29: Fraudulent transfers –
overview, actual fraud
© Charles Tabb 2010
Purpose of fraudulent transfer law
 Protect body of CREDITORS from unfair actions by
the Dr that harm the Cr groups’ financial interests
Hide
assets
Creditors
Driving norms
 1st – NAUGHTY debtor – misbehavior by Dr –
actual, subjective fraudulent intent, to hinder,
delay, or defraud her creditors
 2nd – INHERENT harm to Crs – irrespective of Dr’s
state of mind – action taken necessarily hurts the Cr
group – constructive fraud

Ex., Dr is insolvent, makes a gift – now has fewer assets to pay
Crs, and already did not have enough
Not limited to bankruptcy
 Fraudulent transfer law is not conceptually limited to
a collective proceeding (such as bankruptcy)

Justification for collective action focuses more on inter-cr
 Applies whenever a Dr takes actions that could harm
Cr group (indeed, even if just ONE Cr!)
 So, every State has its own fraudulent transfer law,
and Crs have power outside of Bk to set aside FT
State law models
 (1) UFTA
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(Uniform Fraudulent Transfer Act – pp 490-96)
The current recommended uniform law (since 1984)
In force in 43 states and D.C.
 (2) UFCA
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(Uniform Fraudulent Conveyance Act)
The predecessor uniform law, circa 1918
Only 2 states and Virgin Is. – BUT the law in New York!
 (3) Statute of Elizabeth
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Original English version, 1571!
5 states
history
 Origins: 1571 – Statute of Elizabeth in England
 Had to prove Dr’s actual fraudulent intent
 Protect a transferee for value who lacked notice of fraud
 “Objectification” & uniformity – UFCA 1918
 Formally introduced “constructive” fraud
 Uniform law, adopted in almost every state
 1978 Bankruptcy Code 548
 Modified FT law in several respects, now some differences UFCA
 Modernize, Uniform harmonization, UFTA 1984
 Replaced old UFCA to reflect modern financial issues
 Closer harmonization to 1978 Bk Code
Actual vs constructive fraud
 “Actual” fraud: set aside if prove that Dr made a
transfer with an actual, subjective intention to
hinder, delay, or defraud her Crs
 “Constructive” fraud: strict liability – no mens rea of
Dr required; instead, certain factors in combination
conclusively establish the fraud

Ex. gift transfer by an insolvent Dr
Primary issues
 1st – set aside the transfer? I.e., voidable?
 i.e., was the transfer either actually or constructively
fraudulent?
 2nd -- if set aside – what remedy?
 From whom (if anyone) can Cr or Trustee recover, and
 What (how much) can they recover?
standing
 WHO may sue to set aside a fraudulent transfer?
 In Bankruptcy – the trustee (or DIP)
 Under State law – Creditors

1. “Present”
had a claim at time of transfer
 universal standing


2. “Future”
Claim arose AFTER the challenged transfer
 Lack standing to challenge some types of constructive fraud

Statutes of limitation
 Bankruptcy (548)
 Norm = 2 years


Increased from 1 year in 2005
Asset protection trusts (548(e) = 10 years
 State law
 Norm = 4 years (see UFTA 9)
 Might incorporate in bk case via 544(b) “successor” rule
Remedy?
 Norm – set aside, thus recapture either (i) the
property itself or (ii) its value
 Possible safe harbor for transferee
 If transferee is gave reasonably equivalent value, and was in
good faith (i.e., not know of the fraud), is protected from
recovery
 Means is possible to have a “right without a remedy”
Costas
 Facts:
 Dittlof created revocable trust under Arizona law
 Rachelle Costas (daughter) a beneficiary, remainder interest
 Dittlof died Feb 25, 2002  Costas’ trust share = $34K
 Nov. 7 - Costas executed valid disclaimer under Arizona law
 Dec. 3 – Costas filed chapter 7
 Gaughan (trustee) sued to avoid Costas’ disclaimer as a FT
under 548
Issue?
 Issue in Costas:
 did Dr make a transfer of an interest in property
when she disclaimed the trust interest?
Nature of the state law
 Under Arizona law, a properly executed trust
disclaimer is valid and enforceable, and relates back
for all purposes to settlor’s death
 i.e., by legal fiction it is treated as if beneficiary never
had an interest in the trust property – up in smoke!
Defer to state law?
 Why did the court defer to state law?
 Applied general principle of Butner -- property interests for
federal bankruptcy purposes - created and defined by state law

