DAVID J. WILLIS ATTORNEY
Copyright © 2018. All rights reserved worldwide.
FRAUDULENT TRANSFERS IN TEXAS
By David J. Willis, J.D., LL.M.
In Texas, execution on a valid judgment may not be thwarted by a fraudulent transfer or conveyance ("fraudulent transfer" being a term of art further discussed below) that is designed to hinder, delay, or defraud a judgment creditor, regardless of when the transfer is made—either before entry of judgment or after filing an abstract. Texas Sand Co. v. Shield, 381S.W.2d 48 (Tex. 1964). Any such transfer is voidable under TUFTA sec. 24.008, meaning that if a court examines the transaction and finds it to be shady, it may be set aside. This is old law in Texas, dating back to an 1840 Act of the Republic of Texas. The key has always been how to discern and define a transfer that is fraudulent.
According to current law (the Texas Uniform Fraudulent Transfer Act or "TUFTA," contained in chapter 24 of the Business and Commerce Code), a "transfer" is defined to mean "every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with an asset or an interest in an asset [tangible or intangible], and includes payment of money, release, lease, and creation of a lien or other encumbrance." This is an extremely broad definition that is likely to encompass any conceivable attempt by a judgment debtor to move assets out of reach of creditors.
Primary Applicable Law
TUFTA is located in chapter 24 of the Business and Commerce Code. Also relevant is Tax Code section 111.024 dealing with tax liability on the part of recipients of fraudulent transfers, as well as Penal Code section 32.33 ("Hindering Secured Creditors"). Federal bankruptcy law relating to this topic is found at 11 U.S.C. § 548 but will not be discussed, since this book addresses Texas law exclusively.
An action by a creditor under TUFTA must be brought within one to four years, depending on which section of TUFTA is cited as a cause of action by the creditor. See Tex. Bus. & Com. Code § 24.010.
Of particular interest is TUFTA section 24.005(b)(1)-(11) which includes a nonexclusive list of eleven factors that may be used in determining actual fraud:
- 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 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 not 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.
No one of the foregoing factors will determine a court's decision, but if several of these factors are present in a given case then a finding of fraud is legally supportable. Also, "[a]ctual intent to defraud creditors ordinarily is a fact question. Circumstantial proof may be used to prove fraudulent intent because direct proof is often unavailable. Facts and circumstances that may be considered in determining fraudulent intent include a non-exclusive list of 'badges of fraud' prescribed by the legislature in §24.005(b))." Ho v. MacArthur Ranch, LLC, 395 S.W.3d 325, 328-29 (Tex.App.—Dallas 2013, no pet.).
Under TUFTA, the creditor must carry the burden of proving the elements as to each alleged fraudulent transfer by a preponderance of the evidence. Walker v. Anderson, 232 S.W.3d 899, 913 (Tex. App.—Dallas 2007, no pet.).The statute explicitly states the standard a plaintiff must meet:
§ 24.006. TRANSFERS FRAUDULENT AS TO PRESENT CREDITORS
(a) A transfer made or obligation incurred by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made or the obligation was incurred if the debtor made the transfer or incurred the obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent at that time or the debtor because insolvent as a result of the transfer or obligation.
TUFTA is an unusually cooperative statute when it comes to state courts working together with other states to implement its provisions. TUFTA "shall be applied and construed to effectuate its general purpose to make uniform the law with respect to the subject of this chapter among states enacting it." Tex. Bus. & Comm. Code sec. 24.012.
Limitations apply. An action by a judgment creditor seeking to void a fraudulent transfer is subject to a four-year statute of limitations, but if discovered later, then the applicable period is within one year after the transfer should have reasonably been detected (TUFTA sec. 24.010). "Whether a plaintiff filed his claim within one year of the time when the fraudulent transfer was or could reasonably have been discovered is a question of fact for the [trial judge or jury]." Walker v. Anderson, 232 S.W.3d 899, 909 (Tex.App.—Dallas 2007, no pet.).
Is fraudulent intent required under TUFTA?
No. Proof of intentional fraud is not required for a creditor to prevail on a claim of fraudulent transfer by a debtor—which makes this a rather peculiar form of fraud, an offense which in other areas of the law almost always requires proof of intent. The action or transfer may have been undertaken by a debtor in the belief that is was lawful and even fair, but such a belief may not change the action's potential voidability. The reason can be found in Bus. & Comm. Code sec. 24.006(a), which states that "A transfer made or obligation incurred by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made or the obligation was incurred if the debtor made the transfer or incurred the obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent at that time or the debtor became insolvent as a result of the transfer or obligation." So if the action or transfer had this effect, then the requirement of intent can be dispensed with. Esse v. Empire Energy III, Ltd., 333 S.W.3d 166 609 (Tex.App.—Houston [1st Dist.] 2010, no pet). Looked at in this way, the term "fraud" probably could (and should) be dropped in favor of the phrase "voidable if certain statutory conditions are met." The term one sees in the cases where clear intent is absent is "constructive fraud" which is another way of saying that the debtor's state of mind does not always matter. Accordingly, one sees actual fraud cases where intent is present versus constructive fraud cases where intent may be less susceptible to proof.
