First, let’s get one thing clear.  A fraudulent conveyance, despite its name, doesn’t necessarily involve fraud, and it certainly doesn’t involve driving goods across the state in a wagon pulled by horses.



OK, now that we have that out of the way . . .

With all the news last week about the TOUSA case (pdf) (reversing a prior decision that said $420 million paid to lenders was a fraudulent conveyance), I thought I’d take a moment to talk about fraudulent conveyances generally today, and then get into the details of the TOUSA case in a separate post.

So, what is a fraudulent conveyance (or fraudulent transfer), and why should you care? 

Most lenders care a lot about this issue, because if a court finds that you received money (for example, repayment of a loan) in a fraudulent transfer, the court can order you to return the payment under the avoidance powers provided in the U.S. Bankruptcy Code.  

There are two important things to be aware of.  First, as mentioned, a fraudulent transfer doesn’t necessarily involve what you and I would normally think of as fraud.   Under Section 548 of the U.S. Bankruptcy Code, a fraudulent transfer can be found if:

  1.  there is a transfer of  “an interest of the debtor in property” (not necessarily just money), and
  2. the debtor received “less than a reasonably equivalent value” in exchange for the transfer of its property, and
  3. the debtor was “insolvent” when the transfer was made ( or became insolvent as a result, or had unreasonably small capital, or intended to incur debts beyond its ability to pay).

If these things occur – and the question as to whether they did indeed occur is usually what’s debated in these cases – then there is “constructive fraud” in the transfer.  (Of course, if there is actual fraud (“actual intent to hinder, delay or defraud” creditors), that would also qualify.  It’s just a bit more unusual to see actual fraud in deals involving corporate debtors and sophisticated financial institutions as creditors.)

Often, there will be serious questions about whether the company was insolvent at the time it made the payment.  It isn’t always easy to figure out exactly when the company crossed the line into insolvency, as compared with just being in some financial trouble.

There may also be questions about what value was exchanged in the transfer.  In a simple loan deal, it may be fairly easy to demonstrate that value was exchanged — the company got the loan proceeds and was just paying them back.  It gets more complicated when the company’s subsidiaries, sister companies, or other affiliates make payments on the loan or transfer collateral to support the loan — and, indeed, this was an issue in the TOUSA case.

If the court finds that a fraudulent transfer took place as defined in Section 548, the court can order that the transfer be  “avoided” — taking the money or other property back from whoever got it, and adding it to the assets in the debtor’s estate in bankruptcy.

Next up, we’ll see how these rules were applied in the TOUSA case and talk about what that decision might mean for you and your loan deals.