Are Actual Fraudulent Transfer Judgments Dischargeable In Bankruptcy?

While bankruptcy proceedings generally allow individuals an opportunity to discharge many different liabilities, there are some classes of liabilities—such as those involving fraud—that are not dischargeable in bankruptcy.  The Bankruptcy Code (“Code”) prohibits the discharge of “any debt . . . for money, property, [or] services . . . to the extent obtained by . . . false pretenses, a false representation, or actual fraud.”  11 U.S.C. § 532(a)(2)(A).  The Code does not clarify whether fraudulent transfer judgments are included in the definition of “false pretenses,” “false representation” or “actual fraud.”  However, the Supreme Court recently explained that fraudulent transfers made with wrongful intent constitute “actual fraud,” thereby prohibiting discharge in bankruptcy.  Husky International Electronics, Inc. v. Ritz, 136 S. Ct. 1581, 1586 (2016).

Some classes of liabilities are not dischargeable in bankruptcy proceedings, such as those that include fraudulent transfer judgments (actual fraud).

What Is An Fraudulent Transfer?

A fraudulent transfer is generally defined as “a transfer made or obligation incurred by a debtor if made with actual intent to hinder, delay or defraud any creditor of the debtor” or a transfer made “without receiving a reasonably equivalent value in exchange for the transfer or obligation.”  Fla. Stat. § 726.105(1)(a)-(b).  The hallmarks of fraudulent transfers are “a transfer to a close relative, a secret transfer, a transfer of title without transfer of possession, or grossly inadequate consideration.”  BFP v. Resolution Trust Corp., 511 U.S. 531, 540-41(1994).

Legal systems have struggled to balance an individual’s right to govern their own finances with a debtor’s right to collect what is due since at least 1571, when the Statute of 13 Elizabeth was enacted in England.  13 Eliz. Ch. 5 (1571).  In that Statute, “Parliament made it fraudulent to hide assets from creditors by giving them to one’s family, friends, or associates.”  Husky Int’l Elecs., 136 S. Ct. at 1587.  Since then, the majority of states, including Florida, have adopted the Uniform Fraudulent Transfer Act (UFTA) that incorporates many of the same principles.  See Fla. Stat. §§ 726.105-06.

Actual And Constructive Fraud

Florida’s version of the UFTA (“FUFTA”) addresses two distinct categories (or types) of fraudulent transfers. The first type is an “actual” fraudulent transfer, which focuses on the transferor’s intent to delay, defraud or hinder creditors (Fla. Stat. § 726.105(a)), whereas the second type is a “constructive” fraudulent transfer, which focuses—not on the transferor’s intent—but rather, the economic effects of the transaction (Fla. Stat. §§ 726.105(1)(b); 726.106(1) and 726.106(2)).

Badges Of Fraud

Under UFTA, in determining whether one possesses specific intent to engage in an actual fraudulent transfer, a reviewing court may consider whether one or more “badges of fraud” exist—namely, whether:

  • The transfer or obligation was to an insider;
  • The debtor retained possession or control of the property transferred after the transfer;
  • The transfer or obligation was disclosed or concealed;
  • The debtor retained possession or control of the property transferred after the transfer;
  • The transfer or obligation was disclosed or concealed;
  • Before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit;
  • The transfer was of substantially all the debtor’s assets;
  • The debtor absconded;
  • The debtor removed or concealed assets;
  • The value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred;
  • The debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred;
  • The transfer occurred shortly before or shortly after a substantial debt was incurred; and
  • The debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.

Fla. Stat. § 726.105(2).  While none of these factors are dispositive, the presence of multiple factors may support a finding that a transfer constitutes an actual fraudulent transfer.  In re Miami General Hospital, Inc., 124 B.R. 383, 392 (Bankr. S.D. Fla. 1991).  In the cases of constructive fraudulent transfers, the term “fraud” is very much a misnomer, in that constructive fraudulent transfers may be found where there is no specific intent to defraud a creditor.  Without the actual intent to hinder, delay or defraud a creditor, the question remains as to whether a constructive fraud is deemed a non-dischargeable “actual fraud,” as defined under the Bankruptcy Code.

Husky: The Supreme Court Weighs In

In Husky, the Supreme Court was faced with a Circuit split regarding the issue of whether the term “actual fraud” as used in § 523(a)(2)(A) of the Bankruptcy Code included fraudulent transfers.  Husky International Electronics, Inc., 136 S. Ct. at 1585.  There, the Court reviewed “a transfer scheme designed to hinder the collection of debt.”  Id. at 1586.

