FRAUDULENT CONVEYANCES & PREFERENCES: WHY NOT DO THEM?
The bankruptcy code and the cases interpreting the bankruptcy code provide
disincentives to each of the three possible participants in a fraudulent
conveyance: the Debtor, the Transferee, and the Attorney. Below is a brief
discussion of these disincentives.
A. The Debtor:
Normally, the debtor has less to worry about than anyone. The Debtor does
not have anything and thus has little to loose. In extreme cases of fraud,
the courts may rule that all of the debtor's debts are non-dischargeable.
U.S. v. McClellan, 868 F.2d 210 (7th Cir. 1989).
See also 11 U.S.C. § 727 ("The Court shall grant a debtor a discharge,
unless . . . the debtor, with intent to hinder, delay, or defraud a creditor
or an officer of the estate charged with custody of the property under
this title, has transferred, removed, destroyed, mutilated, or concealed,
or has permitted to be transferred, removed, mutilated, or concealed property
of the debtor, within one year before the date of the filing of the petition;
or property of the estate, after the date of the filing of the petition
. . . .") (emphasis added).
In addition, there are certain types of damages that a debtor should consider
before making a transfer. For example, § 548 of the federal bankruptcy
code contemplates the awarding of prejudgment interest.
In re Shape, Inc., 176 B.R. 1 (Bankr. D. Me. 1994). In
In re Texas General Petroleum Corp., 52 F. 3d 1330 (5th Cir. 1995), the court awarded prejudgment interest
to compensate the estate for the time it was without the use of the fraudulently
Id. at 1339 (federal fraudulent conveyance action).
In re Shape, Inc., 176 B.R. 1 (Bankr. D. Me. 1994) (holding that the awarding of prejudgment
interest in fraudulent transfer proceedings is not intended to be punitive,
but to merely compensate the wronged creditor from deprivation of monetary
value from the loss of payment of a monetary judgment). While punitive
damages are usually not awarded in fraudulent conveyance cases,
Atlanta Shipping Corp., Inc. v. Chemical Bank, 631 F. Supp. 335, affd. 818 F.2d 240 (S.D.N.Y. 1986);
In re Fill, 82 B.R. 200 (Bank. S.D.N.Y. 1987), they have been awarded where the plaintiff
shows that he or she has suffered actual harm or loss.
Colonial Leasing Co. of New England, Inc. v. Logistics Control Group Intern., 762 F.2d 454,
on rehearing 770 F.2d 479 (5th Cir. 1985). Likewise, attorneys fees are rarely awarded
on state based fraudulent conveyance claims or even federal fraudulent
In re Bybee, 945 F.2d 309 (9th Cir. 1991).
Despite the debtor's apparent immunity from civil liability, he or
she can still run afoul of various criminal statutes.
See, e.g., 18 U.S.C. §§' 152, 157 (for the relevant text of these statutes,
infra). For example, in
U.S. v. McClellan, 868 F.2d 210 (7th Cir. 1989), the debtor transferred two of his cars
to his father shortly before filing bankruptcy. The United States wasted
no time in indicting the debtor for fraud and he was sentenced to the
maximum five years in prison.
B. The Grantee/Transferee:
The general rule is that the creditor can only pursue the transferee to
the extent necessary to protect claim against the property transferred;
all else remains in the hands of the transferee.
In re Pajaro Dumes Rental Agency, Inc., 174 B.R. 557 (Bankr. N.D. Cal. 1994);
In re Andersen, 166 B.R. 516 (Bankr. D. Conn. 1994). Although some authority to the contrary
exists, the grantee or transferee may be held liable to the garnishee
or trustee on account of the property so conveyed or of the proceeds therefrom
if the property has been disposed of. 37 C.J.S.
Fraudulent Conveyances § 310. Although not specifically stated, this rule has apparently
been extended to apply to rents generated by the property while in the
See, e.g., 37 C.J.S.
Fraudulent Conveyances § 315 (a creditor can levy on crops grown on land fraudulently conveyed);
Borenstein v. Borenstein, 15 N.Y.S. 2d 539 (judgment declaring transfer fraudulent as to creditor
may require parties to account for all rents, issues, and profits derived
from property after transfer.);
In re Fleet, 122 B.R. 910 (E.D. Pa. 1990) (credits or investments placed into property
were offset by rents.).
