One of the most important things in formulating an asset protection plan is avoiding a “fraudulent transfer”. If an asset protection plan includes a “fraudulent transfer”, it can be undone by a court very easily. This of course begs the question of how a fraudulent transfer is defined. Assuming you don’t live in New York, Virginia, Maryland, Kentucky, South Carolina, Louisiana or Alaska, the concept of fraudulent transfer is defined by your State’s enacted version of the Uniform Fraudulent Transfer Act, or UFTA. This post will look at the basic definition of a fraudulent transfer under UFTA and will preview a series of upcoming posts delving into UFTA a little more in depth. For illustration purposes, we will use the UFTA statute as enacted in New Jersey (NJUFTA), but most if not all of the concepts we will discuss apply in any of the 43 UFTA states.
Under NJUFTA, there are two types of fraud: actual and constructive. In defining the two, it is easier to define constructive fraud first as it is the far more common type of fraudulent transfer.
Constructive fraud is defined by N.J.S.A. 25:2-27:
a. A transfer made or obligation incurred by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made or the obligation was incurred if the debtor made the transfer or incurred the obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent at that time or the debtor became insolvent as a result of the transfer or obligation.b. A transfer made by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made if the transfer was made to an insider for an antecedent debt, the debtor was insolvent at that time, and the insider had reasonable cause to believe that the debtor was insolvent.
In short, constructive fraud hinges on insolvency. If you avoid both transfers into asset protection vehicles that make you insolvent and transfers that take place while you are already insolvent, you have for the most part avoided constructive fraud. The key to this entire statute, then, is the definition of “insolvent”. Under N.J.S.A. 25:2-23(a), “a debtor is insolvent if the sum of the debtor’s debts is greater than all of the debtor’s assets, at a fair valuation”.
In other words, in the simplest example, a debtor whose only asset is $10,000 in cash and whose only liability is a $1,000 credit card bill should not transfer more than $9,000 into an asset protection structure, otherwise he has committed a constructive fraud. Very few debtors will find themselves with such a simple analysis of solvency, and for that reason I will be doing a post very soon entirely on solvency analysis under UFTA, so stay tuned for more details.
Actual fraud, on the other hand, is defined by N.J.S.A. 25:2-25:
A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation: a. With actual intent to hinder, delay, or defraud any creditor of the debtor; or b. Without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor:(1) Was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or(2) Intended to incur, or believed or reasonably should have believed that the debtor would incur, debts beyond the debtor’s ability to pay as they become due.
In short, actual fraud is the more egregious and less common type of fraudulent transfer. This is because it requires actual intent to defraud the creditor. Most of the time when a court finds someone has committed actual fraud, that person was clearly up to no good. Since proving actual intent is nearly impossible, courts are permitted to infer it from presence of the “badges of fraud”, which are enumerated in N.J.S.A. 25:2-26:
a. The transfer or obligation was to an insider; b. The debtor retained possession or control of the property transferred after the transfer; c. The transfer or obligation was disclosed or concealed; d. Before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit; e. The transfer was of substantially all the debtor’s assets; f. The debtor absconded; g. The debtor removed or concealed assets; h. The value of the consideration received by the debtor was [not] reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred; i. The debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred; j. The transfer occurred shortly before or shortly after a substantial debt was incurred; and k. The debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.
The presence of one or two of the badges of fraud in your transfer usually isn’t quite enough to prove actual intent. However, the more badges present, the more likely it is that a court will find actual intent. It is also important to note that some badges, like insolvency, tend to carry more weight than others in a court’s analysis.
You will also notice that one of the badges is our old friend we met when analyzing constructive fraud — insolvency. For this reason, usually when someone has committed actual fraud, they have also committed constructive fraud. The reverse is not usually true.
Not all fraudulent transfers are equal. Creditors whose claims arose prior to any potentially fraudulent transfer can attack the transfer on either actual or constructive grounds, however creditors whose claims arose after the potentially fraudulent transfer must prove an actual fraud.
In the coming weeks, I will flesh out this analysis further with posts on defining solvency, defining “reasonably equivalent value”, and the importance of CPA-prepared financial statements. In the meantime, if you are interested in an asset protection plan that doesn’t run afoul of UFTA, contact me.
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