Husky International Electronics, Incorporated (“Husky”) manufactured components for electrical devices.  Id. at 1585.  Between 2003 and 2007, Husky sold its products to Chrysalis Manufacturing Corporation (“Chrysalis”) and “Chrysalis incurred a debt to Husky of $163,999.38.”  Id.  Daniel Ritz financially controlled Chrysalis and did not pay its debts as they became due.  Id.

Husky sought to pierce the corporate veil and hold Ritz personally liable for Chrysalis’ debts.  Id.  Ritz later filed for bankruptcy and Husky objected to the discharge of Ritz’s debt under 11 U.S.C. §§ 523(a)(2)(A), 523(a)(4), and 523(a)(6).  In re Ritz, 787 F. 3d at 315.

Fraudulent Transfer Judgments Under 11 U.S.C. § 523(a)(2)(A)

Section 523(a)(2)(A) excepts from discharge “any debt . . . for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by . . . false pretenses, a false representation, or actual fraud.”

Writing for the majority, Justice Sotomayor explained that the term “actual fraud” encompasses “anything that counts as ‘fraud’ and is done with wrongful intent. . . .”  Id.  The Court further held that “[t]he term ‘actual fraud’ in § 523(a)(2)(A) encompasses forms of fraud, like fraudulent conveyance schemes, that can be effected without a false representation.”  Id. at 1586.  This broad reading, she explained, is in line with the historical treatment of fraudulent transfers.  Id. at 1587.

Legislative History

In support for its decision, the Court looked to the legislative history of the Bankruptcy Code.  In 1978, Congress added the term “actual fraud” to the list of acts (“false pretenses or false representations”) that prohibit the discharge of a debt in bankruptcy.  Id. at 1584.  The majority explained that by reason of the additional language, Congress “did not intend the term ‘actual fraud to mean the same thing as the already-existing term ‘false representation.’”  Id.  Post-Husky, a misrepresentation is not required for a fraudulent transfer to rise to the level of “actual fraud.”

Dissent

The lone dissent, authored by Justice Thomas, took issue with the broad reading of section 523(a)(2)(A).  In his view, “‘actual fraud’ . . . does not encompass fraudulent transfer schemes.”  Id. at 1590 (Thomas, J., dissenting).  Under this reading, section 523(a)(2)(A) only applies when “fraudulent conduct occurs at the inception of the debt. . . .” Id. (Thomas, J., dissenting).  The dissent emphasizes just how narrow the fraud exception to discharge should be applied.

Why Is Husky Important?

Husky is a deceptively narrow holding in that it states that misrepresentations are not required in all cases of actual fraud.  The Court declined, however, to clarify what actual fraud requires.  Further, there is scant analysis of what “obtained by” means.

One of the unresolved issues arising out of Husky is that badges of fraud may be used to prove actual fraud, however, many of those badges may have nothing to do with the transferor’s intent.  On the other hand, a finding of actual fraud may imply actual intent to delay or defraud creditors.  The two concepts, actual fraud and actual intent fraud, are separate.  In a given case, there may be enough badges of fraud to indicate actual intent fraud but actual fraud is still alive and well under the common law.

Subsequent Proceedings

While the Supreme Court provided guidance on the meaning of “actual fraud” as used in section 523(a)(2)(A), it did not specifically hold that Ritz defrauded Husky.  On remand, the Fifth Circuit remanded to the district court with instructions to remand to the bankruptcy court for further factual findings.  Husky International Electronics, Inc. v. Ritz, 832 F. 3d 560, 563 (5th Cir. 2016).  In doing so, the court agreed that Husky may be able to show that Ritz was liable to Husky.  Id.  Ultimately, the bankruptcy court granted Husky’s request for judgment of non-dischargeability of the debt that Chrysalis owed to Husky.  Husky Int’l Elecs., Inc. v. Ritz (In re Ritz), 567 B.R. 715 (Bankr. S.D. Tex. 2017).

Conclusion On Why Actual Fraudulent Transfer Judgments Are Not Dischargeable In Bankruptcy

While bankruptcy does allow an individual a fresh financial start in many respects, a claimant should not expect to evade creditors through fraudulent transfers—particularly if the purpose of the transfer was made with the intent to delay, hinder, or defraud creditors.  While it is not clear how broadly Husky will be interpreted by the bankruptcy courts, creditors should be aware that in certain circumstances, a fraudulent transfer may constitute “actual fraud” under the Bankruptcy Code, thus giving the creditor an opportunity to object to discharge.  Further, Husky may be a warning to debtors that efforts to avoid repaying an unsecured debt through an actual fraudulent transfer may result in a non-dischargeable debt in bankruptcy.


Authors:
Brandon C. Meadows, Esq.
Evan R. Reid, J.D. Candidate


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