Fraudulent Transfers in Texas

Introduction

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, 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.

Law Applicable to Fraudulent Transfers

Governing law is the Texas Uniform Fraudulent Transfers Act (TUFTA) which is found 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. Sec. 548 but will not be discussed since this book addresses Texas law exclusively.

FRAUDULENT TRANSFERS OF ASSETS

What is an asset?

When discussing fraudulent transfers of assets, one must start with the definition of asset. Under TUFTA Section 24.002(2) 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.).

The TUFTA definition of asset does not include assets that are exempt under 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 non-exempt 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.

Proving intent on the part of the debtor (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).

What is a transfer?

According to TUFTA, 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 attempt by a judgment debtor to move assets out of reach of creditors.

Badges of Fraud

TUFTA contains a non-exclusive list of eleven factors that may be used in determining whether or not actual fraud has occurred:

Bus. & Com. Code 24.005(b)(1)-(11). Transfers Fraudulent as to Present and Future Creditors

(1) the transfer or obligation was to an insider;

(2) the debtor retained possession or control of the property transferred after the transfer;

(3) the transfer or obligation was concealed;

(4) before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit;

(5) the transfer was of substantially all the debtor’s assets;

(6) the debtor absconded;

(7) the debtor removed or concealed assets;

(8) 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;

(9) the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred;

(10) the transfer occurred shortly before or shortly after a substantial debt was incurred; and

(11) 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 then a finding of fraud is legally supportable.

Actual intent to defraud creditors ordinarily is a fact question [to be determined by the court]. 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 [TUFTA] Section 24.005(b)).

See Ho v. MacArthur Ranch, LLC, 395 S.W.3d 325, 328-29 (Tex.App.—Dallas 2013, no pet.).

Transfers to Insiders and Spouses

The largest percentage of fraudulent transfers are transactions conducted with an insider or affiliated person without payment of reasonably equivalent value in return. 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.).

The rights of creditors when it comes to transfers to spouses are governed by Family Code Section 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.

Fraudulent Intent Not Required

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 malign 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.

If the action or transfer had a fraudulent effect then evidence of intent can be dispensed with. Esse v. Empire Energy III, Ltd., 333 S.W.3d 166 (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.

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. Fortunately for debtors, there is a very significant exception to the fraudulent transfer rules.

Burden of Proving Fraud is on the Creditor

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 creditor plaintiff must meet:

Bus. & Com Code Sec. 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 became insolvent as a result of the transfer or obligation.

According to Business and Commerce Code Section 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.”

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” (Bus. & Com. Code Sec. 24.012).

ORDINARY-COURSE-OF-BUSINESS EXCEPTION

Ordinary Course of Life and Business

Texas law recognizes that life and business continue after a judgment. Transactions continue. Business and personal items may be bought and sold. Accordingly there is the following exception to the fraudulent transfer rules:

Bus. & Com. Code Sec. 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. . . .

Events in the ordinary course of life and business may continue. It is just that now (after suit is threated or filed) the debtor may be under scrutiny; and, as a result, either the debtor or his transferee may have to bear the burden of asserting this affirmative defense.

Readers may recognize the above ordinary course of business exception as being very similar in theme and effect to Property Code Section 42.004(c) which protects an individual’s exempt personal property in the event of execution on a judgment. In fact, these exceptions overlap.

CREDITOR RIGHTS AND REMEDIES

Rights of Secured Parties

Restrictions on fraudulent transfers are not 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.).

TUFTA Remedies

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 (Tex.App.—Corpus Christi Jan. 28, 2016, no pet.).

The Business & Commerce Code provides additional remedies:

Bus. & Com. Code Sec. 24.008. Remedies of Creditors

(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 voided be voided as a practical matter, the creditor’s goal will be a money judgment for the value of the asset transferred. Business and Commerce Code Section 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 Finance Code Section 59.008.

Finding Assets: Post-Judgment Discovery

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.

Statute of Limitations

Limitations apply to creditor action. 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.).

RECORDING AND BFPS

Texas Recording Statute

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 states:

Prop. Code Sec. 13001(a). Validity of Unrecord Instrument

(a) 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 bona fide purchaser doctrine operates side-by-side with the recording statute and protects BFPs 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. Accordingly, 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).

Fraudulent Transfers and the IRS

Moving assets beyond the reach of the IRS is a challenge. In the Wren case, the IRS successfully argued that a (primarily) two-factor test should apply. A taxpayer’s transfer is fraudulent: (1) under BOC Section 24.006(a) if the taxpayer does not receive reasonably equivalent value in exchange and was insolvent at the time (or became insolvent as a result of the transfer); and (2) under BOC Section 24.005(a) if the transfer is made with actual intent to hinder, delay, or defraud a creditor. In re Wren Alexander Investments LLC, No. 08-52914-RBK, 2011 WL 671961 (Bankr. W.D. Tex. Feb. 17, 2011).

Conclusion

Asset protection strategies fall into two groups: strategies implemented before collection action and suit by a creditor-plaintiff; and strategies that can reasonably be put into effect after.

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 non-exempt assets into homestead-exempt items (one’s primary residence, cars, etc.) in an 0rdinary-course-of-business 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). When this occurs, the attorney for the debtor 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.