Fraudulent Conveyance in Bankruptcy

Actual fraud requires a transfer of property with the intent to hinder, delay, or defraud a creditor. The creditor challenging the transfer must prove intent, which can be difficult to do. As a result, certain “badges of fraud” can be used to help establish circumstantial evidence of intent.

When there is no overt evidence of intent, courts have held that certain facts and circumstances are suggestive of actual fraud. These are known as badges of fraud. Typically, the badges are situations where the relationship between the parties or the details of the transaction raise suspicion that the transfer was not legitimate. The existence of a single badge of fraud is not determinative of fraudulent intent. However, the presence of several badges can constitute conclusive evidence of an actual intent to defraud.

Common badges of fraud include:

• Transfer for less than the fair market value
• Transfer to family, friends, or close associate relationships (also referred to as “insiders”)
• Transfer of ownership to a third party, but retaining possession and control of the property for the debtor’s use
• Worsening of the debtor’s financial condition after the transfer
• Pattern of transactions or conduct by the debtor after incurring debt or pendency or threat of lawsuits by creditors
• Suspicious timing of the transaction in question
• Concealing facts about or failing to disclose a transaction.

Constructive fraud has two elements. First, the debtor must have received less than reasonably equivalent value in exchange for such transfer or obligation. Second, the debtor must have been insolvent at the time of the transfer or become insolvent because of the transfer.

Unlike actual fraud, there is no requirement to prove fraudulent intent of the debtor. The key issue is showing that the transfer was not made for reasonably equivalent value.

Bankruptcy law does not define reasonably equivalent value. There may be legitimate reasons why a debtor sells property for less than it may appear to be worth. As a result, courts will consider various factors surrounding the transfer to determine if it was for reasonably equivalent value. These factors include the fair market value of the property, whether the transfer was made in good faith in the ordinary course of business, the existence of a special relationship between the parties, other offers or competitive bidding for the property, and the impact of the sale on the funds available to other creditors. In addition, transfers that offered additional businesses opportunities to the debtor may also be considered as part of the determination of reasonably equivalent value.

Notably, a foreclosure sale amount is typically considered a legitimate transfer unless there was collusion, a special relationship, or violation of law.

Transfers by the debtor to a third party are reviewed for a certain period prior to the filing of the bankruptcy. This is known as the “look back” period. Generally, the trustee is limited to a two-year lookback. However, the period is four years if the state where the bankruptcy was filed has enacted laws, like the Uniform Voidable Transactions Act (UVTA), which allows for a longer look back period. The UVTA was formerly known as the Uniform Fraudulent Transfer Act (UFTA) and has been adopted by all but a few states.

New York State enacted the UVTA in 2019. It provides that actions to avoid a constructive fraudulent transfer must be brought within four years of the transfer or obligation to be avoided, while actions to avoid an intentional fraudulent transfer must be brought within either four years of the transfer or obligation to be avoided or within one year of when the transfer or obligation was or reasonably could have been discovered, whichever is later.

The bankruptcy trustee has the power to set aside a fraudulent conveyance and recover either the property transferred or the value of such property for the benefit of the bankruptcy estate. Action may be taken against the immediate recipient (initial transferee) of the property or subsequent transferees. However, there are a few exceptions. First, the trustee cannot recover from a bona fide purchaser who purchases for value, in good faith, and without notice of the rights of others, or any subsequent transferee from a bona fide purchaser. In addition, an exception is made for those who made improvements to the property. They are given a lien on the property securing their interest.