Asset Exemption Transfers

 

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When trying to avoid challenges to asset transfers under the Uniform Fraudulent Transfers Act (UFTA), which outlaws constructive fraud, be careful to follow the rules the best you can.

The law governing asset exemption transfers is muddled. Most exemption planning occurs in a bankruptcy context. The legislative history to the bankruptcy code clearly indicates that Congress's intent was to allow pre-bankruptcy exemption planning. Further, the code has no specific provision outlawing such transfers. Accordingly, some bankruptcy courts routinely allow such transfers, except in the most egregious cases.

On the other hand, despite the legislative history of the code and the lack of a specific provision outlawing these transfers, most bankruptcy courts apply the standards of the UFTA to asset exemption transfers in the same way the UFTA is applied to any other transfers. So some uneven results have been achieved.

Most debtors considering bankruptcy will be insolvent and will automatically meet the first criteria for constructive fraud. Thus, it is important that you be able to establish that you received adequate consideration in return for the transfer to avoid a constructive fraud claim.

This will not present a problem in most cases, because asset exemption transfers usually involve the conversion of nonexempt assets into exempt assets--that is, an equal exchange of value. For example, the purchase of an exempt home for cash involves the receipt of adequate consideration in return (i.e., the home).

The result should be the same when a mortgage is paid down on an exempt residence. However, one bankruptcy court has ruled that, in this situation, the home does not provide any return consideration, and, thus, the transfer is made without the receipt of adequate consideration. This is true, according to the court, even when the mortgage is completely paid off, and the mortgage lien on the home is released.

In reality, of course, when you make a payment for a release of a lien, or simply for a release of part of the debt, the payment is made in return for valuable consideration. How many debtors would believe they received nothing in return in this situation? None. Accordingly, other courts may not follow this rationale. Nevertheless, under this interpretation, the transfer can be undone if the debtor is insolvent, as is likely in pre-bankruptcy exemption planning.