Policies – avoid forum shopping, no windfalls to Crs (treat
same in or out of bk)

And under state law is as if disclaimant never had the property
Drye?
 Supreme Court in Drye faced issue of whether an
IRS tax lien attached to an inheritance,
notwithstanding fact that the taxpayer/beneficiary
disclaimed, & state law had relation-back rule
 Held: tax lien DID attach to “property” inherited
 Reality of disclaiming was that taxpayer channeled property to
someone else
Analogy to Butner/CBOT?
 S Ct in Drye announced a mode of analysis eerily
reminiscent of the bankruptcy property two-step
with Butner & CBOT:
Look to state law to determine what rights
taxpayer has in the property (like Butner)


Then to federal law to see if the state-delineated rights qualify
as “property” for purposes of federal tax lien law (like CBOT)
Trustee argument
 What was the trustee’s argument in Costas, relying
on Drye?
That the debtor’s power to channel
who got the inherited property
(by disclaiming) = “property” for
federal bankruptcy purposes
Debtor’s disclaiming “transfer"
disclaims
 Debtor
Siblings
 Dad dies, Trust Property
What is the right question to ask in bankruptcy?
 Applying Butner & CBOT, what is precise analytical
question you need to ask in a disclaimer case?
 NOT that if disclaimed, ≠ “property” under state law

b/c labeling Q -- “is it ‘property’” = federal Q (CBOT)
 Right question: look at relevant attributes under state
law
 namely, if Dr disclaimed under state law, would
disclaimer be effective against creditors outside of
bankruptcy, even if circumstances suggest fraud
policy
 If a state law disclaimer outside of bankruptcy would
defeat the rights of creditors, even in circumstances
suggesting fraud (e.g., Dr insolvent, relinquished
valuable inheritance & got nothing in return), then
the Butner anti-forum shopping & anti-windfall
policies are implicated
Distinguished Drye
 Court distinguished Drye:
1) timing – in Drye, tax lien already in place before
disclaimer, so is like disclaimer divested the existing
federal property right, whereas in Costas the
disclaimer occurred prior to bankruptcy, so no
federal bankruptcy property interest being divested
– instead never had it in the 1st place
Any arguments - logic is fallacious??
 Is “property” in pre-bk period (for purposes FT law)
any different than “property of estate”
Drye distinction # 2
 Tax liens are just different
 Policy of federal tax law is to grab EVERYTHING
 Even if Crs normally could not reach
 Whereas bankruptcy law norm is
to respect & honor property under
non-bankruptcy law
-> the Butner norm against “windfall by reason of
happenstance of bankruptcy”
Died after bankruptcy?
 Court says would be a different result if Dittlof had
died AFTER Costas had filed bankruptcy, instead of
before
 Why?
 What about 541(a)(5)(A)? (estate includes any
interest Dr acquires “or becomes entitled to acquire”
w/in 180 days after filing, by inheritance)
Special power?
 Relevance to case (or post-bk death hypo) of
inferences to be drawn from 541(b)(1)?
 b) Property of the estate does not include-(1) any power that the debtor may exercise solely for
the benefit of an entity other than the debtor; …
 Suggests that property of estate DOES include any
“power” that the Dr COULD exercise for her own
benefit (such as a general power appointment – or
an election whether to disclaim an inheritance??)
Practical effect?
 Reality of Costas is that Dr can choose for her family
members to get property rather than her creditors,
even if she is insolvent at the time she takes the act
that redirects that property to her family
Actual fraud
 Set aside transfer if DEBTOR had an actual intent
to “hinder, delay or defraud” her Crs
DEBTOR
 the “evil mind” ground
 Focus on the subjective
state of mind of DR
when she made the
challenged transfer
Badges of fraud
 How prove Dr’s subjective state of mind?
 Assuming no Perry Mason-like confessions
 Circumstantial evidence
 Goes by fancy name of “badges of fraud”
Twyne’s Case
 Facts:
 Pierce (Dr) owed ₤400 to Twyne and ₤200 to “C”
 C sued Pierce
 While action pending, Pierce transferred all his property
(worth ₤300) to Twyne by deed of gift
 But, Pierce retained possession of some property (sheep)
 C got judgment vs Pierce
 Sheriff went to levy on sheep,
was blocked – said not Pierce’s
sheep, but Twyne’s
 C sued Twyne to set aside the transfer
Twyne
 Pierce
₤400
₤300
“C”
Twyne
Badges in Twyne
 Held for C – allow to set aside transfer from Pierce to
Twyne and levy on sheep
 Why? Said Pierce had “actual intent” to defraud
 Proof? “badges of fraud”:
1.
2.
3.
4.
5.
6.
The gift was general, of all of Pierce's property, without
excepting even his apparel or anything of necessity.
Pierce retained possession of the property supposedly
transferred, and treated it as his own.
The transfer was made in secret.
The transfer was made while C's suit was pending against Pierce.
Twyne held the property in trust for Pierce.
The deed contained a recital that the gift was bona fide.
Common “badges”
 some of the badges in Twyne are common, especially
 Made in secret
 While C’s suit was pending
 Other badges commonly used over the centuries:
 transfer to a family member or another "insider"
 gift transfer (i.e., for no consideration)
 transfer for less than full consideration
 insolvency of the debtor at the time the transfer was made
 See UFTA 4(b), p. 467
Asset protection trusts
 in an asset protection trust, a Dr both (i) sets up the
trust with her own property (i.e., is settlor) AND
(ii) is the beneficiary of that trust; furthermore,
common for trust to block the power of Crs to collect
from beneficiary’s interest
 DR
Trust
Dr as Beneficiary

