The Uniform Voidable Transactions Act ("UVTA") lists five distinct tests for determining whether a voidable transaction (was: fraudulent transfer) occurred. Largely due to the poor statutory structure of the UVTA, which was inherited unchanged from the Uniform Fraudulent Transfer Act ("UFTA"), and the adoption by the courts of non-descriptive if not utterly misleading and oxymoronic nicknames for these tests, practitioners often have difficulty in figuring out the elements of these tests, or how exactly they differ from one another.
It is will likely be better to utterly forget all that one believes that they have previously learned about the voidable transaction tests and instead adopt the more logical nomenclature below. There are still five tests, which are organized in the order by which they ought to each be tested:
These tests and their elements are shown by the following chart:
Voidable Transactions Tests
Note that three of the elements are common to multiple tests, while six elements are unique to particular tests. A brief overview of the three common elements may be helpful.
Creditor Existed At Transfer
Two of the tests (Insolvency and Insider Preference, collectively known as the section five tests) require that the creditor have existed at the time of the challenged transaction, or what is known as an existing creditor. The other three tests (Financial Weakness, Anticipatory Insolvency and Intent , collectively known as the section four tests) do not require the creditor to have existed at the time of the transaction, but could also include a creditor that appears after the transaction, or what is called a future creditor.
So, why do the section five tests require an existing creditor, but the section four tests do not? There is no good reason for this, and certainly no good public policy reason to support this distinction. Like many other things found in the UVTA, this is simply an anachronism and the carrying on of an old rule simply because it was carried on in the past.
Reasonably Equivalent Value Not Present
Three tests (Insolvency Test, Overextending Insolvency and Sinking Insolvency) require that the transaction have lacked reasonably equivalent value ("REV"), which means that the debtor did not receive back something of about the same value from the transferee as what the debtor gave up to the transferee. Importantly, REV is always measured through the glasses of creditors, and what the debtor got back must be about as valuable from the viewpoint of creditors as what the debtor gave up. The idea behind REV is to prevent depletion of the debtor's financial estate by the debtor either making gifts or trading valuable assets for assets of dubious value.
Debtor Insolvent At Transaction
The two section five tests (Insolvency and Insider Preference) share the common element of insolvency, which employs a balance-sheet analysis to determine if the debtor is at least $0.01 in the red or not. Very simply, if the debtor is in the black, then the debtor is solvent; if the debtor is in the red, then the debtor is insolvent.
But note that one may characterize the UVTA as having effectively three forms of insolvency:
What distinguishes Balance-Sheet Insolvency from Overextending Insolvency and Sinking Insolvency is that Balance-Sheet Insolvency is simply a pure accounting test with no mental element at all, whereas Overextending Insolvency and Sinking Insolvency look to what the debtor knew or should have known about the likely onset of insolvency at the time of the transaction.
Now let's move on to examine each voidable transaction test in detail.
The Insolvency Test is one of the two ancient (going back to Roman law) tests for a fraudulent transfer⸺ the other is the Intent Test of § 4(a)(1) ⸺ as modernized into its current form. There are three elements that the creditor must prove:
Because there is no mental element by anybody involved to be either proven or denied, the Insolvency Test is often the subject of summary judgment rulings by courts in favor of creditors (one of the few places in the law where a plaintiff can win a summary judgment, which requires that no material facts be in serious dispute), and thus is the "creditor's choice" for challenging a voidable transaction.
The Overextending Insolvency Test examines whether the debtor was too financially weak to do some deal, and that deal ultimately cast the debtor into insolvency. There are two elements to this test:
This test seems to come up most often in the mergers and acquisitions or corporate restructuring context, where a financially-distressed company engages in some deal that has the effect of transferring its assets to a White Knight while leaving the creditors of the company holding the bag.
The test, however, is certainly not limited to that context. It may come into play, for instance, in the asset protection planning context where a debtor who is not in financial distress but transfers away the bulk of her assets into a trust, and then some foreseeable liability soon thereafter materializes which casts the debtor into insolvency. The lesson here for asset protection planners is that merely testing for strict insolvency is not enough, but one must look out on the horizon for possible liabilities as well.
