Transfer Troubles: Navigating Fraudulent Laws

Fraudulent transfer law allows a creditor to challenge the transfer of assets to a business entity as a transfer not meant to assist with business operations but instead intended to help the owner insulate the transferred asset from creditor claims. The Uniform Fraudulent Transfer Act is designed to prevent fraudulent transfers and allow a creditor to cancel the transfer. The transfer of assets to an LLC may be viewed as a badge of fraud where the debtor removed assets by transferring to an LLC to enjoy charging order protection. The look-back period is two years before the filing of the bankruptcy petition. Intent to defraud must be proven for a defendant to be found guilty.

Fraudulent conveyance

To file an action for fraudulent conveyance, the transfer must have been made within two years of the date of filing of the bankruptcy petition. A charitable contribution is not considered a fraudulent conveyance if the amount does not exceed 15% of the gross annual income of the debtor for the year in which the transfer is made.

The concept of fraudulent conveyance has evolved from a relatively simple agrarian economy context to now being used to challenge complex modern financial transactions.

Actual fraud

Under 11 U.S.C. Section 548, actual fraud occurs when a debtor intentionally donates or gets rid of property as part of an asset protection scheme. The law allows for a look-back period of two years before the filing of the bankruptcy petition, during which any transfers made with the intent to defraud creditors can be reviewed.

To prove actual intent, courts have developed "badges of fraud," which are considered circumstantial evidence of fraud. These include:

• Becoming insolvent because of the transfer
• Lack or inadequacy of consideration
• Family or insider relationships among parties
• Retention of possession, benefits, or use of the property in question
• Existence of a threat of litigation
• Financial situation of the debtor at the time of transfer
• Existence or cumulative effect of transactions after the onset of the debtor's financial difficulties
• General chronology of events
• Secrecy of the transaction
• Deviation from the usual method or course of business

If actual fraud is proven, a court can require the person holding the assets (the transferee) to hand them over, or provide an equivalent monetary value, to the creditor.

Constructive fraud

To file an action for constructive fraud, the transfer must have been made or incurred within two years before the date of filing of the bankruptcy petition. There are some exceptions to what is considered a fraudulent conveyance. For example, a transfer of a charitable contribution to a qualified religious or charitable entity or organization is not considered a fraudulent conveyance if the amount of the contribution does not exceed 15% of the gross annual income of the debtor during the year in which the transfer is made.

The concept of constructive fraud is important in fraudulent transfer law, which allows a creditor to challenge the transfer of assets to a business entity as a transfer not meant to assist with business operations but instead intended to help the owner insulate the transferred asset from creditor claims. Evidence of intent with respect to transactions involving an entity can be direct, but it is often gleaned from facts and circumstances.

Business planning

Understanding Fraudulent Transfer Laws

Fraudulent transfer laws, also known as fraudulent conveyance laws, are designed to protect creditors' rights and prevent debtors from unfairly transferring their assets to avoid paying debts. The Uniform Voidable Transactions Act (UVTA), previously known as the Uniform Fraudulent Transfer Act (UFTA), and the federal Bankruptcy Code outline the legal framework for fraudulent transfers. These laws enable creditors to challenge and potentially undo fraudulent asset transfers made by debtors.

Types of Fraudulent Conveyance

It's essential to distinguish between two types of fraudulent conveyance: actual fraud and constructive fraud. Actual fraud occurs when a debtor intentionally transfers property or assets with the specific intent to hinder, delay, or defraud creditors. Constructive fraud, on the other hand, refers to unfair transfers that may lack explicit fraudulent intent but result in creditors receiving less than they are legally entitled to.

Timing of Transfers

The timing of transfers is crucial in fraudulent transfer cases. Both the UVTA and the Bankruptcy Code have a "look-back" period, typically two years before the filing of a bankruptcy petition. This means that transfers made within this period can be scrutinized and potentially undone if they are found to be fraudulent.

Indicators of Fraudulent Intent

Courts and creditors look for certain indicators or "badges of fraud" to establish fraudulent intent. These include transferring assets to relatives or insiders, concealing assets, transferring property shortly before or after incurring a debt, and setting up shell corporations. If a court determines that a transfer was made with fraudulent intent, it can cancel the transfer and allow the creditor to seize the assets or their monetary equivalent to satisfy the debt.

Limited Liability Companies (LLCs)

LLCs are often used to protect business owners' individual assets from business creditors. However, if a debtor uses an LLC as a trust substitute to shield assets from personal creditors, the transfer may be considered fraudulent. In such cases, creditors may be permitted to access the assets contributed to the LLC. It's important to note that a contribution of capital to an LLC may not always be considered "reasonably equivalent value", and courts can void such transfers.

When engaging in business planning, it is crucial to seek legal advice to ensure compliance with fraudulent transfer laws. Avoid using business entities solely as a means to hinder or delay creditors, as this can trigger fraudulent transfer laws. Be cautious when transferring assets to LLCs, especially if there are non-debtor members, as it may be required to unwind such transfers. Always ensure that transfers are made for legitimate business purposes and that there is no intent to defraud creditors.

Charging orders

In the context of LLCs and LLPs, a charging order requires the business entity to repay the unsatisfied judgment by redirecting distributions meant for the judgment debtor to the judgment creditor. This mechanism allows judgment creditors to access economic interests that would otherwise be out of reach due to the protections afforded to LLC members.

However, a charging order is not without limitations. For instance, in North Carolina, a creditor cannot obtain a charging order if the debtor no longer owns the membership interest, nor can they force the LLC or LLP to satisfy a judgment on behalf of an employee without a membership interest.

The effectiveness of a charging order can be complicated if the debtor transfers their interest. In such cases, creditors may argue that the transfer was a sham and attempt to enforce the order against the debtor's interest. However, as illustrated in a North Carolina case, if the transfer occurred before the entry of the charging order, the court may rule that the debtor could not have violated the order by failing to remit payments since they held no interest in the LLC or LLP.

While fraudulent transfer laws allow creditors to challenge asset transfers meant to insulate assets from their claims, the mere transfer of assets to a business entity does not automatically constitute fraud. The intent behind the transfer is crucial, and courts will consider various factors, known as "badges of fraud," to determine if the transfer was primarily intended to defeat creditors.

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