Back in 2013, I wrote the article “Existence Of Claim Renders Some Clients Seeking Asset Protection Effectively Dead On Arrival“, which warned against post-claim asset protection. That warning is still valid, but it is long past time to update the warning for some changes in the law that have happened in the interim. Spoiler alert: The law hasn’t gotten better. There are a lot of things that we have to worry about in this area, but the principle barrier to post-claim transfers is the Uniform Voidable Transactions Act (UVTA), along with its older version the Uniform Fraudulent Transfers Act that still exists in some states, and also some ancient fraudulent transfer laws in a few states. For our purposes here, they all operate about alike.
To understand all this, we have to start with the concept of a claim. A claim is an event giving rise to liability. The liability arises when the bad thing happens that will eventually metastasize into a judgment. Thus, the claim arises at the moment of impact when the two cars collide, when the radiologist misses the cancer, when the chef serves the spoiled salmon, you get the picture. Once the claim arises, the voidable transaction laws immediately come into play and any transfers that happen thereafter can be challenged by creditors.
It is this point of impact that is important and whatever happens after that is largely irrelevant. Since the claim has already arisen, it just doesn’t matter if no demand letter has been received, that no lawsuit has been filed, or that there is not a judgment yet. These things just don’t matter. That they have not occurred yet does not provide any defense to a voidable transaction claim. None.
How about personal guarantees? This is the least understood area of fraudulent transfer law although it is pretty simple. When a person signs a personal guarantee, at that instance in time the liability is incurred for payment of the entire debt. All the debt. Not part of the debt, not just the part is underwater. It doesn’t matter that there has not been a default on the debt, or even that payments are still current. The liability for the entire outstanding debt is still on the personal guarantee. Again, it arises for the full amount of the debt at the moment the guarantee is signed. Usually, especially for real estate investors, this means that they are insolvent on a balance-sheet test the second they sign the personal guarantee. This further means that any transfers that are made after a guarantee is signed will violate the voidable transaction laws.
So, we’ve established when a claim arises. There is thus a distinct black-and-white line that divides permissible transfers from voidable transactions. Transfers made before a claim are permissible, assuming the debtor was solvent when the transfers were made, while transfers after a claim are impermissible.
If a transfer is impermissible, meaning that the voidable transaction laws have been violated, a debtor’s situation can quickly go from bad to much worse. Here are just some of the consequences of making a voidable transaction:
- Transferee Becomes A New Target For Creditors. It is a surprise for most people to learn that a voidable transaction lawsuit is not against the debtor, but instead is primarily a lawsuit against the transferee to force the transferee to either return the assets (so the creditor can then levy on it) or pay a money judgment equal to the value of the asset transferred. This means that the transferee becomes a target of creditors. If the transferee is a spouse, family member or close friend, this means that they will now be embroiled in the litigation. This will not only make the transferee’s position miserable, but it will also put additional pressure on the debtor.
- Liability For Attorney’s Fees To Unwind The Transfer. If attorney’s fees were awardable in the underlying action, then attorney’s fees can be awarded to the creditor for the effort to unwind the voidable transaction. These fees can be very substantial, often into the millions of dollars. The liability for these fees are tacked on to the judgment thus potentially making the debtor’s situation much worse. Also, many states impose joint liability for these fees upon the transferee. While the debtor might not care, the transferee may have deeper pockets.
- Civil Conspiracy Damages To Unwind The Transfer. If attorney’s fees are not awardable to unwind the voidable transaction, then the creditor might still recover those fees as damages for a civil conspiracy. Civil conspiracy typically requires an agreement between at least two persons to either accomplish a legal objective by wrongful means or a wrongful objective by legal means. All a creditor has to satisfy is the existence of an agreement, which isn’t that difficult if the debtor and the transferee are close. Also, a civil conspiracy claim can touch everybody who planned or assisted with the transfer, including bankers, financial planners, accountants, attorneys and others.
- Punitive Or Treble Damages. Court opinions in many states now allow for punitive damages to be awarded if the voidable transaction is egregious, meaning was clearly intended to defeat the enforcement of a judgment. Such punitive damages can be awarded to up to ten times the value of the asset transferred. In recent years, creditors have also been successfully asserting Civil RICO claims against debtors and transferees, as well as similar state-law theories, which allow for trebled (three times) damages. Note: Punitive and trebled damages are usually not dischargeable in bankruptcy.
- Denial Of Discharge. If a debtor makes a voidable transaction in the one year immediately preceding the filing of a bankruptcy petition, then Bankruptcy Code § 727 requires that the bankruptcy court deny the debtor a discharge. If this happens, the result is that the debts as of the time of the bankruptcy petition may never be discharged by the debtor. This is usually personally devastating for debtors in a life-changing way, meaning that what might have otherwise been a dischargeable judgment is converted in significant part into a non-dischargeable one.
- Attorney/Client Privilege Can Be Vitiated. If a creditor can make merely a prima facie case that a voidable transaction has occurred, the court may vitiate the attorney/client privilege can be dissolved for all communications in regard to the transaction. This frequently leads to the creditor having access to information about other assets and transfers that the creditor might not otherwise have discovered. In some of my own cases representing creditors, this has frequently turned a difficult judgment enforcement case into a very easy one.
Almost always, the transfer is made by a distressed and panicked debtor soon after the claim arose such that the mere timing of the transfer belies it as any legitimate transaction. Oh sure, the debtor will have an elaborate story as to why the transfer was made, but under the circumstances it is pretty much never a winning story. It will be a story that would make some sense if the debtor didn’t have a claim, but it usually makes no sense at all once the claim has arisen. Judges see fraudulent transfers all the time, will recognize it as a fraudulent transfer, and any credibility that the debtor might have had with the judge will immediately evaporate.
These are the consequences for the debtor and transferee to a voidable transaction. But there can also be significant consequences for other attorneys who assist in a fraudulent transfer. In addition to civil liability for conspiracy or related theories, there can also be significant ethical issues. Attorneys have suffered censure, suspension and even disbarment for planning or assisting with a fraudulent transfer. What is your future income as an attorney worth? Your fee better be at least that.
The bottom line is that the risk of making a voidable transaction is just not worth it for anybody involved. It probably will not work in the end but there are significant, if not horrific, downsides. Again, the key point is when the claim arose. A post-claim transfer is very dangerous if not often suicidal.
This doesn’t mean that there aren’t some attorneys and other planners who will take on a debtor as a client and try to design some transfer so as to at least improve the debtor’s bargaining position. Once in a blue moon this works, but most of the time it doesn’t. Most creditor rights attorneys will salivate when they see a voidable transaction because they know the debtor has made his situation worse and possibly much worse. The rest of the time, the transfer is reversed as a voidable transaction and the attorney will disclaim their advice (but not their fee) to try to save their own skin. It is then the debtor and transferee who suffers. Debtors have to learn that as good as this advice may sound, it is actually terrible advice.
A couple of times a week, I get calls from folks who have suffered some mishap, are panicked, and want to know about their options for asset protection planning. I have to explain to them that the time is way too late for anything like asset protection planning and that they will do nothing but make their situation worse. Then we explore their assets and state exemptions to see what their real options are. That’s the advice these debtors need.
Not bad advice.