Estate Planning: A Frequently Used, But Rarely Successful, Defense Against Fraudulent Transfer Claims

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A bridge too far (photo by Marilyn Swanson)

By: Donald L. Swanson

“Estate planning” is a frequently utilized, but rarely successful, defense against fraudulent transfer claims. Here’s why:

estate planning strategies that make perfect sense when everyone is solvent become cloaked with “badges of fraud” amid insolvency, demonstrating “actual intent to hinder, delay or defraud creditors.”

Estate planning to address financial defaults is usually a bridge too far.

A Fraudulent Transfer Example

Years ago, I’m involved in an estate planning case, where Husband and Wife participate in an estate plan designed for them and for Husband’s extended family. Husband’s parents had been highly-successful entrepreneurs, and their children stand to inherit lots of money upon death of the remaining parent, who is mentally incapacitated and in deteriorating physical health.

–Insolvency

This couple accumulated lots of debt over the years—way more than they could ever repay from current asserts and earnings. But creditors have been understanding, due to expectations of a large inheritance soon.

The estate planning strategy for the extended family and this couple, with all its complexity, has one obvious purpose and goal: to shield Husband’s inheritance from his creditors and to protect the extended family against fallout from actions Husband’s creditors might take.

–Difficulty

Here’s what’s difficult for attorneys involved in this planning effort: the estate planning strategy, (i) makes perfect sense when all siblings are solvent, but (ii) is filled with badges of fraud because of Husband’s insolvency.

When the remaining parent dies, the situation becomes frustrating for everyone involved. Here’s how:

  • Husband’s creditors are being stiffed and see actual intent to defraud in everything that’s happened—so they fight back hard;
  • Estate planning attorneys see perfect legalities and perfect sense in everything they’ve done and can’t imagine anyone could question the propriety of what they’ve done;
  • The extended family is perplexed by all the fuss, perceiving themselves as good guys in a tough situation, and they are frustrated and angry with Husband and his spouse (and their creditors) for problems the extended family now faces; and
  • Husband and wife are shocked at how understanding creditors can turn on them so fast and hard — they become troubled about mounting legal fees and prospects of a bankruptcy filing, and they are mortified and heartbroken when their creditors, ultimately, prevail against them.

An Estate Planning Pushback

I saw recently that a group of estate planners is pushing-back against the Uniform Voidable Transactions Act (“UVTA”) that’s being proposed as an updated version of the Uniform Fraudulent Transfers Act.

The group’s opposition is not to the new language of the proposed statute. Instead, its to new language in the Official Comments.

Their concern is that new Comments language will create greater uncertainties and liabilities in estate planning contexts. Here are two examples of concerns they express . . . and of simple, countering responses.

–First Example

New language (in Comment 9 to Sec. 4 of the UVTA—see second paragraph) cites and discusses Judge Learned Hand’s 1927 proposition of law like this:

A transaction that does not place an asset entirely beyond the reach of creditors may nevertheless “hinder, delay, or defraud” creditors if it makes the asset more difficult for creditors to reach. Simple exchange by a debtor of an asset for a less liquid asset, or disposition of liquid assets while retaining illiquid assets, may be voidable for that reason.

The estate planning group objects to this new language. They offer an illustration of estate planning actions, taken by a hypothetical individual in years 2012 and 2016, followed by a 2018 automobile accident that renders the individual insolvent. They then hypothesize that, under the above quoted language, the hypothetical actions might “possibly” be avoidable for “actual intent to hinder, delay or defraud” the accident victim.

A question in response is this: “How could the hypothetically-solvent individual have intended to ‘hinder, delay or defraud’ the accident victim, when the accident would not occur until years later?” The answer is this: “He/She couldn’t.”

Judge Learned Hand’s 1927 proposition on this point was fundamentally sound when he articulated it—and the proposition has become settled law in the intervening nine decades. Citing and describing it in the Official Comments of the UVTA is fundamentally sound as well.

–Second Example

New language (also in Comment 9 to Sec. 4—see fifth paragraph) provides this contrasting example:

If “entrepreneurs organize a business as a limited liability company, contributing assets to capitalize it, in the ordinary situation in which none of the owners has particular reason to anticipate personal liability or financial distress, . . . the owners’ transfers of assets to capitalize the LLC is not voidable” under the UVTA; but

By contrast, if the same entrepreneurs were to do the same thing “when the clouds of personal liability or financial distress have gathered over some of them, and with the intention of gaining the benefit” of a “creditor-thwarting” statute, such transfers “should be voidable” under the UFTA,

The estate planning group objects to this contrasting example, based on perceived ambiguities in the phrases “ordinary situation” and “financial distress.”

A few propositions in response are:

  • There is nothing new or unusual or startling in this contrasting Comment example;
  • The phrases “ordinary situation” and “financial distress” provide greater precision than the phrase “actual intent to hinder, delay or defraud,” standing alone; and
  • The contrasting Comment example provides greater guidance and understanding on what can and cannot be done in estate planning efforts than would exist without them.

Conclusion

“Estate planning” has always been, and will continue to be, a frequently utilized, but rarely successful, defense against fraudulent transfer claims.

** If you find this article of value, please feel free to share. If you’d like to discuss, let me know.

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