You must first understand what a fraudulent transfer is, and what it is not. Let us start with what it is not: A fraudulent transfer is not a “fraud,” at least, not usually. Instead, the term “fraudulent transfer” is a legal concept describing a transfer in which the transferor intends to deprive a creditor the ability to reach the property that has been transferred. There could be criminal fraud involved, but most often the type of “fraud” we are talking about here is less sinister, a bad intent or series of facts that suggest that the transferor has unfairly transferred assets in a way that prejudices the creditor’s ability to get paid.
At law, there are two primary types of fraudulent transfers that can be committed while you are perfectly solvent, and two additional types of fraudulent transfers that entail insolvency. The two types of fraudulent transfers that you can engage in with a perfectly healthy balance sheet are as follows:
- Actual Fraud: This is a type of transfer in which the transferor actually intends to deprive the creditor the ability to reach the property transferred. In this case, the court is usually presented with compelling evidence showing the transferor’s ill-intended state of mind at the time that the transfer was made.
Example: Phil is driving home from the office one day when he gets into an accident on the interstate. He rear-ends another vehicle, seriously injuring a passenger in the other car. The injured passenger has to be life-flighted to a hospital and is facing possible paralysis. Phil runs into his lawyer’s office the next day and sets about implementing an asset protection trust, hoping to shield his assets from any claim the injured passenger may bring against him.
Analysis: Phil knew that it was substantially likely that the injured passenger would bring a claim against him, and Phil acted with the specific intent of placing his assets out of the reach of the injured passenger’s claim. Accordingly, Phil’s transfer of assets into the asset protection trust would constitute a fraudulent transfer on account of Phil’s actual intent.
- Constructive Fraud: This is a transfer made under circumstances in which a court is likely to conclude that the transferor likely intended, or should have known that his actions were about, to deprive the creditor the ability to reach the property transferred.
Example: Bill has been a frugal saver all his life. Even in his medical practice, Bill keeps the bare minimum of insurance required under state licensing rules. Bill has put all of his wealth in an asset protection trust because, as Bill will tell you, he does not want to take any chances with being sued by an unanticipated creditor. Bill recently joined with some other doctors in securing a bank loan to build a new parking structure next to his medical building. While Bill does not have the personal net worth to pay off the loan, Bill is confident that he can rely on his trust to provide money should he ever truly need help. In the meantime, Bill continues to contribute money to his asset protection trust. A year later, the bank calls the loan due to a downturn in the economy. Bill’s business partners are all bankrupt, and the bank looks to Bill to repay the full balance of the business loan.
Analysis: Bill carries malpractice insurance, which should help him with the anticipated liabilities in his medical practice. However, Bill has not retained sufficient assets to meet his obligation to the bank on his business loan with his partners. The continuing contributions that Bill makes to his asset protection trust are constructive fraudulent transfers; Bill has failed to retain sufficient assets with which to meet his current obligations.