Document Type
Research Memorandum
Publication Date
2014
Abstract
(Excerpt)
One of the main purposes of bankruptcy is to maximize the value of the bankruptcy estate for the benefit of creditors. Consistent with this goal of maximizing the value of a bankrupt estate, a bankruptcy trustee has certain “avoidance powers” that are codified in chapter 5 of the Bankruptcy Code. These broad powers allow the trustee to file adversary proceedings to avoid certain pre- and post-petition transfers of property of the debtor. After a trustee avoids a transfer, the “transferred property is returned to the estate for the benefit of all persons who have presented valid claims.”
One common avoidance power is the trustee’s power to avoid certain pre-petition transfers of property by the debtor to a third party as a fraudulent transfers. Fraudulent transfers may be avoided under federal law, section 548 of the Bankruptcy Code, or under state law according to section 544(b) of the Bankruptcy Code. Under section 548, the trustee may avoid both an actually fraudulent transfer (i.e., a transfer of property of the debtor made with the actual intent to hinder, delay, or defraud creditors) and a constructively fraudulent transfer (i.e., a transfer of property made by an insolvent company in exchange for less than reasonably equivalent value). Under section 544(b), the trustee may avoid any transfer that an actual unsecured creditor could have avoided under applicable state law, which in most states is the Uniform Fraudulent Transfer Act (the “UFTA”) (though in some states it is Uniform Fraudulent Conveyances Act (the “UFCA”)). As a result, the trustee may also be able avoid both types of fraudulent transfers under section 544(b) because the UFTA permits (1) any creditor that was in existence at the time of the subject transfer to avoid a constructively fraudulent transfer and (2) any existing or future creditor to avoid an actually fraudulent transfer.
An essential element in a trustee’s avoidance powers is ability to avoid a “transfer of property made by the debtor.” If there is not a transfer of property from the debtor, but from a different source, then a trustee may not be able to avoid a particular transfer. For this reason, a transfer of property being held in trust cannot constitute a fraudulent transfer because when property is being held in trust, it is for the benefit of another – never entering the holder of the trust’s bankrupt estate.
Recently, in In re Dayton Title Agency, Inc., a trustee sued a paid-off lender to avoid the payment made to the lender on behalf of the debtor’s client as a fraudulent transfer. The Sixth Circuit Court of Appeals held in that a transfer of funds from a trust account to the lender was constructively fraudulent because the elements of the UFTA were met. This Article will examine whether a trustee can avoid a transfer from a debtor’s trust account as a fraudulent transfer and is separated into four parts. Part 1 discusses the basic tenets of fraudulent conveyance law under sections 544(b) and 548 of the Bankruptcy Code, while Part I(a) analyzes why funds held in trust are not subject to fraudulent transfer law. Part II discusses the holdings by the Dayton Title court in Ohio, and the Cannon court in Tennessee. Part III illustrates why Dayton and Cannon are distinguishable cases, and the Conclusion discusses implications of the Dayton court’s holding.