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 proof of certain specified facts conclusively establishes that transfer is fraudulent ◦ irrespective of DR’s actual subjective intention  strict liability.

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Presentation on theme: " proof of certain specified facts conclusively establishes that transfer is fraudulent ◦ irrespective of DR’s actual subjective intention  strict liability."— Presentation transcript:


2  proof of certain specified facts conclusively establishes that transfer is fraudulent ◦ irrespective of DR’s actual subjective intention  strict liability -- redress inherent creditor injury

3  1) useful surrogate for actual fraud  2) some transfers by their very nature injure creditors of the debtor  focus of constructive fraud  on the victims – the creditors – rather than on Dr

4  2 parts:  1) lack of “reasonably equivalent value” ◦ Or “fair consideration” UFCA PLUS  2) sign of financial distress: ◦ A) insolvent or rendered insolvent *MOST important ◦ B) unreasonably small capital ◦ C) incur debts beyond ability to pay as mature

5 “be just before you are generous”

6  Constructive fraud?  (1) – debtor (Generation) was insolvent at time it sold the customer lists  (2) was sale to McGraw-Hill for “reasonably equivalent value”? ◦ Sold for $150K, not know value – but originally asked for $500K

7  If were under UFCA (i.e., in New York), the value comparison prong is “fair consideration”  Defined as 2 facets: ◦ Fair equivalent and ◦ Good faith – meaning of the transferee (e.g., McGraw- Hill)  So if were a UFCA case, EVEN IF said the value was equivalent, if find that transferee not in good faith, find ≠ “ fair consideration ”

8  Constructive fraud?  Again, Farmer Jones was insolvent  However, transfer of mortgages to brother- in-law Dean was for reasonably equivalent value, b/c made the mortgage transfer in exchange for a loan (Dean “took up” Jones’ defaulted & forged bank notes) ◦ Caveat - might not be “fair” consideration UFCA

9  Facts: ◦ Debtor owes 10 creditors $50K; in default on 7 debts ◦ Five creditors bring lawsuits against the Debtor ◦ Debtor’s only nonexempt asset is a valuable painting she inherited from her father, worth $40K ◦ Debtor sells the painting to Art Mann, a wealthy collector, for $38K ◦ Art Mann knows nothing of Debtor’s financial situation ◦ Debtor deposits the cash in her bank, wire transfers the money to a Swiss bank, and disappears ◦ Two months later, an involuntary chapter 7 order for relief is entered against Debtor

10  Dr insolvent? ◦ YES – debts = 50, assets = 40  Less than “reasonably equivalent value”? ◦ NO ◦ Art paid 38, that is “reasonably equivalent” tp the painting’s value of 40 ◦ SO – NOT avoid as constructive fraud

11  Same facts, but sell painting for $20K, not $38K, and is worth $40K  Now IS constructive fraud: ◦ Insolvent, yes, 50 v 40 {indeed, is even worse, b/c is “rendered” even more insolvent – after sale, has only 20 in assets (cash) vs 50 in debts} ◦ Less than Reasonably equivalent value?, Yes, 40 v 20

12  Sells for $38K to Mom  Under Bk Code and UFTA, NOT constructive fraud, b/c = REV (40 v 38)  Under UFCA, possible is = constructive fraud, b/c not “fair consideration” – require fair equivalent in value (ok, 40 v 38) AND “good faith” of transferee (Mom) – whose good faith might be called into question

13  Gives painting to Mom  Obviously = constructive fraud  1) insolvent  2) no REV – a gift

14  Donate to Art Institute  Constructive fraud -- yes  1) insolvent - yes  2) no REV – yes, gift  What about safe harbor for charitable contributions in 548(a)(2), which applies to constructive fraud under 548(a)(1)(B)? Art Institute is a qualifying charity, 548(d)(4) But safe harbor n/a -- transfer must be cash or a financial instrument, 548(d)(3)(B) – not a painting!

