Fraudulent transfer: Overview, definition, and example
What is a fraudulent transfer?
A fraudulent transfer refers to the act of transferring assets or property from one party to another with the intent to defraud, delay, or hinder creditors from recovering debts owed. This type of transfer usually occurs when a debtor is facing financial difficulties or is in danger of being sued or going bankrupt, and they attempt to hide or move assets to avoid having to pay creditors.
Fraudulent transfers are illegal and can result in the reversal of the transfer by a court. These transfers can involve selling assets below market value, transferring assets to a relative, or moving property to an entity that is beyond the reach of creditors.
Why is fraudulent transfer important?
Fraudulent transfer is important because it is a form of financial deception that undermines the fairness of the legal system and the ability of creditors to recover money they are owed. When a business or individual engages in a fraudulent transfer, they are essentially trying to avoid paying legitimate debts by hiding their assets. This behavior can result in significant legal consequences, including penalties, fines, and the reversal of the transfer, meaning the assets will be returned to the original owner or creditor.
For businesses, understanding fraudulent transfer laws is crucial to ensure that assets are not improperly transferred when facing financial distress. It also protects businesses from being involved in illegal transactions that could lead to lawsuits or damage their reputation.
Understanding fraudulent transfer through an example
Imagine a business that is struggling financially and has significant outstanding debts to creditors. In an attempt to avoid paying these debts, the business owner transfers ownership of the company’s valuable property (such as real estate or equipment) to a family member for a fraction of its value, hoping to shield it from creditors.
Later, when the creditors attempt to collect their debts, they discover the transfer and may file a claim alleging that the transfer was fraudulent. If a court finds that the transfer was made with the intent to defraud creditors, the court may reverse the transfer, allowing the creditors to recover the property.
In another example, a business is on the brink of bankruptcy and sells its inventory to a related company at a significant discount, with the intention of protecting the inventory from creditors. This could be considered a fraudulent transfer if it is determined that the sale was made to avoid paying debts.
An example of a fraudulent transfer clause
Here’s how a fraudulent transfer clause might look in a contract:
“In the event that any transfer of assets or property by the Company is found to be a fraudulent transfer under applicable law, such transfer shall be void, and the Company agrees to return the transferred assets or property to the creditor or party entitled to them, as determined by a court of competent jurisdiction.”
Conclusion
A fraudulent transfer is an illegal action where assets are transferred to avoid paying debts, often with the intent to deceive creditors. This practice can lead to legal actions, including the reversal of the transfer and penalties. Businesses must be aware of fraudulent transfer laws to ensure they do not inadvertently participate in or become victims of such activities, which can have severe financial and legal consequences.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.