Be Careful Not to Engage in Fraudulent Non-Transfers
International Wealth & Asset Planning Blog	Sep 20, 2018 Denver, CO
By Edward D. Brown, Esq., CPA, LL.M
We have always recommended that no one participate in any fraudulent transfers (i.e., transfers made with any intent to hinder or delay a creditor). An issue that arose recently in the press was whether a fraudulent transfer could be deemed to occur in the absence of any apparent transfer. This leads to the question, what exactly is a "transfer" for purposes of fraudulent transfer law? The term is broader than you may think.
For example, if a debtor transfers funds into an LLC for a partial ownership in that LLC, knowing that a creditor is on the horizon, this can be a fraudulent transfer. The effect of the contribution to the LLC converts reachable (exposed) funds to an interest in a company that provides "charging order" protection for the debtor. This means that, as has been shown case after case, the use of an LLC can provide asset protection in that a creditor must wait for the debtor to receive a distribution out of the LLC before the creditor can get his hands on the money. This is especially detrimental to the creditor when the debtor is the manager who controls if and when LLC distributions are made. The value of the funds are in effect made less valuable to a creditor. This was the ruling in the classic case of Interpool Ltd. v. Patterson, which ruled that such a conversion was in effect a fraudulent transfer.
Change the facts to a situation in which the debtor funded an LLC in exchange for a 100% ownership interest in the LLC. Charging order protection is much less likely since the concept of charging order arose as a way to prevent a creditor of one member in an LLC (or partnership) to disturb the other members or partners in that entity. Since a 100% owned LLC has no other members, it is more difficult to justify a charging order defense. This was widely covered in commentary on the bankruptcy case In re: Ashley Albright and in the case of Olmstead v. FTC.
A 100% owner of an LLC may welcome a second non-debtor member to buy into the LLC, thereby reducing the original owner's investment in the LLC, causing charging order protections to kick in. The added, but possibly misperceived, accomplishment here is that the debtor made no transfer. Instead, it was a third party member buying into the LLC for fair consideration, which thereby appears to cloak the initial member with protection from his/her creditors. This can certainly work if all occurs for business or investment reasons at a time that no creditor is already on the trail of the "debtor." This is important in that courts will look at the motives behind bringing in that second member, and if the motives are tied to an intent to hinder a creditor or that make the initial member insolvent, then notwithstanding that the initial member made no transfer to the LLC, he/she can still be determined to have engaged in a fraudulent transfer.
Take for example the very recent case of Albert Lacava. Albert was aware of creditor issues at a time that he convinced his wife to contribute funds to his 100% owned LLC (an adverse FINRA ruling against him occurred within days of this transaction). He made no "transfer" during the time he became aware of the FINRA threat, but his wife did make a transfer. So what, you ask? She is not the debtor here, so can she not freely contribute to an LLC without fear of another LLC member's creditors. It took years, but a fraudulent transfer claim was eventually brought through an Ohio court against Albert to collect an almost $200,000 judgment. The creditor prevailed, and in addition to the judgment, received $100,000 in punitive damages and attorney fees.
If Albert's wife could show that her husband (1) received full consideration for his passing an interest in the LLC over to her and (2) that she acted in good faith, she could defeat the fraudulent transfer claim against her husband. As you may surmise, the court did not believe she acted in good faith. It looked too much like a creditor-dodge (the timing alone is a big contributor to that finding). Therefore, she did not meet the second factor above.
It is interesting that the court viewed the other (first) element above as also not being met (the requirement that Albert receive full consideration for his transfer). What transfer?? His wife contributed to the LLC, which created a capital interest in the LLC to her credit, which in effect diluted Albert's ownership in the LLC. However, ignoring the form of the transaction and focusing instead on the substance, Albert in effect "transferred" a large interest in his LLC to his wife for her contribution of $140,000. But he did not receive the $140,000, instead that $140,000 went into the LLC. The court therefore viewed such "transfer" as one in which Albert received no consideration (only the LLC received consideration). Both tiers of the two part test above were therefore not met.
Bottom line, when it appears the motives for a transaction are to hinder a creditor, and the natural result of the transaction does in fact devalue the debtor's available assets, be prepared to have a court determine there is a fraudulent transfer, and thereby allow a creditor to seize the assets.
Query here as well, if Albert's wife had kept her $140,000 to herself instead of contributing it to the LLC, which thereby made that $140,000 within the creditor's reach, did she in effect allow the creditor to recover much more than would have otherwise been available? That is not how fraudulent transfer law is supposed to work. Such laws are to prevent removing funds from a creditor's reach, not add to it. Did the court rule as it did more as a punishment for what it perceived as an attempted "pulling a fast one"?
Cites:
UBS Financial Services, Inc. v. Lacava, 2018 Ohio 3055, 2018 WL 3689450 (Ohio App., Aug. 2, 2018).
Interpool Ltd. v. Patterson, 890 F. Supp. 259 (S.D.N.Y 1995)
In re: Ashley Albright, 291 B.R. 538 (Bkrtcy.D.Colo. 2003)
Olmstead v. FTC, 44 So. 3d 76 (Fla. 2010)
*The information in this article is provided for general informational purposes only, and may not reflect the current law in your jurisdiction. No information contained in this post should be construed as legal advice from Greenspoon Marder LLP or the individual author(s), nor is it intended to be a substitute for legal counsel on any subject matter. No reader of this post should act or refrain from acting on the basis of any information included in, or accessible through, this Post without seeking the appropriate legal or other professional advice on the particular facts and circumstances at issue from a lawyer licensed in the recipient's state, country or other appropriate licensing jurisdiction.