Adkisson's Voidable Transactions - previously known as - Fraudulent Transfers

Caution state

law variances!

Intent Test

UVTA § 4. TRANSFER OR OBLIGATION VOIDABLE AS TO PRESENT OR FUTURE CREDITOR.

Reporter's Comment: 1. Section 4(a)(1) is derived from § 7 of the Uniform Fraudulent Conveyance Act, which in turn was derived from the Statute of 13 Elizabeth, c. 5 (1571). Factors appropriate for consideration in determining actual intent under Section 4(a)(1) are specified in subsection (b).

 

2. Section 4, unlike § 5, protects creditors of a debtor whose claims arise after as well as before the debtor made or incurred the challenged transfer or obligation. Similarly, there is no requirement in § 4(a)(1) that the intent referred to be directed at a creditor existing or identified at the time of transfer or incurrence. For example, promptly after the invention in Pennsylvania of the spendthrift trust, the assets and beneficial interest of which are immune from attachment by the beneficiary’s creditors, courts held that a debtor’s establishment of a spendthrift trust for the debtor’s own benefit is a voidable transfer under the Statute of 13 Elizabeth, without regard to whether the transaction is directed at an existing or identified creditor. Mackason’s Appeal, 42 Pa. 330, 338-39 (1862); see also, e.g., Ghormley v. Smith, 139 Pa. 584, 591-94 (1891); Patrick v. Smith, 2 Pa. Super. 113, 119 (1896). Cf. Restatement (Third) of Trusts § 58(2) (2003) (setting forth a substantially similar rule as a matter of trust law). Likewise, for centuries § 4(a)(1) and its predecessors have been employed to invalidate nonpossessory property interests that are thought to be potentially deceptive, without regard to whether the deception is directed at an existing or identified creditor. See, e.g., McGann v. Capital Sav. Bank & Trust Co., 89 A.2d 123, 183-84 (Vt. 1952) (seller’s retention of possession of goods after sale held voidable); Superior Partners v. Prof’l Educ. Network, Inc., 485 N.E.2d 1218, 1221 (Ill. App. Ct. 1985) (similar); Clow v. Woods, 5 Serg. & Rawle 275 (Pa. 1819) (holding that a nonpossessory chattel mortgage is voidable, in the absence of a system for giving public notice of such interests such as is today supplied by Article 9 of the Uniform Commercial Code).

 

(a) A transfer made or obligation incurred by a debtor is voidable 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:

(1) with actual intent to hinder, delay, or defraud any creditor of the debtor . . ..

Reporter's Comment: Section 4(a)(1) has the meaning elaborated in the preceding paragraph, but it is of course possible that a jurisdiction in which this Act is in force might enact other legislation that modifies the results of the particular examples given to illustrate that meaning. For example, some states have enacted legislation authorizing the establishment and funding of self-settled spendthrift trusts, subject to specified conditions. In such a state, such legislation will supersede the historical interpretation referred to in the preceding paragraph, either expressly or by necessary implication, with respect to allowed transfers to such a statutorily-validated trust. See, e.g., Del. Code. Ann. tit. 12, § 3572(a), (b) (2014). See also Comment 8. Likewise, the historical skepticism of nonpossessory property interests has been superseded as to security interests in personal property by the Uniform Commercial Code. See Comment 9.

 

8. The phrase “hinder, delay, or defraud” in § 4(a)(1), carried forward from the primordial Statute of 13 Elizabeth, is potentially applicable to any transaction that unacceptably contravenes norms of creditors’ rights. Section 4(a)(1) is sometimes said to require “actual fraud,” by contrast to § 4(a)(2) and § 5(a), which are said to require “constructive fraud.” That shorthand is highly misleading. Fraud is not a necessary element of a claim for relief under any of those provisions. By its terms, § 4(a)(1) applies to a transaction that “hinders” or “delays” a creditor, even if it does not “defraud” the creditor. See, e.g., Shapiro v. Wilgus, 287 U.S. 348, 354 (1932); Means v. Dowd, 128 U.S. 273, 288-89 (1888); Consove v. Cohen (In re Roco Corp.), 701 F.2d 978, 984 (1st Cir. 1983); Empire Lighting Fixture Co. v. Practical Lighting Fixture Co., 20 F.2d 295, 297 (2d Cir. 1927); Lippe v. Bairnco Corp., 249 F. Supp. 2d 357, 374 (S.D.N.Y. 2003). “Hinder, delay, or defraud” is best considered to be a single term of art describing a transaction that unacceptably contravenes norms of creditors’ rights. Such a transaction need not bear any resemblance to common-law fraud. Thus, the Supreme Court held a given transfer voidable because made with intent to “hinder, delay, or defraud” creditors, but emphasized: “We have no thought in so holding to impute to [the debtor] a willingness to participate in conduct known to be fraudulent…. [He] acted in the genuine belief that what [he] planned was fair and lawful. Genuine the belief was, but mistaken it was also. Conduct and purpose have a quality imprinted on them by the law.” Shapiro v. Wilgus. 287 U.S. 348, 357 (1932).

