Asset Protection: The Role of Valuation in Assessing Fraudulent Transfer Exposure.

• Author: Boughman, Eric

An often overlooked, but essential component of asset-protection planning is making a careful assessment of a client's financial status. Although timing is generally considered the most critical element of asset protection, due consideration must be given to both the value of assets exchanged and the effect of plan implementation on one's balance sheet.

A fraudulent transfer claim is often the most effective weapon to disrupt an asset protection plan and reach assets transferred beyond a creditor's grasp. Creditors can prove a fraudulent transfer by showing actual or constructive intent to hinder collection under the Uniform Fraudulent Transfer Act. (1)

Actual intent involves a debtor's state of mind and a subjective analysis of whether the debtor intended to avoid a claim. (2) In the context of a lawsuit, proving actual intent is unpredictable because it generally involves trying to prove a defendant's thoughts and intentions. By contrast, "constructive" intent generally involves an objective, two-part test. First, a debtor must have transferred assets in exchange for less than "reasonably equivalent value." (3) Additionally, the asset transfer must generally have left the debtor "insolvent" or undercapitalized to carry on business. (4) Constructive intent, thus, generally involves an objective analysis of financial values. This objective analysis is often the most expeditious method of attacking a transfer as fraudulent.

A professional analysis of "reasonably equivalent value" and "solvency," in connection with a protective transfer, can bolster and clarify asset-protection planning. The same financial analysis is integral to proving a constructive fraudulent transfer.

Reasonably Equivalent Value

Determining whether the debtor received reasonably equivalent value for assets transferred essentially involves a value comparison of "what went out" versus "what was received." (5) Reasonably equivalent value does not necessarily mean equal value. (6) It is often dependent on the circumstances. (7) Timing could be a consideration. Property that must be quickly sold is likely to fetch far less than if listed, advertised, and marketed under regular market conditions.

Another consideration is the perspective from which value is determined. Creditors will argue that assets received by a debtor must be excluded from the solvency calculation to the extent exempt from creditor claims. A debtor may, for example, argue that receipt of protected limited liability company (LLC) equity constitutes reasonably equivalent value received in exchange for the transfer of exposed cash or other personal assets into the LLC; or that receipt of an interest in a protected financial account (such as an IRA) is an equivalent exchange for cash divested to the account. Although the law is unsettled, courts have suggested that the determination of whether the debtor received reasonably equivalent value should be made from the standpoint of the creditor. (8) In a case arising in Florida, the 11th Circuit determined that transfers were not made for "reasonably equivalent value" when they drained assets that would otherwise have been available to creditors. (9)

Based on this interpretation, an ownership interest received by the debtor but not available to a creditor would not satisfy the act's definition of equivalent value. Similarly, receipt of legally exempt or protected assets (in exchange for divested exposed assets) would not count "as reasonably equivalent value," because the assets received would have no value from a creditor's perspective. As an example, the conversion of cash from a personal checking account to a legally exempt IRA would not constitute an exchange for reasonably equivalent value in the fraudulent transfer context because the IRA is untouchable to the creditor. The contribution of cash into an LLC in exchange for an LLC membership interest is also not likely to be deemed reasonably equivalent value unless the interest is subject to foreclosure by a creditor.

Insolvency

The second element of a constructive fraudulent transfer requires proof that a transfer rendered the debtor insolvent. A debtor is considered insolvent if the sum of his or her debts is greater than the fair value of his or her assets. (10) This is generally referred to as "balance sheet" insolvency. (11) The meaning of "fair value" in this context is not defined, but has been described as the sale of assets in a reasonable time at regular market value. (12) Some parties may argue that assets should be valued according to generally accepted accounting principles...