February 15, 2017

Best Practices: Recovering Assets That Have Been Fraudulently Transferred

by Norman E. Greenspan

In making SBA loans, both the SBA and the lenders require that adequate collateral be provided by the borrower to secure the loan.  Security interests are obtained in the borrower’s property.  Additionally, a majority of SBA loans are also secured by guarantees by persons who are not parties to the loan, mostly individuals who have an ownership interest in the borrower, or who have an existing relationship the borrower’s owners.   The underwriting performed to approve the loan necessarily evaluates the sufficiency of these guarantees in determining whether to approve the loan.

As the SBA lending community well knows, there inevitably will be some SBA guaranteed loans that will go into default.  The lender is then obligated to use those remedies available to it, both under the loan agreements and by operation of law, to recover and liquidate the property that secures the loan, including looking to the assets of the loan’s guarantors.  Even then, the shortfalls can be substantial.  For example, in fiscal year 2016, the SBA repurchased approximately $841 Million in loans that it guaranteed, and charged-off approximately $1.7 Billion in losses.  These amounts were lower than in previous years, but nonetheless evidence ongoing shortfalls in recoveries from the assets that secured these loans in the first place.

It should come as no surprise that the borrowers know of the likelihood of an SBA loan default months before the default occurs.  This information is often known to the loan guarantors who are usually the borrower’s owners or have access to “inside” information.  Consequently,  guarantors often learn that they are likely to be on the hook for any shortfall from the liquidation of the borrower’s collateral before the loan is even in default.  This information may prompt some guarantors to take “asset protection” measures.  Not all measures that the guarantors take are necessarily appropriate or legal.

When a guarantor transfers assets to another person or entity for the specific purpose and intent of avoiding payment obligations to the SBA under the guaranty, this is a fraudulent transfer.  Such a transfer gives rise to a civil action for fraudulent transfer under state law (the Uniform Fraudulent Transfer Act has been adopted in over 40 states) and under the Federal Bankruptcy Code.  An important remedy available to the lender is the “clawing back” of the transferred property from the transferee and/or obtaining a judgment against the transferee for the value of the property that was transferred.

There are two types of fraudulent transfers:  those that are actual fraud, and those where there is constructive fraud.  Actual fraud is when a debtor transfers assets as the result of which the debtor is left insolvent or incapable of paying the debt.  Constructive fraud depends on the economics of the transaction in which the transfer takes place.  For example, the transfer of an asset for less than equivalent value thereby leaving the debtor incapable of meeting the financial obligation.  Because the intent of the transferor is difficult to prove (mind readers are not qualified expert witnesses), the courts over time have identified a number of types of transactions where fraudulent intent is presumed.  These transactions are commonly known as the “badges of fraud.”  The “badges of fraud” identified in the Uniform Fraudulent Conveyance Act, as modified in 2014, are: (1) the transfer was to an insider; (2) the debtor retained possession or control of the property after the transfer: (3) the transfer was concealed; (4) the debtor was threatened with a lawsuit before the transfer was made; (5) the transfer was of substantially all the debtor’s assets; (6) the debtor absconded; (7) the debtor removed or concealed assets; (8) the value of any consideration received by the debtor for the transfer was not equivalent; (9) the debtor was insolvent before or shortly after the transfer; (10) the transfer occurred shortly before a substantial debt was incurred; and (11) the debtor transferred the assets to someone who retransferred the assets to an insider.

If there is a loan default, it is likely that the borrower’s property that secures the loan will be insufficient to repay the loan in its entirety.  A judgment against the borrower for the amount of the shortfall likely will not be worth the paper it is written on.  Consequently, it is suggested that once an SBA lender knows of a loan default, or that a loan default is imminent, that it investigate the assets and recent transactions of the guarantors.  A good start is the financial statements that many lenders require the guarantors to submit periodically (although the SBA does not).   If there is suspicion of conduct covered by the “badges of fraud”, or what may be considered constructive fraud, the lender may want to consult with its counsel about the possibilities of pursuing fraudulent transfer claims against persons who have received asset transfers from the loan guarantors.

For more information on recovering assets that have been fraudulently transferred, contact Norman at 215.390.1025 or at