Indiana Law Review


Indiana Laiv Revieiiv
Volume 21 1988 Number 2

Toward True and Plain Dealing: A Theory of Fraudulent
Transfers Involving Unreasonably Small Capital

Bruce A. Markell*

I. Introduction

Fraudulent transfer law' is in the midst of a renewal and a revival.

Ten years ago Congress rewrote the Bankruptcy Code section related to

*B.A., Pitzer College, 1977; J.D., University of California, Davis, 1980. The author

is a member of the California bar and is a partner with the Los Angeles office of Sidley

& Austin. The views expressed in this article are those of the author alone, and do not
necessarily reflect the views of Sidley & Austin or any of its clients.

'There are at least five sources of fraudulent transfer law. The basic text for the

last seventy years has been the Uniform Fraudulent Conveyance Act (UFCA), promulgated

in 1918 by the National Conference of Commissioners on Uniform State Laws (National

Conference). The UFCA is reprinted at 7A U.L.A. 427 (1985). The National Conference
promulgated a new uniform act in 1984, caUing it the Uniform Fraudulent Transfer Act

(UFTA). It is reprinted at 7A U.L.A. 639 (1985). The third source is section 548 of the

Bankruptcy Code (Code). The Code is codified at 11 U.S.C. §§ 101 et seq. (1982). The

fourth source, relevant primarily in the interpretation of older cases, is section 67d of the

now-repealed Bankruptcy Act of 1898 (Act). Like the Code, the Act contained its own sec-
tion covering fraudulent transfers, which, for the most part, mirrored the UFCA. Act

§ 67d, 11 U.S.C. § 107d (1976) (repealed 1979). See infra note 103. Finally, fraudulent

conveyance law was part of the common law received from England, and almost every
state either adopted it through decisional law, or codified its own version by statute. See,
e.g., Molitor v. Molitor, 184 Conn. 530, 535, 440 A.2d 215, 218 (1981) (finding that the

UFCA "is largely an adoption and clarification of the standards of the common law");
Tex. Bus. & Com. Code Ann. § 24.02 (Vernon 1968) (repealed 1987).

An excellent and detailed account of the common law history of fraudulent conveyances
can be found in 1 G. Glenn, Fraudulent Conveyances and Preferences §§ 58-62b

(Rev. ed. 1940). An equally excellent analytical account of the policy goals served by
fraudulent transfer law can be found in Clark, The Duties of the Corporate Debtor to

Its Creditors, 90 Harv. L. Rev. 505 (1977).

469



470 INDIANA LAW REVIEW [Vol. 21:469

such transfers, 2 and four years ago the National Conference of Com-
missioners on Uniform State Laws promulgated a new uniform act for

state adoption. 3 During this period, both state and federal courts have

invalidated, in the name of such fraudulent transfer laws, a broad range
of transactions, including mortgage foreclosures'* and leveraged buyouts.^

These cases have been controversial;^ indeed, many have been the animus
for new legislation.^

The focus of this concern has been "constructively" fraudulent

transfers. This branch of fraudulent transfer law scrutinizes transactions

in which a person transfers property or incurs an obligation^ without

m U.S.C. § 548 (1982), adopted as part of Bankruptcy Reform Act of 1978, Pub.
L. No. 95-598, 92 Stat. 2549 (1978). The Code's effective date was October 1, 1979. Id.

§ 402.

^Uniform Fraudulent Transfer Act, supra note 1.

'See, e.g., Durrett v. Washington Nat'l Ins. Co., 621 F.2d 201, 203 (5th Cir. 1980).

Durrett unleashed a mammoth amount of academic writing and case law. A partial collection
can be found in McCoid, Constructively Fraudulent Conveyances: Transfers for Inadequate

Consideration, 62 Texas L. Rev. 639, 639 nn.1-8 (1983).

-See, e.g.. United States v. Gleneagles Investment Co., Inc., 565 F. Supp. 556 (M.D.

Pa. 1983), affd sub nom.. United States v. Tabor Court Realty Corp., 803 F.2d 1288 (3d

Cir. 1986), cert, denied sub nom. McClellan Realty Co. v. United States, 107 S. Ct. 3229

(1987); Kaiser Steel Corp. v. Jacobs {In re Kaiser Steel Corp.), 17 Bankr. Ct. Dec. (CRR)

911 (Bankr. D. Colo. 1988) (allowing fraudulent conveyance attack on $140,000,000 leveraged

buyout to proceed). See generally Note, Fraudulent Conveyance Law and Leveraged Buyouts,
87 CoLUM. L. Rev. 1491 (1987); see also infra note 152.

*With respect to mortgage foreclosures, see Alden, Gross & Borowitz, Real Property
Foreclosure as a Fraudulent Conveyance: Proposals for Solving the Durrett Problem,

38 Bus. Law. 1605, 1613 n.22 (1983); Zinman, Houle & Weiss, Fraudulent Transfers
According to Alden, Gross and Borowitz: A Tale of Two Circuits, 39 Bus. Law^. 977,
979 (1984). With respect to leveraged buyouts, see Kupetz v. Continental 111. Nat'l Bank
and Trust Co. of Chicago, 77 Bankr. 754, 759-60 (CD. Cal. 1987) (questioning applicability
of fraudulent transfer laws to leveraged buyouts), affd sub. nom. Kupetz v. Wolf, 845
F.2d 842 (9th Cir. 1988); Baird & Jackson, Fraudulent Conveyance Law and Its Proper
Domain, 38 Vand. L. Rev. 829, 850-54 (1985).

The foment caused by Durrett and the various legislative reactions are reviewed
in Kennedy, The Uniform Fraudulent Transfer Act, 18 U.C.C.L.J. 195, 206-08 (1986).
See also 130 Cong. Rec. S7617 (daily ed. June 19, 1984) (amendment effectively overruHng
Durrett, deleted due to lack of ability to debate merits); Cal. Crv. Code § 3439.08(e)(2)
(West Supp. 1988) (transfer not voidable if it results from "[ejnforcement of lien in a non-
collusive manner and in comphance with applicable law . . . ."); Comment (5) to Proposed
Section 3439.08 of the Cal. Civ. Code, Report of Assembly Comm. on Fin. and Ins. on
S.B. 2150, reprinted in Cal. Assembly J. 8569, 8568 (July 8, 1986) [hereinafter Cal. Assembly
J.j (explicitly rejecting Durrett).

The original target of fraudulent conveyance laws was transfers of tangible property
to avoid execution, levy and seizure by the transferor's creditors. See G. Glenn, supra
note 1; Baird & Jackson, supra note 6. The common law later came to the view that a
creditor's incurrence of certain obligations could also offend, in that they would force a
debtor's legitimate creditors to share distributions with individuals whose claims might be
suspect. Accordingly, the UFCA enabled creditors to set aside not only conveyances, but
also obligations, if they were not exchanged for a fair consideration and made while the
transferor or obligor was in a condition of financial stringency. UFCA §§ 3, 4 & 6.



1988] FRAUDULENT TRANSFERS All

receiving a corresponding and reasonably equivalent benefit, such as in

gifts^ or accommodation guaranties. '^ If the transferor is also left in a

specified and defined condition of financial stringency, a "constructively"

fraudulent transfer exists.

Creditors of the transferor can, among other things, seek to set
aside the "constructively" fraudulent transfer, without regard to the

state of mind or intent of the parties.^' In short, the "fraudulent"

transfer need not be made with any intent to defraud; indeed, it can
even have been made with the purest of motives. Nevertheless, as long
as it depletes the transferor's assets and leaves the transferor with what

the law deems insufficient remaining assets, the transfer may be set
aside.

Constructively fraudulent transfers exist if two conditions are present.

The first is the transferor's failure to receive fair consideration or

Section 5 of the UFCA, supra note 1, which covers conveyances which leave the
transferor with unreasonably small capital, however, only extends to conveyances. Obli-

gations are not within its scope. UFCA § 5. The Code and the UFTA, have eliminated
this distinction. 11 U.S.C. § 548(a)(2)(B)(ii) (1982); UFTA, supra note 1, § 4(b)(i).

''See Hyman v. Porter (/« re Porter), 37 Bankr. 56 (E.D. Va. 1984); Reade v.
Livingston, 3 Johns. Ch. 481 (N.Y. Ch. 1818).

'^Although the issue was "left to case law" under the Code, Report of the

Commission on the Bankruptcy Laws of the United States, H.R. Doc. No. 137, 93d
Cong., 1st Sess., Part II, at 177 (1973) [hereinafter Commission Report], current cases

have found accommodation guaranties to be lacking in reasonably equivalent value as

required by section 548(a)(2)(A). Consove v. Cohen {In re Roco Corp.), 701 F.2d 978
(1st Cir. 1983); Whitlock v. Max Goodman & Sons Realty, Inc. {In re Goodman Indus.,
Inc.), 21 Bankr. 512 (D. Mass. 1982). See also Chase Manhattan Bank v. Oppenheim,

109 Misc. 2d 649, 440 N.Y.S.2d 829 (N.Y. Sup. Ct. 1981) (applying New York version
of UFCA). But cf. In re Xonics Photochemical, Inc., 841 F.2d 198 (7th Cir. 1988) (sug-

gesting that affiliate may derivatively obtain sufficient value from intercorporate guaranty).
"Under the UFCA, a creditor holding a "matured" claim has the following options

with respect to remedies: it can seek to set aside, to the extent necessary to satisfy

the creditor's claim, the transaction deemed fraudulent, or it may ignore the conveyance
and seek to levy upon the property in the hands of the transferee. UFCA, supra note
1, § 9. By contrast, holders of "unmatured" claims may also seek to set aside the claim,
but may not levy execution. Instead, they are given equitable remedies to enjoin further
disposition of the property fraudulently conveyed. Id. § 10. One major advance of the

UFCA over the common law was that it eliminated the necessity for a creditor to reduce
its claim to judgment, or to have its execution returned unsatisfied, as a predicate for

maintaining an action. See also American Surety Co. v. Conner, 251 N.Y. 1, 166 N.E.

783 (1929).

Remedies under the UFTA are similar, except that the UFTA eliminates distinctions
between matured and unmatured claims. UFTA, supra note 1, § 7. In addition, the UFTA
offers an option of adding the provisional remedy of attachment. See Prefatory Note to

UFTA, 7A U.L.A. 639 (1985).
The Code allows the bankruptcy trustee or debtor in possession to "avoid" the

transfer. 11 U.S.C. § 548(a) (1982). This, in turn, permits the entity avoiding the transfer

to "recover, for the benefit of the estate, the property transferred, or, if the court so

orders, the value of such property . ..." 11 U.S.C. § 550(a) (1982).



472 INDIANA LAW REVIEW [Vol. 21:469

reasonably equivalent value in exchange for the transfer or the obli-

gation.'^ The second is the presence of a predefined adverse financial

condition, either before the questioned transaction or because of it;'^ in

short, the law requires debtors to be just before they are generous.''* In

this regard, the classic type of precarious financial condition has been

balance sheet insolvency, and most constructively fraudulent transfer

cases explore this concept.'^

The common law and its statutory codifications, however, recognize
at least one other adverse financial condition. Under all forms of fraud-

ulent transfer laws, a voluntary transfer or one for inadequate consid-

eration will be set aside if it leaves the transferor with ''unreasonably

small capital."'^ Although not the subject of a vast body of case law,'^

the origins of this type of fraudulent transfer run deep, and the recent

legislative reformations may have increased its potential as a creditor's
remedy.

This article reviews the origins of the unreasonably small capital

branch of fraudulent transfer law. It then traces its development and

its various formulations under the Uniform Fraudulent Conveyance Act

(UFCA) and the Bankruptcy Act of 1898 (Act). After reviewing recent
cases and the changes made by the Bankruptcy Code of 1978 (Code)
and the new Uniform Fraudulent Transfer Act (UFTA), it then criticizes
two lines of cases which are contrary to the action's historical antecedents

and the goals of modern fraudulent transfer law. It concludes by sug-
gesting unifying themes linking the historical origins of the action with

current case law.

'Ml U.S.C. § 548(a)(1) (1982); UFCA, supra note 1, §§ 4-6; UFTA, supra note 1,
§ 4(a)(1).

'^These conditions are: insolvency, 11 U.S.C. § 548(a)(2)(B)(i); UFCA, supra note
1, § 4; UFTA, supra note 1, § 5; a knowing incurrence by the transferor of debts beyond
the transferor's ability to repay them, 11 U.S.C. § 548(a)(2)(B)(iii); UFCA, supra note
1, § 6; UFTA, supra note 1, § 4(a)(2)(ii); and the topic of this article, unreasonably small
capital or assets, 11 U.S.C. § 548(a)(2)(B)(ii); UFCA, supra note 1, § 5; UFTA, supra
note 1, § 4(a)(2)(i).

''See Claflin v. Mess, 30 N.J. Eq. 211, 212, (1878); Black v. Sanders, 46 N.C. (1

Jones) 67, 68 (1854).

"The Uniform Laws Annotated requires 29 pages to list the annotations for con-

structively fraudulent transfers involving insolvency. 7A U.L.A. 479-504, nn.9-91 (1985)
& 78-9, nn. 10-91 (Supp. 1988).

'*The UFTA changes this formulation to "unreasonably small assets." UFTA, supra
note 1, § 4(a)(2)(i). The change was meant to "focus attention on whether the amount
of all the assets retained by the debtor was inadequate, i.e., unreasonably small, in light

of the needs of the business or transaction in which the debtor was engaged or about

to engage." UFTA, supra note 1, § 4, comment 4.
'^While the casenote annotations for the insolvency section of the UFCA cover 29

pages, see supra note 15, the annotations for the unreasonably small capital section take

up barely five pages. 7A U.L.A. 504-507 (1985) & 80 (Supp. 1988).



1988] FRAUDULENT TRANSFERS 473

II. A Brief History of Fraudulent Conveyance Laws

A. Common Law Origins

American fraudulent transfer laws date from the Statute of Elizabeth,

enacted in 1571.'^ Designed as a penal statute, with the English crown

receiving as its penalty fully one-half of all property recovered, '^ it

prohibited conveyances made with the "intent to delay, hinder or defraud
creditors and others of their just and lawful actions. "^° The statute saw

such conveyances as contributing to ''the overthrow of all true and plain

dealing . . . without which no commonwealth or civil society can be

maintained or continued."^'

Defrauded creditors soon turned this penal statute to their personal

ends. Since such transfers were illegal, and thus presumable void, creditors

reasoned that they could ignore the conveyance and follow the transferred

property into the hands of the party receiving the goods. ^^ In short,

passage of title was ignored, and the party receiving the goods had to

give them up if the debt was just.^^ Courts adopted this reasoning, ^"^

and in 1603 Parliament followed suit and made fraudulent conveyances
a part of the English bankruptcy laws.^^ In 1623 Parliament completed

the process and made these laws civil in nature. ^^

The exact language of the statute, however, seemed to require proof

of "actual" fraudulent intent. Yet one who fraudulently transfers prop-

'«13 Eliz., ch. 5 (1571), repealed by The Law of Property Act, 15 Geo. 5, ch. 20,
§ 172 (1925).

Roman law had recognized as a nominate tort an action fraus creditiorum similar
in purpose and effect to the Statute of Elizabeth. See 1 G. Glenn, supra note 1, § 60;

Radin, Fraudulent Conveyances in California and the Uniform Fraudulent Conveyance

Act, 11 Calif. L. Rev. 1, 1-2, nn.1-2 (1938); Radin, Fraudulent Conveyances at Roman
Law, 18 Va. L. Rev. 109 (1931).