 

Diminution of the assets available to the debtor’s creditors is not necessarily required to “hinder, delay, or defraud” creditors. For example, the age-old legal skepticism of nonpossessory property interests, which stems from their potential for deception, has often resulted in their avoidance under § 4(a)(1) or its predecessors. See Comments 2 and 7(b); cf. Comment 9. A transaction may “hinder, delay, or defraud” creditors although it neither reduces the assets available to the debtor’s creditors nor involves any potential deception. See, e.g., Shapiro v. Wilgus, 287 U.S. 348 (1932) (holding voidable a solvent individual debtor’s conveyance of his assets to a wholly-owned corporation for the purpose of instituting a receivership proceeding not available to an individual).

 

A transaction that does not place an asset entirely beyond the reach of creditors may nevertheless “hinder, delay, or defraud” creditors if it makes the asset more difficult for creditors to reach. Simple exchange by a debtor of an asset for a less liquid asset, or disposition of liquid assets while retaining illiquid assets, may be voidable for that reason. See, e.g., Empire Lighting Fixture Co. v. Practical Lighting Fixture Co., 20 F.2d 295, 297 (2d Cir. 1927) (L. Hand, J.) (credit sale by a corporation to an affiliate of its plant, leaving the seller solvent with ample accounts receivable, held voidable because made with intent to hinder creditors of the seller, due to the comparative difficulty of creditors realizing on accounts receivable under then-current collection practice). Overcollateralization of a debt that is made with intent to hinder the debtor’s creditors, by rendering the debtor’s equity in the collateral more difficult for creditors to reach, is similarly voidable. See Comment 4. Likewise, it is voidable for a debtor intentionally to hinder creditors by transferring assets to a wholly-owned corporation or other organization, as may be the case if the equity interest in the organization is more difficult to realize upon than the assets (either because the equity interest is less liquid, or because the applicable procedural rules are more demanding). See, e.g., Addison v. Tessier, 335 P.2d 554, 557 (N.M. 1959); First Nat’l Bank. v. F. C. Trebein Co., 52 N.E. 834, 837-38 (Ohio 1898); Anno., 85 A.L.R. 133 (1933).

 

Under the same principle, § 4(a)(1) would render voidable an attempt by the owners of a corporation to convert it to a different legal form (e.g., limited liability company or partnership) with intent to hinder the owners’ creditors, as may be the case if an owner’s interest in the alternative organization would be subject only to a charging order, and not to execution (which would typically be available against stock in a corporation). See, e.g., Firmani v. Firmani, 752 A.2d 854, 857 (N.J. Super. Ct. App. Div. 2000); cf. Interpool Ltd. v. Patterson, 890 F. Supp. 259, 266-68 (S.D.N.Y. 1995) (similar, but relying on a “good faith” requirement of the former Uniform Fraudulent Conveyance Act rather than that act’s equivalent of § 4(a)(1)). If such a conversion is done with intent to hinder creditors, it contravenes § 4(a)(1) regardless of whether it is effected by conveyance of the corporation’s assets to a new entity or by conversion of the corporation to the alternative form. In both cases the owner begins with the stock of the corporation and ends with an ownership interest in the alternative organization, a property right with different attributes. Either is a “transfer” under the designedly sweeping language of § 1(16), which encompasses “every mode…of…parting with an asset or an interest in an asset.” Cf., e.g., United States v. Sims (In re Feiler), 218 F.3d 948 (9th Cir. 2000) (debtor’s irrevocable election under the Internal Revenue Code to waive carryback of net operating losses is a “transfer” under the substantially similar definition in the Bankruptcy Code); Weaver v. Kellogg, 216 B.R. 563, 573-74 (S.D. Tex. 1997) (exchange of notes owed to the debtor for new notes having different terms is a “transfer” by the debtor under that definition).

