FRAUDULENT TRANSFER LAWS
Every asset-protection plan must take into account the fraudulent transfer laws. A violation of these laws can result in discipline, civil liability, or criminal liability.
There are two broad categories of voidable transfers:
- Actual Fraud-Transfers made with “actual intent to hinder, delay, or defraud” a creditor. CC §3439.04(a)(1). See below
- Constructively fraudulent transfers. See below
Actual fraud can be established by direct evidence under CC §3439.04(a)(1), although it is more likely established by the presence of the “badges of fraud”—that is, factors courts have traditionally considered in inferring fraudulent intent. Although there are many badges of fraud, the most important are insolvency of the transferor and the lack of adequate consideration received in exchange for the transfer. As a rule, transfers undertaken for estate planning purposes lack consideration.
Badges of fraud include the following (CC §3439.04(b)):
- The transfer or obligation was to an insider.
- The debtor retained possession or control of the property transferred after the transfer.
- The transfer or obligation was concealed.
- Before the transfer was made or the obligation incurred, the debtor had been sued or threatened with suit.
- The transfer was of substantially all of the debtor’s assets.
- The debtor absconded.
- The debtor removed or concealed assets.
- The value of consideration received was not reasonably equivalent to the value of the asset received or obligation incurred.
- The debtor was insolvent or became insolvent shortly after the transfer was made or obligation incurred.
- The transfer occurred shortly before or after a substantial debt was incurred.
- The debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider. See Stahl v Simon (In re Adamson Apparel, Inc.) (9th Cir 2015) 785 F3d 1285 (partial repayment of loan guaranteed by corporate insider under agreement that waived indemnity was not voidable preference).The presence of these badges of fraud allows a court to infer that a transfer was fraudulent, in the absence of direct evidence of fraudulent intent. See, e.g., U.S. v Townley (ED Wash, July 29, 2004, No. CS-02–0384-RHW) 2004 US Dist Lexis 29722, aff’d (9th Cir 2006) 97 AFTR2d 2484, in which the court held that irrevocable trust assets could be reached to satisfy a judgment against the settlors even though they were not named beneficiaries of the trust. The court concluded that there was direct evidence of intent to defraud in the form of a statement that the transfers were intended to protect the transferred assets from the claims of future judgment creditors. However, the court also concluded that the trust could be disregarded because it was the “alter ego” or “nominee” of the settlors under a six-factor test using traditional badges of fraud. See also Goodrich v Briones (In re Schwarzkopf) (9th Cir 2010) 626 F3d 1032 (trust for benefit of minor child was invalid because transfer was made when debtors were insolvent for fraudulent purpose of avoiding creditors). In U.S. v Krause (In re Krause) (10th Cir 2011) 637 F3d 1160, the court held that an IRS lien applied to property transferred to “children’s trusts” by a taxpayer who later filed for bankruptcy. The court held that the transfers were fraudulent conveyances and so void under state law.
In Battley v Mortensen (In re Mortensen) (D Bankr Alaska, Jan. 14, 2011, No. A09–00036-DMD) 2011 Bankr Lexis 5004, the bankruptcy court held that the special 10-year limitations period in 11 USC §548(e) applied and, therefore, the bankruptcy trustee’s fraudulent transfer claim was not barred by Alaska’s 4-year limitations period. The court further found that language in the trust instrument stating that a purpose of the trust was to protect assets from potential future creditors was a “badge of fraud.”
Constructive fraud arises when a transfer is made without fair or adequate consideration, and the debtor
- Is insolvent, or is rendered insolvent as a result of the transfer (CC §3439.05);
- Engages in a transaction or is about to do so with unreasonably small capital (CC §3439.04(a)(2)(A)); or
- Intended to incur or believed or reasonably should have believed that the debtor would incur debts beyond the debtor’s ability to repay (CC §3439.04(a)(2)(B)).Constructive fraud does not require fraudulent intent.
Transfers made to implement estate planning will clearly be for inadequate consideration. For this purpose, adequacy of consideration is determined from the point of view of the creditor. Travellers Int’l v Trans World Airlines (In re Trans World Airlines) (3d Cir 1998) 134 F3d 188.
For purposes of fraudulent transfer law, insolvency is determined under a modified balance sheet approach that excludes assets that are not available to creditors, such as assets held in an exempt retirement plan and assets that are outside the jurisdiction and, therefore, unavailable to creditors. Contingent liabilities are taken into account at their probable values.