15  Facts of Durrett – mortgage sold at foreclosure for $115K, allegedly worth $200K, while Dr insolvent, within one-year reachback period (now is 2 years)  Issue- was foreclosure for 115 “REV” to estimated value of 200? ◦ Policy – foreclosure deprived estate of $85K  5 th Circuit, 1980,held NOT REV and thus = constructive fraud

16  Before Durrett, no one had thought to set aside a mortgage foreclosure as FT ◦ Instead, only challenge under mortgage law – if price so low as to “shock the conscience” ◦ Threw real estate law, & security of land titles, into shock

17  Some debated issues: ◦ 1) does foreclosure even qualify as transfer? Argued not:  A) involuntary by DR  B) the “transfer” made back when mortgage granted & recorded, not when mortgage foreclosed ◦ 2) presumptively valid if follow state procedures?  A) rebuttable presumption is ok – but can still look at value  B) conclusive validity if follow state procedures – UFTA 3(b) “a person gives a reasonably equivalent value if the person acquires an interest of the debtor in an asset pursuant to a regularly conducted, noncollusive foreclosure sale” - 1984

18  1) Congress amended Bk Code -> FT does include involuntary transfers – including foreclosures:  548(a)(1) -- “if the debtor voluntarily or involuntarily-”  101(54) dfn “transfer”: “means – … (C) the foreclosure of a debtor's equity of redemption; or (D) each mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with (i) property; or (ii) an interest in property.  2) changes Congress did NOT make –>considered, but then did NOT adopt, provision ~ UFTA 3(b), which makes following regular procedures per se = REV

19  Facts: ◦ 1987: DR (BFP) borrow money from Imperial to buy house, grant Imperial deed of trust, recorded ◦ July 1989: foreclosure, for $433K (to Osborne) ◦ October 1989: Dr filed ch. 11 ◦ Dr as DIP sued to set aside under 548  Allege property worth $725K, thus not = REV

20  1) transfer of interest of Dr in property w/in one year* of bankruptcy [* now two years ] ◦ Court not dispute that 1984 amendment made the 1989 foreclosure the “transfer” – not 1987 original transfer of deed of trust & recordation  2) while Dr insolvent ◦ conceded  3) less than “reasonably equivalent value” ◦ DIP argued that 433 not REV to 725 ◦ Δ argue since followed state law process, per se = REV

21  foreclosure sale price must conclusively be deemed to constitute "reasonably equivalent value,“ if sale was noncollusive and regularly conducted in compliance with state law ◦ = ◦ i.e., irrebuttable presumption: whatever $ receive at proper foreclosure = REV  Value comparison of price received at foreclosure sale vs alleged FMV is irrelevant

22  1) Value comparison meaningless in foreclosure context ◦ “simply worth less” ◦ “very antithesis” ≠  2) federalism ◦ Security of land titles ◦ “ancient harmony” … “400 years of peaceful coexistence”

23  1 st – effect of decision is to immunize mortgage foreclosures from attack as a fraudulent transfer, which is directly at odds with what Congress did in 1984 amendments

24  2 nd, “ordinary speaker of English” – “Reasonably equivalent value” mandates a value comparison between something ◦ But under majority view isn’t a question even worth asking, b/c will always be satisfied

25  Policy: federal bankruptcy policy – maximize estate  Net effect of decision is to cause estate to lose $292K in value

26  In constructive fraud cases, the decisive issue often is whether the Dr received less than “reasonably equivalent value” in exchange for the transfer  Assuming can prove the requisite financial distress, typically that Dr = insolvent

27  Why does the value issue matter?  Because if Dr was insolvent, and transferred assets and got less back, her crs are worse off – recoverable asset pool depleted  good  bad transfer Creditors

28  Often said that value must be measured from the perspective of the creditors of the Dr, not from the Dr's perspective ◦ E.g., Comment to UFTA: "'Value' is to be determined in light of the purpose of the Act to protect a debtor's estate from being depleted to the prejudice of the debtor's unsecured creditors. Consideration having no utility from a creditor's viewpoint does not satisfy the statutory definition.”

29  Thus, REV for FT purposes is not the same as “consideration” for K law purposes  Hypo: ◦ Sell Blackacre (worth $100K) to Fred for $40K ◦ Would = “consideration” under K law ◦ But ≠ “REV” for fraudulent transfer law  transfer drains $60K out of the Dr’s asset pool

30  Must be careful not to view “REV” as a pure “how deep is the pool before vs after” Q  Hypo: ◦ Dr has $1000 in cash, only asset, and $20K debts ◦ Dr goes to opening day for Cubs, pays $100 for ticket ◦ Now has only $900 left – Crs are worse off, right?  so, is the purchase of the Cubs ticket a constructively fraudulent transfer?