'Parties who knowingly participated in the conveyance "incurr[ed] the penalty and
forfeiture of one years value of the said lands . . . and the whole value of the said goods

. . .
." 13 Eliz., ch. 5, § 2 (1571). Of this amount, "one moitie whereof"—that is, one-

half—went to the crown and the other half went to the "party or parties aggrieved."
Id. A prison term of one half year "without bail" was also provided. Id. See also 1 G.
Glenn, supra note 1, § 61a.

^°13 Eliz., ch. 5, § 1 (1571).

^'Id.

^^Mannocke's Case, 3 Dyer 204b, 73 Eng. Rep. 661 (Q.B. 1571). The famous decision

in Tywne's Case, 3 Coke 80b, 76 Eng. Rep. 809 Star. Ch. (1601) did not involve a

private action. Rather, it was the crown's action to receive its one-half share of the goods

transferred.

^^Bethel v. Stanhope, 78 Eng. Rep. 1037, 1038 (Q.B. 1599).

''Id.

"1 Jac. 1, c. 15 (1603).

2^21 Jac. 1, c. 19, § 7 (1623).



474 INDIANA LA W REVIEW [Vol.21:469

erty can hardly be expected to step up and admit it. Common law
lawyers and judges thus developer' bridges from questionable acts com-

monly associated with fraud to iindings of actual fraudulent intent.

Called "badges of fraud, "^^ these indicia of transactions imbued with

fraud developed into a sort of common law shopping list for those
seeking to levy on property thought to be properly part of a debtor's

estate. ^^ The list's length is testimony to the ingenuity of a debtor who
perceives that it is trapped by its creditors. ^^

Several items merited special attention. Transfers for little or no

consideration—termed "voluntary conveyances"—were especially sus-
pect, ^° since they drained the pool of assets available for creditors without

replenishing the source.^' Yet, if carried to its logical conclusion, setting

aside all gratuitous transfers would void most gifts and other transfers

otherwise deemed socially acceptable. ^^

As a consequence, British common law arrived at the view that
creditors could not attack voluntary transfers so long as the transferor

-^A "badge of fraud" has been defined to be a fact which is calculated to throw

suspicion upon a transaction, and calling for an explanation. Peebles v. Horton, 64 N.C.

374, 377 (1870); M. Bigelow, The Law of Fraudulent Conveyances Ch. XVII, at 515
n.2 (Knowlton, ed. 1911). See also Boston Trading Group, Inc. v. Burnazos, 835 F.2d

1504, 1509 (1st Cir. 1987) (badges of fraud described as "a set of objective criteria . . .

use[d] as a basis for inferring fraudulent intent.").

^^The basic list is published together with Lord Coke's reporting of Tywne's Case.

See Twyne's Case, 3 Coke 80b, 76 Eng. Rep. 809 (Star Ch. 1601).

2^The UFTA lists eleven such badges of fraud, from the status of the transferee as
an insider to the transfer of essential assets to a lienor who then transfers them to an
insider of the debtor. UFTA, supra note 1, § 4(b)(l)-(ll)-

At least one authority existing at the time the UFCA was promulgated divided badges
of fraud into major and minor categories. M. Bigelow, supra note 27, at Ch. XVII.

^"Originally, English common law invalidated all gratuitous transfers. Tywne's Case,
76 Eng. Rep. at 810, note b. See also W. Roberts, A Treatise on the Construction
OF the Statutes 13 Eliz. c. 5, and 27 Eliz. c. 4 Relating to Voluntary and Fraudulent
Conveyances § IV (3d Am. ed. 1845). That view no longer prevails. See infra note 33.

''As Professor McCoid has noted, there is a difference between "voluntary" con-
veyances, which were the aim of most early cases, and transfers for inadequate consideration,

which are the subject of most modern fraudulent transfer cases. McCoid, supra note 4.

See also M. Bigelow, supra note 27, at 519; O. Bump, A Treatise Upon Conveyances
Made By Debtors to Defraud Creditors §§ 57, 247 (J. Gray rev. 4th ed. 1896).
Nevertheless, modern fraudulent transfer law makes no substantive distinction between

the two which, as Professor McCoid notes, probably accounts for confusions such as
Durrett has caused. McCoid, supra note 4.

'^Early case law in America adopted this strict position. The most famous of these

cases was Reade v. Livingston, 3 Johns. Ch. 481 (N.Y. 1818). Although Reade was not

universally followed, see Howard v. Williams, 1 Bail. 575, 583 (S.C. 1830) (limiting Reade
to its particular facts), its holding was sufficiently widespread to be a major cause of

concern to the drafters of the UFCA. Prefatory Note to UFCA, 7A U.L.A. 427, 428
(1985).



1988] FRAUDULENT TRANSFERS 475

was solvent after the transfer." Solvency, in turn, was defined as the

financial state of possessing more assets than liabilities. ^"^ From the
common law lawyer's point of view, this made sense: as long as there
were sufficient assets to satisfy all creditors claims, the gift should be

valid. ^^

/. Two Problems: Subsequent Creditors and Marginal Solvency.—
Stating the principle, however, proved easier than its application. At
least two separate questions arose regarding the application and the scope

of "insolvency." The first was a question of standing: if a transferor

was still solvent after the transfer, were there conditions under which

subsequent creditors could use this badge of fraud to attack the transfer?

The second question was closely related: if a debtor intentionally trans-
ferred just enough property to sympathetic third parties to remain mar-

ginally solvent, what recourse did its present creditors have under the

fraudulent conveyance laws?

The ultimate^^ answer to the first question was short and predictable:
courts tested such transfers as if they were varieties of transfers made
with the actual "intent to hinder, delay or defraud. "^^ Phrased in this

manner, subsequent creditors could attack the transfer only if they bore

the burden of proof of the original fraudulent intent.^* In short, creditors

''See, e.g.. Shears v. Rodgers, 110 Eng. Rep. 137, 139 (K.B. 1832); Jackson v.

Bowley, 174 Eng. Rep. 426, 429 (Nisi Prius 1841).

'"^See, e.g., H. May, The Law of Fraudulent and Voluntary Conveyances 30
(W. Edwards 3d ed. 1908) (insolvency exists "if the property left after the conveyance

is not enough to pay [the transferor's] debts"); Jackson v. Bowley, 174 Eng. Rep. 426,

429 (Nisi Prius 1841) ("if the property left after the conveyance is not enough to pay

[the transferor's] debts, that is insolvency sufficient for the purposes of the plaintiff in

this action.").

^*As Professor McCoid has noted, however, most early courts dealt with cases with
no consideration—so called "voluntary conveyances"—as opposed to conveyances for
inadequate consideration. McCoid, supra note 4. Indeed, some early commentators treated

transfers for no consideration and transfers for little consideration quite differently. See

M. Bigelow, supra note 27, Ch. XVII, at 519; O. Bump, supra note 31, §§ 57, 247.
^^The initial answer was neither clear nor uniform. As stated by Chief Justice Marshall:

"With respect to subsequent creditors, the application of [the Statute of Elizabeth] appears
to have admitted of some doubt." Sexton v. Wheaton, 21 U.S. (8 Wheat.) 229, 243

(1823). See also Williams v. Banks, 11 Md. 198 (1857) (split decision over issue).
"Williams v. Banks, 11 Md. 198, 250 (1857); See also Stratton v. Edwards, 174

Mass. 374, 378, 54 N.E. 886, 887 (1899) (proof must be of an actual intent to harm a
particular creditor; general purpose of securing against hazard of future business per-

missible); Monroe v. Smith, 79 Pa. 459, 461 (1876); Ex Parte Russell, 19 Ch. D. 588,
591, 46 L.T.R. (n.s.) 113, 115 (C.A. 1882).

^«Elwell V. Walker, 52 Iowa 256, 263, 3 N.W. 64, 70 (1879); Clanin v. Mess, 30
N.J. Eq. 211, 212 (1878). Even if transfer was a matter of public record, however, proof

of actual misrepresentation as to ownership of transferred assets could shift the burden

of proving a lack of fraudulent intent back to the transferor. Fisher v, Lewis, 69 Mo.
629, 632-33 (1879).



476 INDIANA LAW REVIEW [Vol. 21:469

had to show that the transfer was "for the purpose" of hindering,

delaying or defrauding future creditors. ^^

This required creditors to connect the transfer's consequences with

the transferor's actual intent.'*^ Factual circumstances often helped. In

Case V. Phelps, "^^ for example, Phelps had transferred all his assets in

trust for his own and his family's benefit; he then immediately started,
with no personal capital, a "travehng Indian show."^^ The New York
Court of Appeals had little problem in finding that this situation evinced

an "intent to defraud creditors whom he [Phelps] expected to owe, and
whom possible losses might render him unable to pay .... This is
fraud in fact . . . ."^^

Lumping subsequent creditors with all other victims of transfers

designed to defraud had other effects. One was that subsequent creditors
sought to use badges of fraud from other strands of fraudulent con-

veyance law in addition to insolvency to fit their situation. One badge
of fraud that seemed to attract creditors consisted of a transfer in which

the transferor engaged in business knowingly left himself just marginally

solvent, and still continued in business.

The rise of this new badge of fraud grew from the perceived

underinclusiveness of simple insolvency. When testing insolvency, all that
was required was the valuation of assets and liabilities; the result flowed

from the numerical difference between the two. But debtors as well as

creditors can add and subtract, and debtors often made voluntary transfers

which left themselves solvent, but just barely so."^^ Courts found such fact

. ''E.g., Mowry v. Reed, 187 Mass. 174, 177, 72 N.E. 936, 937 (1905); Stratton v.
Edwards, 174 Mass. 374, 378, 54 N.E. 886, 887 (1899); Winchester v. Charter, 94 Mass.

(12 Allen) 606, 610-11 (1866); Case v. Phelps, 39 N.Y. 164, 169 (1868).

"To make matters more difficult, at least one commentator believed that such proof
had to be by "clear, full and satisfactory" evidence. O. Bump, supra note 31, § 256, at

296.

'*'39 N.Y. 164 (1868).

''Id. at 165.

'Ud. at 170.

^Bohn V. Weeks, 50 111, App. 236, 240 (1893) (invalidating gift of $6500, when
assets were $7200 to $7300, and when transferor had outstanding and overdue a $400
note); Williams v. Huges, 136 N.C. 58, 59, 48 S.E. 518, 519 (1904) (finding, as a

matter of law, that assets of $11,625 were "not fully sufficient and available for the

satisfaction of the [transferor's] creditors" when liabilities equaled $11,500); Black v.

Sanders, 46 N.C. (1 Jones) 67, 69 (1854) (finding that retention of $7250 in assets to

cover $6848 of liabilities was insufficient, basing holding on poor quality of the assets;

"[n]o man would lend money upon such security"); Crumbaugh v. Kugler, 2 Ohio St.
374, 379 (1854) (retention of $48,000 of property insufficient when outstanding debts

approximated $42,000; insufficiency "owing to expenses incident to sale, and the sacrifice

almost universally affecting forced sales . . . "); Monroe v. Smith, 79 Pa. 459, 461 (1875);
Hunters v. Waite, 44 Va. (3 Gratt.) 25, 47 (1846); Ex Parte Russell, 19 Ch. D. 588, 591,
46 L.T.R. (n.s.) 113, 115 (C.A. 1882) (finding that solvency cannot be based upon the

value of "some odds and ends which can possibly be sold, and on which he puts his
fancy value.").



1988] FRAUDULENT TRANSFERS All

patterns to be badges of fraud—and hence permissible bridges to actual
intent to defraud—if such transfers unfairly shifted the risk of hquidating
assets into cash onto creditors/^ In addition, some courts found similar

unfairness if solvency after the transfer depended upon volatile or tran-

sitory factors, such as the "stability of the market.'"*^

This risk shifting was seen as a species of fraud; the transferor's

ability to convert his assets into cash was diminished, yet trade continued

without notice of this change, usually to the detriment of a creditor

who had relied on a prior course of dealing/^ This was seen as wrong;
as noted by Orlando Bump, an early comm^entator, creditors "have the
right to expect satisfaction of their debts out of [the transferor's] property,

and [the transferor] has no right, in law or morals, to throw upon them

the loss which must necessarily occur in converting it into money. ""^^

As a result of this reasoning, several rationales for this badge of
fraud developed. It was, for example, a badge of fraud to be barely

solvent after making a transfer: if one was left with assets unsuitable

for lending;"^^ if the resulting solvency depended to a great degree on

the stability of the market ;-^° or if one did not provide for reasonably

anticipated^^ or overdue debts. ^^ As with the problem of standing for
subsequent creditors, these responses had an ad hoc flavor. Each case

^'See, e.g., Schreyer v. Scott, 134 U.S. 405, 410 (1890) (stating that it was improper

to knowingly "throw the hazards of business in which [the transferor] is about to engage

upon others, instead of honestly holding his means subject to the chance of those adverse

results to which all business enterprises are liable . . . ."); Mackay v. Douglas, 14 L.R.-

Eq. 106, 121, 26 L.T.R. (n.s.) 721, 723 (Ch. 1872) (in which the thought process of someone

who transfers assets in trust prior to going into a new business was characterized
as follows: " 'I am going into trade; I believe I may make a great deal of money by it,
but nobody knows what may happen, therefore I will make myself safe, I will make this
large fortune safe by settling it on my wife and children absolutely.' "); O. Bump, supra
note 31, § 258, at 297.

^^Carpenter v. Roe, 10 N.Y. 227, 231 (1851) (solvency cannot depend "on the

intelligence to be brought by the next steamer"); Brown v. Case, 41 Ore. 221, 229, 69

Pac. 43, 46 (1902) (solvency cannot be "contingent on stability of the market."). See

also Izard v. Izard, 1 Bail. Eq. 228, 236-37 (S.C. 1831) ("The fluctuations in the value

of property, occasioned by the mercantile condition of the country, cannot however be

ranked among [those] casualties [for which the transferor need not provide].").

'^''See 1 D. Moore, A Treatise on Fraudulent Conveyances and Creditors'
Remedies at Lav/ and Equity § 8, at 277 (1908).

^«0. Bump, supra note 31, § 258, at 297.

'''E.g., Black V. Sanders, 46 N.C. (1 Jones) 67, 69 (1854); see also supra note 46.

Cf. Babcock v. Eckler, 24 N.Y. 623 (1862) (when property retained approximated $10,000,

and debts then equalled $900, transfer upheld).

^See note 46 supra. See also D. Moore, supra note 47.

'^See D. Moore, supra note 47.
''-E.g., Bohn V. Weeks, 50 111. App. 236, 240 (1893).



478 INDIANA LAW REVIEW [Vol. 21:469

Stood on its own facts, with easily stated, but loose and amorphous
rules as general guides for decision.

2. A Synthesis: The New Business Doctrine Augments Insolvency.—
Decisions such as Case v. Phelps^^ galvanized early American judicial

thinking, and helped to form a synthesis between the standing and

marginal solvency cases. The transfer of all of a person's assets in trust

for the benefit of his family, in order to begin a "travehng Indian

show''^"^ did not sit well. Courts saw such opportunism as an impediment

to business generally, and a species of fraud perpetrated upon reasonably

anticipated future creditors. ^^ But at some point such opportunism melds

with the prudence of financial planning; courts grappled with conditions

under which they would find the requisite impermissible intent. In this

struggle, subsequent creditor cases which used strict standing rules were

compared with the marginal solvency cases, which seemed to provide

an analytical basis for the relaxation of the standing limitations. Given

the similarity of the set of injured creditors under both rules, cases

began to conflate standing rules, and drop the requirement of actual

intent. ^^

This blending of rationales initially produced inconsistent results. In

both Hagerman v. Buchanan ^^ and Mackay v. Douglas, ^^ for example,
transferors had conveyed their property in trust prior to entering into

a trading partnership. In both cases, the partnership failed, and creditors

whose debts arose after the conveyance sought to set it aside. Hagerman
allowed the transfer to stand; Mackay invalidated it.

