So this is the fourth in my expected five-part series on fraudulent transfers. In previous blogs, I laid out the basic statutory framework regarding fraudulent transfers, as well as a described generally the difference between actual and constructively fraudulent transfers (Part 1). In Part 2, we took a detailed look at the elements of a fraudulent transfer under both the Bankruptcy Code as well as Texas law. In Part 3, we took a deeper dive into the badges of fraud that courts use to analyze the existence of actual fraudulent intent.  In this 4th part, we will take a more detailed look at insolvency.

The insolvency analysis is unique in that insolvency is both a badge of fraud as it relates to an actual fraudulent transfer, as well as a required element of a constructive fraudulent transfer under both the Bankruptcy Code and the Texas Uniform Fraudulent Transfer Act (“TUFTA”).  The statutory frameworks are similar, but the language of each is analyzed hereinbelow.

Texas Uniform Fraudulent Transfer Act (TUFTA)

 

Under TUFTA, Tex. Bus. & Comm. C. §24.005(b) includes as one of the 11 enumerated badges of fraud under an “actual fraud” analysis the following “badge”:  “(9) the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred”.  Tex. Bus. & Comm. C. §24.005(b)(9)

As to constructive fraud, Section 24.006 goes on to provide as follows:

Sec. 24.006.  TRANSFERS FRAUDULENT AS TO PRESENT CREDITORS.

  1. 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.
  2. 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.

Tex. Bus. & Comm. C. §24.003 defines “Insolvency”:

Sec. 24.003.  INSOLVENCY.

  1. 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.
  2. A debtor who is generally not paying the debtor’s debts as they become due is presumed to be insolvent.
  3. [Repealed]
  4. Assets under this section do not include property that has been transferred, concealed, or removed with intent to hinder, delay, or defraud creditors or that has been transferred in a manner making the transfer voidable under this chapter.
  5. Debts under this section do not include an obligation to the extent it is secured by a valid lien on property of the debtor not included as an asset.

Bankruptcy Code

As noted in Part 3 of this series, the Bankruptcy Code does not enumerate badges of fraud in the statute creating a cause of action for an actual fraudulent transfer.  See 11 U.S.C. §548(a)(1)(A).  However, the Fifth Circuit has recognized as one badge of fraud the financial condition of the debtor both before and after the transaction in question (most circuits have some form of a badge of fraud related to insolvency or the financial condition of the debtor).  Note, however, that despite the fact that insolvency is one badge of fraud, numerous courts consider it to be the “least probative” badge of fraud given that it is present in the majority of bankruptcy cases.  See, e.g., Yaquinto v. CBS Radio, et al., Adv. Proc. No. 19-03226-sgj (Bankr. N.D. Tex., July 13, 2022)

As to constructively fraudulent transfers under the Bankruptcy Code, 11 U.S.C. §548(a)(1)(B) provides that a transfer by the debtor is constructively fraudulent if the debtor:

  • (i) received less than a reasonably equivalent value in exchange for such transfer or obligation; and
  • (ii)
    • (I) Was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation;
    • (II) Was engaged in business or a transaction, or was about to engage in business or a transaction, for which any property remaining with the debtor was an unreasonably small capital;
    • (III) Intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor’s ability to pay as such debts matured; or
    • (IV) Made such transfer to or for the benefit of any insider, or incurred such obligation to or for the benefit of an insider, under an employment contract and not in the ordinary course of business.

In relevant part, the Bankruptcy Code defines “insolvent” in 11 U.S.C. §101(32) to mean:

  • A. With reference to an entity other than a partnership and a municipality, financial condition such that the sum of such entity’s debts is greater than all of such entity’s property, at a fair valuation, exclusive of –
    • (i) Property transferred, concealed, or removed with intent to hinder, delay, or defraud such entity’s creditors; and
    • (ii) Property that may be exempted from property of the estate under section 522 of this title.

      . . .

In making an insolvency analysis, property that is exempted under the Bankruptcy Code (i.e., property that a debtor gets to keep and is therefore not subject to the claims of creditors) is not included as an asset in determining whether the debtor’s debts exceed their assets.  A similar exclusion is found under TUFTA, where it defines “asset” to exclude “property to the extent it is generally exempt under nonbankruptcy law.”  See Tex. Bus. & Comm. C. §24.002(2).

It is important to note that an insolvency analysis must be made with respect to every transaction at issue.  Therefore, simply because a plaintiff establishes that a debtor was insolvent as to one transaction does not mean that such plaintiff has satisfied their burden as to other transactions.

Another important point of analysis is to ensure that only debts of the debtor are included as part of the insolvency analysis.  This might seem obvious, but creditors will frequently attempt to add debts of a business owned by the debtor to an insolvency analysis of the debtor, which is improper and should be noted to the finder of fact.

In our next and last installment, we will focus more on the relative burdens of proof applicable to fraudulent transfer suits.

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