US Attorneys > USAM > Title 4 > Civil Resource Manual
prev | next

57.

Avoidance Powers -- Strong-Arm Clause, Fraudulent Conveyances

A. "STRONG-ARM" CLAUSE [§ 544]

1. § 544(a)
a) Description: trustee has the power and status of a creditor, whether one exists or not, who:
(1) extends credit to the debtor at the time of commencement of the case and obtains a judicial lien on all the debtor's property; or
(2) extends credit to the debtor at the time of commencement of the case and obtains an execution which is returned unsatisfied; or
(3) becomes a bona fide purchaser of real property at the time of commencement of the case. Belisle v. Plunkett, 877 F.2d 512 (7th Cir.), cert. denied, 493 U.S. 893 (1989)(status as bona fide purchaser for value conferred by § 544(a)(3) permits trustee to recover for estate property otherwise subject to a constructive trust for the benefit of partners defrauded by debtor)
b) Application: the extent of a trustee's rights as a "perfect" lien creditor are measured by the substantive law (e.g., recording statutes; U.C.C.) of the jurisdiction governing the property in question. E.g., In re TMIC Indus. Cleaning Co., 19 B.R. 397 (Bankr. W.D. Mo. 1982); In re Ireland, 14 B.R. 849 (Bankr. D. La. 1981).
c) Limitation: courts generally do not permit a trustee to avail himself of the rights of a specially favored creditor (e.g., mechanic's lienholder). See generally 4 Collier On Bankruptcy ¶ 544.02 at 544-11 (15th ed. 1992)
d) Time Considerations:
(1) Unlike preferences and fraudulent conveyances, time restrictions are not imposed, i.e., transaction being challenged need not have occurred within any specified period prior to commencement of the case.
(2) Trustee's rights are determined as of date of filing; therefore, if a secured creditor perfects at any time prior to bankruptcy, his interest may not be attacked under § 544(a).
e) Procedure: To avoid security interest under § 544(a), debtor must file adversary proceeding; he cannot simply note his intent to avoid security interests within a plan. In re Commercial Western Finance Corp., 761 F.2d 1329 (9th Cir. 1985).
f) Examples
(1) Under applicable state law, rights of trustee, as a hypothetical judicial lien creditor holding an execution returned unsatisfied, held superior to rights of purchaser of debtors' house holding unregistered deed. In re Easterly, 18 B.R. 749 (Bankr. D. Tenn. 1982)
(2) Lender's unrecorded interest in sale and leaseback transaction held junior under Florida recording statutes to interest of bankruptcy trustee having status of bona fide purchaser and judicial lien holder. FNMA v. Westmoreland, 19 B.R. 130 (Bankr. N.D. Fla. 1981)
(3) Unperfected lien invalid as against bankruptcy trustee in his capacity as hypothetical lien creditor. In re O.P.M. Leasing Services, 23 B.R. 104 (Bankr. S.D.N.Y. 1982)
(4) Even where debtor had actual knowledge of a defective mortgage, that knowledge is not imputed to him as debtor in possession and he may still exercise all 544(a) powers. In re Matos, 13 C.B.C. 527 (N.D. Ala. 1985).
2. § 544(b)
a) Description: Trustee may avoid on behalf of the estate (1) any transfer of debtor's interest in property or (2) any obligation incurred by the debtor, that an actual creditor holding an allowed unsecured claim could avoid under applicable non-bankruptcy law.
b) Application: the rule of Moore v. Bay, 284 U.S. 4 (1931), i.e., "void as to one, void as to all," is preserved. (In Moore v. Bay, a chattel mortgage was successfully attacked with the trustee relying upon the rights of a creditor who extended credit during "gap" between prior extension of credit and perfection of security interest; Supreme Court held the mortgage was invalid as to not only the prior secured creditor but all creditors coming after the "gap" creditor in whose shoes the trustee stood. Thus, the trustee's recovery inured to the benefit of all unsecured creditors.) Thus, if one triggering creditor can be found, no matter how small his claim, trustee may avoid the entire transfer.
c) Examples
(1) Fraudulent conveyances occurring prior to one year before petition filed (and therefore not covered by § 548 fraudulent conveyance avoidance power) but within time period for recovery under state law. E.g., In re Davis, 138 B.R. 106 (Bankr. M.D. Fla. 1992)(debtor's transfer to daughter of reversionary interest in mortgage occurring more than one yar before petition date was avoidable as fraudulent conveyance under Florida law and section 544(b)); In re John Hatton, Inc., 104 Bankr. 705 (W.D. Pa. 1989)(change of beneficiary of life policy, occurring more than one year before petition, was voidable under Pennsylvania Fraudulent Conveyance Act and § 544(b)); In re Bethune, 18 B.R. 418 (Bankr. N.D. Ala. 1982) (state ten-year statute of limitations applicable in trustee's § 544(b) action to recover fraudulent transfer)
(2) A bulk sale of equipment and inventory made without compliance with notice provisions of Article 6 of U.C.C.
d) Who May Bring The Action?
(1) Nebraska State Bank v. Jones, 846 F.2d 477 (8th Cir. 1988) (creditor who possessed fraudulent conveyance action under non-bankruptcy law lacks standing to bring same action under § 544(b), unless authorized by court after trustee fails to act)
(2) Unisys Corp. v. Dataware Products, Inc., 848 F.2d 311 (1st Cir. 1988) (once trustee abandons § 544(b) claim, creditor with state law claim against transferee may then pursue claim)
e) Burden of Proof
Preponderance of the evidence test, not clear and convincing test. In re Lawler, 141 B.R. 425 (BAP 9th Cir. 1992); cf. Grogan v. Garner, 111 S.Ct. 654 (1991); In re Serafina, 938 F.2d 1156 (10th Cir. 1991).