Hagerman considered "[t]he character of the business, the degree
of pecuniary hazard incurred, the amount of property remaining in the

grantor, the value of the property conveyed, [and] the acts and words

occurring coincidentally with the transaction."^^ The court gave great

weight to the transferor's behef that the partnership, although risky,

was "entirely safe."^ It thus allowed the transferor's testimony to

overcome the "strong evidence of fraudulent intent" which arises when
"a person has entered into a hazardous business, or engaged in a

speculative enterprise, at or soon after the execution of a voluntary

conveyance. "^^

»39 N.Y. 164 (1868).

''Id. at 165.

''Id.

'"E.g., Edwards v. Entwisle, 13 D.C. (2 Mackay) 43, 55-56 (1882) (insolvent debtor's

intent to defraud existing creditors is prima facie evidence of intent to defraud subsequent

creditors); see cases cited infra note 74; O. Bump, supra note 31, § 295.

"45 N.J. Eq. 292, 17 A. 946 (1889).
5«14 L.R.-Eq. 106, 26 L.T.R. (n.s.) 721 (Ch. 1872).
^^45 N.J. Eq. at 302, 17 A. at 948.

"^Id.

'''Id.



1988] FRAUDULENT TRANSFERS 479

In Mackay, a managing clerk had been admitted to a jute trading

partnership.^^ Immediately prior to his admission, however, he had trans-

ferred a valuable leasehold in trust for his wife.^^ Seven months after

his admission, the partnership became ''embarrassed," and declared

bankruptcy four months thereafter. ^'^ The vice chancellor agreed that the
circumstances justified suspicion; he ruled, however, that the transferor

bore "the burden of proving . . . that [he was] in a position to make
the voluntary settlement. "^^

The transferor attempted to meet this burden with evidence of his

good faith and reasonable behef in the success of the venture, ^^ which

presumably would have sufficed under Hagerman. The English court
parted ways with Hagerman's rationale, however, and held that a justified

belief in success was insufficient to sustain the transfer.^^ The court

stated that "the motive therefore in executing this settlement was to

protect this property against his creditors, if creditors he should have;

in other words, to take the bulk of his property out of the reach of

his creditors if any disaster should befall him."^^ The court then found
that "a man who contemplates going into trade, cannot, on the eve of
doing so, take the bulk of his property out of the reach of those who
may become his creditors in his trading operations. "^^ As a consequence,
the court invalidated the transfer. ^°

Cases such as Hagerman and Mackay highlighted the uncertain fate
of subsequent creditors. Different results could be, and were, obtained

depending on the deference given by the deciding tribunal to one's

obHgations to pay contemplated debts. Courts following Mackay required
full provision; courts following Hagerman and its progeny seemed to
allow more leeway for the well meaning, but improvident, transferor.

The confusion caused by the lack of clear guidelines further obscured
the main goal of such cases: augmentation of the under-inclusiveness

of the concept of solvency as an independent badge of fraud. The evil
to be avoided was not the preservation, at any one point in time, of

sufficient assets to pay existing creditors; rather, the goal was to prevent

the unjust failure of the normal commercial expectation that business

"14 L.R.-Eq. 106, 108, 26 L.T.R. (n.s.) 721, 721.

"/</.

"^Id. at 109, 26 L.T.R. (n.s.) at 721.

''Id. at 119, 26 L.T.R. (n.s.) at 722.

^Id. at 114, 26 L.T.R. (n.s.) at 721.

"'Id. at 121, 26 L.T.R. (n.s.) at 723.

^«/^. at 122, 26 L.T.R. (n.s.) at 723.

"^Id. at 122, 26 L.T.R. (n.s.) at 724.

'°Id.



480 INDIANA LAW REVIEW [Vol. 21:469

debt will be paid in a timely manner.^' Indeed, fraudulent or questionable

actions can be taken long before claims ripen or mature,^^ and the

solvency concept does not address these at all.

As noted above, ^^ the failure of the insolvency badge of fraud to
address fully these legitimate questions caused tension. Courts observed

that the risk allocation present in transfers leaving the transferor barely

solvent was similar to the risk allocation involved in insulating assets

from the claims of subsequent creditors. ^"^ Both types of transfers "rob"
the pool of assets—^both present and future—from which trade creditors
customarily expect their claims to be satisfied.

Cases involving transfers of assets prior to the start of a new business
formed the crucible for a new rule, or, in the argot of nineteenth century
fraudulent conveyance law, a new badge of fraud. These new business
cases, exemplified by Hagerman and Mackay, contained examples of
both types of problems with insolvency as a sufficient badge of fraud.

Subsequent creditors were a certainty, and often transferors explicitly

sought to insulate their assets from the risks associated with new business. ^^

As a consequence of the similarity of rationale, cases tended to drop

^'M at 286 ("The true rule by which the fraudulency or fairness of a voluntary
conveyance is to be ascertained . . . is . . . the pecuniary ability of the donor at the time

to withdraw the amount of the donation from his estate without the least hazard to his
creditors, or in any material degree lessening their then prospects of payment."). See also

Clark, supra note 1, at 544 (the "flexible concept of unreasonably small capital, which

relates to insolvency in its pragmatic meaning . . . guaranties that mechanical balance

sheet tests of insolvency, which can be arbitrary and misleading, do not vitiate the ideal.");

Coquillette, Guaranty of and Security for the Debt of a Parent Corporation by a Subsidiary

Corporation, 30 Case W. Res. L. Rev. 433, 454 (1980) (noting that "determinations [of
unreasonably small capital and inability to pay debts as they become due] merely complement

the central concept of insolvency by assuring that creditors do not lose their protection

by reason of the momentary solvency of [a party] at the time of the transaction.")

''^See, e.g.. National Bankruptcy Conference, Analysis of H.R. 12889, 74th
Cong., 2d Sess. 215 (Comm. Print 1936) ("[E]xperience has demonstrated that a dishonest
debtor usually begins his fraudulent activities at a time long prior to four months before
his bankruptcy . . . .").

"See supra text accompanying notes 57-70.

''Cf. Bohn V. Weeks, 50 111. App. 236, 239-40 (1893) (combining discussion of transfers
made by insolvents with gifts made under reasonable circumstances when stating rationale
for rule); Brown v. Case, 41 Ore. 221, 229, 69 Pac. 43, 46 (1902) (discussing approxima-
tions of financial ability to pay creditors after transfer for both insolvents and those on

the brink of insolvency).

Indeed, if the identity of trade creditors, and the relative amounts of their respective

debts, are the same both before and after the questioned transfer, the risk allocation is

virtually identical.

''E.g. Case v. Phelps, 39 N.Y. 164 (1868); Hagerman v. Buchanan, 45 N.J. Eq.
292, 17 A. 896 (1889); Mackay v. Douglas, 14 L.R.-Eq. 106, 26 L.T.R. (n.s.) 721 (Ch.
1872).



1988] FRAUDULENT TRANSFERS 481

the Strict rule that the creditor/plaintiff had to prove actual intent to

defraud, and allowed subsequent creditors standing to attack such trans-

fers.^^

These cases categorized the rule differently. Some stated that the
transferor was impermissibly "throw [ing] the hazards of business in

which he is about to engage upon others. "^^ Others phrased the trans-

feror's act as "cast[ing] upon his creditors the hazard of his specula-

tion."^^ However stated, when courts relaxed standing rules and permitted

certain acts to imply fraud, a frustrated creditor only had to show a

voluntary transfer, the nature of the transferor's business and a lack

of a reasonable reserve against foreseeable risks^^ of that new business. ^°

Once the creditor made this showing, it became the debtor's burden of
dispelling the presumption of fraud that such facts tended to establish. ^^

''E.g., Edwards v. Entwisle, 13 D.C. (2 Mackay) 43, 55-56 (1882) (insolvent debtor's

intent to defraud existing creditors is prima facie evidence of intent to defraud subsequent

creditors); see cases cited supra note 74; O. Bump, supra note 31, § 295.

"Schreyer v. Scott, 134 U.S. 405, 410 (1890).

^«Carpenter v. Roe, 10 N.Y. 227, 232 (1851).

''The concept of risk was often expressed as a "hazard" to be avoided. See supra

notes 11-1%. This concept was sometimes applied not to the general risks of businesses,

but to the nature of the business itself. Indeed, the first draft of the UFCA applied only
to a transferor in a "hazardous" business; this was deleted from the second draft. See

infra text accompanying notes 87-93. Collier indicates that the omission of the qualifying

adjective "hazardous" in the final draft "can be construed only as conscious and de-

liberate." 4 Collier on Bankruptcy H 548.04, at 548-55 to 548-56 n.lO (15th ed. 1988),
and thus strongly indicative of a broad apphcation of section 5.

Notwithstanding this change, some early section 5 cases continued to base their

holdings on findings that the transferor was involved in a hazardous or speculative business.

See, e.g.. State v. Nashville Trust Co., 28 Tenn. App. 388, 190 S.W.2d 785 (1944), cert,

denied, 181 Tenn. 74 (1945); Fidelity Trust Co. v. Union Nat'l Bank of Pittsburgh, 313

Pa. 467, 169 A. 209 (1933), cert, denied, 290 U.S. 680 (1934); People Sav. & Dime Bank
& Trust Co. V. Scott, 303 Pa. 294, 154 A. 489 (1931). The current view, however,
is that even traditional businesses can run afoul of this section. Compare Fidelity Trust
Co. V. Union Nat'l Bank of Pittsburgh, 313 Pa. 467, 169 A. 209 (1933), cert, denied,

290 U.S. 680 (1934) (speculative nature of trading stocks considered) with Teitelbaum v.

Voss {In re TuUer's, Inc.), 480 F.2d 49 (2d Cir. 1973) (business involved was simple

drugstore) and Zuk v. Hale, 114 N.H. 813, 330 A.2d 448 (1974) (business was that of

independent general contractor). See also M. Bigelow, supra note 27, Ch. VIII, § 3, at
237.

'""E.g., Gable v. Columbus Cigar Co., 140 Ind. 563, 567, 38 N.E. 474, 475 (1894);
Fisher v. Lewis, 69 Mo. 629, 632 (1879). See also M. Bigelow, supra note 27, Ch. VII,

§ 3, at 230-31; O. Bump, supra note 31, § 258; 1 G. Glenn, supra note 1, § 335.

''See Elwell v. Walker, 52 Iowa 256, 263, 3 N.W. 64, 70 (1879); State v. Nashville
Trust Co., 28 Tenn. App. 388, 419, 190 S.W.2d 785, 796-97 (1944), cert, denied, 181

Tenn. 74 (1945); Mackay v. Douglas, 14 L.R.-Eq. 106, 113, 26 L.T.R. (n.s.) 721, 722

(Ch. 1872); H. May, supra note 34, at 30-31.



482 INDIANA LAW REVIEW [Vol. 21:469

Such views, however, were hardly uniform, and the dissonance in these

decisions led to a movement to unify and harmonize these disparate

themes. ^^

B. The Uniform Fraudulent Conveyance Act

Differences over standing rules and the interpretation of insolvency

were by no means the only non-uniform interpretations of the Statute

of Elizabeth. Because the prevailing analysis used various factors and

badges of fraud, each having a different weight—both among themselves
and in different cases—non-uniform results were the norm.^^ Conse-
quently, one of the first uniform acts suggested by the National Con-

ference was the Uniform Fraudulent Conveyance Act (UFCA),^^ proposed

in 1916, but not adopted until 1918.

This act, ultimately adopted in 25 states, ^^ preserved the traditional

ability to set aside transactions entered into with actual intent to "hinder,

delay or defraud" creditors. But it went beyond the original language

of the Statute of Elizabeth, codifying and distilling the cases in an

attempt to produce objective tests for classifying a transfer as sufficiently

"fraudulent" to allow creditors to ignore the suspect transaction and

levy upon the items transferred.

The UFCA was revised three times prior to its adoption. Each draft
sought to vahdate certain gifts against creditor attack. ^^ The initial

classification chosen upheld such transfers if the transferor was not left

in one of three discrete descriptions of financial conditions. These con-

•^^One attempt was made in Gately v. Kappler, 209 Mass. 426, 95 N.E. 859 (1911),
in which the court held that it was appropriate for a transferor to provide against unknown
risks, but not to make transfers that unreasonably protected against known debts. Id. at
427-28, 95 N.E. at 859.

"Compare O. Bump, supra note 31, § 255, at 295 (debts guaranteed or which are

co-endorsed not counted for purposes of insolvency) with M. Bigelow, supra note 27,
Ch. VIII, § 3, at 234-35 (opposite).

Indeed, one of the main purposes of the Uniform Fraudulent Conveyance Act was

to resolve the spht among the states over the validity of gifts as against future creditors.
See Prefatory Note to UFCA, 7A U.L.A. 427, 428 (1985); Report of the Committee on
Uniform State Laws, 5 A. B.A.J. 481, 492 n.2 (1919).

^'^See supra note 1.

^^7A U.L.A. 73 (Supp. 1988). Nebraska was the last to adopt it, and did so in

1980. Id. It also has been adopted in the Virgin Islands. Id.

The UFCA's influence, however, extends beyond those states which have adopted it
by statute. Some states which have not enacted the UFCA have accepted its provisions
as accurate restatements of the received learning of the Statute of Elizabeth. MoHtor v.

Molitor, 184 Conn. 530, 535, 440 A.2d 215, 218 (1981) (finding that the UFCA "is largely
an adoption and clarification of the standards of the common law.").

^^See supra note 83.



1988] FRAUDULENT TRANSFERS 483

ditions, however, were further distinguished on the basis of what type

of creditors could use them.

One sticking point in this classification scheme was the appropriate
circumstances under which future creditors could attack a constructively

fraudulent transfer. The first draft of the UFCA, delivered to the
Conference in 1916,^^ contained the forerunner of section 5 of the current

UFCA, which attempted to answer this question. ^^ As promulgated, this
section provided that a voluntary conveyance for less than fair consid-

eration could be set aside if "the person making it is engaged or is

about to engage in a hazardous business or transaction involving risks

exceeding his remaining assets. "^^ Standing to challenge such transfers

was extended to "persons who become creditors ... as the result of
obligations entered into or acts done during the continuation of such

business or transaction."^^

The Conference recommitted the draft to committee.^' The second

draft, promulgated in 1917,^^ significantly changed the text of proposed

section 5. It dropped the "hazardous business" concept, and inserted

in its place the current language regarding unreasonably small capital. ^^

No explanation for the change was made; indeed, the reporter used the
same explanatory notes to elaborate the origins of the section. ^"^

The text was again returned to committee. ^^ The third and final

draft of the UFCA was presented in 1918 at the Conference's annual
meeting in Cleveland. ^^ Although the text of section 5 had not changed, ^^

controversy apparently surrounded it. Immediately prior to adoption of

the motion recommending the UFCA to all the states, a motion was
made to exclude section 5 from the Conference's recommendation.^^ No

*^UFCA (First Tentative Draft), reprinted in National Conference of Commissioners

ON Uniform State Laws, Proceedings of the Twenty-Sixth Annual Meeting of the
National Conference of Commissioners on Uniform State Laws 254 (1916) [hereinafter
1916 Proceedings].

''UFCA § 5 (First Tentative Draft), reprinted in id., at 258.
''Id.

^Id.

