By: Edward D. Brown, Esq., CPA, LL.M
When a creditor is looming, the debtor may be tempted to give away assets to friendly parties so that the creditor will not have recourse to seize as many assets. This was the impetus behind our laws today that hold such actions as voidable transactions (also known as fraudulent transfers) when the intent behind such actions is motivated by the goal of depriving the creditor of reachable assets, or when such actions render the debtor insolvent or the debtor was already insolvent. In these cases, a creditor can argue this to be a failed attempt at asset protection and therefore be afforded the remedy of clawing back the assets that were transferred by the debtor.
The idea here is that a debtor should not be allowed to diminish his net worth as a defensive maneuver in a creditor situation. This raises the issue of whether a sale of assets by the debtor for a promissory note (that has an adequate interest rate provision and a face value equal to the value of the assets being sold by the debtor) will escape the fraudulent transfer trap. At first blush, the debtor’s net worth appears to have remained unchanged, so how can that ever be a voidable transaction?
Courts have considered the creditors’ viewpoint in scenarios involving a transfer by a debtor, with the debtor arguing he received reasonable fair value for the transfer, and as such, no fraudulent transfer claim can be successfully asserted by a creditor. A creditor can however be hindered by such a transaction as a result of no longer having access to “reasonably equivalent value.” For example, a sale of a highly marketable asset in exchange for an installment note could delay a creditor’s ability to collect on a judgment because the debtor holds only a promissory note that necessarily (by design) defers any receipt of funds over perhaps many years (e.g., a thirty year installment sale note) as opposed to an asset that can be easily converted to immediate cash.
In the 2017 case of Fifth Third Bank v. Morales , a debtor sold Colorado real estate to her daughters for a promissory note with a face amount equal to the fair market value of the Colorado property. The note however accrued no interest. The court determined that the note was not sufficient value from the creditor’s standpoint. For one, the note delayed any payments for fifteen years. Two, the purchasers were to inherit the note receivable at some point, so the purchasers had no real economic incentive or obligation in paying the note. Furthermore, the timing of the sale for the note (in the midst of litigation) made the entire sale suspect and therefore prone to being perceived as a fraudulent transfer. Besides, if the face value (the initial principal amount) of the note approximates the value of the real estate sold, but the note has no interest requirement and is unsecured and the payor has no reason to repay the note, the fair market value of the note is actually much lower than the payable amount stated on the face of the note.
Other cases in which a debtor transferred funds in exchange for value (to the debtor) that nevertheless was challenged as a fraudulent transfer include: (i) Interpool Limited v. Patterson , et. al, in which a debtor placed funds into a limited partnership in exchange for a capital interest in that partnership, which cloaked those funds with certain “charging order” restrictions that can stem a creditor’s rights to access those funds, and (ii) Janvey v. Golf Channel, Inc. , in which the debtor who was engaging in a Ponzi scheme paid millions in advertising expenses for air-time on the Golf Channel. In these cases, what the debtor received in these transactions had less value to creditors than what the debtor owned immediately prior to these transactions. It should be noted here though that the Golf Channel did have a good faith defense in that it was not aware of the debtor’s schemes.
In light of cases such as these, a debtor is well advised to not rely on the fact that simply because an asset is exchanged for value during a creditor threat, that such transfer will withstand scrutiny in a court setting.
*The information in this article is provided for general informational purposes only, and may not reflect the current law in your jurisdiction. No information contained in this post should be construed as legal advice from Greenspoon Marder LLP or the individual author(s), nor is it intended to be a substitute for legal counsel on any subject matter. No reader of this post should act or refrain from acting on the basis of any information included in, or accessible through, this Post without seeking the appropriate legal or other professional advice on the particular facts and circumstances at issue from a lawyer licensed in the recipient’s state, country or other appropriate licensing jurisdiction.
About Greenspoon Marder Greenspoon Marder LLP is a full-service law firm with nearly 250 attorneys and more than 20 office locations across the United States. With operations from Miami to New York and from Denver to Los Angeles, our firm attracts some of the nation’s top talent in key markets and innovation hubs. Our core practice areas include Real Estate, Litigation, and Transactional Services, complemented by the capabilities of a full-service firm. Greenspoon Marder has upheld a spot on The American Lawyer’s Am Law 200 as one of the top law firms in the U.S. since 2015, and our goal is to provide exceptional client service by developing a thorough understanding of each client’s business needs and objectives in order to provide strategic, cost-effective solutions.
MEDIA CONTACT
Natalie Villanueva, Director of Marketingnatalie.villanueva@gmlaw.com
This Greenspoon Marder LLP Client Alert is issued for informational purposes only and is not intended to be construed or used as general legal advice nor a solicitation of any type. Please contact the author(s) or your Greenspoon Marder LLP contact if you have any questions regarding the currency of this information. The hiring of a lawyer is an important decision. Before you decide, ask for written information about the lawyer’s legal qualifications and experience.
