Fraudulent Transfers

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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.

Basic Statutory Framework and the Difference Between Actual and Constructive Fraudulent Transfers

Over the last 45 days, I have litigated four separate fraudulent transfer adversary proceedings in Bankruptcy Court.  Through that experience, I have not only reinforced certain principles, but also clarified others and learned a few things along the way.  This is the first in a series of blogs I’m going to write that will not only document these principles for my own benefit and future reference, but also share what I’ve learned (and re-learned) with others dealing with similar matters.

This first of what is expected to be five blogs on fraudulent transfers will focus on the basic statutory framework surrounding fraudulent transfers – both under the Bankruptcy Code as well as Texas law.  Herein, I will additionally cover the basic differences between what is known as “actual” versus “constructive” fraudulent transfers.

Fraudulent Transfer Basics

The term “fraudulent transfer” conjures up a wide variety of visions depending on your perspective and experience.  In its broadest sense, a fraudulent transfer is the transfer of an asset for what is deemed an unlawful purpose.  Usually, it involves the current owner of an asset transferring that asset in an attempt to put it out of reach of someone else – often a creditor; sometimes a business partner or other entity that might claim some right to acquire that asset.

In this series, I am going to focus on fraudulent transfer laws under both the Bankruptcy Code, as well as under Texas law.  Mind you, fraudulent transfer laws around the country are very similar.  And therefore, while the Bankruptcy Code is uniform, state laws are also fairly consistent.  The best way of explaining the concept of a fraudulent transfer in the bankruptcy context is with a relatively simple example.  Most debtors are aware that, when they file for bankruptcy protection, any non-exempt assets that they have are likely at risk of being taken and used to satisfy creditors.  The issue of exempt versus non-exempt assets is beyond the scope of this series, but as a general concept, debtors in most states are allowed to keep a limited number of assets as part of the “fresh start” that bankruptcy is supposed to provide.  In most cases, this includes, at a minimum, a house, a car, and personal belongings, including clothes, jewelry and basic necessities.  These assets are considered exempt assets because they are exempted from the rights of a bankruptcy trustee to take them and use them to satisfy creditors.

Other assets, however, are considered non-exempt, and these assets are the ones that are most at risk in the context of a bankruptcy filing.  As one small example, let’s say a debtor has a small boat.  Under most exemption schemes, a boat is not an exempt asset.  Therefore, in the simplest of fraudulent transfer schemes, a debtor will transfer that boat to, say, a brother-in-law for little to no payment shortly before filing for bankruptcy.  In exchange for allowing the brother-in-law to use the boat on occasion, in a “wink-wink” type of agreement, the brother-in-law will take the boat for a period of time.  During that time, the debtor will file bankruptcy and no longer have a boat to disclose as a non-exempt asset that could be taken for the benefit of creditors.  Once the bankruptcy is over, however, the brother-in-law will give the debtor the boat back.

Fraudulent transfer laws are designed to prevent this type of transfer from occurring.  Or if such a transfer does occur, these laws are intended to allow for the recapture of the assets fraudulently transferred.

Actual versus Constructive Fraudulent Transfer

In the basic example above, the debtor engaged in an actual fraudulent transfer, meaning that the debtor had actual fraudulent intent in engaging in the transfer.  The debtor was aware of the possibility that he could lose his boat, and therefore in an attempt to prevent his boat from being taken, liquidated, and the proceeds used to pay creditors, he transfers it to another with little to no consideration.  However, fraudulent transfer laws have evolved to address other situations where, even if the transferor of the asset did not have actual fraudulent intent, the transfer may be deemed to be fraudulent based on the surrounding facts and circumstances.  Those facts and circumstances will focus on things like the proximity to a bankruptcy filing; the financial status of the transferor at the time of the transfer; and what consideration the transferor receives in exchange for the transfer.

Actual Fraudulent Transfers

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.”  A plaintiff must provide evidence that a 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 (commonly known as “TUFTA”) provides the statutory authority under Texas law to enable avoidance of an actual fraudulent transfer.  The statute similarly 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.”

Constructively Fraudulent Transfers

Under § 548(a)(1)(B), to prove constructive fraudulent intent under the Bankruptcy Code, a plaintiff must show that the debtor/transferor:

. . .

(B) (i) received less than a reasonably equivalent value in exchange for such transfer or obligation; and

(ii)

      1. was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation;
      2. was engaged in business or a transaction, or was about to engage in business or a transaction, for which any property remaining with the debtor was an unreasonably small capital;
      3. intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor’s ability to pay as such debts matured; or
      4. made such transfer to or for the benefit of an insider, or incurred such obligation to or for the benefit of an insider, under an employment contract and not in the ordinary course of business

Similarly, under Section 24.005(a)(2) of TUFTA, to prove constructive fraudulent intent, a plaintiff must show that the transfers were made by a debtor:

. . .

(2) without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor/transferor:

(A) was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or

(B)  intended to incur, or believed or reasonably should have believed that the debtor would incur, debts beyond the debtor’s ability to pay as they became due.

So now that we have the basic statutory framework, as well as a basic grasp of the difference between actual and constructively fraudulent transfers, in future blogs we’ll dig into some of these details.

The expected 5-part series will include:

  1. Basic Statutory Framework and Difference Between Actual and Constructive Fraudulent Transfers (this blog)
  2. Detailed Analysis of the elements of a fraudulent transfer under both the Bankruptcy Code and Texas law;
  3. Badges of fraud under both the Bankruptcy Code and TUFTA;
  4. Insolvency (as both a badge of fraud as well as an element of constructive fraudulent transfer); and
  5. Burdens of proof at trial

 

So stay tuned for more.