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Fraudulent Conveyances in Bankruptcy

Bankruptcy Paperwork

Under the Bankruptcy Code, a fraudulent conveyance occurs when a debtor either:

  1. Transfers property with the intent to hinder, delay, or defraud its creditors, or
  2. Makes a transfer for less than reasonably equivalent value at the time of the transfer within 2 years before the date of the bankruptcy filing, or within 4 years if the bankruptcy case is filed in New York.  

A debtor who gives away property right before a bankruptcy filing may be found to have committed actual fraud. Transferring assets to a relative and setting up shell corporations to shield the assets from distribution in bankruptcy may also be considered fraudulent conveyances. The Bankruptcy Code provides the platform for recovering such conveyances and, in fact, it mandates that such transfers are avoided so that the value can be recovered and redistributed to the debtor’s creditors.

Once it is determined that a particular transfer took place within the statute of limitations period, the threshold questions involve determining whether the transfer is voidable under the actual or constructive fraudulent transfer provisions of the Bankruptcy Code. Actual fraud means that real proof exists, either directly or circumstantially, which demonstrates that the debtor entered into the transaction with the actual intent to hinder, delay, or defraud its creditors. The constructive fraud analysis is twofold. First, constructive fraud is found to exist when a debtor made a transfer but received less than “reasonably equivalent value” for the transferred asset. Most courts have interpreted this to mean “fair market value” of the asset, or “fair consideration” in New York, though an exception exists in the context of foreclosure sales; a debtor transferring its $10 million warehouse for $1 million is an example of receiving less than reasonably equivalent value. The second prong of the constructive fraud analysis asks whether the debtor was insolvent, left with unreasonably small capital, would become insolvent by the transfer, or made the transfer to benefit an insider.

Fraudulent conveyance issues can arise in multiple contexts. The simplest example is a gift given by an insolvent entity to an insider, an insider’s friend, or relative. Fraudulent conveyances also become a concern when a debtor guarantees the debt of its parent or a shareholder. It is often found in these situations that the debtor did not receive fair consideration in exchange for guaranteeing the debt. Another example is in the case of a leveraged buyout (“LBO”). In an LBO, the purchaser pledges the assets of the target company as collateral for the loan used to finance the acquisition. If, due to the transaction, the target company becomes insolvent or undercapitalized and files for bankruptcy, fraudulent conveyance issues can arise. Payments to insiders under employment contracts not made in the ordinary course of business, or excessive compensation (or other benefits) paid by a distressed company to any employee, become potential fraudulent conveyances if the debtor did not receive reasonably equivalent value in exchange.

Fraudulent conveyances are avoidable in bankruptcy. A trustee, or a debtor in possession can bring an action against a transferee to recover the transferred property for the benefit of the estate. However, a transferee can defend against a fraudulent conveyance attack by establishing that any one of the required elements of a fraudulent conveyance were not satisfied. These include:

  1. That the debtor received reasonably equivalent value,
  2. The debtor was solvent at the time of the transfer, or
  3. The transfer did not occur within the look-back period.

In addition to the elements, a transferee can assert that he was a good-faith purchaser, improved or preserved the property, was a mere conduit, or the transfer was a settlement payment.

Whatever your role or interest in pre-bankruptcy transactions, retaining experienced bankruptcy counsel is advisable in order to enforce and preserve your rights. Contact KI Legal for more information by calling (646) 766-8308 or email to discuss.



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