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All the Best Intentions: Inadvertent Voidable Transactions

by Kenneth Katz | Oct 7, 2018 | Judgments

Most claims for voidable transactions fall under what’s known as constructive fraud. In a constructive fraud, a debtor or third party can be held liable for fraudulent conduct even though the offending party did not intend to defraud the creditor. This typically occurs when a debtor transfers property to an “insider,” or to any third party without receiving reasonably equivalent value in return. One common example occurs when a corporate debtor loans money to one of its shareholders while owing a debt to a creditor. The transfer may include property, cash, the hard assets of a business, trademarks, or any other property that can be transferred between two or more entities, between two or more people, or between people and entities.

There are various statutes creditors can use to seek relief for a constructive fraud, which operate similarly but which can provide for different remedies. If a creditor prevails against a third party on a claim for a constructive fraud, one common remedy used by courts is to direct that the third party return the fraudulently conveyed property to the debtor. For example, if a debtor owned a house and transferred the deed to her spouse, the court may order that the deed be put back in the debtor’s name, which would then allow the creditor to foreclose on the house and recover proceeds from the sale of the property.

Sometimes, the fraudulently conveyed property is moved and there is no practical way to reverse the transfer. In that case, the court can issue a judgment against the third party for the value of the transfer, up to the amount owed under the judgment. Using the previous example, if the debtor transfers the house to her spouse, the court could assess the value of the house and issue a judgment in favor of the creditor and against the spouse for that amount. In certain circumstances, the court can actually issue restraining orders prohibiting any future transfers of the property (if the creditor can present evidence that this is a serious risk).

In many situations, fraudulent transfers are no different than non-fraudulent transfers, except that the transferor happens to be a judgment debtor. Situations often arise in which business owners make decisions and transfer assets as they have done for many years, without issue, but the business has now become susceptible to a claim for voidable transaction by constructive fraud because the business was sued and/or a judgment has been entered against it. Essentially, normal business activities may become frauds once a lawsuit is filed or a judgment is entered, including:

transferring or distributing assets;
distributing money to family members;
distributing monies to members or shareholders; and
compensating members or shareholders with a monthly draw rather than a salary.

Each of the above actions may be considered a voidable transaction to the owner(s) or member(s) of a company, or their families, which could leave such individuals open to liability.

In our following article series, we will explore different topics that relate to fraudulent conveyances. Concepts like: