Southern California Bankruptcy Law Blog

Fraudulent Transfers IV

Posted in Debt

This post is the fourth in a series in which I will discuss fraudulent transfers.  The second post discussed the sources for a trustee’s authority to avoid a fraudulent transfer.  This one deals with the mechanics of fraudulent transfer avoidance. 

            D.        Avoiding Fraudulent Conveyances

            1.        The Power To Avoid

The Bankruptcy Code’s fraudulent transfer avoidance power is found in beginning of 11 U.S.C. § 548(a):  “. . . the trustee may avoid any transfer . . . of an interest of the debtor in property . . .” and in 11 U.S.C. § 548(b):

The trustee of a partnership debtor may avoid any transfer of an interest of the debtor in property, or any obligation incurred by the debtor, that was made or incurred on or within 2 years before the date of the filing of the petition, to a general partner in the debtor, if the debtor was insolvent on the date such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation.

The first avoidance passage — from § 548(a) — is quite general and encompasses any sort of fraudulent conveyance, whether or not the debtor was insolvent.  The second provision is much more narrowly tailored, and applies only to a debtor that is a partnership that was insolvent at the time of transfer, or immediately after the transfer.

The trustee will learn of the transfer because the debtor is required to report it in item 10 of the Statement of Financial Affairs.  Failure to report the transfer is perjury, which can be redeemed for free room and board at government expense.

The vehicle for avoiding a fraudulent transfer is an adversary proceeding pursuant to Fed. R. Bankr. Proc. 7001(1): 

The following are adversary proceedings:  a proceeding to recover money or property, other than a proceeding to compel the debtor to deliver property to the trustee, or a proceeding under §554(b) or §725 of the Code, Rule 2017, or Rule 6002.

An adversary proceeding is a full-blown lawsuit, so it’s a big deal.

Why does the Bankruptcy Code provide for the avoidance of fraudulent transfers?  When a debtor files bankruptcy papers an estate is created that consists of all of the debtor’s assets (except those the debtor can exempt).  In theory, the debtor ceases to be liable for those debts (this ultimately happens when the debtor receives a discharge, though some types of debts may not be dischargeable), and the debtor’s debts become claims against the estate.  The estate is the pot from which creditors are to be repaid.  A fraudulent transfer diminishes that pot.  

The Bankruptcy Code’s look-back period for most fraudulent transfer avoidance is two years from the petition date, without time extensions (with emphasis added):

The trustee may avoid any transfer (including any transfer to or for the benefit of an insider under an employment contract) of an interest of the debtor in property, or any obligation (including any obligation to or for the benefit of an insider under an employment contract) incurred by the debtor, that was made or incurred on or within 2 years before the date of the filing of the petition . . .

11 U.S.C. § 548(a)

California’s UFTA look-back period is four years, with additional time under certain circumstances, but never more than seven years (with emphasis added):

A cause of action with respect to a fraudulent transfer or obligation under this chapter is extinguished unless action is brought pursuant to subdivision (a) of Section 3439.07 or levy made as provided in subdivision (b) or (c) of Section 3439.07: (a) Under paragraph (1) of subdivision (a) of Section 3439.04, within four years after the transfer was made or the obligation was incurred or, if later, within one year after the transfer or obligation was or could reasonably have been discovered by the claimant. (b) Under paragraph (2) of subdivision (a) of Section 3439.04 or Section 3439.05, within four years after the transfer was made or the obligation was incurred. (c) Notwithstanding any other provision of law, a cause of action with respect to a fraudulent transfer or obligation is extinguished if no action is brought or levy made within seven years after the transfer was made or the obligation was incurred.

Cal. Civ. Code § 3439.09

The transfer could have been discovered if it was properly recorded with the appropriate government authority (e.g., the County Recorder’s Office), putting the world on constructive notice.  Thus, the trustee has a much longer look-back period when appealing to the UFTA — up to seven years if the transfer wasn’t properly recorded — when avoiding a fraudulent transfer.  However, the only way the trustee can use the UFTA is by appealing to 11 U.S.C. § 544(b) to step into the shoes of an actual creditor who could do the avoidance.  Therefore, if no such creditor exists, the UFTA is unavailable, and the trustee can only use 11 U.S.C. § 548.

