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.