A Bad Idea: Fraudulent Conveyances To Avoid Losses Through Bankruptcy

Sometimes when a debtor is facing bankruptcy, the debtor will make transfers of assets so that the asset cannot end up in the hands of creditors. The debtor will transfer the asset in one of two ways: the debtor will transfer the asset with the full intention of defrauding the creditors (actual fraud), or the debtor will transfer the asset by accepting a markedly reduced value for the asset (constructive fraud). These actions are fraudulent conveyances, and they are a form of fraud.

Trustee Has Power to Recover Assets or Value of Fraudulent Conveyances

When a debtor enters into bankruptcy, a trustee is appointed to administer the debtor’s estate. The trustee is appointed to ensure that the bankruptcy is monitored and handle by an independent party. The trustee is given the power under 11 U.S.C. Section 548 of the Bankruptcy Code to set aside, or void, certain transfers of assets the debtor makes within the two years preceding their bankruptcy filing if the trustee believes that the transfer was a fraudulent conveyance. This means that the trustee can get back the asset, or the value of the asset that was fraudulently conveyed by the debtor. But the trustee’s power to clawback transfers is limited.

• Charitable Exception. Under 11 U.S.C. Section 548(a)(2), the trustee cannot clawback a transfers of assets made by a debtor to charities or religious organizations so long as the transfer is not valued at more than 15% of the debtor’s annual income. The income percentage given by the debtor can be higher if the debtor customarily gives more than 15% his or her income the the charity or religious organization on a routine basis.
• Legitimate Sales of Assets. A trustee cannot void a transfer of an asset from the debtor to a purchaser if the transfer is a sale for the fair market value of the asset transferred. It is only when a debtor makes a sale for less than its fair market value that the transfer appears on its face to be constructive fraud.
• Bona Fide Purchasers. Under 11 U.S.C. Section 548(d)(1), if a person acquires the debtor’s fraudulently conveyed asset as a bona fide purchaser, i.e., as a good faith purchaser with no knowledge of the fraud or the creditor’s outstanding claim to the asset, a trustee may not be able to recover the asset.
• Valuable Improvements Have Been Made. When an asset, such as real estate, has been fraudulently conveyed, but the transferee makes valuable improvements to the property prior to the bankruptcy filing, the trustee might not be able to recover the asset.

Penalties for Fraudulent Transfers

Upon making a fraudulent transfer, which the trustee has to try to get back, the debtor loses the ability to exempt the asset in question from the bankruptcy proceeding. If the trustee believes that your conveyance was actual fraud, the trustee also has the option to file a motion asking the court to dismiss your bankruptcy proceedings. If dismissed, all debts held by the debtor still stand and the debtor may be prosecuted for their fraudulent transactions.

Nothing good can come from making fraudulent transfers. If you have questions about a transfer you would like to make, and you are concerned about the outward appearance of your transfer, contact an experienced bankruptcy lawyer at the Hathaway Law Center to discuss your concerns.