Actual Fraud Restrictions on Withdrawals

April 13, 2006

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When executing a plan to regularly and continuously withdraw funds from the business, the owner must be careful not to run afoul of the restrictions on withdrawals imposed by the Uniform Fraudulent Transfers Act (UFTA).

The actual fraud restrictions, under the UFTA, will apply to all transfers from a business entity to the owners, including distributions to owners on account of their ownership interest (i.e., dividends and ownership reductions), as well as payments for salary, loans and leases.

Actual fraud exists only when it can be proven that the transferor intended to defraud creditors through the transfer. Under this test, a transfer is not automatically deemed fraudulent simply because certain conditions are met.

Instead, courts use a number of criteria to determine the transferor's intent, including:

an assessment of the transferor's motive
the timing of the transfer
the solvency of the transferor at the time of the transfer
whether the transfer was concealed from the creditor
whether the business received adequate consideration in return for the transfer
whether at the time the transfer occurred the debtor had incurred a substantial debt
whether the transfer was made up of all or substantially all of the debtor's assets
whether the transfer was to an insider (i.e., family member or controlled entity)
whether the debtor absconded or tried to hide assets
whether the debtor transferred assets to a lien holder, who then transferred the assets to an insider of the debtor

As described above, actual fraud requires that a creditor prove that the transferor's actual intent in making the transfer was to defraud creditors. This can be a very difficult burden, absent specific circumstances from which this intent can be clearly inferred.

However, a finding of constructive fraud under the UFTA is not as difficult to reach if certain conditions are met.