B. FRAUDULENT CONVEYANCES [§ 548]

1. Description: The trustee may avoid transfers or obligations made or incurred by debtor within one year of filing:
a) If made with actual intent to hinder, delay or defraud creditors; or
b) If made for less than a reasonably equivalent value and:
(1) The debtor was insolvent or became insolvent as a result of the transaction;
(2) The debtor was engaged in business and the debtor's capital remaining after the transaction was unreasonably small for that business; or
(3) The debtor intended to incur debts beyond his ability to pay them as they matured.
2. Actual Fraudulent Intent [§ 548(a)(1)]
a) Elements: (1) transfer within one year of bankruptcy, and (2) actual intent to hinder, delay or defraud.
b) Burden of proof: actual intent to hinder, delay or defraud, a question of fact, must be proved by clear and convincing evidence. In re Metro Paper, Inc., 8 B.C.D. 1027 (Bankr. D.D.C. 1982)
c) Circumstantial evidence consisting of "badges of fraud" may "lead to irresistible conclusion that transferor's conduct was motivated by [requisite actual] intent." 4 Collier On Bankruptcy ¶ 548.02[5] at 548-33 (15th ed. 1982). "Badges of fraud" include: (1) conveyance while suit is pending; (2) conveyance of all property; (3) retention of possession by debtor although title transferred to another; (4) inadequacy of consideration; (5) transfer to family member or related business entity. See, e.g., Twyne's Case, 3 Coke Rep. 80b, 76 Eng. Rep. 809 (1601) (conveyance of all property to one of two creditors with debtor remaining in possession held fraudulent); In re Maxted, 107 Bankr. 289 (D. Mont. 1989) (transfer of real property, within one year of bankruptcy, to ex-son-in-law and current wife for less than one third of value of property was fraudulent); In re Ozark Restaurant Equipment Co., Inc., 77 B.R. 686 (W.D. Ark. 1987) (low markups of equipment sold by debtor to corporation controlled by debtor's owner); In re Laughlin, 18 B.R. 778 (Bankr. W.D. Mo. 1982) (transfer for $1 of property worth $40,000 to debtor's son immediately after service of state court summons)
d) Proof of insolvency or inadequacy of consideration are not necessary but frequently are relevant in determining intent. See In re Vaniman International, Inc., 22 B.R. 166 (Bankr. E.D.N.Y. 1982) [insolvency unnecessary under § 548(a)(1)]
3. Constructive Fraudulent Intent [§ 548(a)(2)]
a) Element One: transfer within one year of bankruptcy
b) Element Two: made for less than reasonable equivalent value
(1) "Value" means "property, or satisfaction or securing of a present or antecedent debt of the debtor, but does not include an unperformed promise to furnish support" to debtor or debtor's relatives. [§ 548(d)(2)(A)] See Bustamonte v. Johnson, 934 F.2d 662 (5th Cir. 1991)($101,000 down payment was not REV for $600,000 in liquidated damages received by purported purchaser from seller in failed transaction). Compare In re Linen Warehouse, Inc., 100 B.R. 856 (Bankr. W.D. Tx. 1989) (FDIC found to be good-faith purchaser for value of assets acquired from bank's receiver and, thus, not subject to § 548 attack) with In re Still, 124 B.R. 24 (N.D. Tx. 1991), aff'd, 963 F.2d 75 (5th Cir. 1992).
(2) Value is determined as of the date of transfer; subsequent appreciation or depreciation is irrelevant. E.g., In re Appomattox Agri-Service, Inc., 6 B.C.D. 1239 (Bankr. W.D. Va. 1980)
(3) Business "good will" may constitute reasonable equivalent value. In re J.K. Chemicals, Inc., 7 B.R. 897 (Bankr. D.R.I. 1981) (debtor maintained best customer's good will by permitting him to use debtor's excess warehouse space)
(4) "Reasonably equivalent value" is determined by market conditions facing willing seller and willing buyer, and not the exigencies facing the debtor-seller. In re Ozark Restaurant Equipment Co., 850 F.2d 342 (8th Cir. 1988)
(5) Foreclosure Sales
