Enhancing the Estate

Author:Gregory Germain
Pages:152-212
 
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Chapter 8: Enhancing the Estate
8.1. Fraudulent Transfers (11 U.S.C. § 548)
The Bankruptcy Code contains its own provision allowing the trustee to avoid fraudulent
transfers made by the debtor prepetition. It is quite similar in its operation to the Uniform
Fraudulent Transfers Act, but gives the recovery to the bankruptcy estate rather than to the creditor
seeking to avoid the transfer. It also contains a different limitations period, creating the possibility
that the state law period for avoiding fraudulent transfers would be longer than the bankruptcy law
period for avoiding fraudulent transfers.
In order for the Trustee to avoid a transfer or obligation under Section 548, the transfer
must have taken place, or the obligation must have been incurred, within two years before the
filing of the petition. 11 U.S.C. § 548(a)(1).
There is one special exception covering transfers to self-settled trusts within 10 years
before bankruptcy. 11 U.S.C. § 548(e)(1). A self-settled trust is a spendthrift trust funded by the
debtor and for the benefit of the debtor for the purpose of shielding assets from the claims of the
debtor’s existing or future creditors. Because of the restriction on the debtor’s ability to withdraw
or transfer the funds in the trust, the corpus would not constitute property of the estate in the
absence of avoidance. See 11 U.S.C. § 541(c)(2). For many years, self-settled spendthrift trusts
were invalid under state law, but after Alaska led the states by creating this legal mechanism for
hiding assets from creditors, other states followed, and it was necessary to add an additional
avoiding power to the trustee’s arsenal.
The Bankruptcy Code’s fraudulent conveyance provisions contain the same basic two-
ground test for fraudulent conveyances: either (1) actual intent to hinder, delay or defraud
creditors, or (2) received less than reasonably equivalent value, and was or became insolvent (or
in an insolvent like condition). 11 U.S.C. § 548(a)(1)(A) and (B). As under the UFTA, value is
given when an existing creditor’s claim is secured or paid. 11 U.S.C. § 548(d)(2)(A).
8.2. The Trustee’s State Law Powers (11 U.S.C. § 544(b))
Section 544(b) allows the trustee to step into the shoes of a creditor who could avoid a pre-
petition transfer under state law. The claim which previously belonged to the creditor now belongs
to the estate. This rule is commonly used to allow the trustee to avoid fraudulent transfers under
the UFTA that would not be avoidable under Section 548 because of the two year limitations
period. It also applies to other state avoidance rules, such as Article 6 of the Uniform Commercial
Code enacted in only some states that allows the avoidance of bulk transfers made without
following the notice provisions of the UCC.
Hidden from the statutory language is the doctrine of Moore v. Bay, 284 U.S. 4 (1931),
which allows the trustee to assert the full rights of the estate against the recipient rather than the
limited rights of the creditor in whose shoes the trustee has stepped.
Section 544(b) does not give the trustee the power to assert state law claims directly the
trustee must find an actual unpaid creditor on the petition date who could have avoided the transfer
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under state law. Unless there is an existing creditor on the petition date with standing to avoid the
transfer, the trustee has no one’s shoes to step into.
8.3. Practice Problems Fraudulent Transfers
Problem 1. When Doctor Debtor was sued for medical malpractice, he immediately
transferred title to his only asset a house worth $1 million to his girlfriend as a gift. The plaintiff
in the malpractice case knew nothing about the transfer. Two years and one day later, on the eve
of trial, Doctor Debtor filed a Chapter 7 bankruptcy proceeding. Can the trustee avoid the transfer
of the house to the girlfriend under Section 548?
Problem 2. Suppose the plaintiff’s malpractice claim in Problem (1) is determined to be
worth $400,000. Dr. Debtor also owed other creditors (credit cards, personal loans, investment
guarantees) $350,000. Assume that only the Plaintiff in Problem (1) could avoid the transfer of the
home under the UFTA. If the trustee is able to avoid the transfer, how much of the transfer can the
trustee avoid? See 11 U.S.C. § 544(b), Moore v. Bay, 284 U.S. 4 (1931).
Problem 3. The day before filing bankruptcy, Dr. Debtor entered into a five year
employment contract with his girlfriend, promising to pay her $250,000 per year to work as a
receptionist in his medical office. Ignoring any claim limitations that we have yet to study, does
the trustee have any way to avoid the girlfriend’s unsecured claim for the present value of
$1,250,000? See 11 U.S.C. § 548(a)(1)(B)(ii)(IV).
Problem 4. One week before the start of the trial in Problem (1), Dr. Debtor gave his last
