Elements of Fraudulent Transfers Under Bankruptcy Code and TUFTA

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Gregory W. Mitchell

Gregory W. Mitchell

Attorney

214.984.3410
gmitchell@freemanlaw.com

Gregory Mitchell joins Freeman Law to lead its bankruptcy practice. Mr. Mitchell is a native of the Dallas area, graduating from Southern Methodist University with a Bachelor’s Degree in Economics in 1991 and with his J.D. in 1994. In 1995, he obtained an LL.M. in Taxation from New York University. Mr. Mitchell currently directs the SMU Dedman School of Law’s federal taxpayer clinic. Mr. Mitchell’s background in tax makes him a natural fit for Freeman Law.

Prior to joining Freeman Law, Mr. Mitchell was the managing partner of The Mitchell Law Firm, L.P., a small firm he started in 2004, where he ran a diverse practice primarily focused on bankruptcy, tax and related litigation matters.

Prior to starting his own firm, Mr. Mitchell served as a Partner and General Counsel with Tax Automation, L.P., a national tax consulting firm. Mr. Mitchell was previously the National Director of Tax Technology at Ryan & Company, a national tax consulting practice, as well as a Senior Manager with KPMG, a “Big Four” accounting firm.

This is the second of an expected five-part series on fraudulent transfers. In my first blog, I laid out the basic statutory framework, as well as described generally the difference between actual and constructively fraudulent transfer. In this second blog, we will take a detailed look at the elements of a fraudulent transfer under both the Bankruptcy Code as well as Texas law.

Actual Fraudulent Transfer

Section 548(a)(1)(A) of the Bankruptcy Code provides the statutory authority to enable avoidance of an actual fraudulent transfer. The statute provides that an actual fraudulent transfer occurs when a transfer is made “with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted.”

Plaintiffs must provide evidence that the Debtor made each transfer with actual intent to hinder, delay, or defraud “any entity to which the debtor [is] … indebted.” § 548(a)(1)(A); Furr v. TD Bank, N.A. (In re Rollaguard Sec., LLC), 591 B.R. 895, 918 (Bankr. S.D. Fla. 2018) (“In order to prosecute a claim based on actual intent to hinder, delay, or defraud a creditor, the plaintiff must show that the alleged fraudulent intent is related to the transfers sought to be avoided.”).

Section 24.005(a)(1) of the Texas Uniform Fraudulent Transfer Act (“TUFTA”) provides the statutory authority under Texas law to enable the avoidance of an actual fraudulent transfer. The statute, similar to the Bankruptcy Code provision, provides that an actual fraudulent transfer occurs when a transfer is made “with actual intent to hinder, delay, or defraud any creditor of the debtor.”

The elements of an actual fraudulent transfer under either the Bankruptcy Code or TUFTA are:

  1. a creditor;
  2. a debtor;
  3. the debtor transferred assets shortly before or after the creditor’s claim arose; and
  4. with actual intent to hinder, delay, or defraud any of the debtor’s creditors.”

See In re Northstar Offshore Group, LLC, 616 B.R. 695 (Bankr. S.D. Tex. 2020 (Isgur)); Matter of Life Partners Holdings, Inc., 926 F.3d 103, 117 (5th Cir. 2019) (citation omitted). Each of these elements will be analyzed in turn.

Creditor

Regarding the first element – the existence of a creditor – “the burden is on the Plaintiffs to demonstrate the existence of an actual creditor with an allowable claim against the debtor.” In re Northstar, 616 B.R. at 724. Further, “the so-called ‘triggering’ creditor must be the same creditor on both the transfer date and the date of commencement of the case.” Id. “If there is no [such] creditor . . . the [plaintiff] is powerless to act under §544(b)(1). Id.

The “triggering” creditor “need not hold the same claim at these two essential points in time.” Id. “Rather, in order to establish standing, the Trustee must identify an unsecured creditor with a claim, which is avoidable under applicable law, on both the transfer date and the petition date, even if that claim at those two points in time is different” Id.

Debtor

This element is self-explanatory and is rarely difficult to establish. Obviously, there must be a debtor that owes at least one creditor for a fraudulent transfer to exist.

Transfer of Assets

This element, like the last, is usually not difficult to establish. The existence of transfers is usually easily verifiable. Very little case law exists on the interpretation of the phrases “shortly before” or “shortly after,” but most cases have interpreted these terms fairly broadly such that, as long as the requisite creditor exists as described above, courts have had little difficulty concluding that transfers occurred “shortly before or after” such creditor’s claim arose.

Actual Intent

Whether a transfer was made with actual fraudulent intent is a fact question. Given that direct evidence of actual intent is rarely available, courts typically rely on circumstantial evidence, known as badges of fraud, to infer intent. The Bankruptcy Code does not explicitly list badges of fraud, but the Fifth Circuit has recognized the following badges of fraud in analyzing actual fraud under the Bankruptcy Code:

  1. the lack or inadequacy of consideration;
  2. the family, friendship, or close associate relationship between the parties;
  3. the retention of possession, benefit or use of the property in question;
  4. the financial condition of the party sought to be charged both before and after the transaction in question;
  5. the existence or cumulative effect of the pattern or series of transactions or course of conduct after the incurring of debt, onset of financial difficulties, or pendency or threat of suits by creditors; and
  6. the general chronology of events and transactions under inquiry.

