What Is a Fraudulent Transfer in Bankruptcy?
In bankruptcy, fraud is a much-dreaded word, and it is often associated with debtors who fail to provide their creditors with the fair value of the money or property they received. After the borrower files for bankruptcy, all the debts they incurred will be analyzed to verify if fraud occurred.
What Does a Fraudulent Transfer Imply?Generally speaking, transfers take the form of different transactions such as purchasing goods or services or simply transferring property or an amount of money from one entity to another. A fraudulent transfer implies the intent of defrauding the other party which is the creditor in case of bankruptcy. A concrete example of fraudulent transfer in bankruptcy is when a debtor or borrower transfers its company's assets to another party in order to prevent the creditor from claiming them.
How Many Types of Fraudulent Transfers Are There?You can encounter two types of fraudulent transfer in bankruptcy: actual fraud and constructive fraud.
Actual fraud occurs in two circumstances; either when the debtor makes a transfer during the year that precedes the bankruptcy filing date or when there is clear proof that a transfer was made in order to defraud a creditor. To regain their right to the transferred assets, the creditor must prove that the transfer was fraudulent and this can be an overwhelming endeavor. Firstly, a debtor who has made a fraudulent transfer will never admit his or her action. Secondly, they would do anything they possibly can in order to prevent the fraudulent transfer from being revealed. Under these circumstances, the court has established a set of fraud indicators which are called fraud badges in order to set apart these transfers. Some common badges examples are:
- Assets that are sold for less than their market value
- Transferring assets and becoming insolvent afterward
- Transferring assets secretly or in suspicious circumstances
- Choosing friends or family members as transferees
- Keep managing the assets even after the transfer
- Assets that became exempt after being transferred
By constructive fraud, we refer to those transfers that provide a preferential creditor treatment to the detriment of other equal creditors. This type of transfer occurs when a creditor agrees to get less than the fair value of the transfer. This transfer should only occur when the debtor can't cover their debts. Several circumstances enable a constructive fraud:
- The transfer aims to help the debtor pay off a debt they can't possibly cover otherwise
- The debtor became insolvent through this transfer or before the transfer took place
- The transfer diminished the debtor's capital drastically
How Are Fraudulent Transfers Handled in Bankruptcy?In bankruptcy, the victims of fraudulent transfers are the creditors. They can seek support and claim their rights to the assets. The bankruptcy trustee will investigate the debtor's transactions and determine whether a fraudulent transfer took place. The trustee has power over the debtor's non-exempt assets which it can liquidate in order to grant each creditor a fair value. The trustee can undo the fraudulent transfers. Often, the transferee will refuse to give the assets back, and a legal lawsuit called adversary proceeding can be filed in this case. This type of lawsuit is similar to any other legal action.