Chapter IV Proving the Elements

• Jurisdiction: United States

Chapter IV Proving the Elements

A. Actual Intent

Under § 548(a)(1)(A), a plaintiff must establish that the defendant made the transfer with "actual intent to hinder, delay, or defraud" a creditor.²⁷⁹ Admissions of such intent are uncommon,²⁸⁰ and actual intent to "hinder, delay, or defraud" creditors therefore may be established by facts and circumstances from which the intent can be inferred.²⁸¹ Identification of the particular creditor intended to be hindered, delayed or defrauded is not required; general intent will suffice.²⁸²

1. Intent of the Transferor

Under § 548(a)(1)(A), only the debtor's intent to hinder, delay or defraud must be proved; a transferee's intent ordinarily need not be established.²⁸³ The intent to hinder, delay or defraud is a disjunctive test; establishing the debtor's intent to hinder, delay or defraud is sufficient.²⁸⁴ However, the plaintiff must show that there was intent to interfere with the creditors' normal collection processes or other rights, as opposed to merely preferring one creditor over another.²⁸⁵

2. Transferee Control of Transferor

An exception to the normal focus on the intent of the transferor arises when a transferee controls the transferor. Where a transferee is in a position of dominance or control over the debtor's disposition of property, the transferee's intent to hinder, delay or defraud can be imputed to the debtor/transferor.²⁸⁶ To invoke the control principle, a plaintiff must allege that (1) the controlling transferee possessed the requisite intent to hinder, delay or defraud the debtor's creditors; (2) the transferee was in a position to dominate or control; and (3) the domination and control related to the debtor's disposition of the property.²⁸⁷

3. Standard of Proof

The standard of proof for actual fraudulent intent varies among jurisdictions. Whether a state's fraudulent conveyance laws adhere to a "clear and convincing evidence" standard or a "preponderance of the evidence" standard in many cases depends on that state's law prior to its enactment of the UFTA.²⁸⁸ Federal jurisdictions are also divided on the standard of proof they require for actual fraudulent conveyance actions under the Bankruptcy Code, although the majority apply the "preponderance of the evidence" standard.²⁸⁹ "The strong current of opinion now holds that actual intent under 11 U.S.C. § 548(a)(1)(A) need only be shown by a preponderance of the evidence.... A minority of courts, however, have continued to adhere to the clear and convincing standard in section 548(a)(1)(A) cases."²⁹⁰

4. The "Badges of Fraud"

Traditionally, those facts and circumstances that support an inference of fraudulent intent have been called "badges of fraud."²⁹¹ The most common recitation of the badges of fraud under 11 U.S.C. § 548(a)(1)(A)²⁹² includes:

(1) lack or inadequacy of consideration;
(2) a close relationship between the transferor and transferee;
(3) the retention of possession, benefit or use of the property by the transferor;
(4) the financial condition of the transferor before and after the transfer;
(5) the existence or cumulative effect of a pattern or series of transactions or course of conduct after the incurring of debt, onset of financial difficulties, or pendency or threat of suits by creditors; and
(6) the general chronology of events and transactions under inquiry.²⁹³

a. Operation of the Badges of Fraud

Courts vary in their opinion of the probative effect of the badges of fraud. Some courts have held that establishing the presence of multiple badges of fraud entitles the plaintiff to a presumption of fraud, upon which the burden shifts to the defendant to provide a legitimate purpose of the challenged transfers.²⁹⁴ Other courts disclaim any automatic inference of fraudulent intent from the badges and instead consider the badges in determining whether the totality of the circumstances indicates the debtor's fraudulent intent.²⁹⁵

Courts have held that there is no requirement that any particular "badges of fraud" must be pled to state a claim for intentional fraudulent conveyance.²⁹⁶ Many courts have held that the existence of "several" badges of fraud is sufficient to establish a fraudulent intent,²⁹⁷ while some courts have observed that fraudulent intent may be pleaded adequately based on the existence of only one badge of fraud.²⁹⁸

b. Particular Badges of Fraud

Certain badges of fraud have been held to be more important than others. For example, some courts have stated that "adequacy of consideration" and "financial condition of the transferor" are the most significant of the badges of fraud.²⁹⁹ Nonetheless, because the focus is on the transferor's subjective intent, courts have held that the debtor's solvency is not outcome-determinative under this badge.³⁰⁰