^'See National Conference of Commissioners on Uniform State Laws, Pro-

ceedings OF THE Twenty-Seventh Annual Meeting of The National Conference of
Commissioners on Uniform State Laws 249 (1917) [liereinafter 1917 Proceedings].

^^UFCA (Second Tentative Draft), reprinted in id., at 250.
^'UFCA § 5 (Second Tentative Draft), reprinted in id., at 254.

'''Id. at 255.

""'Id. at 65-66.

'^UFCA (Tliird Tentative Draft), reprinted in National Conference of Commis-

sioners ON Uniform State Laws, Proceedings of the Twenty-Eight Annual Meeting
OF THE National Conference of Commissioners on Uniform State Laws 348 (1918).

"'Id. at 353.

'''Id. at 52.



484 INDIANA LAW REVIEW [Vol. 21:469

Other section was singled out for this exclusion. While this motion to

exclude ultimately was defeated, the vote was close; of the twenty-nine

states present, only sixteen voted to keep section 5 of the Act.^^ Of the
remaining thirteen states, twelve voted to exclude section 5, and one

state was divided J^° Thus born in controversy, section 5 was presented

to the states.

C. The Bankruptcy Act, the Bankruptcy Code and the Uniform
Fraudulent Transfer Act

Many states soon adopted the UFCA.^°' Following this lead. Congress
in 1938 adopted, almost verbatim, the text of the UFCA as the federal
fraudulent transfer standard in the Bankruptcy Act of 1898 (Act).'^^ The

legislative history lauded the UFCA as incorporating the better reasoned
cases under the Statute of Elizabeth. '^^ Although not adopted, language

stating that the federal statute should be interpreted consistently with

the UFCA was suggested. '^'^

The enactment of the present Bankruptcy Code (Code)^*^^ in 1978

was the first major revision to the statutory text of fraudulent transfer

law. The Code revised the treatment of the characterization of exchange;
"reasonably equivalent value" rather than "fair consideration" became

the test.'°^ The financial stringency test of "unreasonably small capital,"

^Id.

'°^Id.

'°'It was ultimately adopted by twenty-five states and the Virgin Islands. See lA
U.L.A. 427 (1985).

'°^The text was added by amendments to the 1898 Act, known generally as the

Chandler Act. Act of June 22, 1938, c. 575, § 1, 52 Stat. 840, 875 (repealed 1979).

'03"We have condensed the provisions of the Uniform Fraudulent Conveyance Act,

retaining its substance, and, as far as possible, its language." National Bankruptcy

Conference, Analysis of H.R. 12889, 74th Cong., 2d Sess. 214 (Comm. Print 1936).
'**/<i. at 217. Notwithstanding the omission from the final text, one leading com-

mentator states that powerful considerations should be shown to justify a federal court

in departing from well reasoned interpretations of the Uniform Act. 4 Collier on Bank-

ruptcy, supra note 79, 1 548.01, at 548-18 n.25.

^°^See supra note 1.

'°*The two terms were intended to be equivalent with respect to the measurement of

the amount of consideration. Commission Report, supra note 10, Part I, at 211; Comment,

Guaranties and Section 548(a)(2) of the Bankruptcy Code, 52 U. Chi. L. Rev. 194, 198

n.l8 (1985) (citing other relevant legislative history). Under the UFCA, however, "fair
consideration" also includes the concept of good faith. UFCA, supra note 1, § 3. See
generally Comment, Good Faith and Fraudulent Conveyances, 97 Harv. L. Rev. 495
(1983). The Code and UFTA break out the concept of good faith from the concept of
consideration, and make it an affirmative defense, validating the transfer or the obligation

to the extent the transferee gave with good faith. 11 U.S.C. §§ 548(c) (1982) (initial

transferee); 550(b) (mediate and intermediate transferees); UFTA, supra note 1, §§ 8(a),
(d) (same).



1988] FRAUDULENT TRANSFERS 485

however, remained the same, and the reach of the section was expanded

from conveyances to ''obhgations incurred. '"^^

Although the substantive requirements for other types of fraudulent

transfers were little changed, the Code significantly altered (although it

purported not to) the section condemning transfers by insolvents. In

adopting the insolvency test previously used to test "acts of bankruptcy" '^^

and other matters*^^—that of liabilities exceeding assets "at a fair
valuation" ''°—the Code rejected the Act's and the UFCA's reliance on
asset valuation at a "present fair salable value.

"''^ The difference between

the two tests was knov/n,''^ and is significant.^'^ The Code thus makes

proof of insolvency a much more difficult task.
The Uniform Fraudulent Transfer Act (UFTA),''"^ when promulgated

in 1984, adopted most of the Code's changes. Indeed, one of the UFTA's

'"ni U.S.C. § 548(b)(2)(B)(ii) (1982). See also supra note 8 for a discussion of the

differences between the text of the Code and the UFCA.
'°^See, e.g.. Act, supra note 1, §§ 3(a)(3), 11 U.S.C. § 21(a)(3) (repealed 1979)

(suffering imposition of a Hen while insolvent); 3(a)(5), 11 U.S.C. § 21(a)(5) (repealed

1979) (appointment of a receiver or trustee while insolvent).

"^The Act used the "fair valuation" formula in determining whether a person was

insolvent for purposes of assessing preferences. Act, supra note 1, § 60, 11 U.S.C. § 96

(repealed 1979). In addition, under Chapter X of the Act, 11 U.S.C. §§ 501-676 (repealed
1979), a finding of insolvency permitted a court to appoint a receiver. Id. at § 115, 11

U.S.C. § 515 (repealed 1979), and triggered certain protections for dissenting shareholders.

Id. § 216(8), 11 U.S.C. § 616(8) (repealed 1979).

"°"A person shall be deemed insolvent . . . whenever the aggregate of his property,

. . . shall not at a fair valuation be sufficient in amount to pay his debts." Act, supra

note 1, § 1(19), 11 U.S.C. § 1(19) (repealed 1979). Cf. 11 U.S.C. § 101(31) (1982)
(" 'insolvent' means . . . financial condition such that the sum of the entity's debts is

greater than all of such entity's property, at a fair valuation . . . .") (emphasis added).

'''See Act, supra note 1, § 67(l)(d), 11 U.S.C. § 107d(l)(d) (repealed 1979).

"=See e.g., Holahan v. Lewis, 182 F. Supp. 473 (N.D. Fla. 1960). In that case the

court stated:

The Court construes the definition of insolvency as defined in Section 107 as

the controlling one in the application of Section 107 sub. d(2)(a) et. seq. The

definition of insolvency as enunciated in Section 1, Subdivision 19, carries a

far broader sweep than does Section 107. It is apparent that Congress intended

less stringent proof of insolvency in Section 107 than in other phases of bank-

ruptcy proceedings.

Id. at Al()-ll . See also 1 G. Glenn, supra note 1, at § 272.

"'Early courts noted this difference and specifically found that the "fair valuation"

test produced a more liberal and higher total asset value than did the present fair valuation

standard. In re Crystal Ice & Fuel Co., 283 F. 1007, 1009-10 (D. Mont. 1922); Stern v.
Paper, 183 F. 228, 231 (D.N.D. 1910) (court noted that the fair valuation standard is

"liberal" and "ought not to be enlarged."). See also Tri-Continental Leasing Corp., Inc.

V. Zimmerman, 485 F. Supp. 495, 498 (N.D. Cal. 1980); Meyer v. General American

Corp., 569 P.2d 1094, 1096 (Utah 1977). Professor Glenn argued early and strenuously

for the abolition of the fair valuation test in favor of one such as was adopted in the

UFCA. 1 G. Glenn, supra note 1, at § 272.
""^See supra note 1.



486 INDIANA LAW REVIEW [Vol.21:469

implied purposes was to conform the uniform state law with the Code.''^

The UFTA, for example, adopts the reasonably equivalent value test,''^
and the Code's extension of the action to obligations.''^ It also adopts

the Code's revised formulation of insolvency."^

The UFTA, however, broke some new ground. It changes the for-
mulation of section 5's financial stringency condition to "unreasonably

small assets. ''^^^ The UFTA defines "assets" as non-exempt property
which is not subject to a vaHd lien.'^° This change was made to avoid
confusing working capital concepts—which are the heart of the section

—

with corporate law concepts of paid in capital'^'—which are irrelevant
to fraudulent transfer law.'^^ The focus has thus been shifted from

adequacy at inception to adequacy at all reasonably foreseeable times.

The UFTA has been rapidly adopted by at least seventeen states, '^^
with some inevitable variations, mostly in the UFTA's resurrection of
badges of fraud. '^"^ What remains fairly constant, however, is the thrust

'''See Prefatory Note to UFTA, reprinted in 7A U.L.A. 639 (1985).
•'^UFTA, supra note 1, §§ 4(a)(2); 5(a).

"^UFTA, supra note 1, § 4(a)(2)(i). See also supra note 8.

•'^UFTA, supra note 1, § 2, The UFTA expands upon the Code's definition, however,
by creating a rebuttable presumption of insolvency if a transferor is not "generally paying

its debts as they become due." Id, § 2(b). See Cook & Mendales, The Uniform Fraudulent
Transfer Act: An Introductory Critique, 62 Am. Bankr. L.J. 87, 91-92 (1988).

In the context of passing the UFTA, at least one state has tackled head on the issue
of the valuation of assets, adopting views which would have eliminated much of the recent
furor fraudulent transfer law has caused. See, e.g.. Comments (6) and (7) to proposed
Cal. Civ. Code § 3439.02, Cal. Assembly J., supra note 7, at 8574-75 (valuation of
contingent debts).

'"^UFTA, supra note 1, § 4(a)(2)(i).

•^°UFTA, supra note 1, § 1(2).

'^'For cases apparently using corporate capital concepts, see, e.g., Diller v. Irving

Trust Co. {In re College Chemists, Inc.), 62 F.2d 1058 (2d Cir. 1933); Wells Fargo Bank

V. Desert View Bldg. Supplies, 475 F. Supp. 693 (D. Nev. 1978), aff'd mem., 633 F.2d

225 (9th Cir. 1980).

'^^Reporter's Note to UFCA § 4, 7A U.L.A. 654 (1985). See also Comment (4) to
Proposed Section 3439.04 of the Cal. Civ. Code, Cal. Assembly J., supra note 7, at

8577.

'^These are: Arkansas, Cahfornia, Florida, Hawaii, Idaho, Maine, Minnesota, Nevada,

New Hampshire, North Dakota, Oklahoma, Oregon, Rhode Island, South Dakota, Texas,
Washington, and West Virginia. 7A U.L.A. 88 (Supp. 1988). Of these seventeen, only
nine, Cahfornia, Idaho, Minnesota, Nevada, New Hampshire, North Dakota, Oklahoma,
South Dakota and Washington, had adopted the UFCA. Id.

'^California, for example, did not adopt the UFTA recitation of badges of fraud
as indicia of transfers made with the actual intent to hinder, delay or defraud. Cal. Civ.
Code § 3439.04 (West Supp. 1988). It did, however, list those badges of fraud in the
legislative history as a "nonexclusive list of some facts \yhich courts have considered ..."

in finding actual intent. Comment (5) to Proposed Section 3439.04 of the Cal. Civ. Code,
Cal. Assembly J., supra note 7, at 8577.



1988] FRAUDULENT TRANSFERS 487

of the section as deterring transfers for less than reasonably equivalent

value by businesses bordering on insolvency.

III. Case Law Developments

Despite the basic textual differences in the various sources of fraud-

ulent transfer law, the cases are not so diverse. Indeed, with but a few

exceptions, the cases have been true to the original limited intent of the

section. It is to a brief review of these cases that this article now turns.

A. Interpretations of Section 5

After the promulgation of the UFCA, section 5 received little in-
dependent notice. ^^^ The case law that did develop, however, did little

to illuminate the basic question: what is the scope of the unreasonably

small capital section? Several false starts occurred. One view concentrated
on the transferor's * 'working capital"—loosely defined as the excess of
current assets over current liabilities. ^^^ Another looked to a transferor's

"capitalization," taken to be the amount of assets placed at risk in the
business. '2^

The main view, to the extent that one developed, focused on the

transferor's ability to marshal sufficient cash, either from operations,

equity infusions, new loans or some combination of these, to pay expected
creditors. '2^ These cases took a forward looking view, comparing antic-

ipated cash flow against anticipated debt incurrence. ^^^

Most cases, however, avoided taking sides with these definitional
issues, and instead developed per se rules derived from other fraudulent

conveyance law notions, and from corporate law generally. ^^° Section

5's history, however, as well as the historical purpose of promoting

^^^See supra note 15.

'^"See, e.g., Steph v. Branch, 255 F. Supp. 526 (E.D. Okla. 1966), affd 389 F.2d

233 (10th Cir. 1968); Zuk v. Hale, 114 N.H. 813, 330 A.2d 448 (1974).
^^^See, e.g.. Wells Fargo Bank v. Desert View Bldg. Supplies, 475 F. Supp. 693 (D.

Nev. 1978) ("The primary intent of this statute is to prevent an under-capitalized company
from being thrust into the market place to attract unwary creditors to inevitable loss while

one or more preferred creditors are provided relative safety of a security interest in the

company's assets."), affd mem., 633 F.2d 225 (9th Cir. 1980).
'^^Credit Managers Ass'n of S. Cal. v. Federal Co., 629 F. Supp. 175 (CD. Cal.

1985); Steph v. Branch, 255 F. Supp. 526 (E.D. Okla. 1966), affd, 389 F.2d 233 (10th

Cir. 1968); In re Atlas Foundry Co., 155 F. Supp. 615 (D.N.J. 1957); Jacobson v. First

State Bank of Benson {In re Jacobson), 48 Bankr. 497 (Bankr. D. Minn. 1985); Jenney
V. Vining, 120 N.H. 377, 415 A.2d 681 (1980).

'^''See, e.g.. Credit Managers Ass'n of S. Cal. v. Federal Co., 629 F. Supp. 175

(CD. Cal. 1985).
"°5ee infra text accompanying notes 136 to 166.



488 INDIANA LA W REVIEW [Vol . 2 1 : 469

"true and plain dealing,'"^' both augur against such iron clad and

inflexible rules. Section 5 was created to address perceived inadequacies

in section 4'^^—dealing with transfers by insolvents—and even then its
adoption was only by a narrow margin.'" This uncritical expansion not

only ignores the section's historical roots, but also ignores the current

role of fraudulent transfers involving unreasonably small capital.

B. Uncritical Expansion of the Action

Since its enactment, two lines of cases have expanded the scope of

the unreasonably small capital action in unjustifiable ways. The first

line of these cases declared that a pledge of all or substantially all of

a company's assets ipso facto leaves the transferor with unreasonably

small capital.'^"* The second line holds that a finding of insolvency is

per se a finding of unreasonably small capital. '^^ These cases, at first

glance, seem to provide certainty to a confusing area of the law. In

reality, however, they preserve an ossified and incorrect view of fraudulent

transfer law, and an examination of their reasoning demonstrates their

lack of continuing vahdity.

1. Encumbrance of All Assets.—A few cases have held that if a
company has little or no unencumbered assets, it automatically has

unreasonably small capital. The seminal case for this proposition is Diller

V. Irving Trust Co. (In re College Chemists, Inc.).^^^ There, Diller had

sold all of the shares of her company, College Chemists, Inc., to

Weiner.'^^ Weiner agreed to pay the purchase price by causing his new

company, College Chemists, to grant Diller a security interest in all of

its assets. '^^ When College Chemists was declared bankrupt, the trustee
in bankruptcy sued to invahdate the security interest and succeeded. The

basis of its claim was that the transfer of the security interest was a

fraudulent conveyance of the unreasonably small capital variety. '^^

The Second Circuit, in a one page per curiam opinion, affirmed

the invahdation. The court had no problem finding unreasonably small

capital, because it determined that "there was no capital at all, because

'^'See supra text accompanying notes 18 to 21.