See Soza v. Hill (In re Soza), 542 F.3d 1060, 1067 (5th Cir. 2008) (quoting Chastant v. Chestnut (In re Chastant), 873 F.2d 89, 91 (5th Cir. 1989)).

Other circuits have found used similar badges of fraud in their analysis of actual intent.

Under Texas law, TUFTA provides a non-exclusive list of badges of fraud that may be considered to find actual intent on the part of a debtor. The badges of fraud listed in the statute include:

  1. the transfer or obligation was to an insider;
  2. the retained possession or control of the property transferred after the transfer;
  3. the transfer or obligation was 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 absconded;
  7. the debtor removed or concealed assets;
  8. the value of consideration received by the debtor was less than reasonably 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; and
  11. the debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.

Tex. Bus. & Comm. C. §24.005(b).

There is no clear authority on how many badges of fraud must be present to sufficiently establish actual intent under either the Bankruptcy Code or TUFTA. As a matter of law, a finding of fraudulent intent cannot properly be inferred from the existence of just one badge of fraud. See Roland v. United States, 838 F.2d 1400, 1403 (5th Cir. 1988) (requiring several badges of fraud to prove fraudulent intent); United States v. Fernon, 640 F.2d 609, 613 (5th Cir. 1981) (“[T]he party seeking to avoid a transfer must establish, by a preponderance of the evidence, the presence of multiple badges of fraud.”); Ingalls v. SMTC Corp. (In re SMTC Mfg. of Tex.), 421 B.R. 251, 300 (Bankr. W.D. Tex. 2009).

The burden is on the Plaintiff to establish the existence of “actual intent to hinder, delay, or defraud any creditor of the debtor” – including the presence of multiple badges of fraud. See, e.g., In re The Heritage Org., 413 B.R. 438, 464 Bankr. N.D. Tex. 2009). Once that occurs, the burden shifts to the defendant to show that the transferor had a legitimate purpose in making the transfer.” Id.

Constructive Fraudulent Transfer

Under Section 24.005(a)(2) of TUFTA, to prove constructive fraudulent intent, the Plaintiff must show that the transfers were made by the Debtor:

Tex. Bus. & Comm. C. §24.005(a)(2).

Under § 548(a)(1)(B) of the Bankruptcy Code, to prove constructive fraudulent intent, the Plaintiff must show that the Debtor:

. . .

11 U.S.C. § 548(a)(1)(B)

The elements of a constructive fraudulent transfer under the Bankruptcy Code and TUFTA are the same as an actual fraudulent transfer except instead of pleading fraudulent intent, the plaintiff must establish:

  1. ack of reasonably equivalent value for the transfer; and
  2. the transferor was ‘financially vulnerable’ or insolvent at the time of the transaction.

In re Northstar Offshore Group, LLC, 616 B.R. at 721; Matter of Life Partners Holdings, Inc., 926 F.3d at 120; Tex. Bus. & Comm. C. § 24.005(a)(2).

The Plaintiff bears the burden to establish the lack of reasonably equivalent value. See, e.g., Yaquinto v. CBS Radio, et al., Adv. Proc. No. 19-03226-sgj (Bankr. N.D. Tex., July 13, 2022)In re McConnell, 934 F.2d 662, 665 n.1 (5th Cir. 1991); Altus Brands II, LLC v. Alexander, 435 S.W.3d 432, 441 (Tex. App.—Dallas 2014, no pet.).

Under TUFTA, the “reasonably equivalent value” requirement is satisfied when the transferee fully performs an arm’s-length transaction in the ordinary course of business. Id.; see also Janvey v. Golf Channel, Inc., 487 S.W.3d 560, 582 (Tex. 2016).

Under the Bankruptcy Code, “‘reasonably equivalent value’ means that ‘the debtor has received value that is substantially comparable to the worth of the transferred property.’” Yaquinto v. CBS Radio, et al., Adv. Proc. No. 19-03226-sgj (Bankr. N.D. Tex., July 13, 2022) (quoting In re TransTexas Gas Corp., 597 F.3d 298, 306 (5th Cir. 2010), which in turn was quoting BFP v. Resolution Trust Corp., 511 U.S. 531, 548 (1994)).

The Fifth Circuit has recognized that indirect benefits—such as synergy between two joining entities and increased monetary float – conferred from transfers at issue can be recognized to serve as “value” to a debtor. Matter of Fairchild Aircraft Corp. 6 F.3d 1119, 1127 (5th Cir. 1993). Thus, the benefit of an obligation paid for by a debtor need not confer a direct benefit on the debtor.

So that concludes a look at the elements of fraudulent transfers under both the Bankruptcy Code and under Texas law. In our next installment, we will take a deeper dive into badges of fraud under both the Bankruptcy Code and TUFTA. Until then, Happy Holidays!

Bankruptcy Attorneys

Do you need assistance with the topics discussed in this Insights post? Freeman Law can help you navigate these complex issues. We offer value-driven services and provide practical solutions to complex issues. Schedule a consultation or call (214) 983-3410 to discuss your concerns!