Adequacy of consideration is another important badge of fraud. The premise underlying this consideration is that a transferor normally will not transfer funds or property without receiving equivalent value, unless the purpose is to defraud creditors.³⁰¹ Nonetheless (and unlike with a claim for constructively fraudulent transfer), even if adequate consideration is received, the debtor may still be found to have executed the transfer with fraudulent intent.³⁰² Related to the adequacy of consideration is whether the transfer constituted all or substantially all of the debtor's property.³⁰³ A staged transfer of substantially all of the debtor's assets divided into separate conveyances has been considered as one single conveyance.³⁰⁴

The transferee's status as an "insider" is also evidence of the transferor's intent.³⁰⁵ However, courts have held that there must be other evidence to show intent to hinder or delay other creditors as opposed to merely preferential payment to an insider creditor.³⁰⁶ Nonetheless, insider status combined with other badges of fraud bolsters the case for fraudulent intent.³⁰⁷ Even if a transfer to an insider was subject to arm's-length negotiations, the transferee's insider status may still be evidence of the transferor's intent, as the negotiations may not take into account the interests of other creditors.³⁰⁸

The retention of benefit, use or possession over the property by the transferor may indicate the transferor's fraudulent intent in transferring the property.³⁰⁹ For example, transferring assets into a trust from which the transferor is the beneficiary and to whom the trustee grants substantially all requests for disbursements indicates the transferor's intent to use and enjoy the transferred assets at the expense of cred-itors.³¹⁰

Any attempts by the transferor to conceal the transfer from other creditors also may be interpreted as evidence of the fraudulent intent. Acts of concealment can take different forms. For example, misrepresenting the effect of the transfer in a press release can constitute concealment,³¹¹ as can failure to disclose the transfer to creditors who could reasonably be expected to object or take preemptive action.³¹²

The Ninth Circuit has found relevant a transferor's admission that the threat of pending litigation partially motivated his transfer of property.³¹³ Indeed, "actual or threatened litigation against the debtor" at the time of the transfer has been cited as a badge of fraud.³¹⁴ Finally, proof of a Ponzi scheme has been held sufficient on its own to establish actual intent to hinder, delay or defraud creditors.³¹⁵

5. Beyond the "Badges": Alternative Means to Prove Fraudulent Intent

Establishing the presence of traditional badges of fraud is the most common method of proving intent. However, courts have entertained alternative bases of fraudulent intent.³¹⁶

a. Use of Scienter Pleading Standards in Bankruptcy Cases

Some jurisdictions have borrowed the standard for pleading intent in securities fraud cases.³¹⁷ In such cases, intent may be inferred either by pleading facts that (1) demonstrate that the debtor had both the "motive and the opportunity" to commit fraud or (2) constitute strong circumstantial evidence of "conscious misbehavior or recklessness."³¹⁸ However, in some of those cases that allow pleading under the scienter standard, intent is also established using the traditional badges of fraud.³¹⁹

"Motive" can adequately be pled by showing that directors or officers have a special incentive to secure a transaction that goes beyond the ordinary desire to maintain corporate profitability.³²⁰ "Opportunity" can be shown where the defendants hold corporate positions and exercise responsibilities allowing them to access and manipulate financial results.³²¹

The Second Circuit has defined adequately alleged "conscious misbehavior or recklessness" to include allegations that management knew of facts contradicting representations made to third parties, failed to review information that they were obligated to monitor or were ignorant of clear and obvious signs of fraud.³²²

b. Further Examples

The Seventh Circuit held that pledging segregated funds as collateral for a loan to pursue legitimate business objectives evidenced sufficiently fraudulent intent for purposes of § 548, because the heightened risk of nonrecovery of the segregated funds was the natural consequence of the transferor's actions.³²³ Drawing on concepts from mail and wire fraud cases, and noting that the conduct violated commodities regulations, the court found it immaterial whether the defendant intended harm, concluding:

Sentinel did more than just expose its FCM clients to a substantial risk of loss of which they were unaware; Sentinel, in an unlawful manner, exposed its FCM clients to a substantial risk of loss of which they were unaware. Thus, even if Sentinel did not intend to harm its FCM clients, Sentinel's intentions were hardly innocent. For this reason, we find that Sentinel's actions, as determined by the factual findings of the district court, demonstrate an actual intent to hinder, delay, or defraud.³²⁴

While the extent to which alternatives to pleading the badges of fraud become more prominent...