In a previous posting I discussed the concept of preferential transfer.  A somewhat related topic that has serious implications to bankruptcy filers is fraudulent transfer – also known as fraudulent conveyance. 

I.          Fraudulent Transfer Outside Of Bankruptcy

            A.        The Origins Of Fraudulent Transfer Law

The concept of fraudulent transfer has its origins in ancient Rome.  Indeed, the Romans had a well-developed bankruptcy legal system that was established by Julius Caesar – he had considerable debt and created the bankruptcy system to address it.  (This may have been a contributing factor in the decision of the senatorial conspiracy to assassinate him on March 15, 44 B.C.  For a good discussion of Roman bankruptcy law, see Hon. Theodor C. Albert, The Insolvency Law Of Ancient Rome, 28 CAL. BANKR. J. 365 (2006).)

As understood by the Romans, fraudulent transfer involved the transfer of an asset to someone else as a way of shielding it from the legitimate depredations of creditors.  The Romans granted the transferor’s creditors the right to undo (the legal term used is “avoid”) the transfer and seize the asset.

            B.        California’s Uniform Fraudulent Transfer Act

Over the centuries people have tried all sorts of ways around fraudulent transfer law.  As a result, modern fraudulent transfer law is extremely sophisticated. 

                        1.        Fraudulent Transfer Defined

California state law has two independent definitions of fraudulent transfer.  Here The statutory language is found in Cal. Civ. Code § 3439.04(a).

The first definition is pretty straightforward:  A transfer of an asset is fraudulent if it is done with the intent to hinder, delay, or defraud a creditor.  However, it is sometimes difficult to know what another person intends.  For that reason there is a second definition, the gist of which is:  A transfer is fraudulent if it is done without getting a fair market price for the transfer.

                        2.        The Creditor’s Recourse

If a creditor can establish that the debtor made a fraudulent transfer, then the creditor can avoid the transfer, and seize and liquidate the asset (see Cal. Civ. Code § 3439.07 for more details).

How far back in time can the creditor go?  Four years if the transfer could have been readily discovered because it was publicly recorded – such as the recording of a transfer of title of real estate.  However, if the transfer wasn’t recorded, the creditor can go back an additional year past the date when the transfer could have been discovered (see Cal. Civ. Code § 3439.09  for more detail).

It is worth observing that the statutory definition of fraudulent transfer includes the qualifying language: “. . . whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred . . .” This means that a creditor can avoid a fraudulent transfer that was made three years ago, even if the debt to that creditor arose only six months ago!

For example, suppose a senior citizen transferred his home to his son so that when the senior eventually dies his son has more favorable tax treatment than in the usual probate process.  Suppose further, that at the time of the transfer the senior has no debts.  Three years later, the senior has significant debt that he cannot pay.  Then the creditor can avoid the transfer to the extent necessary to cover the obligation, even though the debt arose after the transfer.

II.        Fraudulent Transfer In Bankruptcy

When an individual or a legally married couple files for bankruptcy protection under one of the two most commonly used chapters of the Bankruptcy Code (they are Chapters 7 and 13), the Bankruptcy Court appoints a Chapter 7 (Chapter 13, respectively) trustee to administer the case.  For linguistic convenience we’ll refer to this person as the “Chapter Trustee” as opposed to the United States Trustee – another trustee in the case.

On an informal level we can say that the trustee steps into the shoes of the creditors and inherits their right to avoid any fraudulent transfers.  However, in actuality, things are a bit more complicated.  There are two legal theories under which a Chapter Trustee can avoid a fraudulent transfer.

            A.        Fraudulent Transfer Under The Bankruptcy Code

The Bankruptcy Code also has two definitions of fraudulent transfer.  They are found in 11 U.S.C. § 548(a)  and mirror the definitions found in the California statute.  However, there is one important difference:  the look back period is only two years rather than four.  Thus, if a Chapter Trustee wants to use § 548 to avoid a fraudulent transfer he can only go back two years.

            B.        State Law And The Bankruptcy Code

The Bankruptcy Code provides another way for a Chapter Trustee to avoid a fraudulent transfer:  by appealing to the California Uniform Fraudulent Transfer Act (“UFTA”).  Under 11 U.S.C. § 544 , the Bankruptcy Code permits the Chapter Trustee to step into the shoes of any of the debtor’s creditors, and avoid fraudulent transfers under the UFTA.  This increases the look-back period to four years.  Of course, this is predicated on the debtor having the right kind of creditor to trigger the application of § 544.

III.       Cautionary Note

If you are thinking of filing for bankruptcy protection, do not start to transfer assets to family members.  I sometimes receive calls from potential clients who assure me, with a certain measure of pride, that the equity in the house is protected because they transferred title to a relative.  Unfortunately, since the transfer was fraudulent, filing for bankruptcy protection will practically guarantee the loss of the house to the Chapter Trustee.

If the transfer was relatively recent – say within the last couple of months – it may be reversible.  Then if the equity can be exempted, the house can be saved.