Constructive 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).

Under the UFTA, constructive fraud arises when both:

the transferor receives nothing (or less than full value) in return for a transfer
the transferor is insolvent at the time of, or because of, the transfer, under either a cash flow test (unable to pay debts as they come due) or a balance sheet test (liabilities exceed assets)

When both of these two conditions apply, the transfer is automatically deemed to be fraudulent, irrespective of the transferor's intent. Fortunately, with respect to transfers from the business entity to its owners, constructive fraud is easy to avoid because transfers to the owners for return value take the transfers out of the reach of the definition of constructive fraud. Thus, payments to the owners for salary, loans and leases do not come within the purview of the constructive fraud restrictions.

But in most cases, the UFTA's constructive fraud provisions are supplanted by provisions in the state LLC and corporation statutes.