What Is Fraudulent Conveyance?
Fraudulent conveyance is when a person or business transfers property, money, or other property to avoid creditors or to hide them in litigation or bankruptcy. The activity is illegal under state and federal law, and courts can invalidate the transfer or reverse it in order to treat the creditors fairly. It does not matter if the transfer was to a relative, friend, trust, or even to a corporation. If the transfer was made to delay, harass, or defraud creditors, it is fraudulent.
The Legal Purpose Behind Fraudulent Conveyance Laws
The concept hinges on fairness. The law does not allow for people to dodge responsibilities through the act of hiding what they possess.
It is not illegal to pass on money or dispose of property in general, but it becomes illegal when the main intention is to escape payment to a person you owe.
State and Federal Fraudulent Transfer Laws
All U.S. states have enacted their own versions of these laws, but some employ the older UFTA and others have moved to the newer UVTA. The two are similar in numerous respects.
They characterize a transfer as fraudulent if it was done in fraud of creditors or if it was done without getting fair value in return, especially when the debtor was already insolvent.
Actual vs. Constructive Fraud
There are two general types of fraudulent conveyance: actual fraud and constructive fraud. Actual fraud is the simplest. It is when the person knowingly and willingly transfers a property for the purpose of not giving it to creditors.
Courts typically look for evidence of intent, like trying to keep the transfer secret, being secretive about it, or transferring property soon after the initiation of a lawsuit.
Constructive fraud is different. Constructive fraud does not require evidence of ill intent. Instead, it will rely on the circumstances of the transfer.
If an individual transfers a valuable property without getting something of equal value in exchange when he's penniless or nearly penniless, the law will nonetheless still treat it as fraudulent even if there was no intent to mislead.
That is, if the deal is tainted and makes the person insolvent so much that he won't be able to pay his debts, it can be constructive fraud.
The Consequences of Being Caught
Being caught would be serious. If a court finds someone formed a fraudulent conveyance, it has the ability to reverse the deal. What that does is the person that the property ended up with, whether it was a spouse, child, friend, or business partner, must give it back or make it up in value.
In bankruptcy, that can decide whether someone's financial obligations are wiped out. In the most extreme cases, fraudulent transfers could lead to criminal prosecution, such as bankruptcy fraud, if the person swore on oath or destroyed documents to hide it.
Businesses and Fraudulent Conveyance
Fraudulent conveyance statutes affect not only people. Corporations and companies are also covered. During large mergers or when a company goes bankrupt, deals are closely scrutinized to see if assets were unfairly conveyed.
If a business sells property to another firm it owns or gives a payoff to one favored creditor while sending others packing, the court will turn those acts around.
Offshore Accounts and Concealed Assets
Others also try to hide assets in offshore accounts or place ownership in foreign corporations. While it becomes harder for the fraud to be detected, it does not make it legal.
Courts in the United States can still pursue fraudsters, and most countries aid in fraud investigations. In some cases, law enforcement agents can trace wire transfers overseas and freeze foreign accounts.
Trusts and Fraudulent Transfers
In the case of trusts, many people believe that they provide complete protection against creditors. That's only partially accurate.
A well-written and funded irrevocable trust established when no financial distress is yet on the horizon can shield assets.
But if a trust is established after someone realizes they have debt, litigation, or bankruptcy looming on the horizon, it can be pierced under fraud transfer law.
Even where the trust is in an offshore location, courts are able to enforce action by using contempt powers or going after other assets.
Honest Mistakes Can Be Fraudulent
Perhaps the most essential thing to understand about fraudulent conveyance is that it's not necessarily about nasty people doing clearly unethical things.
Plenty of good people find themselves in a bind simply because they did not know the law. They may convey property to protect it "just in case" or give it away believing they are helping the family.
But if a creditor is excluded from access to those assets, and the law finds the transfer was unfair, it can be undone in spite of all.
How to Avoid Violating Fraudulent Conveyance Law
As a general rule, never gamble in conveying property, especially if you owe debt, have lawsuits pending against you, or are contemplating bankruptcy.
First, always consult with an attorney. Be certain the gift or sale is for a legitimate purpose and for fair value. Don't procrastinate. Timing will be the deciding factor as to whether or not the law will judge your conduct honest or fraudulent.
How Creditors Recover Fraudulent Transfers
If the creditor feels a fraudulent conveyance took place, it can get the intervention of the court and bring a lawsuit. The lawsuit is for the cancellation or annulment of the transfer.
The law calls this a "voidable transaction." The creditor will typically have to demonstrate the party transferring the property did so with the intent to avoid debts.
If the court agrees, it is able to require the return of the asset or force the party that received it to pay for its value.
In bankruptcy, the trustee is also able to step into the shoes of the creditors and pursue fraudulent transfers. The trustee is able to initiate what is known as an "adversary proceeding" in front of the bankruptcy court.
This is actually a request in the bankruptcy case for the court to undo the transfer. If the request is approved, the asset returns to the bankruptcy estate and can be used in paying creditors.
Trustees hold a lot of power and often get to review financial records, so it is difficult to hide improper transfers in bankruptcy.Independent of bankruptcy, the creditors must act independently. They can sue in civil court under state codes such as the Uniform Voidable Transactions Act or the earlier editions such as the Uniform Fraudulent Transfer Act.
