Fraudulent transfers and preference actions are common tools for creditors and debtors alike. They are typically raised by a trustee in a bankruptcy case, but they can also be raised by creditors in state court. A fraudulent transfer occurs when a debtor makes a transfer of property to a creditor or related party with intent to hinder, delay, or defraud creditors. A preference action occurs when a debtor pays one creditor over another before filing for bankruptcy. When brought in state court, these claims generally arise from the Texas Uniform Fraudulent Transfer Act (“TUFTA”), but when brought in federal bankruptcy court they arise under 11 U.S.C. § 548 and § 547. These claims are very common and can result in costly litigation. This article provides an overview of these claims under both state and federal law.
What Are Avoidance Actions?
Avoidance actions permit a bankruptcy trustee, debtor-in-possession, or creditor to recover certain pre-bankruptcy transfers. The idea is that certain transfers reduced the value of the debtor’s estate or unfairly favored some creditors. There are two main types of avoidance actions.
Preference actions: Under 11 U.S.C. § 547, a preference action seeks to recover a transfer to a creditor made within 90 days of bankruptcy (or within one year for an “insider” relationship).
Fraudulent transfer actions: Under 11 U.S.C. § 548 and state fraudulent transfer laws like TUFTA, these actions target transfers made with intent to hinder, delay, or defraud a creditor. TUFTA also targets transfers made for less than a reasonably equivalent value when the debtor was insolvent at the time or became insolvent as a result.
In Texas, TUFTA allows creditors to bring these claims in state court even outside of bankruptcy.
Preference Actions: The 90-Day Window That Can Surprise Creditors
Under 11 U.S.C. § 547, a trustee can avoid a transfer to a creditor made within 90 days of bankruptcy (or within one year for an insider) if certain requirements are met, including that the creditor received more than it would have in a Chapter 7 liquidation. The policy behind preference law is to prevent a race to the courthouse and promote a fair distribution of assets among creditors. However, the practical impact is often surprising. A vendor making a routine collection on an old account might suddenly be asked to return that money months later. For Texas creditors, knowing which defenses apply is important.
Common Defenses to Preference Actions
There are several defenses to a preference claim under 11 U.S.C. § 547:
Contemporaneous exchange for new value (§ 547(c)(1)): The transfer was intended to be a substantially contemporaneous exchange for new value.
Ordinary course of business (§ 547(c)(2)): The transfer was made in the ordinary course of business and on ordinary business terms.
Subsequent new value (§ 547(c)(4)): The creditor provided new value after receiving the alleged preferential transfer.
Enabling loan (§ 547(c)(3)): The transfer was a purchase-money security interest that was perfected in the applicable timeframe. Such evidence may include payment histories, aging reports, industry norms, and correspondence. Financial analysis and expert witness testimony may thus be critical.
Fraudulent Transfers: Actual Intent and Constructive Fraud
A fraudulent transfer action may relate to transfers made years prior to filing bankruptcy. There are two types of fraudulent transfer claims under section 548 and TUFTA.
Actual Fraud
Actual fraud requires proof of an intent to hinder, delay, or defraud creditors. Courts look to “badges of fraud” to establish this, including transfers to insiders or related parties, retention of possession or control, concealment, pending or threatened litigation, transfers that substantially deplete the estate, and receipt of little or no consideration.
Constructive Fraud
Constructive fraud does not require a showing of intent. Rather, it is focused on whether the debtor received reasonably equivalent value and whether the debtor was insolvent or became insolvent as a result of the transfer or was left with unreasonably small capital. Under TUFTA, these claims can be brought outside of bankruptcy proceedings. The lookback period may be up to four years for actual fraud or up to two years for constructive fraud under Texas law.
Solvency Analysis and Valuation’s Role in Avoidance Claims
Avoidance claims may frequently turn on purely financial questions such as whether the debtor was insolvent, whether the creditor received more than it would have received in chapter 7, and whether the consideration received by the debtor was reasonably equivalent to the value of the property transferred. A solvency analysis generally entails three tests:
- Balance sheet test: Did the assets exceed liabilities at fair valuation?
- Cash flow test: Could the debtor pay its debts as they came due?
- Capital adequacy test: Did the debtor have reasonably adequate capital?
