In a bankruptcy context, trustees, debtors in possession, and even creditors, may have the ability to pursue recipients of transfers and to recover from them either the property transferred or the value of such property.
In a Chapter 7 liquidation case, the proper party to pursue a fraudulent transfer is generally the Chapter 7 trustee. In Chapter 11 reorganization, generally, the proper party to pursue the avoidance of a fraudulent transfer is the debtor in possession when a trustee has not yet been appointed. Other parties may pursue fraudulent transfers on behalf of the estate depending on the facts and circumstances of the case. See In re Conley, 159 B.R. 323 (D. Idaho 1993)(creditors obtained court approval to bring avoidance actions against debtor and debtor's parents); In re Housecraft Indus. USA, Inc., 310 F.3d 64 (2d Cir. 2002)(agreement between a creditor and the trustee allowed creditor to prosecute avoidance actions); In re Automotive Professionals, Inc., 389 B.R. 630 (N.D. Ill. 2008)(creditors' committee could obtain derivative standing to bring avoidance actions where Chapter 11 debtor in possession or Chapter 11 trustee failed to assert such claims); In re Rosenblum, 545 B.R. 846 (E.D. Penn. 2016)(creditor brought avoidance action without bankruptcy court permission despite the appointment of a Chapter 13 trustee; the court authorized the filing of the avoidance action nunc pro tunc to allow the creditor to proceed under derivative standing where trustee had chosen not to act).
Generally, the bankruptcy court must first give approval to the party to pursue the claim when the trustee or debtor in possession does not pursue the transfer. The avoidance of the transfer is made for the benefit of the estate; however, a creditor pursuing such an action on behalf of the estate may have its attorney fees paid from the estate assuming the creditor is successful and assuming the creditor seeks approval from the court prior to pursuing the action 11 U.S.C. Section 503.
There are several types of fraudulent transfer actions in a bankruptcy context: (a) constructive, 11 U.S.C. Section 548(a)(1)(B); (b) actual fraud, 11 U.S.C. Section 548(a)(1)(A); or (c) fraudulent transfers based on state law, 11 U.S.C. Section 544. In general, all avoidance actions must be commenced before the expiration of two years from the petition date; or, if it is a case that converted from Chapter 11 where no trustee was appointed and such conversion happened before two years had expired, one year from the conversion date. 11 U.S.C. Section 546.
Constructive Fraudulent Transfer
A transfer of property of the debtor may be avoided when the transfer was made within two years of filing bankruptcy, and the debtor did not receive the reasonable equivalent value and other conditions were satisfied as set forth below. 11 U.S.C. Section 548(a)(1)(B)(i). The date for determining whether the debtor received the reasonable equivalent value is the date of the transfer. In re Morris Comm'ns, NC Inc., 914 F.2d 458 (4th Cir. 1990).
Additionally, either of the following criteria must be satisfied:
1. The transfer was done by an insolvent debtor, 11 U.S.C. Section 548(a)(1)(B)(ii)(I);
2. The transfer was done leaving the debtor with unreasonably small capital or assets, 11 U.S.C. Section 548(a)(1)(B)(ii)(II);
3. The transfer was in anticipation of incurring debts beyond the debtor's ability to pay, 11 U.S.C. Section 48(a)(1)(B)(ii)(III); or
4. The transfer was considered excessive compensation to an insider under an employment contract outside the ordinary course of business, 11 U.S.C. Section 548(a)(1)(B)(ii)(IV).
For example, real property given to a relative as a gift, or for a purchase price that is a fraction of the true value within two years of the petition date would be avoidable as a fraudulent transfer. However, where a party obtains the property by way of statutory relief, the transfer may not avoidable even if the debt satisfied was less than the value of the property. The U.S. Supreme Court ruled that a creditor receives the reasonable equivalent value when the creditor forecloses on a mortgage, if state law requirements have been satisfied regarding a foreclosure sale because satisfaction of due process establishes equivalent value. BFP v. Resolution Trust Corp., 114 S. Ct. 1757 (1994). However, the case analysis in BFP may not apply to a tax foreclosure sale since no competitive bidding was present. See In re Murphy, 331 B.R. 107 (Bankr. S.D.N.Y. 2005); Hampton v. Ontario County et al., 588 B.R. 671 (W.D. New York 2018) (no conclusive presumption of reasonably equivalent value for tax lien foreclosure, even if conducted in accordance with state laws).
Actual Fraudulent Intent
A transfer of property of the debtor may be avoided when the transfer was made within two years of filing bankruptcy and the debtor had the intent to hinder, delay or defraud creditors. 11 U.S.C. Section 548(a)(1)(A). Fraudulent intent may be inferred from the circumstances of the transactions under scrutiny. See In re Graven, 936 F.2d 378 (8th Cir. 1991). The presence of one badge of fraud may create suspicion regarding the transfer; however several badges of fraud can constitute conclusive evidence of actual intent to defraud. Max Sugarman Funeral Home, Inc. v. A.D.B. Inv., 926 F.2d 1248 (1st Cir. 1991); In re Jeffrey Bigelow Design Group, Inc., 956 F.2d 479 (C.A.4 MD 1992)(while each fact does not have to demonstrate actual fraud in order to make transfer avoidable on actual fraudulent transfer theory, facts taken together must lead to conclusion that actual fraud existed).
Fraudulent Transfer Based on State Law
A transfer of a debtor's property or obligation incurred by a debtor may be avoided when it is avoidable under non-bankruptcy law by an actual creditor who has an allowable unsecured claim. 11 U.S.C. Section 544. In Arizona, for example, the state fraudulent conveyance statute provides that fraudulent transfers may be avoided generally within four years from the date of the transfer. A.R.S. Section 44-1009. The interplay between a Section 548 action and Section 544 action in Arizona is set forth in In re Viscount, 232 B.R. 416 (Bankr. Ariz. 1998).
A creditor who has a claim against a debtor that has filed bankruptcy should be diligent in monitoring the case and, if the creditor has adequate evidentiary basis to avoid a fraudulent transfer and the trustee or the debtor in possession is refusing to pursue the claim, the creditor may wish to petition the court for permission to pursue the claim on behalf of the estate. Avoidance litigation is complex and should be pursued by an experienced attorney, but the result of such litigation may hold parties accountable and generate an equitable distribution in the bankruptcy context.
This article should not be considered or construed as legal advice on any fact or circumstance. You should consult your own attorney regarding your own personal situation or any legal question you may have.