What is a fraudulent transfer?

A fraudulent transfer is not fraud per se. It is a transfer done in order to “hinder, delay, or defraud any creditor of the debtor” (UFTA §4(a)(1)). Some transfers are automatically considered a fraudulent transfer; others are fraudulent according to guidelines provided in the UFTA and the whim of a judge.

 If a transfer is found to be fraudulent, the transfer is usually set aside as if it never happened, thus placing the asset back within a creditor’s reach, or the transferee gives the asset(s) to the creditor outright. Particularly egregious fraudulent transfers may also subject the transferor and also possibly (albeit less often) the transferee to fines and penalties. A fraudulent transfer is, however, not considered a crime.

If an asset protection program fails, it will fail one of three ways:

1.  A judge rules that a transfer of an asset into an asset protection structure is fraudulent, and thus reverses the transfer.

2.  A judge rules that the asset protection structure is an alter ego of the client, and thus disregards the limited liability of the entity. Such entities may also be deemed a sham by the judge, which has the same effect.

3. If a transfer to an offshore structure is deemed fraudulent, the judge may or may not then order the client to repatriate offshore assets, to place then back within the reach of the court. If the client is able to do so and doesn’t, he could be thrown in jail for contempt of court.

Of all the ways in which a program can fail, a fraudulent transfer is usually what does a program in. Therefore, avoiding a fraudulent transfer is very important.

Section 4(a)(2) of the UFTA shows a transfer is automatically deemed fraudulent under the following conditions, even if the transfer occurred before a creditor claim (or even the threat of a claim) occurred:

4 (a) A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor's claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation:

…

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

(i) 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

(ii) intended to incur, or believed or reasonably should have believed that he [or she] would incur, debts beyond his [or her] ability to pay as they became due.

Section 5 of the UFTA shows a transfer done after a creditor claim arose is automatically deemed fraudulent under the following conditions:

5 (a) A transfer made or obligation incurred by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made or the obligation was incurred if the debtor made the transfer or incurred the obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent at that time or the debtor became insolvent as a result of the transfer or obligation.

5 (b) A transfer made by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made if the transfer was made to an insider for an antecedent debt, the debtor was insolvent at that time, and the insider had reasonable cause to believe that the debtor was insolvent.

Section 4(a)(1) of the UFTA tells us that a transfer is fraudulent if it’s done “with actual intent to hinder, delay, or defraud any creditor of the debtor.” However, determining such a transfer as fraudulent is not an automatic, cut and dry process. In this case, a judge is given broad latitude to determine whether a transfer is fraudulent by using constructive evidence, which considers the “badges of fraud”, among other things, listed in §4(b) of the UFTA:

...whether:

1. the transfer or obligation was to an insider;

2. the debtor retained possession or control of the property transferred after the transfer;

3. the transfer or obligation was disclosed or concealed;

4. before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit;

5. the transfer was of substantially all the debtor's assets;

6. the debtor absconded;

7. the debtor removed or concealed assets;

8. the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred;

9. the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred;

10. the transfer occurred shortly before or shortly after a substantial debt was incurred; and

11. the debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.

            Note that some of the above badges of fraud are not always applicable. For example, it is normal business practice for a personal residence’s equity to be transferred to a secured lender via a lien, yet the debtor remains in possession and control of the property. In this instance, badge of fraud #2 is not applicable. When a badge of fraud is not a part of normal business, however, a fraudulent transfer determination becomes more likely. Remember that a judge has wide latitude when determining whether a transfer was done with intent to hinder, delay, or defeat a creditor, and thus fraudulent. Therefore, one judge may look at a transfer with one badge of fraud and say it was fraudulent, and a different judge would say the badge of fraud was inadequate to conclude a fraudulent transfer had occurred. It’s a real crap shoot, so your best bet is to avoid as many (or all) badges of fraud as possible.

Finally, although it is sometimes difficult to constructively prove an intent to hinder, delay, or defeat a creditor, a mere ‘preponderance of evidence’ is sufficient to determine a fraudulent transferred occurred, which is a much lower standard than the ‘beyond a shadow of a reasonable doubt’ standard used to determine guilt in a criminal proceeding. The bottom line: if at all possible, set up your asset protection program and get your assets into it long before creditor threat arises.