In addition, personal judgments, damages outside the parameters of the
property improperly conveyed, may be awarded against the transferee if
the transferee knowingly and willingly prevented the debtor's property
from being appropriated by due process of law. 37 C.J.S.
Fraudulent Conveyances § 318. In some jurisdictions, however, an action for damages against
the fraudulent grantee is authorized where the creditor possessed a lien
on the property, and the lien was lost by the fraudulent conveyance.
Id. Personal Judgments have also been held valid in fraudulent conveyance
cases to the extent that the transferee intentionally tries to hide the
asset from the creditor. 37 C.J.S.
Fraudulent Conveyances § 441;
but see Crosswell Enterprises, Inc. v. Arnold, 422 S.E. 2d 157 (S.C. App. 1992) (no personal judgments of transferees
in bulk transfers act.).
There is at least one case that has awarded punitive damages against a
transferee who was "too enthusiastic" about helping the debtor
succeed in a fraudulent transfer. The court in
Gower v. Cohn, 643 F. 2d 1146 (5th Cir. 1981), found that state law would permit the
issue of punitive damages to go to the jury because "[f]raud, if
found, is tortuous conduct" and will justify punitive damages.
Id. at 1161. In this regard, the court reasoned that punitive damages were
proper where there was evidence that the transferee participated in the
Prejudgment interest is also permissible in an action against a transferee.
In re Chattanooga Wholesale Antiques, Inc., 930 F.2d 458 (6th Cir. 1991). Where it is awarded against the transferee/creditor,
the justification is not only to reimburse the estate the funds of which
it was entitled,
In re Art Shirt Ltd, Inc., 93 B.R. 333 (E.D. Pa. 1988) and
In re Energy Co-op., Inc., 130 B.R. 781 (N.D. Ill. 1991), but also to deny the creditor the use
of funds of which he or she is not entitled.
In re Chattanooga, 930 F. 2d at 465. The decision to grant prejudgment interest is within
the sound discretion of the trial judge, and interest begins accruing
on the date of the demand for the return of the money to the estate.
In re Art Shirt Ltd., Inc., 93 B.R. at 342. For a lengthy discussion on prejudgment interest in preference actions,
see In re Investment Bankers, Inc., 135 B.R. 659 (Bankr. D. Colo. 1991).
A transferee can even be required to pay attorneys fees and costs in a
preference action. Once again, the determination and the amount is left
to the sound discretion of the trial judge.
Id. at 670. Nevertheless, they are awarded.
In re Rocky Mountain Ethanol Systems, Inc., 21 B.R. 707 (D.N.M. 1981). The Rocky Mountain case also suggest that
damages against the creditor for rents or profits would also be appropriate,
Id. at 711.
C. The Attorney:
Attorneys can also face serious consequences, criminal, civil and professional,
for assisting and/or participating in preferences or fraudulent conveyances.
For example, 18 U.S.C. § 152 states:
A person who --
(1) knowingly and fraudulently conceals from a custodian, trustee, marshal
or other officer of the court charged with the control or custody of property,
or, in connection with a case under Title 11, from creditors or the United
States Trustee, any property belonging to the estate of the debtor; . . .
shall be fined under this title, imprisoned not more than five years, or both.
Likewise, 18 U.S.C. § 157 provides:
A person who, having devised or intending to devise a scheme or artifice
to defraud and for the purpose of executing or concealing such a scheme
or artifice or attempting to do so --
(1) files a petition under title 11; (2) files a document in a proceeding
under title 11; (3) makes a false or fraudulent representation, claim,
or promise concerning or in relation to a proceeding under title 11, at
any time before or after the filing of the petition, or in relation to
a proceeding falsely asserted to be pending under such title,
shall be fined under this title, imprisoned not more than five years, or both.
Moreover, an attorney can also be liable for such actions. In this regard,
many courts have found an attorney liable to his client for his negligent
conduct in allowing a fraudulent conveyance to occur.