(a) Cases split on whether reasonable equivalent value test may be satisfied where property sold at regularly conducted public sale even though sale price insufficient in comparison to actual market value. Compare Durrett v. Washington Nat'l Ins. Co., 621 F.2d 201 (5th Cir. 1980)(so-called "bright line" test seemingly recognizing REV when 70% of value is bid); First Federal Sav. & Loan v. Standard Bldg. Assoc., 87 B.R. 221 (N.D. Ga. 1988) (non-judicial foreclosure sale did not provide "reasonably equivalent value" where sale price was less than 70% of fair market value); In re Madrid, 21 B.R. 424 (B.A.P. 9th Cir. 1982) (transfer made for 64-67% of market value); with In re BFP, 1992 WL 213193 (9th Cir. 1992)(price received at non-collusive, regularly conducted foreclosure sale irrebutably establishes REV); Grissom v. Johnson, 955 F.2d 1440 (11th Cir. 1992)(rejects "bright line" 70% test in favor of considering "all facts and circumstances"); Barrett v. Commonwealth Federal Savings & Loan Ass'n, 939 F.2d 20 (3rd Cir. 1991)(in determining whether proceeds of a sheriff's sale amount of "reasonably equivalent value," sale should be compared to "typical foreclosure sale," not "typical private sale"); In re Hulm, 738 F.2d 323 (8th Cir.), cert. denied, 469 U.S. 990 (1984)(rejecting "bright line" test for case-by-case analysis); In re Littleton, 888 F.2d 90 (11th Cir. 1989)(nonjudicial foreclosure sale which realized only 63.49% of fair market value of debtor's property would not be set aside as a fraudulent transfer); In re BFP, 1991 WL 237547 (9th Cir. BAP 1991) (price realized at a non-collusive and regularly conducted non-judicial foreclosure sale was, by definition, REV); In re Clark, 99 B.R. 955 (Bankr. W.D. Mo. 1989)(bid of 70% of value not REV); In re Smith, 21 B.R. 345 (Bankr. M.D. Fla. 1982) (sheriff's sale for $1,200 of homestead worth $19,000 set aside as fraudulent conveyance); In re Berge, 9 C.B.C. 53 (Bankr. W.D. Wis. 1983) (excellent discussion reviewing caselaw and finding foreclosure sale for 45% of market value to be a fraudulent conveyance). See collection of cases in In re Morris Communications NC, Inc., 914 F.2d 458 (4th Cir. 1990).
(b) Bundles v. Baker, 856 F.2d 815 (7th Cir. 1988)
(1) sale price at regularly conducted, non-collusive foreclosure sale cannot automatically be deemed to provide "reasonably equivalent value"
(2) court must examine the foreclosure transaction in its totality to determine if procedures were calculated not only to secure for the mortgagee the value of its interest but also to return to the debtor-mortgagor his equity
(3) court must consider such factors as whether there was a fair appraisal of the property, whether the property was advertised widely and whether competitive bidding was encouraged
(6) NOL Elections
 Gibson v. United States, 927 F.2d 413 (8th Cir. 1991)(trustee has power under § 548 and § 549 to avoid debtor's pre- and post-petition irrevocable elections to carry forward net operating losses which, if not utilized, might revert to debtor's personal benefit).
(7) Disclaimer Of Inheritance
 In re Atchinson, 925 F.2d 209 (7th Cir.), cert. denied, 112 S. Ct. 178 (1991)(debtor's disclaimer of inheritance was not a transfer of "an interest of the debtor in property" avoidable under § 548 where, under state law, valid disclaimer related back to testator's gift for all purposes, eliminating any interest beneficiary had in property disclaimed).
c) Element Three: one of the following:
(1) Transfer By Insolvent [§ 548(a)(2)(A)-(B)(i)]
(a) "insolvency" means balance sheet test of debts in excess of assets (less exempt property and fraudulently transferred property). See § 101(31); In re Ocean Line of North Florida, 137 B.R. 540 (Bankr. M.D. Fla. 1992); In re Duque Rodriguez, 77 B.R. 936 (Bankr. S.D. Fla. 1987) (transfer from debtor to his wife two days before bankruptcy held constructively fraudulent and therefore avoidable). In re Perdido Bay Country Club Estates, 23 B.R. 36 (Bankr. S.D. Fla. 1982).
(b) Actual creditor need not exist at time of transfer (change from old Act).
(2) Transfer By Debtor In Business Left With Insufficient Capital [§ 548(a)(2)(A)-(B)(ii)
