drafters of the Uniform Limited Partnership Act inserted this charging order concept into the act to prevent the creditors of a partner from disrupting the partnership business.
However, these same provisions can be utilized in the family limited partnership context to prevent the distribution of funds to the judgment creditor. This is because under relevant partnership law the general partner, who is likely to be a family member or a corporation controlled by family members, can prevent distributions.
The Internal Revenue Service has also held in Revenue Ruling 77-137, that the creditor with a charging order is treated as a substituted limited partner for tax purposes. As a result, the judgment creditor is responsible for the tax consequences resulting from ownership without the capacity to force a dissolution of the partnership or distributions from the partnership.
Video Transcript: What is a fraudulent conveyance?
Why you should avoid a fraudulent conveyance?
How you can avoid a fraudulent conveyance?
That's an issue that will be coming up constantly in asset protection planning.
I think you should avoid fraudulent conveyance claims diligently, but you need to understand what you're avoiding.
What is a fraudulent conveyance? I look at it as: there are several different sets of laws ,but when I take on a new client- and by the way, not one of my clients has ever had a problem with a fraudulent conveyance problem because we do it correctly, we watch the issue very carefully.
I make sure they're represented by outstanding and respected attorneys, if they're in the middle of litigation.
To know if something can be considered a fraudulent conveyance, there's a couple of smell tests that I apply. The first is what I call the post-planning test. This means that after you have completed your plan, you're comfortable that you’ve retained sufficient assets to more than meet your reasonably anticipated debts.
Let me say that again. After the planning is over, you’ve reserved to yourself sufficient assets to more than meet your reasonably anticipated debts.
Now, there's nothing about those assets being dollar bills sitting in the Bank of America. One of my clients owns an oilfield. It is so polluted that anybody who took that oil field would potentially be subject to many tens of millions of dollars to clean it up. So, he leaves it unprotected. His creditors can take it if they want to. It really helps them get aggressive with his other planning.
So, make sure that you have enough money after the planning is over to meet your reasonably anticipated debts, and this includes income from your salary and your earnings, insurance, inheritance and anything else. Just make sure you haven't rendered yourself insolvent. That’s not the goal of asset protection.
The goal of asset protection is to give you some money to fall back on if the world falls apart. So, take the post-planning test and apply it with the actual intent test.
The actual intent goes back to the early rules regarding fraudulent conveyancing, the very first statutory rules, and I’m going to show them to you. In my first book- I had three books- in this first book asset protection trust that was published by Matthew Bender, and this is an abridged version I’m looking at, there is a small section on what is the actual intent test. It's page, right here, it's page 11.
So, I’m going to go to page 11 – by the way, everybody who takes the in-depth courses gets this.
The laws say and I’m going to show you right here. Every transfer with the “actual intent to delay, hinder or defraud creditors is subject to attack even if the creditor is a future unanticipated creditor at the time of the transfer.
There aren't any cases on point. There are cases- and in footnote number 16 is in re Oberst, and this is just one of many that say that as a protection in and of itself is a valid business purpose; and it's fine to protect yourself, but you do not want to do anything to show an actual intent to delay, defraud or hinder creditors. One of the things that they look for when you're analyzing this is what they call badges of fraud.
Here on page 12 are a number of the badges of fraud like the debtor removed the concealed assets. The transfer was of substantially all of the debtor’s assets, the transfer or an obligation was to an insider.
This is a number of the badges of fraud. Here’s 10 of them right here. You can study them if you want to, but the bottom line is, avoid anything that says my intent is to totally destroy Bank of America’s effort to sue me for fraud and I believe it's coming in six months. No way.
The third point I wanted to make is that a good business purpose covers a multitude of sins. This means that if you're engaging in solid asset protection for independent business purpose, for instance, you really want to invest in Swiss currency and you can't do it effectively in the United States.
