Elements of Fraudulent Transfers (Constructive Fraud): Part 2

From a post I originally wrote on March 19, 2012:

On Friday, I wrote about the elements of an actual fraud claim under state law. Today I discuss the type of fraud that courts have referred to constructive fraud, and what the difference is.

Actual fraud generally involves an improper intent on the part of the transferor, which must be proven by clear evidence. [FN1] Such intent is the key element in establishing actual fraud.

The analysis with constructive fraud, on the other hand, does not require any showing of fraudulent intent. Rather, it focuses on the consideration given for a transaction and the financial condition of the party making the transfer.

While there are variations in the versions of the UFTA adopted by state law, in general, the following elements are needed to establish that a transfer was constructively fraudulent [FN2]:

  1. that the debtor transferred property voluntarily;
  2. that the debtor did not receive fair consideration (or “reasonably equivalent value”) at the time of the transfer; and
  3. that the debtor was insolvent or became insolvent as a result of the transfer.

The court will presume that a transfer is constructively fraudulent if the party challenging the transfer can demonstrate that these elements are met. The party defending against the constructive fraud charge typically then will be given an opportunity to rebut the presumption.

In the Premier Data Solutions case, a bankruptcy trustee challenged payments from a corporate debtor’s checking account in the amount of $39,602.03 to the ex-spouse of the corporation’s president. [FN3] The court found that the corporation did not owe the ex-spouse any money and all of the payments made were personal obligations of the corporation’s president on account of orders and agreements in state court divorce proceedings. The court also found that the facts presented at trial clearly established that the corporation was insolvent during the period of the transfers.

The court noted that the determination of reasonably equivalent value is not made by a fixed mathematical formula, but by comparing the value of what was transferred to the value of what was received in exchange. [FN4] Based on these factors, the court found the transfers were made for less than adequate consideration during a period where the debtor corporation was insolvent. The court also found that the ex-spouse’s defense that the money was actually loaned back to the corporation was not credible since funds of the corporation had been used for personal purposes. As a result, the court concluded that the trustee was entitled to judgment.

It is worth noting that the trustee in this case brought her constructive fraud claims under both federal and state law, although the court based its decision only on federal law. While the elements of establishing both actual and constructive fraud under federal and state law are similar, fraudulent transfer claims brought under state law often have a longer lookback period (often four years or more rather than two years), meaning that a creditor relying on state law could challenge a transfer made four or more years ago. [FN5]

The Grube case discussed Friday and the Premier Data Solutions case illustrate the basic elements of fraudulent transfer claims sounding in actual fraud or constructive fraud. Being mindful of factors which could signal a red flag in estate planning or other transfers of property may help both debtors and creditors in avoiding problems and determining appropriate next steps. [FN6]

[FN1] Grochocinski v. Schlossberg (In re Eckert), 388 B.R. 813, 839 (Bankr. N.D. Ill. 2008) (holding that the moving party must prove elements of actual fraud under Illinois law by clear and convincing evidence and collecting cases).

[FN2] See e.g. 740 ILCS 160/5.

[FN3] Skinner v. Gorman (In re Premier Data Solutions, Inc.), 2012 WL 400063, Bankr. No. 08-91050, Adv. 10-9029 (Bankr. C.D.Ill. 2012).

[FN4] Id. (citing Barber v. Golden Seed Company, Inc., 129 F.3d 382 (7th Cir. 1997)).

[FN5] See 11 U.S.C. §§ 548 and 544(b), 740 ILCS 160/5.

[FN6] Persons with further questions are encouraged to consult with a licensed attorney in their jurisdiction. See also disclaimer below.


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