Fraudulent Transfers

Fraudulent Transfers              

One of the powers of a bankruptcy trustee is the power to recover fraudulent transfers.   Contrary to popular opinion, most "fraudulent transfers" do not involve any fraud.

             There are two types of fraudulent transfers.  They are:

             1.         True Fraudulent Transfers.     The law allowing for the recovery of truly fraudulent transfers, intended to hinder, delay or defraud creditors, has been on the books since the Statute of Elizabeth (1570).    A typical fact pattern for an actual fraudulent transfer is a debtor who transfers property to a family member just prior to bankruptcy, so that the property is not sold by the trustee in order to pay creditors' claims.  

Commentators have noted that there is something instinctive in the minds of those contemplating bankruptcy to feel they need to "bury" something so that they are not left totally without resources after their bankruptcy case.   The bankruptcy system, however,  does not work that way, and to engage in such a scheme would disqualify the debtor from receiving a discharge, and would also expose them to criminal penalties. 

             2.         Constructive Fraud.  The second type of fraudulent transfer, which is more widespread, and which involves no actual fraud, are transfers labeled as constructively fraudulent.  A constructively fraudulent transfer exists when property is transferred while the debtor is insolvent (liabilities exceed assets), and the transfer is for less that "reasonably equivalent value".  The idea is to keep the bankruptcy estate from being depleted by sales of property at bargain prices as the cash-strapped debtor slides toward bankruptcy.  An example is a troubled company that, while insolvent, sells manufacturing equipment for 50% of its actual value.  In the case of a constructively fraudulent transfer, the trustee can sue the buyer for recovery of the difference between the real value and the value paid by the buyer.  The Court can also order the return of the property by the purchaser.

The defenses to a fraudulent transfer action are   mainly factual.  In the case of constructive fraud, expert witnesses are needed to fix the value of the property at the time of the transfer, and to determine if the debtor received reasonable equivalent value.  Similarly, whether the debtor was insolvent often involves a detailed inquiry by forensic accountants.  

Due to the costs and uncertainty which face both sides in avoidable transfer cases, both preferences and fraudulent transfers, many such cases settle prior to trial.  If settlement is not reached, then the Bankruptcy Court conducts a trial to determine whether the transfers in question can be recovered by the trustee or debtor in possession.