Creditors
548(e) avoidance
 The elements of that avoiding power are:

Transfer of an interest of the debtor in property
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Made on or within 10 years before the bankruptcy filing
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To a self-settled trust or similar device

By the debtor

Debtor a beneficiary of the trust

Actual fraudulent intent
9.4(a)
 Facts:
 Debtor owes 10 creditors $50K; in default on 7 of the debts
 Five creditors bring lawsuits against the Debtor.
 Debtor’s only nonexempt asset is a valuable painting she
inherited from her father, worth $40K
 Debtor sells the painting to Art Mann,
a wealthy collector, for $38K
 Art Mann knows nothing of Debtor’s financial situation
 Debtor deposits the cash in her bank, wire transfers the money
to a Swiss bank,
and disappears
 Two months later,
an involuntary chapter 7 order for
relief is entered against Debtor
Analysis 9.4(a)
 Fraud?

What “badges”?
 Widespread defaults
 Pending lawsuits
 Insolvent (assets = 40, debts = 50)
 Convert only leviable asset into cash & make
unavailable to Crs (Swiss bank)
 Absconds
-> what about fact got fair value for painting?
Analysis 9.4(a)
 Protected?

i.e., is Art Mann within safe harbor, or is he vulnerable?

11 USC 548(c): … a transferee or obligee of such a transfer or
obligation that takes for value and in good faith has a lien on or
may retain any interest transferred or may enforce any obligation
incurred, as the case may be, to the extent that such transferee or
obligee gave value to the debtor in exchange for such transfer or
obligation.

UFTA: SECTION 8. DEFENSES, LIABILITY, AND PROTECTION
OF TRANSFEREE.
(a) A transfer or obligation is not voidable under Section 4(a)(1)
against a person who took in good faith and for a reasonably
equivalent value or against any subsequent transferee or obligee.
protection
 In what important way are the safe harbors for
innocent transferees who gave value different under
the Bankruptcy Code and the UFTA?
 Would it matter, for example, if the painting that Art
bought for $38K was now worth $150K?
Is Art protected?
 Under 9.4(a), did Art:
 1. Give “value” (548(c)) or “reasonably equivalent
value” (UFTA 8a) ?
 2. was Art “in good faith” ? (same in both)
 If “YES” to both – what are the consequences?
9.4(b)
 Facts:
 Same as a., except:
 Dr sells to Art for $20K, not $38K
 Art then gives painting to his daughter
DR
Art
$20K
Daughter
Gift
Analysis 9.4(b)
 Fraud?
 All the same “badges” as in a, PLUS have the sale of the Dr’s
one nonexempt asset for less than reasonably equivalent value
Analysis 9.4(b)
 Is Art protected (under 548(c) or 8(a))?
 1st, was he “in good faith”?
 Purchase for 50% discount raises serious doubts
 If not = good faith, no protection at all
 Liable under 550(a)(1) as initial transferee