Each test requires professional judgment, knowledge of the industry, and a defensible methodology. Distressed business valuation from a qualified and experienced expert may be pivotal in constructing or defending against an avoidance claim.
When Expert Witness Testimony May Be Dispositive
Avoidance claims may involve disputes as to complicated financial concepts, which may require financial experts to testify regarding matters that are clear to them but difficult for a lay jury to understand. An effective financial expert should be able to present information in a manner that a nonfinancial person can understand, can withstand vigorous cross-examination, and has opinions based on generally accepted methodologies.
The financial expert may offer opinions regarding:
- Solvency: This will entail preparation of an adjusted balance sheet, cash flow projections, and capital analysis
- Valuation of transferred assets: This is necessary to establish reasonably equivalent value
- Payment-history reconstruction: This is relevant to establishing an ordinary-course defense
- Tracing analysis: This follows the flow of funds
- Damages: This establishes the amount recoverable or creditor harm
Expertise in corporate restructuring and turnaround adds practical knowledge to the financial expert’s skill set. Certification as a Certified in Distressed Business Valuation (CDBV) indicates specialized training in the area of valuation of distressed businesses, which is directly applicable to avoidance litigation.
Actionable Steps for Texas Business Owners and Creditors
Whether you are a business owner looking at pre-distress transactions, a creditor being confronted with a preference claim, or an attorney considering an avoidance claim, there are steps you can take to strengthen your position:
- Retain records. Payment records, invoices, correspondence, board minutes, and financial statements should be preserved.
- Retain financial expertise early. Early review and analysis by a financial expert will allow for complete financial reconstruction and issue identification.
- Understand your defenses. Ordinary-course defenses and subsequent new value credits can reduce or eliminate preference exposure.
- Review pre-distress transactions proactively. Review related-party transfers, asset sales, and debt payments before filing.
- Work with an experienced fiduciary and expert. Professionals with trustee, receiver, and expert witness experience can provide a multidimensional perspective.
FAQs
What is the difference between a preference action and a fraudulent transfer action?
A preference action generally targets qualifying payments made within 90 days before bankruptcy, or one year for insiders. A fraudulent transfer action targets transfers involving fraudulent intent or less than reasonably equivalent value when the debtor was insolvent. Preferences focus on timing and fairness among creditors; fraudulent transfers focus on intent and consideration.
Can a creditor pursue a fraudulent transfer claim in Texas without a bankruptcy filing?
Yes. Under TUFTA, creditors can bring fraudulent transfer claims in Texas state court without bankruptcy. Claims may involve actual intent to defraud or transfers without reasonably equivalent value when the debtor was insolvent or rendered insolvent.
How long does a bankruptcy trustee have to bring an avoidance action?
Under Section 546, a trustee generally has two years from the bankruptcy filing date. State-law claims may have different limitations periods, so attorneys should evaluate the period applicable to each claim.
What does “reasonably equivalent value” mean in a fraudulent transfer case?
Courts evaluate whether the debtor received value roughly comparable to what was transferred. Determining that value often requires an independent business or asset valuation, particularly for business interests, real property, or intangible assets.
How can a business owner defend against a constructive fraudulent transfer claim?
Key defenses focus on showing that the debtor received reasonably equivalent value and remained solvent under the balance sheet, cash flow, and capital adequacy tests. A well-supported solvency opinion from a credentialed financial expert can provide critical analysis.
Conclusion: Expert Financial Analysis Is the Key to Avoidance Litigation
Fraudulent transfers and preference actions are among the most consequential issues in bankruptcy and state court proceedings. Whether you are a Texas business owner, creditor, or attorney, the underlying financial analysis can determine the outcome.
Solvency opinions, valuations, payment reconstructions, and credible expert testimony form the foundation of a defensible position. A financial professional with trustee, receiver, and expert witness experience can provide both analytical rigor and courtroom perspective.
John Tittle, Jr., CPA/CFF/CGMA, CTP, CIRA, CDBV, brings over 35 years of experience to avoidance litigation, including 100+ expert witness appearances in federal and state courts. A former Deloitte Partner and public-company CFO, he provides defensible solvency analyses, distressed business valuations, and expert testimony.
Schedule a confidential consultation with John Tittle, Jr. at tittlefinancial.com or call (214) 341-6043.