Southern California Bankruptcy Law Blog

Fraudulent Transfers I

Posted in Debt

In this series I will discuss fraudulent transfers, a concept that has some similarities to preferential transfers — our previous topic — but has much more serious consequences, especially in bankruptcy.  Today I’ll start with a folksy introduction.  In subsequent posts I’ll deal with the much more technical legal aspects of fraudulent transfers.

A.        Introduction

I frequently have conversations with potential clients who assure me that I needn’t worry about the principal residence because the potential client transferred title of the house to a relative.  I used genderless terms in the previous sentence, but the reality is that my interlocutor is usually a man who has transferred title to his wife.  He tells me this with some measure of pride, perhaps believing he’s the first person ever to have thought of this clever idea.

My response is to tell the gentleman that he did what the law refers to as a fraudulent transfer (a.k.a. fraudulent conveyance).  I let him know that the ancient Romans were well aware of this “clever” idea, and had laws to address it.  (See, e.g., Theodor C. Albert, The Insolvency Law Of Ancient Rome, 28 Cal. Bankr. J. 365 (2006).  Sorry, I don’t have a link, so you’ll have to consult your local library to get a copy.)  I add that over the last two thousand years, in response to all sorts of machinations that debtors have tried in their attempts to avoid the strictures of fraudulent transfer law, the law has become extremely sophisticated and now has two independent definitions to the term fraudulent transfer.  I then tell him that careful prebankruptcy planning may be required to prevent problems in the bankruptcy.

The purpose of this series of posts is to define fraudulent transfer, discuss its consequences — the trustee can avoid the transfer, the debtor can be denied a discharge — and examine prepetition prophylaxis and postpetition defenses to avoidance actions.

Before turning to the Bankruptcy Code’s definition of fraudulent transfer, it might be helpful to have a story to hang the definition on — sort of a folksy predefinition definition.  Since the ancient Romans had a fraudulent transfer law, let’s set our story in ancient Rome.

Our hero (maybe antihero is the better term) is a homeowner named Horace, who has a lovely home overlooking the Appian Way.  The house is completely paid for and is worth 200,000 sesterces.  (A sesterce was a silver coin of ancient Rome worth one quarter of a denarius, equal to 2½ asses — we’ll avoid half-assed jokes here.  It was introduced in the 3rd century B.C.)  Horace has fruit trees, a vegetable garden, some chickens, goats, sheep, and a cow.  In other words, with careful managing of his assets he is set for life.  But Horace has very little money, and he has an ambitious streak.  He wants to start a business and needs seed capital.  So Horace asks Crassus the creditor for a loan, and hearing the business proposal, Crassus lends Horace the money.

Unfortunately, events conspire against Horace and the business fails abysmally.  Anticipating that Crassus will soon demand repayment — the current balance on the loan is now, coincidentally, 200,000 sesterces — and having no money with which to repay the loan, Horace decides that he must take action to protect his home from Crassus’s depredations.  His bright idea?  He’ll transfer the home to his brother, Brutus.  That way Crassus won’t be able to seize the house.  Clever idea, right?  Wrong!  The Romans gave Crassus the power to seize the house from Brutus to satisfy the obligation.

What did Horace do?  Let’s be blunt:  He transferred the house to Brutus with the intent to hinder, delay, or defraud Crassus.  That is the essence of the Roman understanding of a fraudulent transfer. 

But there’s a problem with this definition.  It’s that word, “intent.”  After all, the Romans couldn’t read people’s minds, so how could they know what another person intended?  Simple.  They consulted with their god, Vulcan, who was from the planet, Vulcan, and could do mind melds!  You don’t buy that?  Would you believe they had Perry Mason’s ancestor, Perryus Masonus, who would stare intently into the eyes of the transferor and get him to admit to malevolent intent?  No?  Would you believe . . .

Alright, I’ll shift back into 21st century seriousness, while sticking to the ancient Roman fact pattern.  Suppose Horace sold the house to Brutus for 20,000 sesterces.  Would that avoid the problem?  Not quite.  The house was worth 200,000 sesterces, so that transaction is still a fraudulent conveyance.  Crassus would still be permitted to seize the house.  But if Horace sold the house for 200,000 sesterces, then Crassus wouldn’t be able to go after Brutus because he could obtain full satisfaction by seizing the 200,000 sesterces from Horace.

The above discussion was designed to get at the underlying ideas in fraudulent transfer law so that when we get into the statutory language we won’t lose sight of the big picture.

Next time we’ll bring things back into the 21st century legal world in the United States, and connect things to bankruptcy.

 Image courtesy of Flickr (Licensed) by diosthenese