Proving Fraudulent Transfers under Tennessee Law

A recent opinion of the Court of Appeals of Tennessee in a fraudulent transfer case provides an excellent summary and roadmap of what it takes to prove a fraudulent transfer under Tennessee law. The Uniform Fraudulent Transfer Act, which has been adopted in Tennessee, can be a bit much to get one’s head around, at least without a good bit of review and study.  The recent opinion is useful because the facts of it are tailor-made to demonstrate how the provisions of the Act are applied and the result.

Here are the key facts of the case:

• Father owned an LLC, the business of which was installing drywall
• Father owed a Drywall Supplier about $350,000
• In October of 2007, Father signed a note to the Drywall Supplier for the amount he owed
• In March of 2009, Father sold the LLC to his Son for $12,000
• Drywall Supplier filed a lawsuit to set aside the transfer of the LLC to Son, alleging it was a fraudulent transfer

In its fraudulent transfer case, Drywall Supplier alleged that the transfer of the LLC to Son was a fraudulent transfer under the actual fraud statute and, also, under the constructive fraud statute, both of which are part of the Uniform Fraudulent Transfer Act. The trial court found that the transfer was not fraudulent under either provision of the Act. The Court of Appeals affirmed the trial court in all respects.

Under the actual fraud statute, a plaintiff must prove that the transfer was made “with actual intent to hinder, delay, or defraud” a creditor. Since proving fraudulent intent almost always requires circumstantial evidence, the statute lists eleven (11) factors that are to be considered in determining whether there was intent to defraud.  If a plaintiff is able to prove the existence of one or more of those factors (often called “badges of fraud”), a presumption of fraud arises.  Once that presumption has arisen, the burden shifts to the defendant to prove that there was no fraudulent intent.

The trial court held that Drywall Supplier had proven two of the factors. The first factor which it had proven was that the transfer was to an “insider.” (The Act contains a lengthy definition of “insider” which includes a relative of someone in control of an LLC, which Son was.)  The second factor which the trial court found that Drywall Supplier had proven was that, before the transfer to Son was made, Father had been threatened with suit by Drywall Supplier.

Even though Drywall Supplier had proven that it was entitled to the presumption that the transfer was fraudulent, the trial court found that Son had carried his burden of disproving fraud. Here are the facts upon which the trial court relied to find that Son had disproven fraud:

• When Father transferred the LLC, he was 69, not in good health, and wanted to retire
• By the time Father was ready to retire, the LLC was struggling and was not able to obtain bonding for jobs over $25,000
• Father and Son sought the aid and advice of an attorney and of an accountant in setting the value to be paid by Son for the LLC
• Son believed, and the evidence supported, that the primary asset of the LLC was its goodwill. It owned no real estate, trucks or other equipment except for some basic tools
• When the transfer was made, the book value of the LLC was $12,000

Interestingly, both Drywall Supplier and Son employed expert appraisers who valued the LLC at $200,000 (Drywall Supplier’s expert) and $109,000 (Son’s expert). Knowing what I know, which I stress is limited to the facts in the opinion, I would have bet that Son’s own expert’s valuation would have caused the court to determine that there had been a fraudulent transfer.  After all, Son paid only $12,000, and his own expert valued the LLC almost $100,000 higher. The trial court was probably influenced by the fact that Son’s expert appraiser testified that he was compelled to use a non-preferred valuation method because he was not provided with complete financial records of the LLC.

The trial court’s analysis of the Drywall Supplier’s constructive fraud claim was much simpler. To prove a constructive fraudulent transfer, a creditor has to prove that: (1) The creditor’s claim arose before the transfer; (2) the debtor was not paid a reasonable value for what was transferred; and, (3) the debtor was insolvent at the time of the transfer or became insolvent because of the transfer.  Drywall Supplier failed to put on any proof that Father was insolvent at the time of the transfer or became insolvent because of it.

For lawyers who handle fraudulent transfer cases, this case is worth reading.

This post was written by attorney J. Ross Pepper.