'"5ee supra note 71.

'"-See supra notes 99-100.

'"See infra text accompanying notes 136 to 158.

'^'See infra text accompanying notes 159 to 166.
'3^62 F.2d 1058 (2d Cir. 1933) (per curiam).

'''Id.

'''Id.

^'"^Id. The Second Circuit's opinion is silent with regard to whether the trustee had

also sought to show that College Chemists had been made insolvent by the transfer.



1988] FRAUDULENT TRANSFERS 489

Weiner's debt was more than its value. "^"^^ In short, by counting the
acquisition debt, College Chemists' balance sheet liabilities exceeded its

balance sheet assets. To allow the pledge to stand, in the court's view,
would allow "Weiner to carry on the business on an expectancy of

profit." •'^^ The rule in College Chemists has been followed at least three

times, in each case without detailed analysis. •'^^ Although the circum-

stances present in each of these cases may have presented a sufficient
factual basis for their result, they certainly do not compel automatic

relief.

As recognized by several recent cases, '"^^ it does not necessarily follow
that the lack of unencumbered assets constitutes ''unreasonably small"

capital. These cases focus on several factors tending to establish the

availability of cash to operate the business, rather than on a single factor

such as a lack of unencumbered assets. For example, in Credit Managers

Associations of Southern California v. Federal Co.,^^"^ General Electric

Credit Corp. ("GECC"), a well-known asset-based lender, lent over seven
million dollars in a management-lead leveraged buyout. When a labor
strike and other setbacks caused financial problems, GECC increased
its line by over two and one-half million dollars. ''^^ The court properly
considered this an appropriate and anticipated source of capital. '^^

Similarly, in Allied Products Corp. v. Arrow Freightways, Inc.,^^'^
the New Mexico Supreme Court was faced with the exact situation in
College Chemists', a sale of a business in which the buyer caused its

new company to secure the deferred portion of the purchase price with

"*°/Gf. at 1058. The court seemed to infer that the purchase price had been too high;

since "Weiner's debt" equalled the purchase price, the "value" of the assets could only

be less than that amount if Weiner paid too much, with the result that Diller received

a debt in excess of the value of the assets sold. The Second Circuit confirmed this reading

in Teitelbaum v. Voss {In re Tuller's, Inc.), 480 F.2d 49 (2d Cir. 1973). There, under

essentially the same facts as in College Chemists, the court stated that the security interest

in favor of the departing shareholders "left [the transferor] with all of its tangible assets

mortgaged. It was [thus] effectively devoid of capital ....'" In re Tuller's, 480 F.2d at

52.

'''College Chemists, 62 F.2d at 1058.

'^Teitelbaum v. Voss {In re Tuller's, Inc.), 480 F.2d 49, 51-52 (2d Cir. 1973); Pirrone

V. Toboroff {In re Vaniman Int'l, Inc.), 22 Bankr. 166, 186 (Bankr. E.D.N.Y. 1982);
Sharrer v. Sandlas, 103 A.D.2d 873, 477 N.Y.S.2d 897, motion for leave to appeal denied,

63 N.Y.2d 610, 473 N.E.2d 1190, 484 N.Y.S.2d 1024 (1984), reargument denied, 64 N.Y.2d

885, 476 N.E.2d 1008, 487 N.Y.S.2d 1029 (1985). Accord In re Atlas Foundry Co.,

155 F. Supp. 615, 617 (D.N.J. 1957) (court found that encumbrance of assets to finance

leveraged acquisition reduced the "free assets of the bankrupt corporation to a point too

low to permit it to carry on its operations with safety.").

'"^See infra text accompanying notes 144 to 158.

'^629 F. Supp. 175 (CD. Cal. 1985).
'''Id. at 186.

"^Id. at 184.

'^^04 N.M. 544, 724 P.2d 752 (1986).



490 INDIANA LAW REVIEW [Vol. 21:469

the company's own assets. In Allied Products, however, the new owner
invested over $100,000, personally guaranteed over $250,000 in trade

debt, and renegotiated other debt.'"^^ Although the court found that the

"security interests made future financing difficult, if not impossible,"''*^
it also found, presumably from the new owner's efforts and investments,

that there was "uncontradicted testimony" as to remaining capital. '^°

The rule of College Chemists ignores these alternative sources of

operating capital. As established in Credit Managers and in Allied Prod-

ucts, borrowing against or selling unencumbered assets is only one of

many commercially reasonable methods of raising cash. A company may
seek additional equity capital, either through capital contributions from

existing owners or by the sale of equity interests to new investors.'^' It
may issue unsecured debt. If there is a senior blanket security interest,
a new lender may lend more on the same assets secured by a junior
lien, the existing lender may itself lend more, or the existing lender may
subordinate its interest to a new lender. In short, even though debt may
exceed aggregate asset value, as was the case in College Chemists, many
avenues exist to funnel cash into the company.

In addition to this failure to consider all possible sources of operating

capital. College Chemists and its progeny disregard the true economic

effect of the types of transactions involved. The transaction examined

in College Chemists involved a pattern familiar to acquisitions generally;

a portion of the consideration passing to the seUing equity interests is

deferred and expected to be paid from future profits of the business

sold. The buyer, in turn, uses its newly acquired control to cause the

company bought to secure the deferral with the assets of the company
sold. Recently, these transactions have been called leveraged buyouts.'"

College Chemists condemns these transactions, based upon the view that

such transfers allow the transferor to conduct business on "an expectancy

of profit,"'" presumably for the sole benefit of the transferor. But in

'''Id. at 545, 724 P.2d at 753.

'«M at 548, 724 P.2d at 756.
''°Id.

'"Professor Clark has recognized that the provision of additional equity can be

relevant. Clark, supra note 1, at 560.

'"S^e generally Carlson, Leveraged Buyouts in Bankruptcy, 20 Ga. L. Rev. 73 (1985);

Baird & Jackson, supra note 6; Comment, supra note 1. Indeed, some commentators have
indicated that the new UFTA may be more lenient in allowing successful fraudulent transfer
attacks on leveraged buyouts. Cook & Mendales, supra note 118, at 91 ("a leveraged
acquisition that left a corporation with little or no unencumbered property would be even

more readily subject to attack than under present law").

'"Diller v. Irving Trust Co. (In re College Chemists, Inc.), 62 F.2d 1058, 1058 (2d

Cir. 1933). See also Mackay v. Douglas, 14 L.R.-Eq. 106, 121, 26 L.T.R. (n.s.) 721, 723
(Ch. 1872) (characterizing the thought process of someone who transfers assets in trust



1988] FRAUDULENT TRANSFERS 491

College Chemists the person benefitting from the transfer—the seller

—

was not the transferor. In short, in a leveraged buyout, the "culprit,"

if any, is the departing equity owners. It is decidedly not the third party

financing the transaction.

Two observations flow from this review of the position of the parties.
If a third party finances the leveraged buyout, setting aside its lien or

obligation may automatically give rise to an action by the financing
party for return of the loan funds or other consideration on equitable

theories such as unjust enrichment. ^^'* Accordingly, in the bankruptcy

context the remedy of invalidation is not without its detractions.'^^

Second, since the real flow of funds is from the operating company to
its departing shareholders, a question exists whether fraudulent transfer

law even applies. '^^ State laws on dividend restrictions exist for the

protection of creditors against shareholders' ability to divert corporate

funds. '^^ Not only are these statutes crafted to deal directly with this

type of transfer, but the original drafters of the UFCA declined to
include such a section in the UFCA, even though it had been proposed

prior to going into a new business as follows: '"I am going into trade; I believe I may
make a great deal of money by it, but nobody knows what may happen, therefore I will
make myself safe. I will make this large fortune safe by settling it on my wife and
children absolutely.'").

^^^See Restatement of Restitution § 17 (1937) (person who has paid money or void
or voidable agreement may receive restitution). See also Stratton v. Manning, 139 Cal.
App. 2d 723, 727, 294 P. 2d 66, 68 (1956).

'^^In a state court setting, the issue is typically one of priorities between two creditors,

the plaintiff and the transferee/defendant. In a bankruptcy context, however, the plaintiff

represents all creditors, and the benefits of the avoided transfer are preserved for the

benefit of the bankruptcy estate. 11 U.S.C. § 551 (1978). Invahdating a transfer and

reducing the status of that lien creditor to one of an unsecured creditor may or may not
help other unsecured creditors. See, e.g., H. Rep. 595, 97th Cong., 1st Sess. 376 (1977);

S. Rep. 989, 95th Cong., 2d Sess. 91 (1982). For example, if significant unencumbered

assets existed prior to invalidation, and the claim sought to be invahdated was undersecured,

the result of a successful action might be detrimental to unsecured creditors, i.e., it would

result in a lesser dividend. Accordingly, the rights inuring to the benefit of a defeated

lien creditor are important, and must be considered by the debtor or trustee. Further

subordination, to that of equity interests, would require additional and more egregious

acts. See generally Bank of New Richmond v. Production Credit Ass'n of River Falls
(In re Osborne), 42 Bankr. 988, 996-97 (W.D. Wise. 1984); DeNatale & Abram, The
Doctrine of Equitable Subordination as Applied to Nonmanagement Creditors, 40 Bus.
Law. 417 (1985).

'^^Although cases exist which permit a fraudulent conveyance attack on dividend

payments, these cases do not critically consider the policy reasons, examined infra at note

158, as to why fraudulent transfer law ought not to be so extended. Consove v. Cohen
{In re Roco Corp.), 701 F.2d 978, 982 (1st Cir. 1983); Fox v. MGM Grand Hotels, 137
Cal. App. 3d 524, 187 Cal. Rptr. 141 (1983).

'''See Prefatory Note to UFTA, 7A U.L.A. 639 (1985).



492 INDIANA LAW REVIEW [Vol. 21:469

in the first draft. '^^ Against this background, it makes Httle sense to

bring fraudulent transfer law to bear upon the problem, let alone erect

a per se rule against such transactions.

2. From Insolvency Directly to Unreasonably Small Capital.—

A

second line of cases has developed another unwarranted per se rule:

that a finding of insolvency is automatically a finding of unreasonably

small capital. '^^ This rule does violence to the carefully structured standing

rules applicable to fraudulent transfers and achieves results inconsistent

with the UFCA's original intent. As such, it should be repudiated.
The vice of this rule is demonstrated by recalling the standing rules

for fraudulent transfers: a transfer which renders a transferor insolvent

may be attacked by any of the transferor's then-existing creditors, but
not by creditors whose debts arise after the transfer. The rationale for

this distinction is that future creditors at least have the opportunity to

inquire as to the transferor's financial condition and decline to trade

if the information obtained was negative. '^° Those who were creditors
at the time of the transaction had no such opportunity.

'^^Section 8 of the First Tentative Draft of the UFCA was entitled "Payment of
Dividend by Corporation." 1916 Proceedings, supra note 87, at 259-60. The Second

Tentative Draft omitted this section "as belonging to a Corporation [Act] rather than a

Fraudulent Conveyance Act." 1917 Proceedings, supra note 91, at 258. Professor Glenn

also believed that restrictions on corporate dividends were not the province of fraudulent

conveyance laws. 1 G. Glenn, supra note 1, § 604, at 1043-47. See also Coquillette, supra

note 71, at 446-48.

Professor Clark argues strenuously for coverage of corporate dividends by fraudulent

transfer laws, based in part on his view that dividend restriction statutes are "virtually

meaningless" because they are rigid, bright line tests, focusing on "formalistic accounting

conventions" rather than on the UFCA's "purposive concept of capital." Clark, supra
note 1, at 556, 558-59 n.l54. Professor Clark seems to discount the UFCA's historical
origins, and also gives too little deference to state legislatures in the control of the corporate

creatures they create. Instead, he exalts the flexibility of the common law over the perceived
restricting influence of legislation. It makes little sense, however, to enact statutes specifically

designed to regulate the shareholder/corporation relationship if common law concepts will
always, or nearly always, usurp their function. Given the set of balances a legislative

body strikes in creating corporations with their limited liability to exist. Professor Clark's

position seems to pass wide of the mark.

'^^United States v. Gleneagles Investment Co., Inc., 565 F. Supp. 556, 580 (M.D.

Pa. 1983), aff'd sub nom. United States v. Tabor Court Realty Corp., 803 F.2d 1288

(3d Cir. 1986); New York Credit Men's Adjustment Bureau, Inc. v. Adler, 2 Bankr. 752,
756 (S.D.N.Y. 1980); White v. Coon {In re Purco, Inc.), 76 Bankr. 523, 529 (Bankr.
W.D. Pa. 1987); Louisiana Indust. Coatings, Inc. v. Pertuit {In re Louisiana Indust.
Coatings, Inc.), 31 Bankr. 688, 698 (Bankr. E.D. La. 1983) ("A negative capital position
represents ipso facto an unreasonably small capital with which to do any business")

(emphasis in original).

'^'Crumbaugh v. Kugler, 2 Ohio St. 374, 379 (1854) (subsequent creditors "give credit

to their debtor as he is—for what he has, not for what he once had"); Monroe v. Smith,



1988] FRAUDULENT TRANSFERS 493

In contrast, a transfer which leaves a transferor with unreasonably
small capital may be attacked not only by present creditors, but future
creditors as well. This standing rule derives from the historical antecedents
of the section that equated "securing against the hazards of business"
with fraud on future creditors, since they were the target of the malign
intent.'^'

Regardless of the origin of the distinction in standing, however, the
distinction exists. At bottom, it implies strongly that a transferor may
be insolvent, and yet still retain an adequate amount of capital or cash
flow. This proposition is not as wild as it may first seem: insolvency
under the UFCA developed into an incredibly creditor-protective cal-
culation. Assets which could not be quickly sold were given no value,
regardless of their cost;'^^ contingent assets could be disregarded; '^^ and
guaranties and other contingent obligations were valued at facCj^^"* with
little consideration of offsetting rights. '^^ As a consequence, companies
which held relatively liquid assets such as land could quite easily be
insolvent, but could still operate effectively and could generate sufficient

79 Pa. 459, 462 (1876) ("It is difficult to perceive how one who had knowledge of such
a conveyance before he dealt with the grantor, and hence must have acted in view of it,

could, by any possibility, be defrauded thereby"). See also Todd v. Nelson, 109 N.Y.

794, 797, 16 N.E. 360, 364-65 (1888).

•^'Schreyer v. Scott, 134 U.S. 405, 409-10 (1890); Winchester v. Charter, 94 Mass.

(12 Allen) 606, 610-11 (1866); D. Moore, supra note 47, § 8, at 277.

'"Corbin v. Franklin Nat'l Bank {In re Franklin Nat'l Bank Securities Litigation),

2 Bankr. 687, 711-12 (E.D.N.Y. 1979), affd mem., 633 F.2d 203 (2d. Cir. 1980) (book

value of stock of subsidiary had no present fair salable value; court reasoned that since

"there were no purchasers or bidders for [the stock] in May and June of 1974, [the]
stock, reahstically speaking, had no value."); Chase Nat'l Bank v. United States Trust

Co., 236 App. Div. 500, 503, 260 N.Y.S. 40, 44 (1932) ("Not every asset, but only such

as are salable, enter the equation."); Fidehty Trust Co. v. Union Nat'l Bank of Pittsburgh,

313 Pa. 467, 169 A. 209 (1933), cert, denied, 291 U.S. 680 (1934) (reversing trial court's

refusal to give "present" controlling meaning).