(a) Section intended to prevent under-capitalized company from attracting unwary creditors to inevitable loss while one or more creditors are preferred and protected. Wells Fargo Bank v. Desert View Building Supplies, Inc., 475 F. Supp. 693, 696 (D. Nev. 1978), aff'd, 633 F.2d 225 (9th Cir. 1980).
(b) Debtor need not be rendered insolvent; proof of gross diminution in capital, lateness in paying bills, or other financial jeopardy may be sufficient. See Wells Fargo Bank, supra; N.Y. Credit Men's Adjustment Bureau v. Adler, 2 B.R. 752 (S.D.N.Y. 1980).
(3) Transfer By Debtor About To Incur Debts Exceeding His Ability To Pay [§ 548(a)(2)(A)-(B)(iii)]
(a) Chronological relationship between transfer and subsequently incurred debts is insufficient; must prove that transfer or obligation was contemporaneous with intent or belief that other creditors would be injured. See 4 Collier On Bankruptcy ¶ 548.05 at 548-50 (15th ed. 1982)
(b) Insolvency at time of transfer or obligation not required.
(c) Examples: Kingdom Uranium Corp. v. Vance, 269 F.2d 104 (10th Cir. 1959) (transfer of residence during trial of large tort claim against debtor); In re Process-Manz Press, Inc., 236 F. Supp. 333 (N.D. Ill. 1964), rev'd on other grounds, 369 F.2d 513 (7th Cir. 1966), cert. denied, 386 U.S. 957 (1967) (distribution of $2 million in working capital to stock holders by financially hard-pressed debtor).
4. Transfers By Debtor Partnership To General Partners With One Year Of Bankruptcy Are Voidable If Debtor Was Insolvent Or Rendered Insolvent [§ 548(b))
5. Rights And Liabilities Of Transferee [§§ 548(c) and 550]
a) Initial transferee may enforce lien or obligation to the extent it gave value, so long as it acted in good faith. See Bullard v. Aluminum Co. of America, 468 F.2d 11, 13 (7th Cir. 1972) (good faith depends upon extent to which transaction carries "ear-marks of an arms-length transaction"); Burroughs v. Fields, 546 F.2d 215 (7th Cir. 1976) (fiduciary capacity of officer/director transferee important in determining good faith).
b) Subsequent transferee: if a good faith, bona fide purchaser for value, trustee may not recover [§ 550(b)(2)].
6. Leveraged Buy-Outs
Compare United States v. Tabor Court Realty Corp., 803 F.2d 1288 (3rd Cir. 1986), cert. denied, 483 U.S. 1005 (1987)(holding that § 548 may be applied to a leveraged buy-out); Wieboldt Stores, Inc. v. Schottenstein, 94 B.R. 488 (N.D. Ill. 1988)(same); Murphy v. Meritor Savings Bank, 126 B.R. 370 (Bankr. D. Mass. 1991)(same); In re Ohio Corrugating Co., 70 B.R. 920 (Bankr. N.D. Ohio 1987)(same); with Mellan Bank N.A. v. Metro Communications, Inc., 945 F.2d 635 (3rd Cir. 1991), cert. denied, 112 S. Ct. 1476 (1992) (securing acquisition loan with all the acquired company's assets does not per se render the company insolvent); Kaiser Steel Corp. v. Charles Schwab & Co., 913 F.2d 846 (10th Cir. 1990); Kupetz v. Wolf & Vine, Inc., 845 F.2d 842 (9th Cir. 1988)(LBO cannot be avoided under § 548). See also Kaiser Steel Corp. v. Pearl Brewing Co., 952 F.2d 1230 (10th Cir. 1991), cert. denied, 112 S. Ct. 3015 (1992)(§ 546(e), which exempts "settlement payments" from trustee's avoidance powers, prevents avoidance of corporate distribution to shareholders made as part of LBO that left company insolvent). See generally Lieb and Feinstein, LBO Litigation, Financial Projections and the Chapter 11 Plan Process, 21 Seton Hall L.R. 598 (1991).

7. Sovereign Immunity
United States v. Nordic Village, Inc., 112 S. Ct. 1011 (1992) (§ 106(c) does not waive sovereign immunity for action seeking avoidance of post-petition payment to IRS where no proof of claim filed).

Rebel Coal Co., Inc. v. United States, 944 F.2d 320 (6th Cir. 1991)(action to recover preference not a compulsory counterclaim to proof of claim for fines for mine safety violations); In re Bluegrass Coal Co., Inc., 1989 Bankr. LEXIS 1502 (Bankr. E.D. Ky. Aug. 29, 1989)(No. 80-00024)(citing Hoffman, action under § 544 and § 548 to recover proceeds from pre-petition sale of debtor's property applied to non-debtors' tax obligations dismissed because no claims filed and no waiver found by IRS for money judgment under § 106(c)).

[cited in USAM 4-4.410]