Most lawyers have sat across the desk from a nervous client who is about to be sued for a large sum of money. It is not uncommon for a client in such dire straits to try to limit his exposure with a plan along the lines of “I’ll just transfer my house to my brother” or “I’ll just turnover all my paychecks to my son” or “I’ll just take on some ‘debt’ to make myself judgment proof.”
It is our obligation as attorneys to advise a client in this situation that his options are not quite so simple. Once known as a “fraudulent conveyance,” and more recently as a “fraudulent transfer,” if Pennsylvania adopts the recommendation of the Uniform Law Commission known as a “voidable transaction,” the result is the same. Under Pennsylvania law a transfer made or obligation incurred is voidable by a creditor if the debtor made the transfer or incurred the obligation with actual or constructive intent to hinder, delay or defraud any creditor. The concept of “actual intent” to defraud is largely self-explanatory. The notion of “constructive intent” to defraud is less clear.
Generally speaking, a debtor is deemed to have constructive intent to defraud a present or future creditor, or is deemed to have intended to defraud a present or future creditor if that debtor makes a transfer without receiving a reasonably equivalent value in exchange, and the debtor either:
1. Was engaged or about to engage in a business or transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or
2. Intended to incur, or believed or reasonably should have believed that the debtor would incur, just beyond the debtor’s ability to pay as they became due.
In addition, a transfer made or obligation incurred by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made or the obligation incurred if (1) the debtor made the transfer or incurred the obligation without receiving a reasonably equivalent value in exchange, and (2) the debtor was insolvent at the time or became insolvent as a result of the transfer or obligation. In short, a creditor whose claim arose before the challenge to transfer or obligation was made or incurred need only prove that the debtor was insolvent and received no reasonably equivalent value in exchange for the transfer or obligation and need not prove actual or constructive intent to defraud a creditor.
Once a fraudulent transfer is established, the questions become what can the creditor do about it, and what are the risks for the debtor and the transferee? Here it is worth remembering that a creditor’s remedies are not self-executing. The creditor must chase down the fraudulent transaction, and this can be both difficult and expensive. For this reason, some debtors willfully move forward with fraudulent transfers on the theory that the creditor will have more work cut out for him in getting paid than would otherwise be the case.
But if a creditor does choose to pursue the transfer, there are a number of potential remedies that are at least theoretically available under the terms of the Uniform Fraudulent Transfer Act. First, a court may void the transfer or obligation to the extent necessary to satisfy the creditor’s claim. This could entail the retransfer of the transferred asset back into the debtor’s name, or the cancellation of the debtor’s legal obligation to a third party. Second, the court may issue an attachment against the transferred asset, thereby permitting the court to take direct control of the asset, and potentially allowing for its sale as a resource to pay the debt owing to the creditor.
The court may also issue an injunction against further transfers by either the debtor or the transferee, or both. Thus, if the debtor has any assets remaining after the fraudulent transfer in controversy, the court could at least prevent the debtor from transferring those remaining assets. The court may thereby also prevent the transferee from yet another conveyance of the asset or obligation. The court may also appoint a receiver to take charge of the transferred asset.
The astute reader will recall that we refer to these remedies as “at least theoretically available.” The potential problem with all of these remedies is that these remedies implicate the rights of a third party to the original debt – someone who may or may not be a party to the underlying litigation. If, as is often the case, the creditor files suit against the debtor before the fraudulent transfer is made, then any proceedings against the fraudulently transferred asset or any proceedings to cancel the fraudulently incurred debt will implicate the due process rights of the transferee. Accordingly, the transferee must be brought within the jurisdiction of the court, either by way of a separate legal action or by way of joining or inter-pleading the transferee into the existing case.
Further, the extent of the creditor’s rights will depend on whether the claims matured or liquidated, or reduced to judgment. That is, maybe within his legal rights to ask a court to enjoin further fraudulent transfers or further fraudulent obligations if that creditor’s claim is not already liquidated (i.e., reduced to a specific dollar amount) and reduced to judgment, then that creditor would not have a right to receive immediate payment from the transferred asset or the fraudulently incurred obligation.
Fraudulent transfers are an unfortunate reality that will remain an issue for creditors and lawyers alike so long as there are debtors who do not want to pay their obligations. And so long as fraudulent transfers remain a reality, the Fraudulent Transfers Act will prevent pitfalls for both debtors and creditors alike.
If you have questions regarding voidable or fraudulent transfers, make an appointment today to consult with an attorney from Wolf, Baldwin & Associates, P.C. We look forward to hearing from you.