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January 20, 2021

Fraudulent Conveyances

Has this happened to you? You sell a product to a company in New York State whose principal personally guarantees payment. The buyer fails to pay and has already sold your product to a third party. Your buyer has no assets when you try to collect. So you sue the buyer’s principal on the personal guarantee. Unfortunately, the principal has transferred his or her assets to a family member. 

But you may still be able to collect the debt because of the New York State Debtor-Creditor Law (NYDCL). The NYDCL provides that a “fraudulent conveyance” by the debtor can be reached by the creditor, meaning the creditor can “disregard the conveyance and attach or levy execution upon the property conveyed.” NYDCL §278 (1)(a).

What is a fraudulent conveyance?

A conveyance is defined as “includ[ing] every payment of money, assignment, release, transfer, lease, mortgage or pledge of tangible or intangible property, and also the creation of any lien or incumbrance.” NYDCL §270. But when is a conveyance fraudulent?

Under the NYDCL, there is intentional fraud and also presumptive fraud. Conveyances that are not for fair consideration are presumptively fraudulent—it is not necessary to prove an intent to defraud the creditor—when the conveyance is for less than fair consideration. “Every conveyance made and every obligation incurred by a person who is or will be thereby rendered insolvent is fraudulent as to creditors without regard to his actual intent if the conveyance is made or the obligation is incurred without a fair consideration.” NYDCL § 273.

The NYDCL says fair consideration is given for property or obligation when a) in exchange for the property or obligation as a fair equivalent for it, and in good faith, property is conveyed or an antecedent debt is satisfied or b) the property or obligation is received in good faith to secure a present advance or antecedent debt in an amount not disproportionately small compared with the value of the property or obligation obtained.

In short, if the conveyance is for significantly less than fair-market value, the conveyance is not for fair consideration. Fair market value is mostly an objective standard, whether real estate, hard goods, or intellectual property. If real estate that is assessed at $500,000 is deeded to a family member for $1, or if a truck with a blue book value of $30,000 is sold for $1,000, the transaction is not for fair consideration.

What about that part of NYDCL §273 that requires the debtor to be rendered insolvent as a result of the conveyance? NYDCL §271 explains that “[a] person is insolvent when the present fair salable value of his assets is less than the amount that will be required to pay his probable liability on his existing debts as they become absolute and matured.” This definition makes sense because, if the person has assets that are greater than the person’s debts, the debtor possesses assets against which the creditor can collect the amount owed. So if Bill Billionaire owes Jane Smith $10,000, and Bill Billionaire deeds a $500,000 property to a family member for $1, Mr. Billionaire still has $100 billion or so in loose change against which Jane Smith can collect the $10k he owes her. 

What is intent to defraud?

The reality is that conveyances for substantially less than fair consideration often occur because the person making the conveyance intends that the conveyance will thwart creditors. In our original example, the principal of your buyer who personally guaranteed the purchase and then conveyed property for less than fair consideration likely did so to stop you from collecting the debt against them personally. Maybe son or daughter now “owns” that Rembrandt after paying mom or dad 50 bucks for it.

Under NYDCL §276, “[e]very conveyance made and every obligation incurred with actual intent, as distinguished from intent presumed in law, to hinder, delay, or defraud either present or future creditors, is fraudulent as to both present and future creditors.” If there is actual intent to defraud creditors as a result of the conveyance, it is neither necessary to prove the conveyance was for less than fair consideration nor that the conveyance rendered the debtor insolvent. Obviously, however, these two elements will be indicia of actual intent to defraud. Bill Billionaire clearly wasn’t trying to hinder Jane Smith from collecting the $10k he owed her. On the other hand, when the principal of your buyer conveyed that Rembrandt, it was the only asset they had to pay the amount owed to you. The actual intent to defraud you is manifest by the timing of the conveyance and the impact of the conveyance on the principal’s net worth.

If the court concludes there has been actual intent to defraud, the court will award legal fees to the creditor. NYDCL §276-a. Depending on how much work the creditor’s lawyer has to do to chase down the debtor and reach the fraudulent conveyance, the creditor’s legal fees could be significant. But if the court does not conclude there is actual intent to defraud, no legal fees will be awarded. This is a glaring contrast between the US and Canadian legal systems. The winner does not automatically get their legal fees paid by the loser in US courts, absent a contract or statute that provides for when legal fees will be awarded, or in the rare case when the conduct is so egregious that punitive damages are awarded. The counseling point: make sure your contracts contain a legal fee provision.

What if money isn’t yet owed?

NYDCL §279 anticipates the possibility that the fraudulent conveyance has occurred before the creditor sent the invoice to the debtor. In this case, the person who received the fraudulent conveyance can be restrained by the court from disposing of the property. The statute provides where a conveyance made or obligation incurred is fraudulent as to a creditor whose claim has not matured, he may proceed in a court of competent jurisdiction against any person against whom he could have proceeded had his claim matured, and the court may:

  • Restrain the defendant from disposing of his property
  • Appoint a receiver to take charge of the property
  • Set aside the conveyance or annul the obligation
  • Make any order that the circumstances of the case may require

This is a very significant tool to employ. It can maintain the status quo until the court can sort it all out. 
 

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