Your business receives payment for goods or services that your business provided to a customer (“XYZ Inc.”). Your business is paid from the customer’s corporate account. You know that the payment came from XYZ Inc.’s corporate account because the check or credit card used for payment is in the name of XYZ Inc. However, three years later, you receive a letter from the “trustee” of XYZ Inc., now a debtor in bankruptcy, demanding payment of the money your business received for having provided goods or services to XYZ Inc. The letter advises that according to the bankruptcy trustee’s investigation and analysis, your business received a payment from XYZ Inc., which the trustee believes was “fraudulently” made by XYZ Inc. The letter claims that this “transfer” (i.e., the payment) is a fraudulent transfer and is, therefore, avoidable and recoverable by the trustee on behalf of the bankruptcy estate of XYZ Inc.

You immediately contact the attorney who is representing the trustee, and you explain that your business did not act fraudulently in receiving the transfer because your business actually rendered goods or services to the customer at a fair market price. The attorney for the trustee explains that your business is not the one who acted fraudulently, but rather, it was the debtor who did so by transferring the money to your business. The trustee also contends that the debtor received no value in return. You hear nothing back from the attorney until, several months later, your business is served (by mail) with an adversary complaint filed in the bankruptcy case asserting a claim for a fraudulent transfer and demanding return of the payment.

Fraudulent Transfers

The Bankruptcy Code and Florida Statutes provide courts an assortment of tools to undo transfers from the debtor within a certain time period. Fraudulent transfers may be undone by a court’s putting the property back in the debtor’s hands for administration by the bankruptcy trustee. Pursuant to Bankruptcy Code §§ 544, 548 and 550, and Chapter 726 of the Florida Statutes, a bankruptcy trustee may recover monies paid within the four-year period preceding the date on which the debtor filed for bankruptcy protection which were made with the actual intent to hinder, delay or defraud a creditor of the debtor, or for which the debtor did not receive reasonably equivalent value. These transfers are called “fraudulent transfers.”

Although the state law fraudulent transfer provisions are similar to the fraudulent transfer provisions contained in the Bankruptcy Code “in form and substance,” one material difference exists—state law has a more favorable four-year look-back period versus a two-year look-back period allowed under the Bankruptcy Code. Therefore, a bankruptcy trustee can, under Florida state law, look-back for transfers to avoid as far as the four years preceding the date on which the debtor filed for bankruptcy.

There are two types of fraudulent transfers in bankruptcy. The first is actual fraud, which involves a debtor’s intent to defraud its creditors. The second is referred to as a constructive fraud, which involves a debtor’s transfer made in exchange for inadequate consideration.

Actual Fraud

A claim asserting an actual fraudulent transfer must allege facts sufficient to show that it is plausible that both (1) the debtor transferred an interest in property, and (2) the transfer was made with actual intent to hinder, delay or defraud creditors. Actual fraud requires proof of the debtor’s intent. Given the difficulties in establishing a debtor’s actual intent, courts generally look at the totality of the circumstances and the badges of fraud surrounding the transfers to establish the requisite intent. Badges of fraud include, but are not limited to: (1) the transfer was to an insider; (2) the debtor retained possession or control of the property after the transfer; (3) the transfer was concealed; (4) before the transfer was made the debtor had been sued or threatened with suit; (5) the transfer was of substantially all of the debtor’s assets; (6) the debtor absconded; (7) the debtor removed or concealed assets; (8) 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; and (9) the debtor transferred the essential assets of the business to a lienor who transferred the asset to an insider of the debtor. § 726.105(2), Fla. Stat. Even an involuntary transfer can be made with actual intent.

Constructive Fraud

Contrasted from actual fraud, constructive fraud does not require a showing of intent. To state a claim for avoidance of a transfer based upon constructive fraud under bankruptcy and Florida law, the trustee must allege facts sufficient to show the probability that: (1) there was transfer of an interest in debtor’s property made within two years (or four years under Florida law) prior to the petition date; (2) the debtor received less than a reasonably equivalent value in exchange for such transfer; and debtor (3)(i) was insolvent on the date that such transfer was made or such obligation was incurred, (ii) was engaged in business with an unreasonably small amount of capital, (iii) intended to incur debts beyond debtor’s ability to pay such debts, or (iv) made such transfer to or for the benefit of an insider outside of the ordinary course of business. When something of value is given in exchange for the transfer, the question becomes whether the value given was really adequate for the property transferred.

Your options.

Your business may have defenses available to a claim of either actual or constructive fraud. The most common defense is that your business provided “value” to the debtor and acted in “good faith.” But your business, as the recipient of the transfer, bears the burden of proving that your business gave value to the debtor and received the property in good faith.

Knowing your rights under the Bankruptcy Code is key to protecting your property.