Not have painting, so trustee gets judgment for value of painting,
i.e., for $40K
9.4(b) protection, cont.
 2nd, even if somehow Art is in good faith, even
though got a 50% discount, what about “value”?
 In bankruptcy 548(c) – should be no difference in
analysis, b/c, if in good faith, just protect to same
extent, viz., to extent gave value, here, $20K


Note problem, though – lien on what?
UFTA provides (in 8(d)(3)) for this case simply by reducing the
amount of the judgment
Art v Dr, estate
 Assuming that trustee can recover from Art, what are
Art’s rights?
 Art has claim against the DR for the $20K he paid for the
painting

Allowed in bankruptcy case, under 502(h) once pays back trustee
 And the debt might well be nondischargeable for fraud
under 523(a)(2)

Which means Art can go after Dr after bankruptcy, if he can find
him!
Daughter’s protection?
 Remember that Art gave the painting to his daughter
 1) daughter no defense under 548(c) – only works for
transferee from the DR – and she gave no value
anyway
 2) daughter liable under 550(a)(2) as a secondary
transferee – either give back painting, or its value

No defense 550(b), b/c did not give value, and Art not
protected
Single satisfaction
 Note, though, that trustee is entitled only to a single
satisfaction, under 550(d)
9.4(c)
 Facts:
 Same as a., except Dr sells to her mother, not Art
DR
MOM
$38K
Analysis 9.4(c)
 Fraud?
 Badges?
All the same as before, PLUS a transfer to a family member –
historically one of the most significant badges
 In some states, transfers to family members raise a presumption of
fraud, and shift the burden of going forward to defend the
legitimacy of the transfer

Analysis 9.4(c)
 Is Mom protected?
 Gave “value”
 But her “good faith” will be scrutinized very closely –
looks like she may have cooperated with her
daughter in a fraudulent scheme designed to (i) put
the painting itself out of reach of Dr’s crs and (ii) give
Dr the cash
9.4(d)
 Facts:
 Same as a., except Dr gives painting to her mother
DR
MOM
Gift
Analysis 9.4(d)
 Fraud?
 All the same badges as before
 Plus transfer to relative
 Plus gift transfer – nothing in exchange
 This is the classic fraudulent transfer – just give your property
to a relative so your Crs can’t get it
Analysis 9.4(d)
 Mom protected?
 No – gave no value so no protection 548(c) (and
good faith dubious anyway)
 And as initial transferee is strictly liable 550(a)(1) –
must give back painting to trustee, or its value
9.4(e)
 Facts:
 Same as a, except Dr donates painting to Art Institute
DR
Art Institute
Gift
Analysis 9.4(e)
 Fraud?
 Same badges as before, plus outright gift
Analysis 9.4(e)
 Is Art Institute protected?
 NO – not under 548(c), b/c gave no value
 Not under “charitable contribution” safe harbor of
548(a)(2), b/c that is limited to


Constructive fraud cases, not actual fraud
And anyway only if is a cash donation, or financial instrument,
548(d)(3)
 Strictly liable as initial transferee, 550(a)(1)
9.5(a)
 Facts:
 1996: Debtor planning on starting new business as a sole proprietorship
 At time, had debts of $50K and assets of $100K; no lawsuits pending
 Projected income statements showed a net positive monthly cash flow of $9K
(expenses of $15K, income of $24K)







