An often-used asset protection strategy has been to swap exposed assets for long-term promissory notes. For example, a debtor owned real estate might sell the real estate to a family member. The purchase price would be paid by the family member giving a long-term promissory note to the debtor. Advocates of this strategy would argue that the sale of the real estate was not a transfer made to defraud the debtor’s creditors, because the debtor merely substituted one asset, the real estate, for another asset, the long-term promissory note. They argued that the debtor’s net worth was unchanged.
A recent decision by the US District Court for the District of Colorado determined that such a swap amounted to a fraudulent transfer that a creditor could overturn. Furthermore, the Court found that the debtor and her family members had engaged in a civil conspiracy.
In that case, the mother sold real estate to her daughters after a bank obtained a judgment against her and placed a lien on the real estate. The mother received a no interest, 15-year promissory note for the value of the real estate. Because the facts of this case are somewhat extreme because the debtor implemented the swap after the bank obtained a judgment and had begun collection activity, it is not clear whether the Court would have reached the same conclusion if the swap was undertaken before the creditor obtained a judgment. However, the Court’s analysis suggests that if a debtor swaps assets, especially with a family member, the Court would be willing to reach the same conclusion unless the debtor could prove that the actual fair market value of the long term promissory note was equal to the value of the real estate, taking into account the term of the promissory note, the note’s interest rate and the credit worthiness of the purchaser.
Mr. Hendel has been practicing wealth preservation planning for over thirty -five years.