Is it a fraudulent conveyance for debtor to transfer upside down real estate to another person?
Many asset protection clients own once-valuable properties which are currently upside down. If a creditor gets and records a judgment the creditor will establish a subordinate lien on the property. The judgment creditor is unlikely to foreclose the judgment when the property has no equity. However, if and when the real estate market recovers and the property’s value comes back the creditor’s lien eventually will be “in the money.” Even though an improved real estate market will enable the debtor to sell the property and payoff the mortgage all the money over and above the mortgage will go to the judgment creditor’s subordinated lien. The debtor will never see any money from this property.
If the debtor conveys title of the property to his spouse, a friend, or a newly formed LLC the judgment creditor’s lien will not attach, and and the new transferee can sell the property at some point free and clear of the judgment lien. The judgment creditor might try to reverse the debtor’s transfer as a fraudulent transfer intended to evade the creditor’s judgment even where there the debtor had no equity in the property at the time of the transfer. Can there be a fraudulent transfer of zero value?
Based upon the definitions in in the fraudulent transfer statutes (Section 726.102 ) I believe that the transfer of a property which is upside down at the time of the transfer cannot be reversed as a fraudulent transfer. The statutes define a “transfer” as the disposition or parting with “an asset.” The statute then defines “assets” as any property of the debtor but not including the debtor’s property to the extent encumbered by a valid lien. Therefore, real estate encumbered by a valid mortgage in excess of property value is not an “asset” for purposes of fraudulent transfer analysis.
Then there is property which as no value but is not encumbered by a lien. For instance, suppose a debtor transfers share of a new LLC which is just beginning business and has not made money. The debtor’s LLC shares are assets because they are not encumbered by a lien. The shares have no market value. Is the change of ownership of the LLC shares to, for example, the debtor and spouse a type of fraudulent transfer. This transfer is not excluded by statute definitions, but the debtor still has the argument that a transfer of zero value leaves the creditor in no worse position than before the transfer.
Page last updated on May 22, 2020