What Are Fraudulent Transfers Under Section 548 of the Bankruptcy Code?

Under Section 548 of the United States Bankruptcy Code, the bankruptcy trustee can avoid fraudulent transfers made within two years preceding filing of a bankruptcy petition. If a creditor asserts a claim of fraudulent transfer in a bankruptcy case, the claim creates a separate adversary proceeding within the case.

Complex laws and rules apply to fraudulent transfer determinations. If you are contemplating bankruptcy, it is important to be aware of the rules. You should discuss any recent property transfers with a bankruptcy lawyer before filing a bankruptcy petition.

Provisions of Section 548 of the Bankruptcy Code

The provisions of Section 548 allow the bankruptcy trustee to avoid any obligation or transfer of the debtor’s interest in property made within two years before filing the bankruptcy petition, if the debtor voluntarily or involuntarily:

1. Made the transfer or incurred the obligation with actual intent to hinder, delay, or defraud any entity to which the debtor owed a debt; or
2. Transferred the property without receiving a reasonably equivalent value, under certain circumstances.

The section also authorizes the trustee to avoid transfers of property made within ten years before filing of the petition if:

• The debtor made the transfer to a self-titled trust or similar device;
• The debtor is a beneficiary of the trust; and
• The debtor made the transfer with the actual intent to defraud creditors.

In circumstances detailed in the Bankruptcy Code, Section 548 does not apply to certain transfers to charitable organizations.

Court decisions on transfers under this section acknowledge the purposes of the fraudulent transfer provisions as:

• Preserving assets of the bankruptcy estate to pay creditors; and
• Protecting creditors from last-minute reductions in the debtor's pool of assets available to pay creditors.

Fraudulent transfers under Section 548 fall into two different categories: Transfers involving actual fraud, and transfers involving constructive fraud. The facts surrounding a transfer determine whether a transfer qualifies involves actual or constructive fraud.

If fraud is established and the trustee voids a transfer, the trustee can recover the transferred property or its value from the transferee, subject to exceptions. Section 550 of the Bankruptcy Code addresses liability of the transferee of an avoided transfer.

Actual Fraud in a Debtor's Property Transfer

Actual fraud in a transfer occurs if the transfer meets the criteria in Item 1 above, if the debtor made the transfer with actual intent to defraud creditors. Insolvency and malice are not required to establish the intent to defraud.

Since proving the debtor’s state of mind is difficult, courts look to specific “badges of fraud” to demonstrate the required intent. Those badges include evidence that:

• The debtor absconded with the proceeds immediately following receipt;
• The transfer involved lack of consideration (value), when both the debtor and transferee know that creditors will not be paid as a result;
• There is a significant disparity between the value of the property transferred and the payment made for the property;
• The transferee is an officer, or agent or creditor of an officer, of a corporate debtor;
• The debtor was insolvent; or
• A special relationship existed between the debtor and the transferee.

In evaluating the debtor’s intent relating to a transfer in a Section 548 challenge by a creditor or trustee, the bankruptcy court will weigh all these factors. A finding of intent does not require all of them to be present.

Constructive Fraud in a Debtor’s Transfer of Property

In transfers involving constructive fraud (Item 2 above) do not involve the debtor’s intent or state of mind. Under the Bankruptcy Code, a transfer is constructively fraudulent if the debtor received less than reasonably equivalent value and the debtor:

• Was insolvent on the date of the transfer or became insolvent because the transfer;
• Engaged in or was about engage in a business transaction for which the debtor’s remaining property constituted unreasonably small capital;
• Intended to incur or believed that he or she would incur debts beyond the his or her ability to pay as the debt matured; or
• Made the transfer or incurred the obligation to or for the benefit of an insider under an employment contract and not in the ordinary course of business.

In determining whether constructive fraud exists in a transfer, courts consider certain factors, including:

• Value of the transferred property, including whether it is equal to the value received by the debtor;
• Actual market value of the property transferred and received;
• Nature of the transaction, including whether it was an arm’s-length transaction; and
• Presence (or absence) of good faith of the transferee of the property.

As with situations involving claims of actual fraud, the bankruptcy court reviews a claim of constructive fraud based on the specific facts relating to the transaction.

Impact of Section 544 of the Bankruptcy Code and Illinois State Law on Fraudulent Transfers

Section 544 of the Bankruptcy Code often comes into play in fraudulent transfer cases. Under that section, the trustee can rely of state law relating to fraudulent transfer claims if there is a creditor who could challenge the transfer under applicable state law.

The Illinois Uniform Fraudulent Transfer Act enables creditors to void a fraudulent transfer made for four years prior to filing of the bankruptcy petition. If a state law claim exists, it effectively extends the two-year time limitation in Section 548 of the Bankruptcy Code to four years.

Effect of Section 548 of the Bankruptcy Code on Your Bankruptcy

Section 548 insures the orderly financial distribution process established by the Bankruptcy Code. By authorizing the trustee to avoid fraudulent transfers, it maximizes the assets of the bankruptcy estate.

An attempt by a debtor to transfer assets out of the reach of the bankruptcy process prior to filing a bankruptcy petition can result in a Section 548 challenge from a creditor or the bankruptcy trustee. If you are contemplating bankruptcy, you should discuss your situation with an experienced bankruptcy attorney before making any asset transfers that may fall under Section 548.

Talk With a Burr Ridge, Illinois Bankruptcy Attorney

Modestas Law Offices assists clients with Chapter 7 or Chapter 13 bankruptcy cases. In some situations, we also represent clients, including creditors, in bankruptcy adversary proceedings.

We serve Illinois clients in Chicago, Cook County, DuPage County, and Will County. To accommodate clients who are busy during weekdays, we are available to meet in the evening and on weekends. Contact us to schedule your initial free consultation.