I frequently receive inquiries about whether transferring a house into a friend’s name before filing for bankruptcy is a viable strategy. Beyond the severe risks of bankruptcy fraud, there are other crucial considerations. A Chapter 7 or Chapter 13 bankruptcy trustee has the authority to invalidate such transfers, potentially selling the property and distributing the proceeds to creditors.
Understanding Fraudulent Conveyance
Fraudulent conveyance, or fraudulent transfer, occurs when a debtor intentionally transfers property to another party to obstruct, delay, or defraud creditors. This typically involves transferring assets to friends, business partners or family members to shield them from creditors during bankruptcy proceedings. Both the Bankruptcy Code and state laws allow such transfers to be voided by a bankruptcy trustee or creditor if they fall within a specific lookback period. The trustee can then recover and redistribute the assets to creditors.
What Constitutes a Transfer?
The Illinois Uniform Fraudulent Transfer Act (IUFTA), as defined in 740 ILCS 160/2(l), states that a “transfer” includes any method, direct or indirect, of disposing of or parting with an asset or interest, whether voluntary or involuntary.
This encompasses various forms of asset dissipation, including:
- Gifting Property: Transferring real estate, personal property, or vehicle titles to others without compensation, including transfers into tenancy by the entirety.
- Selling Assets Below Market Value: Selling a car, house, or other valuable asset for significantly less than its fair market value.
- Transferring Ownership of Business Interests: Changing ownership of corporate shares or partnership interests without fair compensation.
- Shifting Bank Account Funds: Moving money between accounts, especially to friends or family.
- Creating Trusts: Establishing trusts to remove assets from the debtor’s estate.
- Conveying Life Insurance Policies: Transferring ownership of life insurance policies.
- Contributing to Joint Accounts: Adding substantial funds to joint accounts to protect assets from creditors.
- Reassigning Lease Agreements: Transferring lease rights on rental property to someone else to avoid inclusion in the bankruptcy estate.
- Signing Over Royalty Rights: Assigning the right to receive royalties from intellectual property, such as books, patents, or music, to another party.
- Forgiving Debts: Cancelling or forgiving a personal loan or debt owed by a friend or relative, especially if done shortly before or during bankruptcy.
How Bankruptcy Trustees Avoid Fraudulent Conveyances
Bankruptcy Code 11 U.S.C. § 544(b) grants the trustee the authority to avoid certain transfers by asserting:
“the trustee may avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim that is allowable under section 502 of this title…”
This means that if there is at least one creditor who could challenge the transfer as fraudulent under state law, the trustee can step into their shoes and use their rights to void the transfer in bankruptcy. In this context, the applicable Illinois state law is the Uniform Fraudulent Transfer Act (UFTA). At a bare minimum, a trustee must show the “who, what, when, where, and how” of the fraud. Presser v. Acacia 836 F.3d 770
Lookback Period for Fraudulent Conveyances
The IUFTA establishes the following lookback periods in Illinois:
- 740 ILCS 160/10(a): Provides a four-year lookback period for fraudulent transfers, starting from the date the transfer was made or from when the transfer could reasonably have been discovered.
- 740 ILCS 160/10(b): Extends the lookback period to seven years if the transfer was made with actual intent to defraud creditors, beginning from the date of the transfer.
Proving the Fraudulence of a Transfer
A trustee’s action to set aside a fraudulent transfer is primarily based on the debtor’s subjective intent to defraud and whether the transfer was made for less than reasonably equivalent value while the debtor was insolvent or became insolvent as a result. Transfers are generally not deemed fraudulent if the debtor received fair value.
Proving a debtor’s intent to defraud can be difficult. To assist in establishing this intent, the IUFTA provides specific “badges of fraud.” Section 5 (740 ILCS 160/5) outlines these indicators, which help to define fraudulent transfers. Fraud in fact involves actual intent to deceive or defraud creditors and requires clear and convincing evidence. The creditor must present factual evidence and proofs to the court to show that the transfer was fraudulent.
Subsection 5(a)(1): A transfer is deemed fraudulent if it was made with actual intent to hinder, delay, or defraud creditors, regardless of whether the creditor’s claim arose before or after the transfer.
Subsection 5(b): Outlines specific factors to determine actual intent:
- Transfers to insiders
- Retention of control over transferred property
- Disclosure or concealment of the transfer
- Prior or imminent lawsuits
- Transfer of substantially all assets
- Absconding or asset concealment
- Insolvent or became insolvent shortly after the transfer was made
- Transfers near significant debt incurrence
- Transfer of essential business assets to insiders
Types of Fraud in Law
The IUFTA identifies two types of “fraud in law,” also known as constructive fraud. Unlike fraud in fact, fraud in law does not require proof of actual intent to defraud. Instead, it is determined by the nature of the transaction and its impact on creditors.
Section 5(a)(2) allows fraudulent conveyance claims to be made if the debtor does not receive a reasonably equivalent value for the transfer and either:
(1) engages in a transaction with unreasonably small assets in relation to the transfer, or
(2) should have foreseen that they were incurring debts beyond their ability to pay (insolvency)
This section explicitly addresses both the transfer of assets and the incurrence of obligations. Consequently, taking on debt can be deemed fraudulent and subject to avoidance, just as with the outright transfer of assets.
Section 6(a) permits claims if:
(1) The creditor’s claim arose before the transfer
(2) The debtor did not receive reasonably equivalent value for the transfer
(3) The debtor was insolvent at the time of the transfer or became insolvent as a result
A claim under Section 5(a)(2) can be pursued regardless of when the creditor’s claim arose, while a claim under Section 6(a) applies only if the creditor’s claim existed prior to the transfer.
Generally, cases based on fraud in law are easier for the trustee to prove and more challenging for the debtor to defend compared to cases based on fraud in fact.
What Constitutes a Creditor Claim
The IUFTA was enacted in 1984 to establish a more modern standard for preventing fraudulent conveyances. This legislation updated the requirements for what constitutes a “claim” under the Act. Previously, for a creditor to pursue a claim based on fraudulent conveyance, they had to first obtain a legal judgment through a lawsuit. However, under the new framework introduced by the UFTA, a creditor only needs to have “a right of payment, whether or not the right is reduced to judgment.” Additionally, the UFTA defines a creditor as “a person who has a claim.” This broad definition means that a legal judgment is no longer required to assert a claim under the Act. Simply owing money to another person under a valid legal agreement will likely be considered a claim.
Evaluating the Risks of Asset Transfers
Dealing with fraudulent transfers and their implications is complex and requires careful legal analysis. If you are considering making a transfer or are concerned about the impact of past transfers, seek advice from an experienced attorney. Steven Grace, a Chicago bankruptcy attorney, offers free phone consultations to help you navigate these challenges. Consult a professional to ensure your decisions are legally sound and in your best interest.