See, e.g., Soderquist v. Kramer, 595 So.2d 825 (La.App. 9th Cir. 1992). Further, an attorney can even
be held liable to third parties for such actions. For example, in
Stochastic Decisions, Inc. v. DiDomenico, 995 F. 2d 1158,
certiorari denied, 114 S. Ct. 385, 510 U.S. 945, 126 L. Ed. 2d 334 (2d Cir. 1993), an attorney
was held liable to third party creditors in money damages for assisting
a client in making a fraudulent conveyance.
See also Prudential Ins. Co. v. Dewey, Ballantine, Bushby, Palmer & Wood, 605 N.E.2d 318 (N.Y. 1992);
Collins v. Binkley, 750 S.W.2d 737 (Tenn. 1988). The ultimate deterrent, however, is disbarment.
Case law is loaded with examples where an attorney was disbarred for knowingly
concealing property on the eve of bankruptcy.
See, e.g., In re Appel, 62 A.2d 442 (N.Y. 1978);
People v. Schwarz, 814 P.2d 793 (Colo. 1991).
D. Preference and Fraudulent Conveyance Problems
1. Debtor files bankruptcy on April 1, 1997. Trustee discovers the following
payments to a creditor:
||Date of Check
||Date Bank Honored
||December 28, 1996
||December 31, 1996
||January 15, 1996
||Returned for insufficient funds
||March 27, 1997
||April 2, 1997
January 1, 1997 is a holiday. Ninety days from April 1, 1997 is January
1, 1997. The Creditor testifies that he did not know anything about the
insolvency of the debtor and would never participate in any kind of fraud
against the other creditors of the estate. Can the Trustee recover the
$10,000 preference payment? Can he recover the $25,000?
2. Debtor files for Bankruptcy on April 1, 1997, the Trustee discovers
a February 15, 1997 payment from the debtor of $50,000 to "Bookies-R-Us"
in Las Vegas, Nevada. The Debtor testifies at the 341 that he was paying
off a Superbowl Bet and that if Chris Jackie had not missed that damn
field goal he would never have had to file bankruptcy. Can the Trustee
recover the $50,000 as a preference or fraudulent conveyance? Can the
Trustee sue Chris Jackie for missing that damn field goal? Can the Trustee
recover the money?
3. Debtor files for Bankruptcy on April 1, 1997. On February 1, 1997, the
debtor had assets of $1,000,000, secured debts of $600,000 and unsecured
debts of $2,500,000. On February 1, 1997, a minority group of shareholders
of the debtor purchased the secured obligation of the Debtor for $500,000.
On February 15, 1997, the majority shareholder (Mr. B) and a majority
of the board of directors (Mr. B and his wife) agreed to a leverage buyout
in which the companies assets were sold to the Straw Corporation for $100,000
plus the assumption of debts. The $100,000 was immediately distributed
to Mr. B because of numerous capital loans (in excess of $300,000) that
he made to the Debtor over the years and in exchange for Mr. B making
no claim to the assets of Straw. Mr. B executed releases. On March 1,
1997, the minority shareholders foreclosed on their recently purchased
security interests and at the foreclosure sale, a company owned and operated
by the Minority Shareholders purchased the assets of Straw, formerly the
assets of the Debtor, for the amount of the secured debt. Do we have a
preference or fraudulent conveyance against Mr. B. Do we have a preference
or fraudulent conveyance against the minority shareholders, Straw and/or
the new company set up by the minority shareholders? Is there anything
we can do for the unsecured creditors?
4. Debtor is a physician with a history of bad investments. He submitted
overstated financial statements to various banks showing a net worth of
approximately 6$ million. Several of the listed assets were known to the
debtor to be worthless.
The following year he was a Defendant in a lawsuit for breach of contract.
As the jury deliberated, he and his wife arranged a ski vacation in Europe,
billing the airfare to their American Express account. On the last day
of the jury's deliberation, the debtor executed an agreement with
his father, transferred various household goods and two cars, in return
for $30,000. The following day, the jury returned a verdict against the
debtor in the amount of $1 million.
Soon thereafter, the debtor and his wife departed on their European vacation,
charging their expenses to American Express. A few days after returning
from Europe, the debtor filed a Chapter 11 petition. Some months later,
with no plan for reorganization having been filed, the petition was converted
to a Chapter 7. The debtor's creditors filed an adversary proceeding
against the debtor seeking and succeeding in having the debts declared
non-dischargeable on the basis of fraud.