The result will be based on the facts of the case, but if the court determines there is a pattern of wrongdoing, such as transferring all of one's assets, concealing ownership, or using family members as a facade, it will more than likely decide in favor of the creditor.
Sometimes, the courts will issue temporary orders freezing assets until a case is decided. This is called a preliminary injunction.
It prevents the person from selling, concealing, or transferring the asset further. In extreme cases, the court may call for a receiver to obtain control of the property until the suit continues. This is especially common where large amounts of money or property are involved.
How Long Do Creditors Have to Act?
Laws of fraudulent transfers impose a time limit in the form of a statute of limitations. This stipulates the period within which a creditor may sue after the transfer has occurred.
Under the Uniform Voidable Transactions Act and the majority of states, creditors have approximately four years from the date of the transfer in which to file an action.
But if the creditor can prove that fraud was hidden or not right away known, they may get more time. Most states allow at least one year from the date when fraud was discovered to bring a claim, even if the original transfer took place more than four years ago.
In bankruptcy, it's usually two years prior to the filing of the bankruptcy, but that isn't to say that transfers more than two years old are always secure.
If a state's code provides for more time, the trustee can try to utilize that state code to go beyond the two years. In extreme instances, courts have reached as far as ten years, particularly if fraud was involved or there was offshore activity.
It's also important to mention that the clock starts running from when the transfer was made, not when the creditor finds out.
That's why financially troubled individuals must be extremely cautious. Even if they think they're being legal, the transfer could end up being their downfall years later if it seems to be fraudulent or hurtful to creditors.
Defenses Against Fraudulent Conveyance Claims
If you're charged with receiving a fraudulent transfer, you have a few defenses to make. The most common is likely "good faith" and "reasonably equivalent value."
This defense assumes that you had no notion anything was wrong and that you gave something of value in return. For example, if you bought a car from an individual who then was sued by creditors and you paid a fair market value, you might not have to yield it, even if it was part of a large scam.
The other defense is an expired statute of limitations. When the creditor takes too long, it can get the claim dismissed. Courts will also consider whether the transfer was made in the ordinary course of business or not.
When the transaction was an ordinary, honest business practice and was not conducted to evade debts, it could be exempted.
When the case is heard and the property is already exhausted or sold, courts might demand the recipient to pay for the worth of the property and not its return.
Yet, if the person no longer has money or cannot afford, the court might issue a judgment, which can cause wage garnishment or seizure of other properties.
It can also be said that the transfer was made before any debt. If property was transferred or given away years before the person ever owed money or had a lawsuit against them, the court would hold it to be a valid gift or sale.
The nearer to money problems the transfer is, however, the harder it becomes to prove it was innocent.
International Transfers and Offshore Hiding
Others think that they can beat fraudulent transfer law by removing assets overseas. They might wire funds to an offshore bank, put property into an offshore trust, or establish an offshore corporation in a country with strict privacy laws.
Although it makes it difficult for creditors to find and recover assets, it is not always effective.
U.S. courts can issue contempt orders and mandate compliance. If the person does not comply, they may be punished in the way of fines or even imprisonment. The court may also go after assets which still remain in America.
For example, if a person hides money in the Cayman Islands but still owns a house in Florida, the court can confiscate the house.
Foreign courts can be aided by creditors to enforce judgments pursuant to international agreements or treaties.
In some high-profile cases, judges have required individuals to return offshore money or forfeit their right to pay debts in bankruptcy.
Judges are quite strict when someone obviously attempts to evade the law with foreign accounts. Even when dealing with complicated schemes, courts can trace the money and untangle the scheme.
Final Thoughts
Fraudulent conveyance, or fraudulent transfer, is when someone tries to transfer money or property with the intent of preventing their creditors from obtaining it. These tricks may seem sneaky in the short term but typically carry harsh legal consequences.
Whether you're swimming in debt, are being sued, or are creating your estate plan, knowing what the law considers honest behavior and what is a fraud will help.
In its simplest form, fraudulent transfer law promotes equity. It prevents people from shirking their duties by hiding assets or transferring them into dubious situations.
The statutes apply to all entrepreneurs, individuals, and even large corporations. And if you're receiving a piece of property, don't assume you're home free. If you knew or should have known that something wasn't legitimate, the law may hold you liable for the fraud.
Averting fraudulent conveyance starts with honest, properly documented financial stewardship. Don't wait until a lawsuit or financial emergency comes knocking to straighten up.
If you want to protect your assets, do it promptly, legally, and under the guidance of professionals. Any attempt to cover your trails once problems emerge will almost always haunt you back.
For those already being sued, get your legal advice at once. There must still be some means of clearing the issue without losing a lot if you have been acting bona fide. But if you wait and try to cover up, the courts will not be sympathetic.
Fraudulent conveyance is more than a mere technical legal term. It's a serious issue for real people and their own well-being in the future.
Whatever your motive for wishing to provide for your family, run a business, or get paid what is due to you, an awareness of this law may be the game-changer. Be smart, be fair, and above all, don't play around with your cash when others are watching.
