Fraudulent Transfers

Fraudulent Transfer Law is talked around a lot in asset protection planning, but it is rarely addressed head-on. The purpose of this page is to present the basics of Fraudulent Transfer Law, so that when you hear the phrase you will have a good idea what it is.

In plain english, a Fraudulent Transfer (a/k/a “Fraudulent Conveyance”) is a transfer which a debtor makes for the purpose of defeating a creditor’s collection efforts against the debtor. This typically happens when, say, a debtor attempts to “sell” everything to his wife, cousin or business partner for $5 to keep his stuff out of the hands of his creditors. If the court figures out that the transaction is a sham to defeat the creditor, the court will set aside the transaction and make the person holding the assets give them to the creditor.

The modern law relating to fraudulent transfers derives from a case decided by the late Lord Coke in 1601, see, e.g., Twyne’s Case, 3 Coke 80b, 76 Eng.Rep. 809 (Star Chamber 1601), and the law really hasn’t changed that much over the course of the last 400 years, except for a slow infusion of bankruptcy principals in determining whether a debtor is insolvent.

In a nutshell, Fraudulent Transfer Law is this: You can’t do anything which would impair the rights of your unsecured creditors, if you do then the courts will simply ignore what you have done.

Gifts and Donations

Fraudulent Transfer Law is primarily aimed at people who try to make gifts to other people to avoid their creditors.

The unexpressed rationale is that the gift was only made to keep creditors from getting it, and the gift will either be controlled by the person who made the gift, or they will get it back after the creditors go away. So right off the bat there is a control test: If you have made a gift to keep it away from creditors, but you really still control it, the gift will be a fraudulent transfer.

Another unexpressed rationale is that you shouldn’t be making gifts if you are broke (if you are broke you should be receiving gifts!). So there is also an insolvency test: If you have made a gift while you are insolvent, the gift will be a fraudulent transfer.

Finally, you shouldn’t be doing anything which would lessen your creditor’s rights. So there is an intent test: If you make a gift with the intent of keeping it away from your creditors, the gift will be a fraudulent transfer. This is why you should never call an asset protection plan an asset protection plan, and why you should incorporate other planning into the plan. Call it anything else – a tax plan, an estate plan, whatever – just not an asset protection plan.

Obviously, on one is going to admit that their intention was to keep it away from their creditors. This argument does not protect the gift, it just makes it a little harder to prove, because fraudulent transfers can be proved by circumstantial evidence.

How Are Fraudulent Transfers Avoided?
The safest way to avoid fraudulent transfers is make sure that all transactions are at least close to being “for value.” While “for value” transactions can still be set aside as a fraudulent conveyance, it is very, very hard for a creditor to prove.

Another factor is that the transaction must have economic substance. A transaction which does not have economic substance is likely to be deemed a fraudulent transfer, but a transaction which makes good economic sense under the circumstances is going to be very, very difficult for a creditor to defeat.

While a conveyance for value will not guarantee that the transfer will stand up, see, e.g., Cioli v. Kenourgios, 59 Cal.App. 690, 211 P. 838 (1922) (debtor’s sale of all assets and shipment of proceeds out of the country held to be fraudulent conveyance notwithstanding adequacy of consideration), if a transfer is for equal or near-equal consideration then you have a much, much higher chance that the transfer will not be deemed to be a fraudulent transfer, see, e.g., Bank of Sun Prairie v. Hovig, 218 F.Supp. 769 (W.D.Ark. 1963); Lumpkin v. McPhee, 59 N.M. 442, 286 P.2d 299 (1955); Weigel v. Wood, 355 Mo. 11, 194 S.W.2d 40 (1946); Wareheim v. Bayliss, 149 Md. 103, 131 A. 27 (1925).

The Bottom Line: Use limited partnerships and corporations whenever possible because transfers made to a limited partnership or corporation are “for value” and let the creditor worry about having to force the limited partnership or corporation to pay up – something which may be very difficult for the creditor to do.

Post-Judgment Asset Protection

Most fraudulent transfer issues arise where planning is undertaken only after the Client has incurred debts or suffered an unfavorable judgment. This is more dangerous for the planner than it is for the Client, because not only can a transaction be set aside, but a court in some states can award additional damages against both the Client and the planner. You should plan beforehand when it was much less expensive for you and risky.

The glitz and glamour of offshore trust planning has overshadowed the practical fact that most asset protection cases are won or lost by commercial litigators in post-judgment collection and enforcement hearings in the local state and federal courts. These debtor-creditor disputes rarely focus upon the structure created by the debtor to shield his assets; instead, the salient issues almost inevitably concern the method of transfer of the assets into the structure. If the transfer is defendable, the structure is largely irrelevant (so long as the debtor has no ownership or control of that structure). But the converse isn’t true: If the structure is defendable, the transfer to the structure may still be set aside as a fraudulent transfer.

Questions of whether particular transfers are or are not fraudulent transfers represent some of the most important questions in asset protection planning. These issues are resolved by reference to the UFTA in the 41 states that have adopted it. Thus, the study of the UFTA, its history, and the cases that have interpreted the Act, will provide the broadest overview in most U.S. states as to what type of` transactions will, or will not, stand up to creditor scrutiny.

Additionally, in each state the UFTA will sometimes be interpreted with reference to “other law” in that state, and such interpretation can dramatically change the impact of the Act. Thus, what would be a fraudulent transfer in Arizona might be a protected transaction in Kansas. And what would be brilliant planning for a debtor in New York might be a misdemeanor in Texas.

This section of our site is meant to give an overview of the UFTA and fraudulent transfer law in general, and not to answer specific questions in a specific state as to what is or isn’t a fraudulent transfer. You or your attorney seeking resolutions to such questions in a particular state must consult the particular Act for that state and the cases cited thereunder.

To view the text of the California UFTA.