However, the income projection depended on Debtor accurately
predicting the direction of worldwide gasoline prices
Debtor had spent the last 20 years working in the energy field
Recognizing the inherent riskiness of his business plan, Debtor in 1996
transferred $50K to an asset protection trust in the Cook Islands  Debtor was
the sole beneficiary of this trust
For several years, business worked well. However, after U.S. invasion of Iraq,
gasoline prices initially fell, but then rose dramatically; by July of 2005, gasoline
was selling for double what it had been two years earlier. Debtor, unfortunately,
had made a big investment predicting a decline in gasoline prices.
Debtor filed chapter 7 bankruptcy in August 2005
At the time of filing, Debtor had assets of $250K and debts of $900K
Trustee brought suit to avoid the 1996 transfer to the Cook Islands trust.
Analysis 9.5(a)
 What section would trustee sue under?
 548(e):
 within 10 years before the bankruptcy;
 to a self-settled trust;
 transfer was by the debtor;
 debtor is a beneficiary of trust; and
 the debtor made such transfer with actual intent to defraud
present or future crs
Only part at issue is debtor’s actual fraudulent intent
9.5(a)
 What arguments would you make that Dr DID have
actual fraudulent intent?
 What arguments did NOT have such intent?
9.5(b)
 Same facts as a., except Dr made transfer to Cook
Islands trust in June 2005, just 2 months before filed
bankruptcy
 How does this change the analysis of the debtor’s
actual fraudulent intent?
Alan Drey
 Facts:
 Generation, business magazine publisher,
bought subscription lists from Alan Drey, a list broker, and
executed promissory note
 Defaulted on note, in March, Drey got default judgment $98K,
notified Generation
 Generation insolvent at the time & thereafter
 Customer lists only substantial asset
 Generation undertook to sell those lists
 Eventually negotiated with McGraw Hill

Continued next slide
Facts, cont.
 Generation, through Pres. (Handler) offered to M-H for









$500K
M-H knew of judgment for Drey
M-H called Drey, confirmed judgment in effect
Drey called G, asked “what’s up,” & G lied – said not going out
of business or selling
G agree to sell lists to M-H for $150K
Sale put G out of business
M-H requested indemnity; knew G in financial straits
G asked M-H to keep sale confidential
No notice given to Drey of sale
$150K put in secret trust account, used to buy G insiders shares
in new business, pay some other Crs– but zero paid to Drey
issues
 Issues in Alan Drey?
 1st – was it an actually fraudulent transfer?
 i.e., did Generation have an actual intent to hinder, delay or
defraud Drey?
 2nd, if so, is McGraw-Hill a protected innocent
purchaser for valuable consideration, w/o knowledge
of the fraud?
Fraud?
 Why did court find actual fraudulent intent? i.e.,
what are all the badges of fraud here?
Protected?
 Why did court find that McGraw-Hill was NOT a
protected transferee?
What remedy?
 When a creditor sets aside a fraudulent transfer, they
may either (i) recover the asset or (ii) get a judgment
form the transferee for the value of the asset
 Here, Drey did not recover the asset, but instead got
a money judgment agst M-H for the value of the
asset (up to amount of Drey’s $98K judgment)
 Why?
Dean v Davis
 Facts:








Farmer Jones
owed Bank $1600 on forged notes
Bank threatened criminal prosecution unless Jones made good
Jones begged his father for help, and father got Jones’ brother-inlaw (Dean) to take over the Bank debt, with Jones then to be liable to
Dean on 4 promissory notes for the $1600
In exchange, Jones gave Dean collateral – mortgaged
everything to Dean – store stuff, farm, etc.
The notes came due within week (before mortgage even executed) ,
Jones defaulted, Dean took possession of all collateral
Jones insolvent at time, had many Crs
Involuntary bk filed against Jones
Mortgaged property sold, yielded ~ $1600 – so unless mortgage set
aside, Dean gets everything & other Crs nothing
Dean v Davis
 Jones
$1600, notes
Dean
Bank
Other
creditors
Why not a preference?
 Trustee (Davis) of Jones’ bankruptcy sued Dean to
set aside the mortgage on 2 theories: (1) preference
and (2) fraudulent conveyance
 Supreme Court held: Not a preference
 Mortgage from Jones to Dean and Dean’s claim against Jones
were substantially contemporaneous, i.e., no antecedent debt
Fraud?
 Supreme Court held that Jones acted with an actual
fraudulent intent against his general creditors when
he transferred the mortgage to Dean
 Why?
{Jones}
 Why wasn’t it a good defense that Jones received
equivalent value in return for the loan by Dean (viz.,
the assumption of the bank debt)?
Protected?
 Supreme Court also held that Dean was not a
protected transferee (need “good faith and a present
fair consideration” [predecessor to 548(c)])
 But didn’t Dean give fair value? In effect, loaned
Jones $1600, got a mortgage in exchange