 

In § 4(a)(1), the phrase “hinder, delay, or defraud,” like the word “intent,” is a term of art whose words do not have their dictionary meanings. For example, every grant of a security interest “hinders” the debtor’s unsecured creditors in the dictionary sense of that word. Yet it would be absurd to suggest that every grant of a security interest contravenes § 4(a)(1). The line between permissible and impermissible grants cannot coherently be drawn by reference to the debtor’s subjective mental state, for a rational person knows the natural consequences of his actions, and that includes the adverse consequences to unsecured creditors of any grant of a security interest. See, e.g., Dean v. Davis, 242 U.S. 438, 444 (1917) (equating an act whose “obviously necessary effect” is to hinder, delay, or defraud creditors with an act intended to hinder, delay, or defraud creditors); United States v. Tabor Court Realty Corp., 803 F.3d 1288, 1305 (3rd Cir. 1986) (holding that the trial court’s finding of intent to hinder, delay, or defraud creditors properly followed from its finding that the debtor could have foreseen the effect of its act on its creditors, because “a party is deemed to have intended the natural consequences of his acts”); In re Sentinel Management Group Inc., 728 F.3d 660, 667 (7th Cir. 2013). Whether a transaction is captured by § 4(a)(1) ultimately depends upon whether the transaction unacceptably contravenes norms of creditors’ rights, given the devices legislators and courts have allowed debtors that may interfere with those rights. Section 4(a)(1) is the regulatory tool of last resort that restrains debtor ingenuity to decent limits.

 

Thus, for example, suppose that entrepreneurs organize a business as a limited liability company, contributing assets to capitalize it, in the ordinary situation in which none of the owners has particular reason to anticipate personal liability or financial distress and no other unusual facts are present. Assume that the LLC statute has the creditor-thwarting feature of precluding execution upon equity interests in the LLC and providing only for charging orders against such interests. Notwithstanding that feature, the owners’ transfers of assets to capitalize the LLC is not voidable under § 4(a)(1) as in force in the same state. The legislature in that state, having created the LLC vehicle having that feature, must have expected it to be used in such ordinary circumstances. By contrast, if owners of an existing business were to reorganize it as an LLC under such a statute when the clouds of personal liability or financial distress have gathered over some of them, and with the intention of gaining the benefit of that creditor-thwarting feature, the transfer effecting the reorganization should be voidable under § 4(a)(1), at least absent a clear indication that the legislature truly intended the LLC form, with its creditor-thwarting feature, to be available even in such circumstances.

 

Because the laws of different jurisdictions differ in their tolerance of particular creditor-thwarting devices, choice of law considerations may be important in interpreting § 4(a)(1) as in force in a given jurisdiction. For example, as noted in Comment 2, the language of § 4(a)(1) historically has been interpreted to render voidable a transfer to a self-settled spendthrift trust. Suppose that jurisdiction X, in which this Act is in force, also has in force a statute permitting an individual to establish a self-settled spendthrift trust and transfer assets thereto, subject to stated conditions. If an individual Debtor whose principal residence is in X establishes such a trust and transfers assets thereto, then under § 10 of this Act the voidable transfer law of X applies to that transfer. That transfer cannot be considered voidable in itself under § 4(a)(1) as in force in X, for the legislature of X, having authorized the establishment of such trusts, must have expected them to be used. (Other facts might still render the transfer voidable under X’s enactment of § 4(a)(1).) By contrast, if Debtor’s principal residence is in jurisdiction Y, which also has enacted this Act but has no legislation validating such trusts, and if Debtor establishes such a trust under the law of X and transfers assets to it, then the result would be different. Under § 10 of this Act, the voidable transfer law of Y would apply to the transfer. If Y follows the historical interpretation referred to in Comment 2, the transfer would be voidable under § 4(a)(1) as in force in Y.

 

JayNote: This is the "intent test" a/k/a "actual fraudulent transfer".

There is only one element:

 

(1) the debtor intended to delay or defeat the rights of any creditor.

 

The phrase "any creditor" allows for the transfer of intent, i.e., the test is satisfied as to creditor #2 even if the debtor only intended to hinder the rights of creditor #1.

 

The creditor's intent may be proven by reference to the factors in Section 4(b).

 

This test applies without regard to whether the claim occurred before the transfer or vice versa, i.e., it applies to future creditors.

 

Very importantly, because "intent" is an circumstance- and thus evidence-intent question of fact, and therefore unsuitable for summary judgment in favor of the creditor, it is the worst test that a creditor can use to prove a fraudulent transfer, and therefore should be used only in the alternative to one of the other tests. However, time and time again, I've watched creditors myopically focus on this test, which is a usually a mistake grandioso.

