Bankruptcy is frightening enough without people starting to throw the word ‘fraud’ around. Debtors may simply be trying to protect themselves in a bad financial situation, and suddenly it seems like poor money management can lead to jail time. However, this is not the case.
What Is a Fraudulent Transfer?
A debtor is someone who owes money to a creditor. A fraudulent transfer, or fraudulent conveyance, is when a debtor moves assets in a way that will prevent a creditor from being repaid. Fraudulent transfers can take the form of transferring money, transferring titles and ownership, or selling assets. The law only applies when the debtor is attempting to discharge their debts through bankruptcy proceedings.
Timing is key when it comes to determining whether a transfer or sale can be considered a fraudulent conveyance. If the transaction is made prior to filing for bankruptcy, it may be considered a fraudulent conveyance. How far back a court will look depends on where you are. In Hawaii, the statute of limitations is usually four years.
Civil or Criminal
Just to put your mind at ease, we’ll say this up front. If you have been found to have made a fraudulent conveyance prior to or during bankruptcy proceedings, you are not liable for criminal charges. In fact, Supreme Court Justice Scalia has said that it is only reasonable for people to attempt to protect their assets, just as it is reasonable for creditors to seek payment.
A fraudulent transfer or conveyance may be grounds for civil action, specifically suing to retrieve the assets to pay a debt. However, it will almost certainly not result in criminal charges. Criminal fraud is another thing altogether and is closer to genuine theft than a fraudulent conveyance.
Actual vs. Constructive Fraud
Fraudulent transfers are usually divided into two types: actual fraud and constructive fraud. The differences can be subtle, and it may be best to consult a lawyer. However, the broad differences between the two types are fairly straightforward.
Actual fraud includes an element of intent to defraud. That means that a debtor purposefully attempts to move assets to hide them from bankruptcy court, so that they cannot be used to settle any debts. This can be difficult to prove, but it comes with correspondingly serious consequences. It is possible that debts that might otherwise have been discharged in bankruptcy will still be owed, if a debtor attempts to hide assets.
Constructive fraud is the second type, and where it differs is that element of intent. With constructive fraud, while a debtor may not have meant to hide assets or prevent them from being used to pay off debt, that is the practical effect.
Most often, constructive fraud occurs when a debtor sells an asset for less than it’s worth, for example, selling a car to a friend or family member. A sale or other transaction can also be considered constructive fraud if it results in insolvency. In these cases, the creditor can sue to have the transferred assets returned so they can be used to settle a debt.
Badges of Fraud
Whether or not fraud has been committed is not always clear. People filing, or intending to file, for bankruptcy still have to pay bills and routine expenses. When does a purchase or transfer cross the line from necessary to fraudulent? It can be difficult to tell. Intent can be particularly difficult to determine, as the people involved rarely just come out and say what they’re trying to do.
To simplify matters somewhat, the courts have established certain hallmarks, or ‘badges’ of fraud that are used as guidelines to determine when fraud has been committed. These are not conclusive proof of fraud, and one ‘badge’ is not usually enough. Courts consider them circumstantial evidence, though, and if enough of them pertain to a particular case, a court will usually consider fraud to have been committed.
Badges of fraud can include, but are not limited to:
- Becoming insolvent because of a transfer
- Friendship or insider relationship among parties
- The retention of possession, or the benefits of possession
- The existence of the threat of litigation
- The general chronology of events
- Secrecy
- A deviation from the usual course of business
Consequences of a Fraudulent Transfer
As mentioned above, a fraudulent transfer or conveyance is not a criminal matter. However, the consequences can still be serious.
At a minimum, the court will order the return of the assets, or reversal of the transaction, so that the assets involved can be used in the paying of debts. There are protections for the other person involved in the transaction. If they acted in good faith, without knowledge of the debtor’s financial situation or legal status, they can usually keep the proceeds of the transfer. Other arrangements might be made, including reimbursement.
However, there is relatively little the debtor can do in a case where they have been found to have committed fraud. In the worst case scenario, the debt involved is not discharged in bankruptcy proceedings, and the debtor will still owe the full amount.
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