Articles and Publications

Financial institutions can mitigate losses by asserting fraudulent conveyance claims

June 9, 2020

Related PeopleMichael W. Debre

Practice AreasFinancial Services

The Great Recession taught us that fraudulent activity increases during economic downturns. With unemployment claims increasing at unprecedented levels and businesses struggling to survive, financial institutions should expect an increase in fraud. One of the most common schemes against a creditor is a fraudulent conveyance. This article discusses the actions that constitute a fraudulent conveyance and the legal remedies creditors have against such conduct.

What is a fraudulent conveyance?

A fraudulent conveyance is when a party transfers something of value to a third party in order to keep the asset beyond the reach of the transferor’s creditors. One common example is when an insolvent borrower transfers property to an entity controlled by a family member and receives nothing of value in return. Another example is when a defaulting borrower converts a non-exempt asset (such as cash) to an exempt asset (such as an Individual Retirement Account) so his creditor cannot garnish the cash to satisfy a claim. If a borrower successfully conveys an asset fraudulently, the creditor is often left with an uncollectable judgment and a significant loss. However, if the asset is fully encumbered, a fraudulent conveyance claim cannot be asserted.

How do courts determine whether a conveyance is fraudulent?

Courts generally consider a number of factors, known as “badges of fraud,” when determining whether a conveyance is fraudulent. The most critical factors are whether: (1) the transferor was insolvent when the transfer occurred; (2) the transferor received sufficient consideration for the asset; (3) the transfer was made to an insider such as a family member or affiliated entity; and (4) the transferor maintained control over the asset after the transfer. Other factors include whether: (5) the transfer was concealed; (6) the transferor had been threatened with legal action before the transfer; and (7) the transferred asset constituted virtually all of the transferor’s assets.

Fraud can be proven when only a single badge is present, but the case is stronger when multiple badges are established. In order for the creditor to prevail, the evidence must be clear and convincing.

What remedies does a creditor have against a fraudulent conveyance?

Courts have significant flexibility protecting parties harmed by fraudulent conveyances. In the past, Chuhak & Tecson attorneys have successfully obtained injunctive orders at the beginning of a lawsuit, which effectively froze the asset until a final judgment was entered. Such an injunction often leads to settlement because the debtor is barred from transferring the asset and/or depleting it. At the end of a case, the court can “void” the transfer, which returns the asset to the debtor subject to the creditor’s claim. The court can also enter a money judgment against the transferee of the asset, which is useful if the transferee has further transferred, concealed or dissipated the asset.

The court may also grant “other relief” as the circumstances require. In a recent case, Chuhak & Tecson attorneys successfully argued that “other relief” included an award of punitive damages for the creditor which was previously unclear under Illinois law. Punitive damages, or monetary penalties against a party engaging in fraud, can be used to reimburse a creditor for attorneys’ fees incurred during the lawsuit. Following the recent decision the creditor’s leverage increased significantly, as the transferee was exposed to a potentially significant money judgment for her role in the fraud.

What if the debtor files for bankruptcy?

A bankruptcy filing does not protect a debtor from a fraudulent conveyance claim. This includes when a distressed debtor fraudulently transfers assets and then files a Chapter 7 petition claiming no assets for distribution to creditors. To preserve its claim, a creditor should carefully compare the financial statements received throughout the loan relationship with the debtor’s bankruptcy schedules. If assets have effectively disappeared since the loan inception, that issue should be brought to the bankruptcy trustee’s attention and/or the creditor should inquire about the same at the creditor’s meeting. If the trustee is unwilling to take action, the Bankruptcy Code allows a creditor to file its own “adversary” case within the bankruptcy to assert its fraudulent conveyance claim. In the adversary case, the Bankruptcy Court will look at the same factors described above and the proof requirements are essentially the same.

Fraudulent conveyance claims are complex and can be forfeited if not asserted in a timely fashion. Therefore, if you are aware of a possible claim, it is best to contact one of the Banking attorneys at Chuhak & Tecson as soon as possible.

Client alert authored by Michael W. Debre (312 855 4603), Principal.

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.