Trustees, Beware: § 548 Provides Cause of Action to Avoid Transfers

Bankruptcy trustees are armed with several familiar tools to recover assets for the benefit of the bankruptcy estate. One commonly used tool is state law avoidance powers, which is granted to trustees by § 544(b). However, trustees (and their attorneys) should be aware that § 548 provides an additional, independent cause of action to avoid transfers. The importance of this additional federal remedy was illustrated recently in the Northern District of Iowa.

In late 2016, debtor Bill Vorhes filed for chapter 7 bankruptcy. Mr. Vorhes’s schedules disclosed that he owned several assets and that he had transferred several assets — including farmland, equipment and securities — to several self-settled trusts. The bankruptcy trustee initiated adversary actions to avoid Mr. Vorhes’s transfers to the various trusts, and early on the trustee won summary judgment that the transfers were voidable under Iowa’s Uniform Voidable Transactions Act (UVTA) (via § 544(b)) as a matter of law. Using that finding as offensive mutual collateral estoppel, the trustee sought to avoid a transfer of real estate to the “Blue Mountain Wagyu Trust,” also under Iowa’s UVTA.

The bankruptcy court concluded that the same facts existed with respect to the transfer to the Blue Mountain Wagyu Trust, and accordingly that the transfer would be voidable as a matter of law under Iowa’s UVTA. However, the trust’s attorney argued that the real estate was homestead property and that because Iowa law exempts homestead property entirely, the transfer should not be avoided because no harm could accrue to creditors. The bankruptcy court agreed, holding that transfers of exempt property are not fraudulent and that debtors have a right to transfer exempt property regardless of motive.[1]

The trustee realized that the court’s holding, while effectively ending his chances to recover under Iowa law, did not foreclose recovery under § 548’s independent federal remedy. As a result, the trustee filed a second motion for summary judgment, citing to the same facts but arguing that the transfer is voidable pursuant to § 548, and that, unlike Iowa law, federal law does not provide that transfers of exempt property are per se exempt from avoidance. In fact, the trustee cited to an 8th Circuit BAP case — Sullivan v. Welsh (In re Lumbar) — directly deciding the issue under Minnesota law.[2]

The bankruptcy court concluded that the trustee was correct, and that while Iowa law determines the extent of a debtor’s property interests for purposes of § 548, federal law determines the voidability of a debtor’s property transfers for purposes of the statute.[3] Therefore, the court concluded that “the exemption status of the property is irrelevant to whether the transfer is avoidable under § 548.”[4]

This case teaches several important lessons for bankruptcy practitioners. When a debtor transfers exempt property, even though state law may shield the transfer from fraudulent conveyance attack, the federal bankruptcy laws may nonetheless enable the bankruptcy trustee to set aside the transfer as fraudulent. The trustee likely faces a high burden, but where the combination of relevant facts weigh in the trustee’s favor, the trustee can prevail.

Bankruptcy trustees should therefore be aware of all remedies available to them so that they don’t miss an opportunity to augment the bankruptcy estate. Asset-protection practitioners should be cognizant of the power of a federal bankruptcy trustee, and should therefore caution and advise clients of the potential dangers of a subsequent bankruptcy proceeding.