By: Donald L Swanson
“The trustee may avoid . . . any obligation . . . incurred by the debtor, that was made or incurred“ with actual fraudulent intent or as constructive fraud.
–From § 548 of Bankruptcy Code (emphasis added).
Similar language is contained in the Uniform Voidable Transactions Act—and in its predecessor acts—for 100+ years. [Fn. 1]
But actions to avoid debts as fraudulent transfers are rare—and largely unknown, it seems.
A Bad Experience
I remember, many years ago, appearing in a far-away bankruptcy court for the first time. I’m representing, back then, a group of unsecured creditors in a Chapter 11 that has a large insider debt claim supported by a blanket first-lien.
In my first filing, I assert that the insider debt claim is avoidable as a fraudulent transfer (both actual and constructive) under both § 548 of the Bankruptcy Code and the home state’s Uniform Fraudulent Transfer Act.
At the first hearing, I’m making my pitch, and the Judge’s frown is turning to a scowl. He finally barks this interruption:
- “You can’t avoid a debt as a fraudulent transfer!!”
I remember being stunned by that and thinking: “Ruh-roh . . . this isn’t going well.”
The truly irritating thing about that event is this: I’m right! The statutes, both federal and state, declare—in clear and unmistakable language—that I’m right. But the judge won’t listen and shoots me down.
A 2022 Opinion
A 2022 bankruptcy court opinion agrees with me—it avoids a debt claim as a fraudulent transfer. The opinion is Kartzman v. Latoc, Inc. (In re The Mall at the Galaxy, Inc.), Adv. Pro. No. 12-1769, New Jersey Bankruptcy Court (Doc. 197, issued April 29, 2022).
Here’s what happens.
–Trustee’s Avoidance Claim
The Trustee seeks to avoid, (i) a $2 million promissory note obligation between Latoc as lender and Debtor as borrower, and (ii) Debtor’s $592,875.03 pre-petition payment on that obligation. Trustee argues:
- Debtor did not receive reasonably equivalent value for the $2 million promissory note obligation or for Debtor’s $592,875.03 pre-petition repayment; and
- both the promissory note obligation and the repayment are avoidable as constructively fraudulent transfers, under both state and bankruptcy laws.
–Bankruptcy Court Ruling
The Bankruptcy Court agrees with Trustee:
- finding that the Latoc loan proceeds, upon receipt by Debtor, were immediately transferred to an unrelated entity, with no prospect of being returned to Debtor;
- finding, as a result, that Debtor did not receive reasonably equivalent value for either the promissory note obligation or the pre-petition repayment;
- avoiding both the promissory note obligation and the repayment as constructively fraudulent transfers, under both state and federal laws; and
- entering judgment in favor of Trustee and against Latoc—avoiding the promissory note obligation, for recovery of $592,875.03 plus interest, and disallowing Latoc’s Proof of Claim “unless and until the full judgment amount, including . . . interest, is paid to the Trustee.”
The Bankruptcy Court’s ruling is, of course, on appeal. The appeal is still pending.
So . . . there we have it.
Debt obligations can be avoided as fraudulent transfers, under both § 548 of the Bankruptcy Code and under similar state laws, such as the Uniform Voidable Transactions Act and its predecessor, the Uniform Fraudulent Transfer Act.
Footnote 1. Similar language began in the Uniform Fraudulent Conveyance Act (promulgated around of the turn of the century—from 1800s to 1900s), remained substantively unchanged in the Uniform Fraudulent Transfer Act (promulgated in 1984), and continues with only cosmetic changes in the Uniform Voidable Transactions Act (promulgated in 2019).
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