'"See, e.g., Kepler v. Atkinson {In re Atkinson), 63 Bankr. 266, 269 (Bankr. W.D.
Wise. 1986) (unmatured claim against insolvent person has no value under Wisconsin

version of UFCA). Cf. Wight v. Rohlffs, 48 Cal. App. 2d 696, 121 P. 2d 76 (1942) (under
precursor of UFCA; court only considered assets subject to court process in California
and excluded consideration of transferor's interest in Massachusetts probate estate).

'^Chase Manhattan Bank (N.A.) v. Oppenheim, 109 Misc. 2d 649, 652, 440 N.Y.S.2d

829, 831 (N.Y. Sup. Ct. 1981); Marine Midland Bank v. Stein, 105 Misc. 2d 768, 770,

433 N.Y.S.2d 325, 327 (Sup. Ct. 1980). But cf. Cate v. Nicely {In re Knox Kreations,
Inc.), 474 F. Supp. 567, 571-72 (E.D. Tenn. 1979), affd in part, rev'd in part on other

grounds, 656 F.2d 230 (6th Cir. 1981) (corporate guaranty which was not likely to be

enforced not counted as liability under Tennessee version of UFCA); In re Xonics
Photochemical, Inc., 841 F.2d 198, 200 (7th Cir. 1988) (contingent liabilities must be dis-

counted to reflect probability that contingency will materialize).

'^'Tri-Continental Leasing Corp., Inc. v. Zimmerman, 485 F. Supp. 495, 499 (N.D.
Cal. 1980); Bergquist v. First Nat'l Bank of St. Paul {In re American Lumber Co.), 5
Bankr. 470, 475-76 (D. Minn. 1980); 1 Collier on Bankruptcy, supra note 79, 1 101. 31 [5],
at 101-66.



494 INDIANA LAW REVIEW [Vol. 21:469

capital to augment the existing capital baseJ^^ Therefore, the application

of a per se rule subsuming unreasonably small capital within insolvency

would appear unwarranted. Its blind appHcation produces an antinomy;

the automatic extension of standing to future creditors upon proof of

insolvency—which is a result consciously not included in the statute.
These two per se rules combine with the intensely fact-bound nature

of the analysis in all other cases to create a featureless framework for

critical analysis of unreasonably small capital cases. Given the action's

history, and the general trend of current case law, a synthesis is possible

which contains a principled and logical analytical framework for future

cases. It is to that task that this article now turns.

IV. Tow^ARD True and Plain Dealing: A Proposed Synthesis

With the Code's and the UFTA's softening of creditor-protective
definitions of insolvency, ^^^ lawyers seeking to set aside questionable

transfers will inevitably come to rely more heavily upon the unreasonably
small capital section. '^^ It does not require proof of insolvency and

neatly avoids the issue of standing. In addition, the case law interpreting

the section is scarce and, at best, cryptic, allowing for good faith

arguments for expansion.

Against this background, it is inevitable that arguments will arise

pressing for new or expansive interpretations of this action. ^^^ Fast
application of the new UFTA or the new provisions of the Code may,
however, outpace the original intent behind the action; that is, curing

specific perceived deficiencies with the concept of insolvency. '^° The

received learning and the jurisprudence of section 5 argue against such

easy apphcations.

In addition, the frailties of the two lines of cases set forth above

can point to a better understanding of the unreasonably small capital

action. First, the deficiencies of College Chemists and its progeny un-

'^C/. American Insulator Co. v. Marsh Plastics, Inc. {In re American Insulator Co.),

60 Bankr. 752, 755 (Bankr. E.D. Pa. 1986) (valuation of land acquired in 1920 at cost,

as indicated by applicable rule, would unduly skew insolvency calculation in favor of

insolvency; recent appraisals used instead).

'*'5ee yupra text accompanying notes 108 to 113.

'^^See, e.g., Alces & Dorr, A Critical Analysis of the New Uniform Fraudulent
Transfer Act, 1985 U. III. L. Forum 527, 560 (categorizing application of unreasonably
small assets test of UFTA as "easy, even tautological" in the case of failed businesses);
Cook & Mendales, supra note 118, at 91 ("a leveraged acquisition that left a corporation
with little or no unencumbered property would be even more readily subject to attack

than under present law").

™See supra text accompanying notes 70 to 72.



1988] FRAUDULENT TRANSFERS 495

derscore the importance of a broad definition of capital. '^^ Next, the

inherent contradiction of cases making the unwarranted leap from in-

solvency to unreasonably small capital shows that inadequacy of capital

must stand on its own ground to preserve the structure created by the
standing rules of both the UFCA and the UFTA.'^^ Each of these concerns
is addressed below.

A. Defining "Capital"

Initially, in order to determine what is "unreasonably small" capital,

the definition of "capital" or "assets"'^^ must be made clear. One recent
case surmised that it was "the unadjusted value of all assets, however

encumbered."*'^'* The UFTA definition of "assets," however, rejects this
view by explicitly excluding "assets" to the extent they are subject to

valid encumbrances.'^^ Also rejected is any notion that "capital" includes

only invested or "risk" capital, '^^ and the notion that "capital" consists

only of free or unencumbered assets. *^^

So much for what "capital" is not. Some hint of what it is can
be gleaned from the text of the statute. Both the Code and the UFTA
require that the "capital" or "assets" be adequate "in relation to the

[transferor's] business or transaction."*^^ This formulation forces a for-

ward looking view; it requires a transferor to retain adequate wherewithal

for future businesses or transactions.

'^'See supra text accompanying notes 150 to 152.

^'^^See supra text accompanying notes 159 to 166.

'"The remainder of this article will refer to "capital" rather than assets. This use

comports with the intent of the UFTA to clarify, rather than change, the scope of the
section. See Reporter's Note to UFTA § 4(b)(1), 7A U.L.A. 654 (1985).

'^''Jacobson v. First State Bank of Benson {In re Jacobson), 48 Bankr. 497, 501

(Bankr. D. Minn. 1985).

'^'Section 1(2) defines "asset" to mean "property of a debtor, but the term does
not include: (i) property to the extent it is encumbered by a valid lien ..." (emphasis

supplied). Cf. Comment (3) to Proposed Section 3439.04 of the Cal. Civ. Code, Cal. Assembly
J., supra note 7, at 8576-77 ("The premise of this Act is that when a transfer is for

security only, the equity or value of the asset that exceeds the amount of the debt secured

remains available to unsecured creditors and thus cannot be regarded as the subject of

a fraudulent transfer merely because of the encumbrance resulting from an otherwise valid

security transfer.").

''^"The reference to 'capital' in the [UFCA] is ambiguous in that it may refer to
net worth or to the par value of stock or to the consideration received for the stock

issued. The special meanings of 'capital' in corporation law have no relevance in the law

of fraudulent transfers." Comment (4) to Proposed Section 3439.04 of the Cal. Civ. Code,
Cal. Assembly J. 8569, supra note 7, at 8577. See also Reporter's Note to UFTA § 4,
7A U.L.A. 654 (1985).

'"See supra text accompanying notes 136 to 158; Clark, supra note 1, at 555 n.l40

(equating "net worth" with "capital").

"41 U.S.C. § 548(b)(2)(B)(ii) (1982); UFTA, supra note 1, § 4(a)(2)(i).



496 INDIANA LAW REVIEW [Vol. 21:469

Courts have recognized this perspective; "capital" has been extended

to reasonably foreseeable future cash flow, be it from operations, '^^

equity capital infusions, '^° residual equity in equipment obtained through

the use of purchase money financing^^' or new and commercially rea-
sonable loans. '^^ As a consequence, the test for unreasonably small
"capital" should include these concepts; the aggregate amount of "cap-

ital," in short, would include all reasonably anticipated sources of

operating funds, which may include new equity infusions, cash from
operations or cash from secured or unsecured loans over the relevant

period. '^^

B. Determining ''Unreasonably Small*' Amounts of Capital

If capital comprises all available cash resources over the relevant

period, what constitutes "unreasonably small" amounts of it? An outline
of the answer can be given by examining existing unreasonably small

capital cases for the elements of a successful case.'^"^ This examination

•^'Credit Managers Ass'n of S. Cal. v. Federal Co., 629 F. Supp. 175, 184 (CD.
Cal. 1985) (consideration of future cash flow from operations in determining whether

remaining capital was sufficient).

'«oAllied Products Corp. v. Arrow Freightways, Inc., 104 N.M. 544, 724 P. 2d 752

(1986); Kupetz v. Continental 111. Nat'l Bank and Trust Co. of Chicago, 77 Bankr. 754,

762 (CD. Cal. 1987) (failure of witness to consider effect of principal shareholder's secured
guaranty a factor in not believing testimony regarding unreasonably small capital), aff'd

sub nom. Kupetz v. Wolf, 845 F.2d 842 (9th Cir. 1988).

•^'Lackawanna Pants Mfg. Co. v. Wiseman, 133 F.2d 482, 485 (6th Cir. 1943).

'^^M (court considered commercial reasonableness of purchase money chattel mort-

gage); Credit Managers Ass'n of S. Cal. v. Federal Co., 629 F. Supp. 175 (CD. Cal.

1985) (court considered, after increase had occurred, likelihood at time of transfer that

primary lender would increase credit line). See also Kupetz v. Continental 111. Nat'l Bank

and Trust Co. of Chicago, 77 Bankr. 754, 762 (CD. Cal. 1987) (failure of witness to
consider possible refinancing or new loans a factor in not accepting witness' conclusion

of unreasonably small capital), aff'd sub nom. Kupetz v. Wolf, 845 F.2d 842 (9th Cir. 1988).

'*^As used in this context, "relevant period" means that time span from the date of

the transfer to the date of non-payment, limited only by the applicable statute of limitations.

By way of example, if the statute of limitations is four years, the non-payment occurs

one year after the transfer, but the transferor's expected capital, when judged from the

vantage point of transfer, would have been adequate for three years, no action will lie.

See infra text accompanying notes 235-54. Similarly, under this hypothetical, no action

will lie for any failures to pay which occur after four years due to the bar of the statute

of limitations. Finally, again under this hypothetical, a non-payment which occurs three

and one-half years after the transfer—within the four year statute of limitations but beyond
the period of adequacy of capital—would be actionable.

'*^In this outline, pre-UFCA cases and authorities are used. This use is not only
appropriate given the paucity of section 5 cases, see supra note 15, but also due to the

uncertain origins of section 5 itself. As noted above, section 5 was hotly contested in the
original convention which adopted the UFCA. See supra text accompanying notes 98-100.
This disagreement indicates that the final text was less than a perfect fit for the concept

as developed by the common law. The use of pre-UFCA cases to tailor the unreasonably
small capital action as an accessory and adjunct to the insolvency branch of constructively

fraudulent transfers should thus be permissible.



1988] FRAUDULENT TRANSFERS 497

demonstrates that, by definition, the challenger must first establish that

the transfer was for less than a reasonably equivalent value. Once shown,

the creditor must then show the following: the transfer was made by
a person in business or for a business transaction; that non-payment of

the plaintiff's claim was a reasonably foreseeable effect given the amount

of the transferor's remaining and reasonably foreseeable cash resources;

and that, in at least a "but for" sense, the lack of adequate resources

caused the non-payment.

I. The First Requirement: A Business or Business Transaction.—
The first requirement is textual: a transfer must be made by one who
is "engaged or is about to engage in a business. ''^^^ Additionally, the

business must be one that requires working capital, or liquid funds, in

the business' daily activities. ^^^ The historical antecedent for this re-

quirement lies in the notion that carrying on a business is an implicit

representation of an ability to pay those debts incurred in the business;

no such requirement attends to individuals in their personal affairs. '^^

The statute also extends to those "engaged or . . . about to engage

in a . . . transaction'' for which the remaining property is inadequate. '^^

The statute is silent as to the distinction between a "business" and a

"transaction." One case, however, has interpreted "transaction" to cover
joint ventures; that is,temporary associations to achieve a Hmited business

purpose. '^^ This reading is consistent with the text of the original statute;

•«^UFCA, supra note 1, § 5 (emphasis supplied). See also 11 U.S.C. § 548(a)(2)(B)(ii)

(1982); UFTA, supra note 1, § 4(a)(2)(i).
'^^lannacone v. Capital City Bank (In re Richards), 58 Bankr. 233 (Bankr. D. Minn.

1986) (company which merely held title to assets for purposes of securing a debt was not

engaged in business which needed capital); Jacobson v. First State Bank of Benson (In

re Jacobson), 48 Bankr. 497 (Bankr. D. Minn. 1985) (section 548(a)(2)(B)(ii) found in-

applicable because, although debtor was in business, no showing that additional capital

was necessary; indeed, transferee showed that business could be run more effectively with

the use of less capital). Cf. Tarbox v. Zeman (Jn re Zeman), 60 Bankr. 764 (Bankr. N.D.
Iowa 1986) (fact that involuntary transfer forced transferor to cease business established

that property was necessary to business, and that its transfer left the transferor with

unreasonably small capital).

'^'See, e.g., Winchester v. Charter, 94 Mass. (12 Allen) 606 (1866); Todd v. Nelson,
109 N.Y. (64 Sickels) 316, 16 N.E. 360 (1888). See also Kepler v. Atkinson (/« re Atkinson),

63 Bankr. 266, 269 (Bankr. W.D. Wise. 1986) (mother's guaranty of son's debt was not
a business or transaction contemplating business).

'««11 U.S.C. § 548(a)(2)(B)(ii) (1982); UFTA, supra note 1, § 4(a)(2)(i); UFCA, supra
note 1, § 5.

'^^Holcomb V. Nunes, 132 Cal. App. 2d 776, 283 P.2d 301 (1955). See Kepler v.

Atkinson {In re Atkinson), 63 Bankr. 266, 269 (Bankr. W.D. Wise. 1986), in which the
court held that a mother's guaranty of her son's debts was not a "transaction" of the

type contemplated in the UFCA, and stating that the section "appear[s] to be principally
directed to those situations in which a party is about to engage in a business venture



498 INDIANA LAW REVIEW [Vol. 21:469

it limits the population of potential plaintiffs to those who become
creditors "during the continuance of such . . . transaction. "'^° The UFTA
carries on this concept with its requirement that the "remaining assets

of the debtor [be] unreasonably small in relation to the . . . transac-

tion."'^' Both of these sections limit the type of transactions which may
qualify; both require a showing of a need for capital or assets for the

continuance of the transaction. This limitation also leads to the second

requirement: that non-payment was a reasonably foreseeable effect of

the lack of adequate resources.

2. The Second Requirement: A Reasonably Foreseeable Connec-
tion.—The second requirement can most easily be seen as an analogue
to section 4 of the UFCA deaUng with transfers by insolvents. The
objective of section 4 was creditor protection by requiring the transferor

to retain sufficient assets to meet all debts. '^^ Yet, as the early cases

showed, many debtors took advantage of vagaries surrounding asset
valuation and difficulties regarding the proof of intent, and left themselves

solvent, but just barely so.'^^

Section 5 of the UFCA was an attempt to close these gaps. It
imposes an additional burden on transferors; they must not leave them-

selves with unreasonably small—or inadequate '^'^—capital or reserves.
This protects present creditors from valuation squabbles and future

creditors from the debtor who would gamble on their extension of
credit. '^^ It is important to note, however, that the statute does not

make the transferor the insurer of adequacy; it only condemns as fraud-
ulent those transfers which leave the transferor with ''unreasonably small

capital."

