Fraudulent transfers in bankruptcy take place when the person filing for bankruptcy transfers assets to another person for less than their fair value. Fraudulent transfers can occur before or after the bankruptcy filing and are often done in an attempt to hide assets from the trustee.
There are two main types of fraudulent transfers: actual fraud and constructive fraud. Actual fraud occurs when the debtor makes a transfer with the intent to defraud their creditors. One example that is commonly seen is when the debtor transfers an asset to a relative so that they do not have to declare that asset as their own on their bankruptcy petition. Constructive fraud occurs when the debtor makes a transfer without receiving reasonably equivalent value in return and the transfer means that the debtor is unable to pay their debts.
Fraudulent transfers can have significant consequences in bankruptcy. The major problem with a fraudulent transfer is that they can affect the debtor’s eligibility for bankruptcy. If a transfer is done before filing for bankruptcy, they may be found to be ineligible for bankruptcy under the “bad faith” provision of the bankruptcy code. This means that if the transfer is found to have been made in bad faith, the debtor may be denied a discharge which means that they would still be liable for their debts.
Another issue with fraudulent transfers is that if the bankruptcy trustee discovers that the debtor made a fraudulent transfer the trustee can start a lawsuit to recover the transferred asset.
If the debtor made a fraudulent transfer before filing for bankruptcy, the bankruptcy trustee may be able to undo the transfer and recover the transferred assets. If the debtor made a fraudulent transfer after filing for bankruptcy, the bankruptcy trustee may be able to recover the transferred assets for the benefit of the bankruptcy estate through a special type of action called a fraudulent conveyance action. A fraudulent conveyance action is a lawsuit brought by the bankruptcy trustee to recover assets that were transferred for less than their fair value within two years of the bankruptcy filing.