Attorneys who represent businesses and individuals in commercial disputes, frequently encounter situations in which a financially distressed party wants or tries to “shield” assets from creditors. This is done by transferring ownership of those assets to family members, corporate insiders, or affiliated business entities.
But many such transactions risk running up against so-called “fraudulent transfer” or “voidable transfer” statutes. These place significant restrictions on when, how, and to whom a business can sell or transfer property. Fraudulent/voidable transfer laws put powerful tools in the hands of creditors to protect their financial interests. Any transaction to which those laws may apply involves substantial risk.
Here’s a quick overview of the purpose and applicability of fraudulent/voidable transfer laws, and who should pay close attention to them.
Purpose of fraudulent/voidable transfer laws
If a debtor does not pay a debt, the creditor generally has the legal right to satisfy its claim by seizing the debtor’s assets. Fraudulent/voidable transfer laws exist to protect that right. Their principal function is to make it costly for debtors and third parties to engage in any form of asset transfer that “hinders, delays, or defrauds” a creditor.
A creditor has up to four years in most cases to seek a court order nullifying (or “avoiding”) any transaction deemed fraudulent/voidable. The laws also give creditors the right to place liens on the transferred property to obtain injunctions against the debtor. They can request the appointment of a trustee and seek money damages against the debtor, the transferee, and certain other third parties.
When do fraudulent/voidable transfer laws apply?
Fraudulent/voidable transfer laws do not restrict all transfers of property by an individual or business that owes money to a creditor. Importantly, they generally do not restrict a debtor’s ability to sell an asset for market value in a good faith, arms-length transaction. However, in doing so, debtors can often face other legal or commercial restrictions.
Instead, fraudulent/voidable transfer laws only aim for the types of debtors and transactions deemed most likely to threaten creditors’ rights. Broadly speaking, fraudulent/voidable transfer laws apply to:
- Transactions that are intended to “hinder, delay, or defraud” a creditor; and
- Transactions by debtors who currently are insolvent, or who are likely to become insolvent as a result of the transaction. In this case, the debtor does not receive reasonably equivalent value for the property transferred.
Transactions by financially strapped debtors tend to merit scrutiny under fraudulent/voidable transfer laws when they involve asset sales. Especially to family or insiders, steep discounts to market value, or debtors retaining rights in or continuing to exercise control over the transferred property.
Who should be on the alert for potential fraudulent/voidable transfers?
An asset sale or conveyance of the property by a financially distressed business or individual may well implicate fraudulent/voidable transfer laws. Any creditor potentially affected by such a transaction should analyze it carefully to identify and address its commercial and legal implications.