Subsection 544(b) focus on an actual creditor is a stronger requirement than that found in 11 U.S.C. § 544(a), where the trustee can initiate an avoidance action by stepping into the shoes of a hypothetical creditor, even if no real creditor exists that could prosecute the action.  Unfortunately for the trustee, § 544(a) does not involve avoiding a fraudulent transfer, and focuses instead on avoiding a judicial lien, a nulla bona return (i.e., the return of an unsuccessful writ of execution), and a lien that can be avoided by a bona fide purchaser of real property.

You may have noticed that I said that the Bankruptcy Code’s look-back period for most fraudulent transfer avoidance actions is two years.  Does that mean that the Code has other look-back periods?  Yes, for the special case of a transfer to a self-settled trust or other similar vehicle (with emphasis added):

(1) In addition to any transfer that the trustee may otherwise avoid, the trustee may avoid any transfer of an interest of the debtor in property that was made on or within 10 years before the date of the filing of the petition, if —

(A) such transfer was made to a self-settled trust or similar device;

(B) such transfer was by the debtor;

(C) the debtor is a beneficiary of such trust or similar device; and

(D) the debtor made such transfer with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made, indebted.

(2) For the purposes of this subsection, a transfer includes a transfer made in anticipation of any money judgment, settlement, civil penalty, equitable order, or criminal fine incurred by, or which the debtor believed would be incurred by —

(A) any violation of the securities laws (as defined in section 3(a)(47) of the Securities Exchange Act of 1934 (15 U.S.C. 78c (a)(47))), any State securities laws, or any regulation or order issued under Federal securities laws or State securities laws; or

(B) fraud, deceit, or manipulation in a fiduciary capacity or in connection with the purchase or sale of any security registered under section 12 or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78l and 78o (d)) or under section 6 of the Securities Act of 1933 (15 U.S.C. 77f).

11 U.S.C. § 548(e)

What then is a self-settled trust?  A self-settled trust is a trust in which the settlor is also the person who is to receive the benefits from the trust.  If the settlor/beneficiary is the debtor, then the trust becomes part of the bankruptcy estate when the debtor files because the trust is an asset of the debtor.  This is quite different from the situation where the debtor is the trustee for someone else’s trust.  Then the corpus of the trust belongs to the beneficiary rather than the debtor.

If the debtor transferred anything into the self-settled trust during the ten years prior to filing, the transfer is fraudulent and therefore avoidable.  See, e.g., In re Cutter, 398 B.R. 6, 21 (B.A.P. 9th Cir. 2008) (quoting Nelson v. California Trust Co., 33 Cal.2d 501, 202 P.2d 1021 (Cal.1949):  “It is against public policy to permit a man to tie up his property in such a way that he can enjoy it but prevent his creditors from reaching it, and where the settlor makes himself a beneficiary of a trust any restraints in the instrument on the involuntary alienation of his interest are invalid and ineffective.”)  Therefore, while the creation of a non-self-settled trust can, under certain circumstances shield assets, depositing assets into a self-settled trust will not.

            2.        The Timing Of The Transfer

In order to determine whether the trustee can avoid a transfer as fraudulent, it is essential that the Court determine when the transfer took place.  If it was before the look-back period, the trustee cannot avoid the transfer.  Subsection 548(d)(1) provides:

For the purposes of this section, a transfer is made when such transfer is so perfected that a bona fide purchaser from the debtor against whom applicable law permits such transfer to be perfected cannot acquire an interest in the property transferred that is superior to the interest in such property of the transferee, but if such transfer is not so perfected before the commencement of the case, such transfer is made immediately before the date of the filing of the petition.

The triggering event then is typically when the transfer was recorded.  This also comports with the way California courts interpret the timing of transfer under the UFTA.  See, e.g., Fujifilm Corp. v. Yang, 223 Cal. App. 4th 326 (Cal. App. 2014) (fraudulent transfer occurred when quitclaim deed was recorded, rather than when the deed was delivered).

In the next post I will discuss the consequences of fraudulent transfers in bankruptcy, and the importance of prebankruptcy planning in cases where the debtor has made fraudulent transfers.

If you are facing overwhelming debt and are think fraudulent transfers might be an issue in your case, contact a highly knowledgeable and skilled bankruptcy attorney to guide you through the process.

 

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