The Sinking Insolvency Test involves the case where the debtor knows the ship will soon be underwater, and tries to offload some assets to the transferee before the water finally washes over the deck. There are two elements:
While the latter element is technically different from insolvency as defined in the UVTA, the practical effect is about the same since a debtor that cannot pay its debts as they come due is presumed to be insolvent. This is similarly a test that most often appears in the mergers and acquisitions or restructuring context.
It should be noted that one could quite aptly characterize the Insolvency Test, the Overextended Insolvency Test and the Sinking Insolvency Test as the financial distress tests, since that is the essence of what they test albeit through different methods. If a debtor is in financial distress and makes a transfer without receiving reasonably equivalent value in return, then it is likely that at least one of these three tests will be met.
The Insider Preference Test gets it name from bankruptcy law, where a debtor paying ("preferring") one creditor over another becomes subject to the preference rules whereby the asset transferred can be brought back into the debtor's estate and shared with all creditors. Because of this, the Insider Preference Test is not really a fraudulent transfer test at all. The test is the most complicated of all the voidable transaction tests since it has five elements:
Like the Insolvency Test, the Insider Preference Test requires:
Unlike the Insolvency Test, however, the Insider Preference Test does not require that the debtor have not received reasonably equivalent value from the transferee. To the contrary, the debtor might have received REV from the transferee. In lieu of that requirement, the Insider Preference Test requires three additional factors:
In other words, the insider transferee should have been aware that the debtor was underwater, but did a deal with the debtor anyway so that the transferee could get paid off even if other creditors got stiffed. That's what the Insider Preference Test is about.
There is a significant question about whether the Insider Preference Test belongs in the UVTA, with probably the better view being that states should simply adopt their own preferential transfer regimes as separate law, and then excise this test from the UVTA. This is exactly what, for example, California has done ⸺ the Golden State does not include the Insider Preference Test at all but that issue is considered by other law.
The test that most practitioners associate with a voidable transaction is the Intent Test of § 4(a)(1). The Intent Test has but a single element:
The Intent Test is effectively a catch-all test of last resort which posits that if a creditor cannot prove a voidable transaction through any other test, then the creditor can still do so by showing that the debtor intended to diminish the rights of creditors. That the Intent Test is the catch-all test is confused by the fact that it is unfortunately the first test listed in the UVTA, and so practitioners tend to focus on it first when their case might be much easier made through another test.
Of course, debtors will almost always deny that such was their intention, so the test is effectively an objective test that looks at the totality of the facts and circumstance which surround the transaction to determine the debtor's intent with little regard for the debtor's self-serving denials.
To assist the court in making this determination, the UVTA includes in § 4(b) the so-called "Badges of Fraud", being a non-exclusive list of factors that the courts should look at in determining the debtor's intent. Whether the Badges are more helpful than harmful is dubious since courts frequently miss their entire purpose which is to highlight particularly telling facts and circumstances, and instead engage in an improper counting of the Badges to see who has the most. Indeed, the Uniform Fraudulent Conveyance Act ("UFCA"), as the predecessor to the UFTA/UVTA did not list any Badges, and § 548 of the U.S. Bankruptcy Code likewise eschewed the Badges. Probably the better position is to punt the Badges as a bad idea that has lingered too long.
The downside to any intent-based test is that it is very difficult for a creditor to win on summary judgment, and the debtor has an equal chance to convince a lay jury that no matter how egregious a particular transaction otherwise looks, there simply was no intent present to cheat creditors. The smart creditor will therefore look to satisfy any other test before resorting to the Intent Test, while novices will jump right into the Badges of Fraud and start floundering around there first.
A Final Word
The fundamental problem with the UVTA is its poor structure, which makes these tests much more difficult to discern and apply than the situation needs to be. To say that a complete redrafting of the UVTA is long overdue would be a substantial understatement. Hopefully, there will be a revised UVTA (RUVTA) in the not too distant future.