Chapter I Causes of Action

• Jurisdiction: United States

Chapter I Causes of Action

A. Introduction

Fraudulent conveyance litigation, fairly common in today's large corporate bankruptcy cases, can be a critical tool in maximizing distributable value for general unsecured creditors. A "fraudulent conveyance" or "fraudulent transfer" is a pre-petition transfer made or obligation incurred by a debtor that is deemed by law to be inappropriate and therefore not worthy of legal recognition and subject to avoidance.¹ "The purpose of fraudulent conveyance law is to make available to creditors those assets of the debtor that are rightfully a part of the bankruptcy estate, even if they have been transferred away."²

Fraudulent conveyance law has been around for hundreds of years, often litigated and analyzed, twice-studied for enactment of uniform statutes and reconsidered by Congress for incorporation in the Bankruptcy Code.³ The law was originally enacted in Elizabethan England, then re-crafted in early 20th century America as the Uniform Fraudulent Conveyance Act (UFCA).⁴ When developing the Bankruptcy Code and, in particular, its own fraudulent conveyance section (§ 548), Congress considered the UFCA and made revisions where it deemed appropriate.⁵ After the enactment of the Bankruptcy Code in 1978, a new uniform state statute was drafted, the Uniform Fraudulent Transfer Act (UFTA). The UFTA has since been enacted in all but two states and is made available to debtors in bankruptcy via the "strong-arm" powers set forth in Bankruptcy Code § 544.⁶

Fraudulent conveyance theories are one of the Bankruptcy Code's primary mechanisms by which transfers may be avoided. The body of fraudulent conveyance case law has developed significantly over the last few decades through its application to many forms of complex business transactions, including corporate financings, spinoff's and leveraged buyouts.⁷ This chapter discusses the historical development of fraudulent conveyance jurisprudence and introduces the elements of fraudulent conveyance causes of action under the contemporary legal framework.

B. Intentional Fraudulent Conveyances

Fraudulent conveyances are either "intentional" or "constructive." Intentional fraudulent conveyances involve a transfer made by the debtor with actual intent to hinder, delay or defraud its creditors.⁸ The debtor's mens rea, or intent, rather than its objective financial condition at the time of the transfer is the dispositive factor in an intentional fraudulent conveyance claim.⁹

The concept of intentionally avoiding one's creditors by hiding one's property is not a new one. "Until the seventeenth century, England had certain sanctuaries into which the King's writ could not enter. A sanctuary was not merely the interior of a church, but certain precincts defined by custom or royal grant. Debtors could take sanctuary in one of these precincts, live in relative comfort, and be immune from execution by their creditors. It was thought that debtors usually removed themselves to one of these precincts only after selling their property to friends and relatives for a nominal sum with the tacit understanding that the debtors would reclaim their property after their creditors gave up or compromised their claims."¹⁰

In response to this practice, the Elizabethan English legislature enacted the "Statute of Elizabeth," which prohibited conveyances made with the "intent to delay, hinder or defraud creditors and others of their just and lawful actions."¹¹ The purpose of the Statute of Elizabeth was to punish the debtor-transferor and allow the English Crown to receive, as a penalty, one-half of all property recovered.¹² "So, the untoward act that the Statute of Elizabeth contemplated was not one where the debtor gives money to creditor A and thereby leaves less in the pot for creditor B. It was rather a situation in which the debtor seeks to frustrate recovery on the part of all of his creditors by transferring title of his assets to another with the express purpose of reclaiming those assets once the debtor was beyond his creditors' reach. In other words, the Statute of Elizabeth did not seek an even distribution among all creditors; it merely sought to prevent situations in which the debtor attempted to safeguard his assets for his own enjoyment of them."¹³ As one commentator has described it, "[t]he quintessential Elizabethan fraudulent conveyance would involve the fast action of a sheep farmer, who, having been warned that the sheriff was about to descend on his flock to enforce a creditor's writ, would hastily ship his sheep over to his brother's pasture — where they would stay until the Statute of Elizabeth corralled them back."¹⁴

Prohibitions on intentional fraudulent conveyances have long been part of American bankruptcy law. For example, former § 67 of the 1898 Bankruptcy Act contained a prohibition on intentional fraudulent conveyances, but the reach-back period was only four months prior to the bankruptcy.¹⁵ Former § 70(e) of the 1898 Bankruptcy Act expanded this right by providing the debtor recourse to state law reach-back periods (similar to current Bankruptcy Code § 544).¹⁶ Between 1898 and the most recent amendments to the Bankruptcy Code in 2005, the bankruptcy laws relating to intentional fraudulent conveyances evolved via several significant developments, including:¹⁷

• a 1950 amendment deleting the provision of former § 70(c) that gave the trustee the status of a judgment creditor with an execution returned unsatisfied as to all property not coming into the possession of the bankruptcy court (amended again to restore the trustee to this status in 1966);
• the enactment of Bankruptcy Code § 548 in 1978; and
• a 1998 amendment to insulate a good-faith charitable contribution from a fraudulent transfer attack by a trustee in a bankruptcy case (the Religious Liberty and Charitable Donation Protection Act of 1998, Pub. L. No. 105-183).

As part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), Congress, among other things, "extended the reachback period for most fraudulent transfers to two years from the previous one year, added a new provision allowing a solvent company to challenge certain out of the ordinary course employment contracts with insiders, extended the protection given to certain financial instruments and added a new section designed to attack state-authorized self-settled spendthrift trusts."¹⁸

Today, the Bankruptcy Code affords a debtor two mechanisms for attacking intentional fraudulent conveyances. First, Bankruptcy Code § 548(a)(1)(A) provides a debtor with the power to avoid intentional fraudulent conveyances.¹⁹ Second, Bankruptcy Code § 544(b)(1) vests the debtor with avoidance rights otherwise exclusively reserved for unsecured creditors under nonbankruptcy law.²⁰ In order to assert a claim under § 544(b)(1), the debtor must identify at least one unsecured creditor that has standing to pursue such claim.²¹ The debtor then "steps into the shoes" of that unsecured creditor and may assert the claim.²² Bankruptcy Code § 544(b)(1) is used primarily to enable the bankruptcy estate's prosecution of fraudulent conveyance claims under state law with longer statutes of limitations.²³ Most states have enacted one of two model fraudulent conveyance statutes to govern such claims.²⁴ The UFTA has been adopted with some variations by the majority of states, while two states, New York and Maryland, still follow the older UFCA.²⁵ The UFTA, UFCA and Bankruptcy Code § 548 all contain similar provisions.²⁶

The elements of an intentional fraudulent conveyance cause of action are set forth in § 4 of the UFTA and § 7 of the UFCA. Both Uniform Acts "declare a transfer made or an obligation incurred with actual intent to hinder, delay, or defraud creditors to be fraudulent" as follows:

• "Every conveyance made and every obligation incurred with actual intent, as distinguished from intent presumed in law, to hinder, delay or defraud either present or future creditors, is fraudulent as to both present and future creditors." UFCA § 7.
• "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 ... with actual intent to hinder, delay, or defraud any creditor of the debtor...."²⁷

Section 4(b) of the UFTA lists several factors for courts to consider in determining actual intent: (1) the transfer or obligation was to an insider; (2) the transferor retained possession or control of...