Richard Gleissner

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 transferred funds. Id. at 1339 (federal fraudulent conveyance action). See also 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 conveyance claims. 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, see 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 transferee's possession. 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 fraudulent scheme. Id.

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, if proven. 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:

Amount Date of Check Date Bank Honored
$10,000 December 28, 1996 December 31, 1996
$25,000 January 15, 1996 Returned for insufficient funds
$25,000 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.

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