Adversary Proceedings in Bankruptcy: Fraudulent Transfers

Learn about adversary proceedings in bankruptcy based on a fraudulent transfer.

An adversary proceeding for a fraudulent transfer is a lawsuit within your bankruptcy that the bankruptcy trustee files to recover property you gave to someone else within two years before you filed bankruptcy. Whether the lawsuit will be successful will depend upon a number of factors, outlined below.

When is a Transfer Fraudulent?

A bankruptcy trustee can sue for a fraudulent transfer if the debtor (the person who filed bankruptcy) transferred money or property to another within two years before the bankruptcy filing date and transfer was fraudulent. The trustee files the adversary proceeding against the person or entity that received the transferred property. The case turns on whether the trustee can establish that the transfer was fraudulent.

The trustee can prove either actual fraud or constructive fraud.

Actual Fraud

Actual fraud is difficult to prove -- the trustee must show that the debtor transferred the property with actual intent to hinder, delay or defraud creditors. For example, if the debtor has $10,000 in a bank account and gives that money to his father for the purpose of keeping it from the bankruptcy estate, the trustee might have a case for actual fraud. (To find out how the trustee investigates fraud, see our article on When the Trustee Suspects Fraud.)

Example. Alice owes $50,000 to various creditors. She has a money market account worth $8,000. She wants to file bankruptcy, but she does not want the trustee to take her money market account to repay creditors, so she transfers the account into her friend's name. Alice's actions likely constitute actual fraud, as she transferred her property in an effort to hinder creditors.

Constructive Fraud

Constructive fraud is much easier to prove. The trustee does not need to prove any fraudulent intent on the part of the debtor; in fact, the transfer may have been completely innocent. However, bankruptcy law deems a transfer fraudulent even if it was made with innocent intentions if:

The debtor did not receive reasonably equivalent value for the transfer (i.e., gave something away or accepted a low amount for it) and one of the following occurred:

  • the debtor was insolvent at the time of the transfer (his debts exceeded his assets)
  • the debtor was doing business and the transfer left the debtor with unreasonably low capital
  • in making the transaction, the debtor intended to incur debt that he knew was beyond his ability to pay, or
  • the debtor made the transaction for the benefit of a business insider under an employment contract.

Most fraudulent transfer adversary proceedings are brought because the debtor did not receive reasonably equivalent value and was insolvent at the time of the transfer.

Example 1. Joe gave his car to his best friend, Mark, as a gift. At the time, Joe owned $10,000 worth of property but owed $45,000 on his credit cards. Eighteen months later, Joe filed bankruptcy. The bankruptcy trustee will likely have a cause of action for fraudulent transfer based on constructive fraud because the transfer occurred within two years of Joe's bankruptcy filing, Joe did not receive reasonably equivalent value for the car, and Jose was insolvent at the time of the transfer.

Example 2. Tim had a record collection worth $1,500. He sold it to his sister Donna for $200. He knew the sale price was low, but he gave her a good price as a favor. At the time of the transfer, Tim's assets were worth less than $5,000, but his debts exceeded $20,000. If the trustee can show that $200 was not reasonably equal to the value of the record collection, the trustee will probably be able to prove constructive fraud.

For more information, please see Nolo's section on Adversary Proceedings in Bankruptcy.

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