31  Except from the point of view of St. Louis Cardinals fans, Dr got “value” when bought Cubs ticket ◦ Even though depleted her recoverable asset pool  Why? The ticket conveyed the right to attend the baseball game – a fair market transaction ◦ Can see this from fact Dr could have resold the ticket (e.g., StubHub) instead of actually going to the “friendly confines”

32  For same reason, would be “value” for FT purposes if DR ate dinner at a fancy restaurant (comparison court used in Chomakos) – even though after dinner Dr had fewer leviable assets ◦  Dr has to pay for dinner!  A present debt that must be satisfied, = “value”

33  Can justify the consumption cases as not violating the rights of creditors and as obtaining a “REV” for Dr’s transfer if insist on compliance with an objective market determinant of value  If Creditors worry that Dr is “consuming” too much (e.g., too many Cubs games, too many fancy dinners), the recourse is for Crs to commence an involuntary bk case – strip Dr of power to decide how to deploy her assets

34  Series of cases in 1990s (prior to 1998) raised issue of whether = FT for insolvent Dr to tithe to his church in year before bk  Only question was whether the donations to church were for “REV” ◦ If not, then indisputably = FT  What arguments on value issue in church cases? * is this the same as going to Cubs game or not?

35  Specific result in charitable contribution cases was changed in 1998 when Congress created a safe harbor for charitable contributions ◦ Not change the theory in FT law, just a political deal  Limits: ◦ Only if constructive fraud ◦ Up to 15% dr’s income ◦ Note must be cash or financial instrument

36  Before filed bankruptcy, George & Nikki Chomakos gambled a lot at the Flamingo Hilton  Net, came up $7,710 in the hole  Were insolvent the whole time  Trustee sought to recover the losses as constructively fraudulent ◦ Insolvent -- conceded ◦ No “REV” – this is the issue

37  Lost more than they won, which hurt Crs  House advantage – casino bound to win over time – odds are stacked  If church loses, surely casino must too! vs

38  Have to measure at the time of the transfer, when the bet is made – BEFORE the outcome of the bet is determined  Here, there was a mathematical chance would come up as 24

39  Remember our discussion of the valuation fallacy, using the shell game  Dr placed a $3 bet on the pea being under shell # 1 – if wins, gets $9 (i.e., no house advantage)  When placed bet, had a 1/3 chance of being right  So ex ante, value of chance = 1/3 x $9 = $3  For FT, argue got exact value in exchange for $3 bet

40  In prior hypo, what if shell entrepreneur would only pay $3.33 on a winning $3 bet?  Now of course value Dr receives ex ante = 1/3 x $3.33 = $1.11  Which arguably is not “reasonably equivalent” to the $3 bet the Dr placed

41  assume Dr has debts of $12K, assets of $10K ◦ i.e, is insolvent  Dr risks her entire $10K on a 50-50 bet (a flip of a coin)  payoff if the Debtor wins is $20,000 (i.e., no house advantage). Of course, if she loses the bet, the payoff is zero.  Question: calculate the projected payout – before the coin is flipped -- from the perspective of (i) Creditors and (ii) Debtor.

42  Value of bet -> Perspective of Creditors:.5 (12) +.5 (0) = 6 [win–pay in full] + [lose – get nothing] * If no bet, Crs get 10 (i.e., all Dr’s assets)  Value of bet –> Perspective of D.5 (8) +.5 (0) = 4 * If no bet, Dr gets nothing (insolvent, Crs get everything)

43  From perspective of Creditor group, then, this is a bad bet – even though the Dr had a 50-50 chance, and even though there were no house odds – the payoff to the Creditors was way less than the value transferred  The reason is that the Creditors enjoy little of the upside from a winning bet (only 2 grand), and all of the downside from a losing bet  in short, the Dr is gambling entirely with the Crs’ money! Dr gets all the upside, no downside

44  The risk/reward calculus for insolvent or almost insolvent Drs has led to a perception of the proper role of FT law as a means of regulating Drs from taking excessive risk when fall into or would become insolvent  Do we want Dr who has become insolvent to be able to bet all of their assets on # 24?

45  compare gambling as “value” to: Cubs Dinner Church donation

46  Are there any limits on the “it was fun for me” theory of value?  What if DR’s favorite form of entertainment, from which he derived unspeakable joy, was to light his money on fire and watch it burn? ◦ assume this Dr was insolvent

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