What Is Fraudulent Conveyance and How Does It Work?

A fraudulent conveyance, also known as a fraudulent transfer, is a civil action involving the movement of assets to shield them from creditors. This action is designed to put property beyond the reach of a creditor, often occurring in the context of impending bankruptcy, debt collection efforts, or divorce proceedings. The purpose of laws governing these transfers is to ensure that creditors have a fair opportunity to recover what they are owed. If a court determines a transfer was fraudulent, it can be undone, making the assets available again to satisfy the outstanding debt.

Identifying a Fraudulent Conveyance

A fraudulent conveyance involves three distinct parties. The first is the debtor, who is the individual or entity that owes a debt and transfers an asset. The second is the creditor, the party to whom the debt is owed. The final party is the transferee, the person or entity that receives the asset from the debtor.

The term “transfer” is defined broadly and covers a wide range of actions. It includes obvious transactions like selling a house or gifting money, but can also encompass creating a lien on a property or the foreclosure of a debtor’s equity in an asset. A transfer is not automatically deemed fraudulent. Instead, the law provides two primary pathways for a transfer to be classified as fraudulent.

The first path is “actual fraud,” which is determined by examining the debtor’s intent to interfere with a creditor’s ability to collect a debt. The second path is “constructive fraud,” which does not require any proof of intent and is based entirely on the financial circumstances surrounding the transfer itself.

Actual Fraud and the Badges of Fraud

Actual fraud is centered on the debtor’s intent to “hinder, delay, or defraud” a creditor. Proving what a person was thinking is often difficult, as direct evidence of fraudulent intent is rare. To address this, courts and legal frameworks, such as the Uniform Voidable Transactions Act (UVTA), have developed a set of circumstantial indicators known as “badges of fraud.” The presence of several of these badges can create a strong inference of fraudulent intent.

One of the most common badges of fraud is a transfer to an “insider.” An insider is a person with a close relationship to the debtor, such as a family member, a business partner, or a corporation controlled by the debtor. Another badge is the retention of possession or control over the property after the transfer has occurred. If a person sells their home to a friend but continues to live in it and act as the owner, it suggests the transfer was not a true change of ownership.

The concealment of the transfer is also a strong indicator of fraudulent intent. Failing to record a real estate deed or making a large cash transfer without proper documentation can be viewed as an attempt to keep the transaction hidden from creditors. The timing of the transfer is also scrutinized; a transfer made shortly after being sued is suspicious.

Other significant badges include the transfer of substantially all of the debtor’s assets, a debtor who becomes insolvent immediately after a major transfer, and a transfer for less than “reasonably equivalent value.” While no single badge is conclusive, a combination of these factors paints a picture of the debtor’s intent for the court.

Constructive Fraud The Financial Tests

Unlike actual fraud, constructive fraud does not consider the debtor’s intent. A transfer can be deemed constructively fraudulent based on an objective analysis of the transaction’s financial reality. This determination rests on two main tests: the value test and the insolvency test. Both conditions must typically be met for a court to unwind the transfer on these grounds.

The first element is the “value test,” which examines whether the debtor received “reasonably equivalent value” in exchange for the asset transferred. This does not mean the price must be the exact fair market value, but it must be a commercially reasonable exchange. For instance, selling a vehicle worth $40,000 to a relative for $1,000 would not be considered reasonably equivalent value. Value can also extend beyond direct monetary payment, such as the satisfaction of a pre-existing debt.

The second element is the “insolvency test,” which assesses the debtor’s financial condition at the time of the transfer. The most common is the “balance sheet test,” where a debtor is considered insolvent if their total liabilities are greater than the total value of their assets. Another way is the “cash flow test,” which considers whether the debtor is able to pay their debts as they come due. A transfer can be voided if the debtor was insolvent at the time of the transaction or was made insolvent as a result of it.

Creditor Actions and Look-Back Periods

When a transfer is identified as fraudulent, creditors have a powerful remedy and can file a lawsuit to “avoid” or “set aside” the transaction. This action unwinds the transfer, allowing the creditor to recover the property directly from the transferee who received it. If the property has since been sold or is otherwise unavailable, the creditor may be able to obtain a money judgment against the transferee for the value of the asset.

This right to challenge a transfer is not indefinite and is governed by a “look-back period,” which functions like a statute of limitations. Under the Uniform Voidable Transactions Act (UVTA), which has been adopted by most states, the general look-back period is four years from the date of the transfer. For cases of actual fraud, the UVTA allows an action to be brought within one year of when the transfer was reasonably discovered, if that is later than the four-year period.

In a bankruptcy case, the look-back period is defined by federal law. Section 548 of the U.S. Bankruptcy Code provides a two-year look-back period for a bankruptcy trustee to challenge fraudulent transfers. However, the bankruptcy code also allows the trustee to utilize state law, so if a state’s look-back period is longer, the trustee can take advantage of that extended timeframe.