The largest percentage of fraudulent transfers are transactions conducted with an insider or affiliated person without payment of reasonably equivalent value in return (two of the badges of fraud listed above). An insider is "an entity whose close relationship with the debtor subjects any transactions made between the debtor and the insider to heavy scrutiny." Tel. Equip. Network, Inc. v. TA/Westchase Place, Ltd., 80 S.W.3d 601, 609 (Tex.App.—Houston [1st Dist.] 2002, no pet.). According to Bus. & Comm. Code sec. 24.004(d), the term "'Reasonably equivalent value' includes, without limitation, a transfer or obligation that is within the range of values for which the transferor would have sold the assets in an arm's length transaction." Combine these definitions and it is clear that intentionally moving assets out of reach of creditors can indeed be a challenge in the face of this law.
The rights of creditors when it comes to transfers to spouses are governed by Tex. Fam. Code sec. 4.106, which states that" a provision of a partition or exchange agreement made under this subchapter is void with respect to the rights of a pre-existing creditor whose rights are intended to be defrauded by it." Note the requirement of intent.
Creditor relief usually begins with an injunction. Under TUFTA, "injunctive relief is an available remedy to a fraudulent transfer for which the claimant asserts an equitable interest" in order to preserve the status quo until trial. Sargeant v. Al Saleh, 2016 WL 362772, a 9 (Tex.App. —Corpus Christi Jan. 28, 2016, no pet.). Tex. Bus. & Com. Code sec. 24.008(a)(3)(A) provides:
(a) In an action for relief against a transfer or obligation under this chapter, a creditor, subject to the limitations in Section 24.009 of this code, may obtain:
(1) avoidance of the transfer or obligation to the extent necessary to satisfy the creditor's claim;
(2) an attachment or other provisional remedy against the asset transferred or other property of the transferee in accordance with the applicable Texas Rules of Civil Procedure and the Civil Practice and Remedies Code relating to ancillary proceedings; ?or
(3) subject to applicable principles of equity and in accordance with applicable rules of civil procedure:
(A) an injunction against further disposition by the debtor or a transferee, or both, of the asset transferred or of other property;
(B) appointment of a receiver to take charge of the asset transferred or of other property of the transferee; ?or
(C) any other relief the circumstances may require.
If a transfer cannot be practicably voided, the creditor's goal will be a money judgment for the value of the asset transferred. Bus. & Comm. Code sec. 24.009(b) provides that "the creditor may recover judgment for the value of the asset transferred . . . against: (1) the first transferee of the asset or the person for whose benefit the transfer was made; or (2) any subsequent transferee other than a good faith transfer who took for value or from any subsequent transferee." The person for whose benefit the transfer was made "may include the actual debtor or someone attempting to avoid a debt. Citizens Nat'l Bank v. NXS Constr., Inc., 387 S.W.3d 74 (Tex.App.—Houston [14th Dist.] 2012, no pet.).
For rules relating to restraining orders on financial institutions which hold funds on behalf of customer debtors, see Texas Finance code sec. 59.008.
Nothing in the foregoing is intended to diminish the rights of lenders holding a security interest in the property of the debtor. The creditor can always foreclose. "A secured party is entitled to foreclose on its security interest in the event of default. [Doing so] does not constitute a voidable transfer. Nor is the subsequent transfer of the assets from the foreclosure sale actionable under [TUFTA]." Yokogawa Corp. v. Skye Int'l Holdings, 159 S.W.3d 266, 269 (Tex.App.—Dallas 2005, no pet.).
Exception: Ordinary Course of Business or Financial Affairs
24.009(f) A transfer is not voidable under Section 24.006(b) of this code:
(1) to the extent the insider gave new value to or for the benefit of the debtor after the transfer was made unless the new value was secured by a valid lien;
(2) if made in the ordinary course of business or financial affairs of the debtor and the insider; or
(3) if made pursuant to a good-faith effort to rehabilitate the debtor and the transfer secured present value given for that purpose. . . .
Readers may recognize the above "ordinary course of business exception" as being similar in theme and effect to Property Code section 42.004(c) which protects exempt property in the event of execution on a judgment. Life and business continue after a judgment. Transactions continue. Business and personal items may be bought and sold. It is just that now, the debtor is under scrutiny and either the debtor or his transferee may have to bear the burden of asserting this affirmative defense.
