FRAUDULENT TRANSFERS §§544(b) & 548

1. FRAUDULENT TRANSFERS §§544(b) & 548 Two sources of similar, but not identical, fraudulent transfer law: 11 U.S.C. §548: Allows a trustee or debtor in possession to avoid fraudulent transfers made within two years of the petition date. The two year limitation first goes into effect for bankruptcy cases filed after April 20, 2006. Prior to that time the statute is one year 11 U.S.C. §544(b) and applicable state law version of the Uniform Fraudulent Transfer Act (“UFTA”), which in California is Cal. Civ. Code §§3439 et. seq. Under California Law the statute of limitations is 4 years. Cal. Civ. Code §3439.09. Use of 544(b) requires that there be a creditor holding a claim allowable in bankruptcy who could assert the state UFTA claim.

2. POLICY • To protect creditors from a diminution of assets otherwise available to pay creditor claims • To discourage the dishonest debtor • Morre v. Bay, 284 U.S. 4 (1931) the avoiding power right, upon which §544(b) is based, is • (i) taken from the pre-petition creditor and given to the estate; and • (ii) is not limited to the damages suffered by the creditor who held the avoiding power pre-bankruptcy • Example: Assume debtor made a fraudulent transfer of property worth $1,000,000. Under state law one creditor with a claim for say $100 can avoid the transfer. Assume that no other creditor has a right under applicable state law to avoid the transfer and that the creditor with the $100 claim is entitled to have that claim paid from the property transferred. What is the effect of bankruptcy if the $100 claim exists as of bankruptcy?

3. ACTUAL FRAUDULENT TRANSFERS • 11 U.S.C. §548(a)(1)(A) the trustee may avoid a transfer made within 2 years if the debtor voluntarily or involuntarily “made such transfer or incurred such obligation 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 or such obligation was incurred, indebted. • Cal. Civ. Code §3439.04 “A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation as follows: • (a) With actual intent to hider, delay or defraud any creditor of the debtor. . .”

4. EXAMPLE • Debtor owned a residence worth $100K. While driving Debtor gets into an accident and had no insurance. Fearing that he would be lose his home if sued for the accident, on March 1, the day of the collision, without consulting with an attorney, Debtor deeded the house to his mother for no consideration and the mother recorded the deed the following day. Debtor continued to live in the residence. When the plaintiff in the auto accident sued the Debtor for $1,000,000 Debtor filed chapter 7 to discharge the personal liability. Debtor did not schedule the home. • What happens if bankruptcy is filed within one year from the date of the transfer of the home? • What happens if it is filed more than 2 years from the date of transfer? • If the SOFA was filed truthfully and debtor was willing to lose the home in exchange for a discharge and Plaintiff objected to discharge under Section 727(a)(2) should the objection be sustained?

5. Constructive Fraudulent Transfers Policy: To protect the estate from depletion. Over the years fraudulent intent was inferred by the courts from certain “badges of fraud.” Under the UFTA and §548 certain specified facts conclusively establish that the transfer at issue is fraudulent, irrespective of the debtor’s actual subjective intent. These types of transfers have become known as “constructive fraud.” • §548(a)(1)(B) trustee may avoid a transfer made within 2 years if the debtor voluntarily or involuntarily • (i) received less than a reasonably equivalent value in exchange for such transfer or obligation and • (ii)(I) was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation; • (ii)(II) was engaged in business or a transaction, or was about to engage in a business or a transaction, for which any property remaining with the debtor was an unreasonably small capital; • (ii)(III) intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor’s ability to pa as such debts matured; or • [NEW] (ii) (IV) made such transfer to or for the benefit of an insider, or incurred such obligation to or for the benefit of an inside, under an employment contract and not in the ordinary course of business.

6. State Constructive Fraudulent Transfers • Cal. Civ. Code §3439.04 [Acts Constituting Fraudulent Transfers – Intentional Acts] provides that a “transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation as follows: • …(b) Without receiving a reasonably equivalent value in exchange for the transfer or the obligation, and the debtor • (1) Was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or • (2) Intended to incur, or believed or reasonably should have believed that he or she would incur, debts beyond his or her ability to pay as they came due. • Cal. Civ. Code §3439.05 [Acts Constituting Fraudulent Transfers – Transfers During or Resulting In Insolvency] provides that a “transfer made or obligation incurred by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made or the obligation was incurred if the debtor made the transfer or incurred the obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent at the time or the debtor became insolvent as a result of the transfer or obligation.”

7. EXAMPLE • [Page 404]Debtor owned Blackacre, an unencumbered parcel of real property purchased a few years earlier for $100,000. The market value of Blackacre was recently appraised at $120,000 to $140,000. Debtor needing cash to pay creditors, advertised the sale of Blackacre at a price of $110,000 payable with in 10 days. Buyer offered to pay $80,000 payable immediately. Debtor protested that the amount was far below market value. Several other people expressed interest in buying for $110,000 but none was able to raise the cash within 10 days. Debtor reluctantly sold to buyer for $80,000 and used the proceeds to pay creditors. At the time of sale, Buyer knew that the Debtor was being hounded by creditors but did not have actual knowledge that the debtor was insolvent. Two months later buyer sold Blackacre to a good faith purchaser for $120,000. Good faith purchaser had no knowledge of the transaction between Debtor and Buyer. Shortly after the sale to Good Faith Purchaser, Debtor filed a petition in Chapter 7 bankruptcy. • Can the trustee avoid the sale of Blackacre under Section 548?

8. Charitable Donations - §548(a)(2) • Added to the law in 1994, Section 548(a)(2) was designed to protect charitable donations from avoidance as fraudulent conveyances • Section 548(a)(2) provides that a “transfer of a charitable contribution [def. §548(d)(3)] to a qualified religious or charitable entity or organization [def. §548(d)(4)] shall not be considered to be a transfer covered under paragraph (1)(B) in any case in which – • (A) the amount of that contribution does not exceed 15 percent of gross annual income of the debtor for the year in which the transfer of the contribution is made; or • (B) the contribution made by the debtor exceeded the percentage amount of gross annual income specified in subparagraph (A), if the transfer was consistent with the practices of the debtor in making charitable contributions.

9. ASSET PROTECTION TRUSTS • 11 U.S.C. §548(e) was enacted to deal with self settled asset protection trusts. • Provides a 10 year reach back for transfers made to a self settled trust in which the debtor was a beneficiary which was made 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. • Special inclusion of transfers made in anticipation of any money judgment, etc. in connection with any violation of securities laws, or fraud or deceit or manipulation in a fiduciary capacity or in connection with the purchase or sale of any security registered under the Securities and Exchange Act of 1934.