'^UFCA, supra note 1, § 5 (emphasis supplied); see also 11 U.S.C. § 548(a)(2)(B)(ii).

'^•UFTA, supra note 1, § 4(a)(2)(i) (emphasis supplied).

^^^See supra text accompanying notes 53 to 82.

^"^^See supra text accompanying notes 44 to 52; M. Bigelow, supra note 27, § 3, at
230-33.

'^''The Reporter's Notes to the UFTA indicate that "unreasonably small" and "in-
adequate" are essentially interchangeable. Reporter's Notes to § 4 of the UFTA, 7A
U.L.A. 654 (1985) ("The subparagraph focuses attention on whether the amount of all

assets retained by the debtor was inadequate, i.e., unreasonably small, in light of the

needs of the business or transaction in which the debtor was engaged or about to engage").

'^'The classes protected against this gamble are broad. They include taxing agencies

as well as regulatory authorities. United States v. Gleneagles Investment Co., 565 F. Supp.

556 (M.D. Pa. 1983) (indication that factor in finding unreasonably small capital under

Pennsylvania law was that transferor failed to provide adequately for union health care

contributions and for environmental "backfiUing" obligations to Pennsylvania), aff'd sub

nom. United States v. Tabor Court Realty Corp., 803 F.2d 1288 (3d Cir. 1986), cert, denied

sub nom. McClellan Realty Co. v. United States, 107 S. Ct. 3229 (1987); United States v.

Vertac Chem. Corp., 671 F. Supp. 595, 617 F. Supp. 595, 617 (E.D. Ark. 1987) (United

States and state environmental agencies have standing to attack fraudulent conveyances under

Tennessee version of UFCA); United States v. 58th Street Plaza Theatre Inc., 287 F. Supp.
475 (S.D.N.Y. 1968) (taxing authority).



1988] FRAUDULENT TRANSFERS 499

But what is an
*

'unreasonable" amount? As noted in many cases,
the exact amount varies with the particular case.*^^ This does not translate,

however, into a toothless, relative, standard. Rather, the existing cases

can be distilled into the following: capital remaining after a transfer is

unreasonably small when the unpaid creditor/plaintiff can show its non-

payment was a reasonably foreseeable effect^^^ of the transferor's failure

to retain, or failure to provide for, an adequate amount of resources

from and after the transfer to satisfy the unpaid plaintiff/creditor's

claim. ^^^

An essential element of this formulation is the presence of a con-
nection between the disputed transfer and non-payment of the creditor's

claim. This requirement is historical; section 5 was distilled from cases

which allowed creditors to attack a transfer only if they could somehow
connect their non-payment with some universally agreed inference that

the transferor, at a relevant time, knowingly left itself with too little

reserves. ^^^

'^^Wells Fargo Bank v. Desert View Bldg. SuppUes, 475 F. Supp. 693 (D. Nev. 1978),

affd mem., 633 F.2d 225 (9th Cir. 1980); Zuk v. Hale, 114 N.H. 813, 330 A.2d 448

(1974); 1 G. Glenn, supra note 1, § 335.

'^^If the claim was subject to a bona fide dispute, the showing would entail proof

that the claim was genuine, and that non-payment, after the normal course of dispute

resolution, was the result of inadequate capital. Cf. 11 U.S.C. § 303(h)(1) (1982) (only claims

not subject to bona fide dispute may be counted in meeting jurisdictional minimum amount

for involuntary bankruptcy). In addition, holders of subsequent claims related to expenses

which are necessary, such as utilities and trade suppliers, will fare better than holders of

subsequent non-essential expenses, in that holders of such "non-essential" claims will have

a more difficult time showing a connection between the transfer and their non-payment.

^^^See Comment, supra note 5, at 1509 (assuming transfers that leave transferors with
few unencumbered assets must be "causally linked" to inabihty to pay debts in order to
create fraudulent transfer liability). See also cases cited infra note 199; Kepler v. Atkinson

{In re Atkinson), 63 Bankr. 266, 269 (Bankr. W.D. Wise. 1986) (Capital retained must
be measured "relative to the nature of the venture.").

This test may be applied differently depending upon whether the plaintiff is an
individual creditor, a bankruptcy trustee or debtor in possession. In the case of the

private party plaintiff, the date of non-payment will set the relevant period for the review
of the adequacy of capital. See supra note 183. With respect to trustees and debtors in

possession, the plaintiff is a representative of all creditors, either under the strong arm
powers of 11 U.S.C. § 544(b) or under 11 U.S.C. § 550(a). As such, the trustee or debtor
in possession would be able to use an extended period of relevancy, bounded at one end
by the date of the transfer and at the other end by the date fixed by the applicable
statute of limitations. In addition, a trustee or debtor in possession would have a relaxed
version of causation; the hierarchy of necessity would no longer be relevant given the
broad representation of the trustee. See supra note 197. See also Moore v. Bay, 284 U.S.
4 (1931).

"'In Sexton v. Wheaton, 21 U.S. (8 Wheat.) 229 (1823) for example, the Supreme
Court considered the connection between the transfer and the loss claimed by the creditor.
In Sexton, there had been a two year delay between the challenged transfer and the
creation of the creditor's debt. In finding that this period of time was sufficient to cleanse



500 INDIANA LAW REVIEW [Vol. 21:469

This type of requirement, although not articulated as such, has

played a vital role in many section 5 cases finding fraudulent transfers.
In Fidelity Trust Co. v. Union National Bank,^^ for example, a de-

pression-era bank president engaged in stock speculation to support

artificially the price of the bank's stock. Even though the president was

found to be solvent after the transfer in question—by at least $80,000^°'

—

the court looked to the nature of the speculation and found that "[tlhe

precarious chance of successful issue of business conducted with such

slender margin must be considered, "^°^ and that the scale of business

rendered the remaining capital inadequate. ^°^ In short, the wide swings

inherent in such trade required large reserves; by deliberately reducing

the reserves by the transfers—which went to premium payments on the
Hfe insurance policies that were the subject of the lawsuit—it was rea-
sonably foreseeable that his resultant insufficiency of capital would result

in unpaid creditors. ^^'^

Similarly, in McBride v. Bertsch,^^^ a fruit juice manufacturer and

seller conveyed all his personal property, worth $30,000, in trust for his

the transfer, the Court noted that at the time of the transfer, Wheaton, the transferor,

"had no view to trade. Although his failure was not very remote from the date of the

deed, yet the debts and the deed can in no manner be connected with each other; they

are as distinct as if they had been a century apart." Id. at 250. See also Kearny Plumbing

Supply Co. V. Gland, 105 N.J. Eq. 723, 149 A. 530 (1930) (refusing, under New Jersey
version of section 5, to draw "unfavorable inference" as to unreasonably small capital

when non-payment occured two years after transfer); Mackay v. Douglas, 14 L.R.-Eq.
106, 122, 26 L.T.R. (n.s.) 721, 723 (Ch. 1872) ("If a person enters into no contract

which would result in insolvency, and was not contemplating anything which might have

that result, such a settlement would be perfectly good. . . ."); M. Bigelow, supra note

27, § 3, at 231 ("There must be a connection between the gift and the subsequent credit.").

More recently, in In re Process-Manz Press, Inc., 236 F. Supp. 333, 346 (N.D. 111.

1964), rev'd on jurisdictional grounds, 369 F.2d 513 (7th Cir. 1966), cert, denied sub

nom. Limperis v. A.J. Armstrong Co., Inc., 386 U.S. 957 (1967), the court found evidence

of unreasonably small capital from a demonstrated inability to pay debts as they matured

after the transfer, and from numerous bank overdrafts. See also New York Credit Men's
Adjustment Bureau, Inc. v. Adler, 2 Bankr. 752, 756 (S.D.N.Y. 1980).

^'»313 Pa. 467, 169 A. 209 (1933), cert, denied, 290 U.S. 680 (1934).

^°'M at 476, 169 A. at 212-13.

^"^Id. at 482, 169 A. at 215.

^^^M at 476, 169 A. at 213.

2°^Tha: different amount of reserves would be required by different transferors was

a point noted early and widely. M. Bigelow, supra note 27, § 3, at 233, 237; O. Bump,
supra note 31, § 257, at 297. See also Bakst v. Presley (/« re E.D. Presley Corp., Ltd.),

44 Bankr. 781, 783 (Bankr. S.D. Fla. 1984) (operation of Canadian securities firm requires

substantial liquid assets). Indeed, in the early case of Hunters v. Waite, 44 Va. (3 Gratt.)

25 (1846), the transferor was characterized as "a man of sanguine temperament, and ex-
tremely imprudent habits." Id. As such, the Court scrutinized carefully his transfer, and
found it lacking for failure to consider his "imprudent habits" in providing for the future.

Id. at 47.

^"'McBride v. Bertsch, 58 F.2d 797 (W.D. Mich. 1930), aff'd, 58 F.2d 799 (6th Cir.

1932).



1988] FRAUDULENT TRANSFERS 501

family. At the time of the transfer, he had $11,000 in debts. ^^^^ Although

"substantially" all of these debts were paid when the transferor went

bankrupt three year later, ^^^ the court found that the seller had "prac-

tically no capital," but an intent "to continue in the business and to

incur large indebtedness in and about its expansion and operation. "^^^

These expansion plans highlighted the inadequacy of the remaining cap-

ital. A business may exist on the cash and income it generates; it is
reasonably foreseeable, however, that expansion financed concurrently

from income may require some reserves. Without such reserves, the court
invalidated the transfer. ^^^

McBride left unanswered a crucial question—whether the transfer
would have withstood scrutiny if no expansion was contemplated. Recent

cases have addressed this problem by concentrating on a business' ability

to generate sufficient cash from operations, or to issue debt or equity

securities for cash.

One such case was Wells Fargo Bank v. Desert View Building

Supplies, Inc.^^^ There, the sole shareholder of a corporation caused the

corporation to borrow funds on a secured basis. ^'* He later removed
these funds from the corporation to pay a personal loan to the same

bank. 212 Although the corporation had equity of over $57,000 after the

transaction, 213 ^]^g court noted that, prior to the transaction, the cor-

poration had only been marginally profitable. The incurrence of the

secured loan thus not only reduced the pool of unsecured assets, it

imposed a further drain on the corporation's cash flow through the

introduction of new and additional debt service. Accordingly, its only

hope was to expand sales—with the hope of expanding profits and
additional cash—but the debt service on the secured loan effectively
prevented it from successfully undertaking this expansion.21^ With this

connection between the reasonably anticipated effect of the transfer and

^"^Id. at 797.

^°'Id. at 798.
;

^°'Id.

2'M75 F. Supp. 693 (D. Nev. 1978), affd mem., 633 F.2d 225 (9th Cir. 1980). In

Sweney v. Carroll, 118 N.J. Eq. 208, 178 A. 539 (1935), decided under section 5 of the

UFCA, the resources of an individual who was building a house were at issue. The
plaintiffs were unsatisfied trade creditors. In deciding whether a previous transfer had left

the individual with sufficient funds, the court took into account that "[t]here was no

intent or expectation of building the house on credit." Id. at 215, 178 A. at 543. Since

the court found that this intent was not unreasonable, it upheld the transfer. Id.

^"475 F. Supp. 693, 695 (D. Nev. 1978), affd mem., 633 F.2d 225 (9th Cir. 1980).

^'Ud.

'''Id. at 697.



502 INDIANA LAW REVIEW [Vol. 21:469

the non-payment thus established, the court found the transfer invahd.^'^

A more detailed analysis of cash flow was at issue in Credit Managers
Association of Southern California v. Federal Co.^^^ There, General

Electric Credit Corporation (GECC) had financed a management-lead
leveraged buyout, in which management purchased their company. Cres-

cent Foods, from The Federal Company. As in Desert View, management

caused their new company, Cresent, to pledge its assets as security for

both the loan from GECC and the deferred portion of the purchase
price to Federal. Unlike Desert View, however the court found that the

extensive cash flow projections prepared to convince GECC to make its
loan reasonably showed that Cresent would have "sufficient expected

cash flow to stay in business. "^'^ Under the circumstances, the court

found the remaining capital to be adequate. ^'^

Other cases have also looked to cash flow, albeit in more oblique

manners. Some cases have looked to ''working capital," which is some-
times defined as the difference between liquid or short term assets and

short term Habilities. Thus, in Zuk v. Hale,^^^ a special equity master
found the transferor had $5,000 in "working capital" at the time of

the transfer. 22° Although there was evidence that the transferor's business

of being a general contractor generally required $7,000 to $13,000 in

such "working capital, "^21 the transferor's retention of a lower figure

was supported on testimony that it would be sufficient in that case if

receivables were timely paid.^^^ in other words, the amount of the
contractor's expected cash receipts was adequate to cover his expected

debts.

A different result was reached in Steph v. Branch .^^^ In Steph a
shareholder sold the stock in his business to another, who in turn secured
the deferred portion of the purchase price with the assets of the business. ^^^

The business also agreed to pay this deferred portion over time.^^^ Again,

there was a finding of solvency at the time of the transfer, ^^^ but there

was testimony from accountants that the range of "reasonable" capital

^'^629 F. Supp. 175 (CD. Cal. 1985).
'''Id. at 184.

'''Id. at 187-88.

^•^14 N.H. 813, 330 A.2d 448 (1974).

''°Id. at 816, 330 A.2d at 450.

'''Id. at 816, 330 A.2d at 451.

'"Id.

'"155 F. Supp. 526 (E.D. Okla. 1966), aff'd, 389 F.2d 233 (10th Cir. 1968).

"^Id. at 528.

'"Id.

"^Id. at 529 (court found that insolvency occurred some three months after the
transfer).



1988] FRAUDULENT TRANSFERS 503

was from $10,000 to $50,000.^^^ From this testimony, the court had no
trouble finding that working capital of $5,000 was inadequate. ^^^

In each of these cases the nature of each business and its individual

operating needs set the range of reasonable capital. ^^^ If, as in Steph,

the remaining capital was not in this range, the capital was unreasonably

small. ^^° Cases such as Credit Managers and Zuk, however, show that

not all failed businesses with meager capital qualify as businesses with

"unreasonably small" capital. ^^^ From this analysis, it can be seen that
non-payment for reasons other than inadequate resources may not qualify
under section 5 and its progeny. For example, under this analysis a

transferor could defeat an unreasonably small capital action if it could

show that it had adequate reserves but did not pay the debt due to a

bona fide dispute over whether the debt was due.^^^ In short, the proof

required seems to be that, all other things being equal and the debt

being valid, non-payment was the reasonably foreseeable effect of in-

adequate operating reserves, not other commercial defenses to payment. ^^^

As a result, if the transferor can show a course of trade justifying the

amount of reserves retained, or can produce reasonable cash flow pro-

^"M at 532.
-'^Similarly, in In re Atlas Foundry Co., 155 F. Supp. 615 (D.N.J. 1957), the court

made an explicit finding that although the questioned transfer left the transferor solvent,

it left the transferor with "cash capital" of only $25,000, which was insufficient to meet

its standard requirement of $200,000 to $300,000 in such cash capital. See also Kearny

Plumbing Supply Co. v. Gland, 8 N.J. Misc. 789, 151 A. 873 (1930) (transfer made in

a month in which net worth dropped from $3868 to a negative $941.19 was made at a

time when transferor had unreasonably small capital).

^^"In re Process-Manz Press, Inc., 236 F. Supp. 333, 346 (N.D. 111. 1964), rev'd on

jurisdictional grounds, 369 F.2d 513 (7th Cir. 1966), cert, denied sub nom. Limperis v.

