The concept of Fraudulent Conveyance is one of the most often asked about issues when I speak with a new client. In this article we will take a much closer look at what it really is.

Fraudulent Conveyance: A conveyance (or transfer) in the ownership of an asset in which the owner has an intent, by making the transfer, to delay, hinder or defraud a creditor or creditor claim.

The key is INTENT! In other words what was the state of mind of the transferor when the transfer was made. In turn this must also be combined with an effect of the transfer in actually delaying, hindering or defrauding an actual creditor.

  • No state of mind to do such a thing, means no fraudulent conveyance.
  • No actual creditor, which is delayed, hindered or defrauded, then also no fraudulent conveyance.

The actual analysis is not always so clear and is very situational. So let’s look at some examples:

EXAMPLE #1:

Mr. Jones has $6 million of assets, and $4.5 Million in debt (common since Mr. Jones is in real estate). Thus, he is solvent (assets are in excess of liabilities). He is also current on all his mortgage payments and everything is looking good for his portfolio.

Some of his properties have positive equity (fair market value – debt) and some have little, none or even a bit of negative equity. And he has positive cash flow (cash flow from rents more than covers his payments).  In January while attending a fundraiser, he commits a $100,000 donation to his favorite charity, payable by year-end. However, in May, he learns that his primary property has an environmental issue and its market value drops significantly. This lowers his total assets value to $4 Million, with the same $4.5 Million in debt.

The question is:

Can he still make the donation, or would he be guilty of a fraudulent conveyance?”

ANSWER:

The answer is this case is YES, he can continue to complete the gift. The reason is that it can be clearly shown that at the time he made the commitment to give the gift, he did not have any intent with respect to the gift and a creditor. This is because after the gift, he was still solvent, meaning his assets were in excess of his debts.

Now that he is technically insolvent, nothing about the original intent has changed. And this can easily be shown by the facts as we have outlined them. This would be especially true if he continues to stay current on his mortgages, and although the environmental issue is a setback, he fully intents to recover basically without a hitch.

FACT CHANGE:

Now let’s change the facts a little. Let’s say that the issue was not isolated to one building, but rather was a sharp and unexpected downturn in his entire real estate portfolio due to market conditions. Let’s also say that it is unlikely that he will recover and that he may have to walk away from most or even all of his property.

Can he still complete the $100K gift? Again YES, as long as at the time the gift was committed his mindset had nothing to do with avoiding a debt. However, let’s add the fact that he is calling you to see if he can increase the size of his gift to say $1 Million and wants to know if that will still be exempted. Here the answer is likely no.

Why it becomes a NO on an increase is that his reason for wanting to increase the gift is now very likely because he would rather see that money go to his favorite charity vs. to his creditors. So his INTENT is to hinder a creditor from accessing his assets. And this would almost certainly be considered a fraudulent conveyance.

REMEDY:

So on our revised facts, what would the remedy of the court be? This answer is also surprising to many people and even attorneys. The remedy is simply to bring the transfer back. Mr. Jones is not liable for a crime, or guilty of fraud. He simply must reverse the gift of $1 Million – that’s it.

EXAMPLE #2:

Dr. Smith has $3 Million in assets consisting of a home, savings and his office building (excluding the value of his practice). He has a $1 Million malpractice insurance policy and he tells you that a patient is suing him. He has come to you because he wants to protect his assets. You also learn that the claim is for nerve damage during a procedure and that his malpractice carrier is actively defending the claim. Trial is still a year or more away and his carrier believes that the case will probably be settled once discovery is complete.

The question is:

Is it too late for him to set up an Asset Protection Plan?”

ANSWER:

In the case of our doctor Smith, the issue turns on the likelihood that the claim will be covered by the insurance. For 90% of the calls I receive like this, the doctor can do the planning because the likelihood the claim will be covered is very high. So if nerve damage cases typically have a settlement/award range from $250K- $1 Million, then we can expect the claim to be covered. This means that protecting his assets now is just fine with no restrictions.

On the other hand, if the settlement/award range of nerve cases is $1-$5 Million then doing asset protection is a bit more difficult, but still possible. This would require more research and detail before moving forward. Nevertheless, in many cases asset protection may still be advisable to add an additional element which the plaintiff must consider and encourage settlement of the claim within policy limits.

One option is to leave sufficient assets outside of the planning to cover the expected value of the claim. This would allow the Dr. to protect some of his preferred assets, such as cash and investments, while leaving less desirable assets ‘available’ for a creditor.

A second option is to put all of the available assets into the planning, but to ‘exempt’ the lawsuit in question. This provides the protection of all the assets from other potential creditors and reserves the current lawsuit out of the protection. This will completely avoid the issue of a fraudulent conveyance. Additionally, the exemption can be required to be ‘approved’ by the court in which the Trustee is located, and if the Trust is triggered that could mean an additional step for a creditor to access the money. This can serve to keep the issue well away from fraudulent conveyance, while still creating some level of hurdle for an attacking creditor.

EXAMPLE #3:

Mr. Green has $9 Million in assets. He is a successful businessman and has his hand in many diverse businesses. He has many creditors related to those ventures, but is current with all of them and has no one in particular threatening his assets.

He is calling to set up and Asset Protection Plan, and seems very willing and able to complete the plan you begin to recommend to him. However, when you ask him if he is married he says while he is now, he is interested in how this planning would work in the event of a divorce.

You learn that he has been married for 25 years, has 3 grown kids and started out with basically nothing. His wife has never worked and they live in New York. All of the assets are in his name, except the family home, worth $1.3 Million and an IRA set up for his wife with $500K in it.

The question is:

Can you continue with setting up an Asset Protection plan for just him?”

ANSWER:

This is a fact pattern that I would avoid. While it may appear that Mr. Green is planning with separate assets, it is very hard to imaging that at least some portion of those assets would not be awarded to Mrs. Green in a divorce. Thus, I would not set up a plan for just him with all of the assets in his name.

It is acceptable for him to do Asset Protection planning, but he either needs to do one of the following:

  1. Plan individually, but only with separate assets as set forth in a clear agreement with the spouse as to the character of the property, potentially in the form of a post-nuptial agreement
  2. Plan, with the spouse as part of the plan and clarify within the plan the character of the contributed property.
  3. Plan individually, but specifically exempt the protections of the plan from any divorce proceeding and not attempt to use the plan in a divorce.

It is simply not advisable to allow the client to attempt to convert community assets, regardless of whose name they are in, to separate assets and protect them.

MY ADVICE – Plan within one of the 3 options above, or pass on the client.

CONCLUSION

The bottom line is that fraudulent conveyance is not always a bright line. Every case should be analyzed in detail and considered on its own individual facts. However, more often than not, I find that I am able to help my client move forward on some type of planning, even if they have an outstanding issue. This is a great service to them and often leads to a huge decrease in the amount of stress that the lawsuit is causing them. This alone has value in successfully navigating the issue. By removing a degree of fear and worry, the client is in a much better position to reach a positive outcome in the case.

Remember, these are examples and are meant to serve as a guide, not legal advice.  If you have questions about a specific case, I suggest you contact me directly to discuss in detail.

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