$50,000 in cash to his lawyers as a retainer to represent him in the trial. The retainer agreement
provided that the $50,000 was a flat fee covering the lawyer’s services through trial regardless of
the length or amount of work required in the trial, and was to be deemed earned when paid . Can
the trustee recover the $50,000 as a fraudulent transfer?
Problem 5. Dr. Debtor’s mother loaned him $25,000 one month before bankruptcy. The
day before bankruptcy, Dr. Debtor secured his mother’s loan with a lien on his medical equipment
worth $35,000, by signing a security agreement, and filing a UCC-1 financing statement with the
secretary of state. Can the trustee avoid the security interest as a fraudulent transfer? See 11 U.S.C.
§ 548(d)(2)(A).
Problem 6. Big Corp owns 100% of the stock of Little Corp, as well as 100% of the stock
of other subsidiary corporations. Big Corp’s bankers require all of Big Corp’s subsidiaries to sign
guaranties of Big Corp’s $20,000,000 line of credit. This is known as an upstream guaranty.Can
Little Corp’s bankruptcy trustee avoid the guaranty as a fraudulent transfer?
Problem 7. What if Little Corp’s lender required Big Corp to guaranty Little Corp’s line
of credit, and Big Corp filed bankruptcy. This is known as a downstream guaranty. Could Big
Corp’s trustee avoid the guaranty as a fraudulent transfer?
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8.4. Cases on Fraudulent Transfers
8.4.1.1. BFP v. RESOLUTION TRUST CORPORATION,
511 U.S. 531 (1994)
Justice Scalia delivered the opinion of the Court.
Petitioner BFP is a partnership, formed by Wayne and Marlene Pedersen and Russell
Barton in 1987, for the purpose of buying a home in Newport Beach, California, from Sheldon and
Ann Foreman. Petitioner took title subject to a first deed of trust in favor of Imperial Savings
Association (Imperial) to secure payment of a loan of $356,250 made to the Pedersens in
connection with petitioner's acquisition of the home. Petitioner granted a second deed of trust to
the Foremans as security for a $200,000 promissory note. Subsequently, Imperial, whose loan was
not being serviced, entered a notice of default under the first deed of trust and scheduled a properly
noticed foreclosure sale. The foreclosure proceedings were temporarily delayed by the filing of an
involuntary bankruptcy petition on behalf of petitioner. After the dismissal of that petition in June
1989, Imperial's foreclosure proceeding was completed at a foreclosure sale on July 12, 1989. The
home was purchased by respondent Paul Osborne for $433,000.
In October 1989, petitioner filed for bankruptcy under Chapter 11 of the Bankruptcy Code.
Acting as a debtor in possession, petitioner filed a complaint in bankruptcy court seeking to set
aside the conveyance of the home to respondent Osborne on the grounds that the foreclosure sale
constituted a fraudulent transfer under § 548 of the Code. Petitioner alleged that the home was
actually worth over $725,000 at the time of the sale to Osborne.
The bankruptcy court found, inter alia, that the foreclosure sale had been conducted in
compliance with California law and was neither collusive nor fraudulent. The District Court
affirmed. A divided bankruptcy appellate panel affirmed. The Court of Appeals for the Ninth
Circuit affirmed.
Section 548 of the Bankruptcy Code sets forth the powers of a trustee in bankruptcy (or, in
a Chapter 11 case, a debtor in possession) to avoid fraudulent transfers. It permits to be set aside
not only transfers infected by actual fraud but certain other transfers as well--so called
constructively fraudulent transfers. The constructive fraud provision at issue in this case applies to
transfers by insolvent debtors. It permits avoidance if the trustee can establish (1) that the debtor
had an interest in property; (2) that a transfer of that interest occurred within one year of the filing
of the bankruptcy petition; (3) that the debtor was insolvent at the time of the transfer or be came
insolvent as a result thereof; and (4) that the debtor received "less than a reasonably equivalent
value in exchange for such transfer." 11 U.S.C. § 548(a)(2)(A). It is the last of these four elements
that presents the issue in the case before us.
The question presented here, therefore, is whether the amount of debt (to the first and
second lien holders) satisfied at the foreclosure sale (viz., a total of $433,000) is "reasonably
equivalent" to the worth of the real estate conveyed.
The Courts of Appeals have divided on the meaning of those undefined terms. In Durrett
v. Washington Nat. Ins. Co., 621 F.2d 201 (1980), the Fifth Circuit, interpreting a provision of the
old Bankruptcy Act analogous to § 548(a)(2), held that a foreclosure sale that yielded 57% of the
property's fair market value could be set aside, and indicated in dicta that any such sale for less

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