Or you really want a certain product that is only available through an offshore trust or an offshore banking relationship, and there are many great investments that are not available to you as citizens and not available out of the United States; because really the promoters of most solid international investments often have decided that it's not worth it to deal with U.S. citizens.
Because that means they're dealing with the IRS, the SEC, the FTC and the multitude of governmental bureaucratic organizations that are considered pests by many people but that – so they don’t want to do business with you as people.
I want you to always have a valid business purpose for what you're doing even if you have an actual intent to take care of Bank of America and their potential fraud suit, don’t advertise it. Make sure you haven't rendered yourself insolvent- and guys look at number five, time cures all evils. Time cures all evils. Do your planning when the financial seas are calm.
Do it well in advance of problems. If you do that, the statute of limitations on fraudulent conveyances will probably have passed before anything happens to you.
The statute of limitation in most countries with decent laws is somewhere between zero and four years. You can pick the shorter statutes. You can get it to zero to two years very easily and in the United States, four years would do you well almost everywhere unless there’s actual fraud. Avoid anything like that. You do not want to get in trouble.
How do these people get in trouble over fraudulent conveyance issues?
The Lawrence of the world, the Andersons of the world, we always hear about these people doing asset protection and being thrown in the clinker. Well, every single one of those cases so far is decided correctly. In every single one of those cases, we had a bad person rendering himself insolvent and rendering insolvent when he was completely aware of his obligations. The Andersons are crooks. They rendered themselves insolvent after their partner in some phony television marketing scam was actually indicted.
They were told that they were subjects of the investigation and then they hid all their money. They hid all their money in the Cook Islands which is one of the reasons I don’t go there very often because they’ve gotten – the Cooks have managed to take every bad, case in the books and yes, asset protection works even when done for bad people at the wrong time, but I have never wanted to be in the middle one.
And how do they get in trouble?
Well, you see number four, criminal contempt. They got thrown in jail for criminal contempt not for doing asset protection; but for putting themselves in a position where they refused to comply with the judge’s order, and the judge in each case made a determination that they were capable of complying. That’s called criminal contempt.
I've written about that exhaustively. You're going to get a lot of material on it, but the bottom line, is you're not going to go to jail for contempt of court if you have no power to comply with a judge’s order. A properly done asset protection plan renders you incapable of complying with the judge’s order, but you don’t want to do that the day before the judge’s order comes down or even when that’s a reasonable probability.
You want to do asset protection when the financial seas are calm. J. Atkinson, a good friend of mine invented the doctrine of disbelief, which is basically his way of saying: if a judge doesn’t believe that you’ve been dealing in good faith- and in fact you’ve rendered yourself incapable of complying with his order, meaning his order to return the funds, but he doesn’t believe you're really, you're really incapable. He doesn’t believe that when the financial seas are calm again you can't get your money, and those judges will sometimes go against you.
I've never had it happen because I don’t take cases where people are engaged in fraudulent conveyances. You should not do it. There are other ways rather than the safer and easily- implemented asset protection trust and international insurance policies that are extremely good protection in normal civil litigation.
But do your planning when the financial seas are calm and you won't even be worrying about asset protection being classified as a fraudulent conveyance.
It really is just taking care of your family ,and do it when the financial seas are calm. By the way, even if you’ve had that wake-up call, the lawsuit has been filed and somebody is making a $50,000 or a $250,000 claim against you, don’t get paralyzed.
A simple lawsuit is not always the end of the world. A simple letter is not always the end of the world, as long as we retain sufficient assets to meet your reasonably anticipated debts; we almost always can come up with a good reason to engage in conduct, which happens to have some asset protection flavor.
It's a tight rope walk. It's a more expensive test. It's a more expensive process, and it's not something I ever suggest you try to do on your own. In this course, I’m giving you the tools to do asset protection on your own, but don’t take this lightly.
You can create significant trouble for yourself if you get cavalier. Remember, judges hate being disenfranchised, and that’s what we're doing; and if you're going to disenfranchise them, you better do it with a smile and you better be believable.