 

(b) { This paragraph § 4, a/k/a the "Badges of Fraud" which are taken into account in the proof of a claim arising under § 4(a), is treated here }

 

(c) A creditor making a claim for relief under subsection (a) has the burden of proving the elements of the claim for relief by a preponderance of the evidence.

 

Reporter's Comment: 10. Subsection (c) was added in 2014. Sections 2(b), 4(c), 5(c), 8(g), and 8(h) together provide uniform rules on burdens and standards of proof relating to the operation of this Act.

 

Pursuant to subsection (c), proof of intent to “hinder, delay, or defraud” a creditor under § 4(a)(1) is sufficient if made by a preponderance of the evidence. That is the standard of proof ordinarily applied in civil actions. Subsection (c) thus rejects cases that have imposed an extraordinary standard, typically “clear and convincing evidence,” by analogy to the standard commonly applied to proof of common-law fraud. That analogy is misguided. By its terms, § 4(a)(1) applies to a transaction that “hinders” or “delays” a creditor even if it does not “defraud,” and a transaction to which § 4(a)(1) applies need not bear any resemblance to common-law fraud. See Comment 8. Furthermore, the extraordinary standard of proof commonly applied to common-law fraud originated in cases that were thought to involve a special danger that claims might be fabricated. In the earliest such cases, a court of equity was asked to grant relief on claims that were unenforceable at law for failure to comply with the Statute of Frauds, the Statute of Wills, or the parol evidence rule. In time, extraordinary proof also came to be required in actions seeking to set aside or alter the terms of written instruments. See Herman & MacLean v. Huddleston, 459 U.S. 375, 388-89 (1983) and sources cited therein. Those reasons for extraordinary proof do not apply to claims for relief under § 4(a)(1).

 

For similar reasons, a procedural rule that imposes extraordinary pleading requirements on a claim of “fraud,” without further gloss, should not be applied to a claim for relief under § 4(a)(1). The elements of a claim for relief under § 4(a)(1) are very different from the elements of a claim of common-law fraud. Furthermore, the reasons for such extraordinary pleading requirements do not apply to a claim for relief under § 4(a)(1). Unlike common-law fraud, a claim for relief under § 4(a)(1) is not unusually susceptible to abusive use in a “strike suit,” nor is it apt to be of use to a plaintiff seeking to discover unknown wrongs. Likewise, a claim for relief under § 4(a)(1) is unlikely to cause significant harm to the defendant’s reputation, for the defendant is the transferee or obligee, and the elements of the claim do not require the defendant to have committed even an arguable wrong. See Janvey v. Alguire, 846 F.Supp.2d 662, 675-77 (N.D. Tex. 2011); Carter-Jones Lumber Co. v. Benune, 725 N.E.2d 330, 331-33 (Ohio App. 1999). Cf. Federal Rules of Civil Procedure, Appendix, Form 21 (2010) (illustrative form of complaint for a claim for relief under § 4(a)(1) or similar law, which Rule 84 declares sufficient to comply with federal pleading rules).

 

11. Subsection (c) allocates to the party making a claim for relief under § 4 the burden of persuasion as to the elements of the claim. Courts should not apply nonstatutory presumptions that reverse that allocation, and should be wary of nonstatutory presumptions that would dilute it. The command of § 13—that this Act is to be applied so as to effectuate its purpose of making uniform the law among states enacting it—applies with particular cogency to nonstatutory presumptions. Given the elasticity of key terms of this Act (e.g., “hinder, delay, or defraud”) and the potential difficulty of proving others (e.g., the financial condition tests in § 4(a)(2) and § 5), employment of divergent nonstatutory presumptions by enacting jurisdictions may render the law nonuniform as a practical matter. It is not the purpose of subsection (c) to forbid employment of any and all nonstatutory presumptions. Indeed, in some instances a judicially-crafted presumption applied under this Act or its predecessors has won such favor as to be codified as a separate statutory creation. Examples include the bulk sales laws, the absolute priority rule applicable to reorganizations under Bankruptcy Code § 1129(b)(2)(B)(ii) (2014), and the so-called “constructive fraud” provisions of § 4(a)(2) and § 5(a) of this Act itself. However, subsection (c) and § 13 mean, at the least, that a nonstatutory presumption is suspect if it would alter the statutorily-allocated burden of persuasion, would upset the policy of uniformity, or is an unwarranted carrying-forward of obsolescent principles. An example of a nonstatutory presumption that should be rejected for those reasons is a presumption that the transferee bears the burden of persuasion as to the debtor’s compliance with the financial condition tests in § 4(a)(2) and § 5, in an action under those provisions, if the transfer was for less than reasonably equivalent value (or, as another example, if the debtor was merely in debt at the time of the transfer). See Fidelity Bond & Mtg. Co. v. Brand, 371 B.R. 708, 716-22 (E.D. Pa. 2007) (rejecting such a presumption previously applied in Pennsylvania).

