Fraudulent Transfer

Mike King
October 11, 2011 — 1,804 views  
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Let's start with how not to defraud creditors.  Lawrence Clarkston was a classic dumb debtor!  (In re Clarkston, 387 B.R. 882 (Bkrtcy.S.D.Fla. 2008)).  Lawrence Clarkston owned real estate in North Carolina.  He owed $97,000 for child support to one of his ex-wives.  The property in North Carolina was Mr. Clarkston's only significant asset.  He was insolvent! 

Mr. Clarkston deeded the property in North Carolina to his then-former wife, Connie Clarkston (not the one to whom he owed the child support).  All he received for deeding the property to the former wife was that she paid off the mortgage of $13,800.  She sold the property two months later for $44,712.41.  Mr. Clarkston then filed for Chapter 7 bankruptcy.  (Did we mention that Mr. Clarkston was living with his then-former wife, Connie Clarkston at the time of transfer of the property?)  Some time after that, Lawrence Clarkston and Connie Clarkston remarried. 

After taking testimony and analyzing the case, the bankruptcy court entered judgment against Connie Clarkston for the amount of the fraudulent transfer she had received from Lawrence Clarkston.  Nothing in the reported decision tells us whether the remarriage survived the ruling by the bankruptcy judge. 

While Lawrence Clarkston's transfer to defraud creditors earned him a nomination for dumb debtor of the year in 2008, case law is filled with examples of debtors transferring property for insufficient consideration to family members or friends.  Giving stuff away to keep it from your creditors won't work if your creditors pursue their rights! 

So what are the rules?  Most states have adopted some version of the Uniform Fraudulent Transfer Act.  In Section 4, the Uniform Fraudulent Transfer Act sets forth the guidelines for determining whether a transfer is fraudulent as to a creditor and can be set aside by a court.  The Act provides as follows: 

§ 4.      Transfers Fraudulent as to Present and Future Creditors.

(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:

(1)     with actual intent to hinder, delay, or defraud any creditor of the debtor; or

(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.

(b) In determining actual intent under subsection (a)(1), consideration may be given, among other factors, to 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.

So, in Mr. Clarkston's case, the court noted that he was unlikely to testify that he had intentionally defrauded creditors.  Therefore, it relied upon the Fraudulent Transfers Act and found that there were "badges of fraud," including (1) a relationship between the debtor and the transferee, (2) a lack of consideration for the transfer, (3) the insolvency of Mr. Clarkston at the time of transfer, (4) transfer of Mr. Clarkston's entire estate, (5) a reservation of the benefits from the property by Mr. Clarkston, (6) secrecy or concealment of the transaction, and (7) threat of litigation at the time of the transfer.  While any single "badge of fraud" might only raise suspicions, the court noted that the presence of several of these "badges of fraud," may form the basis for finding actual fraud supporting a claim to get the property back from the transferee. 

If, on the other hand, you are not dealing with the dumb debtor transferring to the live-in ex, you may have more problems setting aside a transfer.  For example, if adequate consideration has been paid, a conveyance cannot be set aside without actual proof of fraudulent intent.  Conveyances into exempt property categories, such as homestead exemptions, may be tougher to attack.  (See, Fidelity National Title Insurance Co. v. Schroeder, Cal.Rptr.3d 854 (5th Dist. 2009)).  Transfers for legitimate purposes, such as estate planning are less likely to be set aside, especially if the transfers occur before the threat of collection action.  Transfers to charities, may or may not be fraudulent transfers depending upon the facts. 

While the outcome of any fraudulent transfer case will depend upon the facts, dumb debtors and their family members and friends will generally lose because the transfers are to related parties for inadequate consideration.  More sophisticated business-driven or estate planning transfers (especially with regard to exempt assets) are less likely to be set aside by a court.  Transfers made before the threat of insolvency or collection action are also less likely to be set aside. 

If you need some advice or assistance with regard to making proper transfers or attacking fraudulent transfers or conveyances, please call me. 

Mike King

Gammage & Burnham PLC

Michael R. King is a founding partner of Gammage & Burnham, P.L.C., a Phoenix law firm with diverse areas of emphasis. His practice primarily centers around bankruptcy and creditors' rights, commercial litigation, including uniform commercial code cases, and real estate and business law. Mr. King is a former of the Creditor/Debtor Rights Committee and is a current member of the Bankruptcy, Real Estate and Construction Law Sections of the State Bar of Arizona. He is the past chair of the Board of Trustees of the Maricopa County Bar Foundation. Mr. King is an active alumnus of The University of Arizona, where he received his B.A. and J.D. degrees, with distinction and high distinction.