The Relevance of Recording and BFPs
Whether or not a conveyance of real property was recorded at the county clerk's office can be important in determining whether or not a judgment creditor can reach the property. The Texas recording statute (Prop. Code sec. 13001(a)) states that a "conveyance of real property or an interest in real property or a mortgage or deed of trust is void as to a creditor or to a subsequent purchaser for valuable consideration without notice unless the instrument has been acknowledged, sworn to, or proved and filed for record as required by law."
The common law "innocent purchaser doctrine" operates side-by-side with the recording statute and protects bona fide purchasers who pay reasonably equivalent value for the property. A person is a BFP (and therefore protected) if he or she is a good-faith purchaser of legal title to real property; pays valuable consideration; and does so without actual or constructive notice of the judgment lien—meaning the buyer cannot have any awareness (from whatever source) of the existence of a judgment against the seller. So a last-minute transfer by the judgment debtor to his brother-in-law for ten dollars and other valuable consideration will fool no one and is voidable. "A person who invokes [the bona fide-purchaser] affirmative defense carries the burden of establishing good faith and the reasonable equivalence of the consideration obtained." Hahn v. Love, 321 S.W.3d 517, 526 (Tex.App.—Houston [1st Dist.] 2009, pet. denied).
What is an asset?
One can start with determining what does not constitute an asset. Under section 24.002(2) of TUFTA the term "asset" does not include property to the extent it is encumbered by a valid lien. However, "the value of property in excess of a valid lien [i.e., the equity] . . . is an 'asset' as defined by UFTA. Citizens Nat'l Bank v. NXS Constr., Inc. 387 S.W.3d 74, 82-83 (Tex.App.—Houston [14th Dist.] 2012, no pet.). Nor does "asset" include property to the extent it is generally exempt under non-bankruptcy law (details below) or an interest in property held in tenancy by the entireties to the extent it is not subject to process by a creditor holding a claim against only one tenant, under the law of another jurisdiction.
Assets Exempt under State Law
The TUFTA definition of "asset" does not include exempt assets under non-bankruptcy law including the Texas homestead laws contained in article XVI, section 50 of the Texas Constitution and Property Code chapters 41 and 42. However, Property Code section 42.004 provides that a transaction may be set aside if nonexempt assets are used to buy or pay down indebtedness on exempt assets "with the intent to defraud, delay, or hinder" a creditor. This reaches back two years. However, proving such intent (and therefore getting the transfer set aside) can be difficult, particularly if the debtor asserts that the transaction occurred in the ordinary course of business, which is a solid defense in Texas under Property Code section 42.004(c).
Judgments are final after thirty days, after which post-judgment discovery (interrogatories, requests for production, and depositions directed at the defendant by a judgment creditor) are commonly used not only to determine the location and value of the defendant's assets but also whether or not there is a trail suggesting fraudulent transfers. The scope of this process can be wide indeed, reaching back several years. A debtor can be held in contempt (resulting in a fine or jail) for failing to provide timely responses, so one should never ignore post-judgment discovery.
Fraudulent Transfers and the IRS
In re Wren Alexander Investments LLC, No. 08-52914-RBK, 2011 WL 671961 (Bankr. W.D. Tex. Feb. 17, 2011), illustrates the difficulty in moving assets beyond the reach of the IRS. In this case, the IRS successfully argued that the taxpayer's transfer was fraudulent (1) under BOC section 24.006(a) since the taxpayer did not receive reasonably equivalent value in exchange and was insolvent at the time of or became insolvent as a result of the transfer, and (2) under section 24.005(a) since the transfer was made with "actual intent to hinder, delay, or defraud" a creditor, present or future.
Implications for Asset Protection Planning
Asset protection strategies fall into two groups: strategies implemented in advance of collection action and suit by a creditor/plaintiff; and strategies that can reasonably be put into effect afterward. After suit is filed, creditors are on the lookout for the movement of assets intended to defeat their legitimate claims. A Texas defendant may be limited to attempting to convert nonexempt assets into homestead-exempt items (one's primary residence, cars, etc.) in an "ordinary business" type of way, holding cash at home, and prepaying certain key items (taxes, attorney's fees, and the like which are unlikely to be questioned as fraudulent). The debtor's attorney needs to be able to plausibly argue to a court that the steps taken by the debtor could reasonably have been taken in the ordinary course of life or business, regardless of whether or not the debtor was subject to collection on a judgment.
Information in this article is provided for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes as legislatures meet and important cases are decided. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well. Although we will respect your confidentiality, this firm does not represent you unless and until it is retained and agrees in writing to do so.
Copyright © 2018 by David J. Willis. All rights reserved worldwide. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, www.LoneStarLandLaw.com.