 

Defense Peculiar To The Intent Test Of § 4(a)

§ 8(a) A transfer or obligation is not voidable under Section 4(a)(1) against a person that took in good faith and for a reasonably equivalent value given the debtor or against any subsequent transferee or obligee.

Reporter's Comment: 1. Subsection (a) sets forth a complete defense to an action for avoidance under § 4(a)(1). The subsection is an adaptation of the exception stated in § 9 of the Uniform Fraudulent Conveyance Act. Pursuant to subsection (g), the person invoking this defense carries the burden of establishing good faith and the reasonable equivalence of the consideration exchanged.

 

Prefatory Note (UVTA 2014): Defenses. The amendments refine in relatively minor respects several provisions relating to defenses available to a transferee or obligee, as follows: (1) As originally written, § 8(a) created a complete defense to an action under § 4(a)(1) (which renders voidable a transfer made or obligation incurred with actual intent to hinder, delay, or defraud any creditor of the debtor) if the transferee or obligee takes in good faith and for a reasonably equivalent value. The amendments add to § 8(a) the further requirement that the reasonably equivalent value must be given the debtor.

 

JayNote: This is generally known as the "Transferee's Good Faith Defense", and it applies only to the Intent Test claims under §4(a)(1). There are two elements:

 

(1) The Transferee was in good faith, i.e., did not knowingly assist the Debtor in an attempt to defeat the rights of the Creditor; and

 

(2) The Transferee gave the Debtor "reasonably equivalent value" for the asset.

 

The last clause "against any subsequent transferee or obligee" means that, if there are successor Transferees, the first one who can assert the defense will cut off liability for all who Transferees who follow, even if they are not in good faith or did not give reasonably equivalent value.

UVTA - Logical Organization (Designed For Litigators)

Click here to go to the Voidable Transactions Decision Chart

Overview of UVTA -- The process and result

 

UVTA - Numerical Organization (Confusing & Difficult To Use)

The Uniform Law Commission's complete copy of the UVTA with comments in PDF format is available here. The webpage for the UVTA, showing states that have enacted and much other information regarding the Act is found here.

 

1 - Definitions

(1) Affiliate -- (2) Asset -- (3) Claim -- (4) Creditor -- (5) Debt -- (6) Debtor -- (7) Electronic -- (8) Insider -- (9) Lien -- (10) Organization -- (11) Person -- (12) Property -- (13) Record -- (14) Relative -- (15) Sign -- (16) Transfer -- (17) Valid Lien

2 - Insolvency

3 - Value

4 - Transfer Or Obligation Voidable As To Present Or Future Creditor

(a)(1) {Intent Test} -- (a)(2)(i) {Capitalization Test} -- (a)(2)(ii) Equity-Sense Insolvency Test

(b) {Badges of Fraud}

5 - Transfer or Obligation Voidable As To Present Creditor

(a) {Insolvency Test} -- (b) {Insider Preference Test}

6 - When Transfer Is Made Or Obligation Is Incurred

7 - Remedies Of Creditor

8 - Defenses, Liability, And Protection Of Transferee Or Obligee

{Main Provisions} -- (b) and (c) {Money Judgment}

9 - Extinguishment Of Claim For Relief

10 - Governing Law

11 - Application To Series Organization

12 - Supplementary Provisions

13 - Uniformity Of Application And Construction

14 - Relation To Electronic Signatures In Global And National Commerce

15 - Short Title

16 - Repeals; Conforming Amendment

 

 

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© 2017 Jay D. Adkisson. All rights reserved. No claim to government works or the works of the Uniform Law Commission. The information contained in this website is for general educational purposes only, does not constitute any legal advice or opinion, and should not be relied upon in relation to particular cases. Use this information at your own peril; it is no substitute for the legal advice or opinion of an attorney licensed to practice law in the appropriate jurisdiction.  This site http://www.voidabletransactions.com Contact: jay [at] jayadkisson.com or by phone to 949-200-7773 or by fax to 877-698-0678.