Fraudulent Transfer or Voidable Transaction? A Look at Fraudulent Conveyance Regulations

by Johnston Clem Gifford on Creditors' Rights. Published March 17th, 2021

State laws dealing with asset transfers concerning bankruptcy are getting a closer look because of a new version of the Uniform Fraudulent Transfer Act

Key takeaways:

A fraudulent conveyance or fraudulent transfer is an attempt to prevent creditors from reaching a debtor’s assets by transferring them to a third party.
The US Bankruptcy Code and state law both regulate fraudulent transfers and provide remedies for creditors.
In state law, the common tool for addressing debtors’ transfers is the Uniform Fraudulent Transfer Act (UFTA) or its new version, the Uniform Voidable Transactions Act (UVTA).
The Bankruptcy Code and most state laws recognize two types of fraudulent transfers: actual fraud and constructive fraud.
Fraudulent conveyance laws can provide remedies for creditors, but their details vary by jurisdiction.

“Fraudulent conveyance” is a centuries-old term that has been in the news recently because of its prominence in high-profile bankruptcy cases. A common complication of debtor/creditor relations in bankruptcy, a fraudulent conveyance or fraudulent transfer is an attempt to prevent creditors from reaching a debtor’s assets by transferring them to a third party.

Section 548 of the United States Bankruptcy Code establishes the fundamental law of fraudulent transfers in bankruptcy. Section 550 deals with the transferee’s defenses, with some language that speaks to the limitations of fraudulent transfer actions in bankruptcies. In most states, the primary tools for addressing debtors’ transfers are adopted versions of a “model act” known as the Uniform Fraudulent Transfer Act (UFTA) or its new version, the Uniform Voidable Transactions Act (UVTA). Individual states may adopt a model act with specific changes, thus giving it the force of law.

A brief history

Modern fraudulent transfer laws trace their roots back to Elizabethan England and “the Statute of 13 Elizabeth” passed by the English Parliament in 1571. In the United States, both the federal Bankruptcy Code and state laws address fraudulent transfers.

At the state level, the common law of fraudulent conveyance was first codified by the Uniform Fraudulent Conveyance Act of 1918, which was replaced by the Uniform Fraudulent Transfer Act (UFTA) in 1984. This model act, which had been enacted in 43 states, was revised in 2014 and renamed the Uniform Voidable Transactions Act (UVTA). By 2020, 21 states had enacted versions of the revised act, and two more (New Jersey and Massachusetts) have introduced legislation to do so in 2021.

Types of fraud

The revision and renaming of the UFTA recognized that the act should apply to some transfers that are inconsistent with standard definitions of fraud and pertain to civil (not criminal) remedies. The Bankruptcy Code and most state laws recognize two types of fraudulent transfers: actual fraud and constructive fraud.

Actual fraud occurs when a debtor intentionally donates or gets rid of property as part of an asset-protection scheme. For example, a debtor who gives away property in preparation for a bankruptcy filing commits actual fraud. Other examples include transferring assets to a relative and setting up shell corporations.

In constructive fraud, intent is irrelevant. If a debtor receives “grossly inadequate consideration” for the transfer of an asset, or if the debtor cannot pay debts either when they made the transfer or as a result of the transfer itself, the threshold has been met. An example of constructive fraud is any asset sold for less than fair market value within a certain period before a bankruptcy filing.

Because value is subjective, whether the value received was adequate compensation becomes a question for the courts. States vary significantly in how they define value and consider asset transfers, using language such as “upon consideration deemed valuable in law” and “reasonably equivalent value.”

The federal and state statutes of limitations in fraudulent transfer cases

The federal bankruptcy code provides a two-year “look-back period” and a two-year statute of limitations on fraudulent transfer actions. A transfer is considered fraudulent only if it occurred within two years prior to a bankruptcy filing.

States vary widely on these time limits. Even if they adopt either the UFTA or UVTA model acts, both of which specify a look-back period of four years, states may set the amount of time a creditor has to file a claim of fraudulent transfer against a debtor in court.

Most states’ laws provide a statute of limitations of four to six years on fraudulent transfer claims, allowing a trustee to “clawback” up to six years to avoid transfers. No jurisdictions allow a transfer to be set aside if it occurs after a bankruptcy filing. In cases where the federal government is an unsecured creditor of the debtor (e.g., the debtor owes federal taxes), the statute of limitations is even longer.

The Texas UFTA

Texas’s current law is the Texas Uniform Fraudulent Transfer Act or “TUFTA,” contained in Chapter 24 of the Business and Commerce Code. The Texas legislature has joined many other states in declining to adopt the revised UVTA as of this year.

The TUFTA outlines conditions similar to those in both the US Bankruptcy Code and the UFTA/UVTA. If a fraudulent conveyance in Texas meets particular conditions for dishonest conduct under the TUFTA, generally, the transferred assets will not be protected from collection to satisfy a judgment.

Creditors need to prove intent to prove a debtor has committed fraud. Like other state laws, the Texas statute lists conditions that may indicate intent (also called “badges of fraud”). These include:

The transfer or obligation was concealed or remained in the possession of the debtor
The transfer was of substantially all the debtor’s assets
The debtor absconded
The debtor was insolvent

If courts find a debtor in violation of the TUFTA, creditors may be free to seize the asset in question. In Texas, creditors can void a fraudulent transfer up to four years from the date it was made.

The effect of fraudulent transfers

A ruling of fraud related to a bankruptcy case allows the trustee to recover the property or the property’s value and make it part of the bankruptcy estate, with some exceptions. Because of the negative impact these transfers can have on creditors, those suspecting the fraudulent transfer of property may be able to obtain a temporary restraining order and a preliminary injunction to prevent the transfer before it occurs.

Fraudulent conveyance laws provide some critical protections for creditors. But given their complex nature (and the recent changes to model legislation governing an extremely old concept), it is always wise to seek expert legal counsel when you suspect fraudulent asset transfers.

Johnston Clem Gifford’s Distressed Debt & Bankruptcy lawyers routinely advise commercial and retail banks, credit unions, hedge funds, REITs, consumer finance lenders, insurers, secured and unsecured creditors, creditors’ committees, bankruptcy trustees, and other parties affected by financial insolvency issues. Contact us online or by calling (214) 974-8000.