Fraudulent Transfer Rules

For as long as there have been commercial transactions, people have attempted to conceal their ownership of property in order to defeat the claims of their creditors. Concealment may take the form of physically hiding money or jewelry, or it may take the form of “gifts” to friendly parties or relatives. Sometimes, such “gifts” are accompanied by secret agreements to return the property after the trouble has passed.

In an effort to protect creditors from this endless game of hide and seek, English speaking courts have, for approximately 400 years, sought to invalidate transfers made by a person with the intent to defraud his creditors. Any transfer of property which is proved to be a “fraudulent conveyance” may be set aside by a court. Under these circumstances, the transfer will be ignored and the property will be treated as if still owned by the debtor. That means that the property will then be available to be seized by the judgment creditor. This law is currently embodied in the Federal Bankruptcy Code and the Uniform Fraudulent Transfer Act, which are similar in coverage and effectively state the applicable laws in most circumstances. For simplicity’s sake, we will cover the California version which will, of course, vary in some respects from that of other states.

A transfer is subject to being set aside as a “fraudulent transfer” in at least four circumstances:

• The transfer is made with the “actual intent to hinder, delay, or defraud any creditor of the debtor”;
• The transfer does not involve the receipt of “reasonably equivalent value” and the person making the transfer becomes insolvent (or was insolvent prior to the exchange);
• The transfer does not include the receipt of “reasonably equivalent value” and the person making the transfer knows (or should have known) that with his remaining resources he will be unable to pay future debts; and/or
• The transfer is without “reasonably equivalent value” and the person making the transfer continues to operate a business with assets that are “unreasonably small” in relation to typical existing or proposed business transactions.

A “transfer” encompasses not only the disposition of assets but taking on additional debt or obligations without receiving an equivalent benefit. For example, giving a friend a mortgage on your home without receiving the cash loan proceeds could qualify as a fraudulent transfer.