A. J. Armstrong Co., Inc., 386 U.S. 957 (1967) (court found evidence of unreasonably

small capital from a demonstrated inability to pay debts as they matured after the transfer,

and from numerous bank overdrafts); accord New York Credit Men's Adjustment Bureau,
Inc. V. Adler, 2 Bankr. 752, 756 (S.D.N.Y. 1980). See also Fidelity Trust Co. v. Union

Nat'l Bank of Pittsburgh, 313 Pa. 467, 169 A. 209 (1933), cert, denied, 291 U.S. 680

(1934) (court found transferor solvent, but not sufficiently so to carry on stock speculation

business).

^3«5ee also United States v. 58th St. Plaza Theatre, Inc., 287 F. Supp. 475 (S.D.N.Y.

1968) (court found that capital was inadequate if tax liability were to be assessed at full

amount claimed; left unanswered whether transferor was bound to consider full amount

of liability or only discounted value after probability of success was taken into account).

"'"But the law does not require that companies be sufficiently well capitalized to

withstand any and all setbacks to their business. The requirement is only that they not

be left with 'unreasonably small capital' at the time of the conveyance alleged as fraudulent."

Credit Managers Ass'n of S. Cal. v. Federal Co., 629 F. Supp. 175, 187 (CD. Cal.
1985).

^^^See supra text accompanying notes 197-98.

"'C/. 11 U.S.C. § 303(h)(1) (1982) (order for relief on involuntary petition not allowed

when debts not being generally paid are subject to a bona fide dispute).



504 INDIANA LAW REVIEW [Vol. 21:469

jections from the time of the transfer, covering the time period in which

the plaintiff's claim arose, ^^"^ it will have shown that, although it had

small capital, the amount was not unreasonably so.^^^

3. The Final Requirement: A Direct and Causal Link Between the
Transfer and Non-Payment.—The last prerequisite to finding inadequate
capital is that the transfer must directly lead to non-payment. Initially

excluded by this test are cases where there is an alternate and cheaper

manner in which to conduct the business; in short, the transferor's

profligacy may be used as a supervening cause. ^^^ A case in point is
Jacobson v. First State Bank (In re Jacobson).^^^ In that case, the court
found that alternate ways of conducting the business after the transfer

—

by renting the land and equipment transferred—would have been cheaper,
and presumably would have avoided creditors' non-payment. ^^^ Accord-

ingly, it found the remaining capital was adequate. ^^^

This additional requirement is also necessary because subsequent

events may make it inequitable to prefer a creditor over a transferee.
Take, for example, the occurrence of an unforeseen and unforeseeable

calamity after a transfer. If this calamity would have accounted for

non-payment even if adequate reserves had been retained, the presence

of this intervening and supervening cause should bar fraudulent transfer

liability. Likewise, if a transferor leaves itself with unreasonably small

capital, but later builds up capital or assets to a reasonable level.

"'•For differences in treatment between private party plaintiffs and plaintiffs whose

standing derives from the Code, see supra text accompanying note 198.

"'The outside limit within which the parties to the transaction are at risk is Hmited

by the applicable statute of limitations. See supra note 198. The UFTA suggests a four
year limitation period for transfers involving unreasonably small assets, UFTA, supra note
1, § 9; the Code hmits the period to one year prior to the date the bankruptcy petition

was filed. 11 U.S.C. § 548(a) (1982). The rule under the UFCA is not uniform; some
states have statutes of limitations as long as six years, McNeills v. Raymond, 287 F.

Supp. 232, 237-38 (N.D.N.Y. 1968), aff'd in relevant part, 420 F.2d 51 (2d Cir. 1970),

and at least one case has suggested that no statute of limitations under the UFCA may
apply against the United States as sovereign. United States v. Gleneagles Investment Co.,

Inc., 565 F. Supp. 556, 583 (M.D. Pa. 1983), aff'd sub nom. United States v. Tabor

Court Realty Corp., 803 F.2d 1288 (3d Cir. 1986). This may prove to be a boon to
bankruptcy trustees, see 11 U.S.C. § 544(b) (1982) (bankruptcy trustee has standing of

any creditor as of the date the petition was filed).

"^See Hunters v. Waite, 44 Va. (3 Gratt.) 26 (1846) (imprudent habits of transferor

considered when evaluating transfer).
"M8 Bankr. 497 (Bankr. D. Minn. 1985).
"«/6/. at 501.

"^It did this by finding that the property transferred was not "necessary to the

continued operation of Plaintiff's business." Id. Cf. Tarbox v. Zeman {In re Zeman),
60 Bankr. 764, 768 (Bankr. N.D. Iowa 1986) (involuntary transfer which forced transferor

to cease business established that property was necessary to business, and that its transfer

left the transferor with unreasonably small capital).



1988] FRAUDULENT TRANSFERS 505

subsequent creditors should have no abihty to challenge the original

transfer. 2-^0

The case law has recognized this common sense notion. Early cases
recognized that "losses in trade, or by fire, or by storms" cut off

liability to future creditors. ^'^^ More recent cases have added to this list.
For example, in Jenney v. Vining,^'^^ a husband and wife had transferred

ownership of their house from joint ownership to sole ownership by the

wife.^"*^ Later, one of the husband's business associates challenged this

transfer in order to levy execution on the house. ^'^'^ The husband had

not paid the judgment leading to the levy because, four months after

the transfer, he and his business had entered into a new venture, and

that venture had failed. ^"^^

After finding that the transfer left the husband solvent, ^"^^ the equity

master found that the new venture was not in contemplation at the time
of the conveyance, and was the cause of the demise of the husband's

business.2^^ In short, although the master, by implication, found that

non-payment was reasonably foreseeable given the low level of capital

left by the transfer, he also found the new venture was not reasonably
foreseeable. This subsequent event was thus held to override the level

of capital remaining after the transfer.

Similarly, in Credit Managers Association of Southern California v.

Federal Co.,^"^^ a management led leveraged buyout failed. An attack
was mounted along unreasonably small capital lines. Although the court
found that capital was adequate on the basis of cash flows developed

at the time of the cash flows, ^"^^ it also inquired into intervening events.

In particular, the transferee pointed to two unforeseen events: the loss

of a major customer, ^^° and a four month labor strike by the Teamsters'
union. ^^' Both of these events adversely affected an admittedly marginal

operation; indeed, the court characterized the strike as a "crippling blow

from which [the transferor] never fully recovered. "^^^ As a consequence.

^'"'The historical antecedent for this proposition is set forth in M. Bigelow, supra
note 27, § 3, at 227 n.l; D. Moore, supra note 47, § 10, at 283.

'^'O. Bump, supra note 31, § 262, at 300-01. See also M. Bigelow, supra note 27,
§ 3, at 229.

''HIO N.H. 377, 415 A.2d 681 (1980).

''Ud. at 378, 415 A.2d at 682.

'''Id.

^^Id.

^'Id. at 379, 415 A.2d at 683.

^«629 F. Supp. 175 (CD. Cal. 1985).
''*'^Id. at 187. See also supra text accompanying notes 144 to 146.

25°M at 184.

'''Id.

'''Id. at 186.



506 INDIANA LAW REVIEW [Vol. 21:469

the court did not allow the ultimate failure of the business to lead, in

an "almost tautological manner"^" to a finding of unreasonably small

capital. Rather it viewed these events to be in the nature of supervening

causes, excusing or exonerating the transferor. This holding recognizes

that businesses fail for all sorts of reasons, and that fraudulent transfer

laws are not a panacea for all such failures. ^^^^

C. Burdens of Proof

Once a transfer has been isolated for the above analysis, practical

questions arise: who has the burden of producing evidence on the points
set forth above, and who has the burden of persuading the trier of fact
of the truth of each point? Under the UFCA, the plaintiff would have
each of these burdens. ^^^ If applied directly to the above analysis, this

would require the plaintiff to present evidence and to prove the truth

of each of the following: lack of fair consideration or reasonably equiv-

alent value; that the transferor was in business or about to be engaged

in business; that non-payment was reasonably foreseeable at the time

of the transfer due to the transferor's lack of adequate present and

future resources; and that, but for the transfer, the plaintiff's claim

would have been paid.

A well-recognized exception, however, permits the court to infer a
proscribed financial state once the plaintiff has shown a lack of fair

consideration or reasonably equivalent value.^^^ The burden then shifts

to the transferor, or, more likely, the transferee, ^^^ to show that the

transferor's financial state permitted such a cheap transfer. The under-

lying premise of this exception derives from the typical state court setting:

^"See Alces & Dorr, supra note 168 at 560.
^'^See M. BiGELOW, supra note 27, § 3, at 227 n.l.
^^^See, e.g., Bodino v. Barondess {In re Good Time Charley's, Inc.), 54 Bankr. 157,

162 (Bankr. D.N.J. 1984) (applying New Jersey law, the court dismissed case because,
after showing a lack of fair consideration, trustee "failed to present evidence to establish"

unreasonably small capital); T W M Homes Inc. v. Atherwood Realty & Inv. Co., 214
Cal. App. 2d 826, 29 Cal. Rptr. 887 (1963) (California version of section 4 of the UFCA);
Holcomb V. Nunes, 132 Cal. App. 2d. 776, 283 P.2d 301 (1955) (California version of
section 5 of the UFCA).

"^Kingdom Uranium Corp. v. Vance, 269 F.2d 104 (10th Cir. 1959) (applying New
Mexico law); Tri-Continental Leasing Corp. v. Zimmerman, 485 F. Supp. 495, 499 (N.D.
Cal. 1980) (applying California law); Neumeyer v. Crown Funding Corp., 56 Cal. App.
3d 178, 187-89, 128 Cal. Rptr. 366, 371-73 (1976) (citing similar cases from New York,
Pennsylvania and Maryland).

^"In most cases, the transferee will be the primary target, since resort to fraudulent

transfer law by its nature presupposes that the transferor/debtor is unable to satisfy its

obligations to the creditor/plaintiff. See, e.g., Neumeyer v. Crown Funding Corp., 56
Cal. App. 3d 178, 187-89, 128 Cal. Rptr. 366, 371-73 (1976).



1988] FRAUDULENT TRANSFERS 507

two creditors battling over whether one should be able to retain the

benefits of a cheap transfer. Since the transferor is typically not present, ^^^

or without incentive to defend, ^^^ the shift makes sense; it forces the

recipient of a cheap transfer to justify its retention.

This shift appHes, however, only to cases in which the UFCA or
the UFTA provide the governing law; it does not apply to cases brought
under section 548 of the Code since the assumptions supporting the shift

do not apply.^^^ The debtor in possession or the trustee^^^ is most likely

to possess financial information regarding the transferor, and, presumably

is in the best position to recreate the transferor's financial state. More-

over, these entities are directly attacking their predecessor's bargain, and

thus may be in a better position to control or color the proof regarding
it.

This division of proof and the equitable allocation of labor it entails

is sound, and should be carried through to the analysis set forth above.

A transferor or its favored transferee should be able to better establish
whether the transferor was engaged in business. With respect to adequacy

of resources and causation, liberal discovery should enable plaintiffs to

at least establish a prima facie case.^^^ In addition when the burden

^^*In Neumeyer, for example, the transferor had long since disappeared and could

not be compelled to attend the trial. 56 Cal. App. 3d at 182, 128 Cal. Rptr. at 368.

^^'^See supra text accompanying notes 196-97.

^^Corbin v. Franklin Nat'l Bank {In re Franklin Nat'l Bank Securities Litigation),

2 Bankr. 687, 710 (E.D.N.Y. 1979), aff'd mem., 630 F.2d 203 (2d Cir. 1980) (under

Act); Jacobson v. First State Bank of Benson {In re Jacobson), 48 Bankr. 497, 501 (Bankr.

D. Minn. 1985) (burden of proof on debtor ir possession as plaintiff); In re Tabala, 11

Bankr. 405, 408 (Bankr. S.D.N.Y. 1981); 4 Collier on Bankruptcy, supra note 79, 1
548.10, at 548-123 to 548-124. Compare Credit Managers Ass'n of S. Cal. v. Federal

Co., 629 F. Supp. 175, 183 (CD. Cal. 1985) (assignee for benefit of creditors empowered
to use presumption under state decisional law) with Kupetz v. Continental 111. Nat'l Bank

and Trust Co. of Chicago, 77 Bankr. 754, 762 (CD. Cal. 1987) (bankruptcy trustee did
not show he met state law conditions for presumption), aff'd sub. nom. Kupetz v. Wolf,

845 F.2d 842 (9th Cir. 1988).

^*'In some jurisdictions, entities other than the debtor in possession or trustee may
bring a fraudulent transfer action. Hansen v. Finn {In re Curry and Sorensen, Inc.), 57
Bankr. 824, 828-29 & n.3 (Bankr. 9th Cir. 1986); see generally Karasik, Standing to Initiate
Adversary Proceedings in a Bankruptcy Case, 92 Com. L.J. 83 (1987). Because the standing
of these parties appears to be derivative to the trustee or the debtor in possession, the

burden shift should not apply. Currey and Sorensen, Inc., 57 Bankr. at 828. See Kupetz
V. Continental 111. Nat'l Bank and Trust Co. of Chicago, 77 Bankr. 754, 762 (CD. Cal.
1987) (finding insufficient factual basis to justify state law burden shift), aff'd sub. nom.
Kupetz V. Wolf, 845 F.2d 842 (9th Cir. 1988).

^"In In re Process-Manz Press, Inc., the court found evidence of unreasonably small
capital from a demonstrated inability to pay debts as they matured after the transfer,
and from numerous bank overdrafts. 236 F. Supp. 333 (N.D. 111. 1964), rev'd on juris-
dictional grounds, 369 F.2d. 513 (7th Cir. 1965), cert, denied sub nom. Limperis v. A.J.



508 INDIANA LAW REVIEW [Vol. 21:469

shift discussed above is available, ^^ a plaintiff will also be able to state

and make its case by simply showing that the transfer was for less
than reasonably equivalent value. This burden shift is also supported

by the fact that, under cases such as Credit Managers, a transferor or

transferee can provide a complete defense by producing reasonable and

realistic cash flow projections from the vantage point of the transfer. ^^^

V. Conclusion

Although the unreasonably small capital section of the fraudulent

transfer laws has not drawn great attention, it has developed a significant

body of case law. As shown above, a general theme for future application
of the section can be distilled from these precedents. An action will lie
under the unreasonably small capital section if a transfer is made for
less than reasonably equivalent value, and if: the transferor is engaged

in business or a business transaction; non-payment of the plaintiff's

claim was reasonably foreseeable at the time of the transfer due to the

inadequacy of the transferor's reasonably foreseeable present and future

resources; and but for the transfer and the inadequacy of the transferor's

resources, the plaintiff's claim would have been paid.

This analysis views the unreasonably small capital section in its

historical context; that is, as an auxiliary and adjunct to the section of

the fraudulent conveyance law on transfers by insolvents. It also is a

tool to distinguish and discredit at least two unwarranted per se rules

that have developed in the unreasonably small capital jurisprudence.

Given the renewed interest in fraudulent transfers generally, and the

likely increased resort to the unreasonably small capital section specif-

ically, the analysis developed in this article can be used to restore part

of fraudulent transfer law to its original place. Consistency and "true

and plain dealing" could then be restored to an area of the law not

necessarily known for those virtues.

Armstrong Co., Inc., 386 U.S. 957 (1967). See also New York Credit Men's Adjustment
Bureau, Inc. v. Adler, 2 Bankr. 752, 756 (S.D.N.Y. 1980).

^-^^See supra text accompanying notes 256-57.

^^Credit Managers Ass'n of S. Cal. v. Federal Co., 629 F. Supp. 175, 184 (CD.
Cal. 1985).