The Ethics of Transfers: ''Fraud'' versus ''Fraudulent Transfers''

One significant issue in the creditor-debtor battle involves the term "fraud" as used in the ethical rules. The term "fraud" is specifically defined under the Model Rules.

Under Rule 1.2(d): Scope of Representation, "A lawyer shall not counsel a client to engage, or assist a client, in conduct that the lawyer knows is criminal or fraudulent..." Model Rule 8.4(c) defines professional misconduct to include "[engaging] in conduct involving dishonesty, fraud, deceit or misrepresentation."

Model Rules 1.2(d) and 8.4(c) are the only references in the Model Rules to conduct of the attorney or client which involves fraud. Does that term also encompass the terms of "fraudulent conveyance" or "fraudulent transfer" as defined under the Uniform Fraudulent Transfer Act, the Uniform Fraudulent Conveyance Act, or a similar remedy statute?

The term "fraud" or "fraudulent" under the Model Rules denotes "conduct that has a purpose to deceive." The definition makes no reference to a definition or element of a fraudulent conveyance or fraudulent transfer as applicable to the Uniform Fraudulent Transfer Act, Uniform Fraudulent Conveyance Act, or a similar statute. The definition appears to be in keeping with the understanding that the "fraud does not include conduct, although characterized as fraudulent by statute or administrative rule, which lacks an element of scienter, deceit, intent to mislead or knowing failure to correct misrepresentations which can be reasonably expected to induce detrimental reliance by another." Thus, the term "fraud" under the Model Rules refers to the law of deceit and not other conduct which is described by statute or administrative rule.

It is clear that recovery based on common law fraud under the law of deceit requires a finding of a misrepresentation and a detrimental reliance by creditors with the damage occasioned thereby. The party creating the fraud is a necessary party to the action. In an action filed under a fraudulent conveyance remedy, no such circumstances exist.

Fraudulent conveyance statutes are directed to the ability of a creditor to trace and recover property from a third party. For these purposes the transferee holding the subject property or the property itself is the necessary party to a fraudulent conveyance action. Essentially what is required is a showing of a transfer of property at an undervalue or in a specified manner that prejudices the creditor.

The fraudulent conveyance statutes (UFTA and UFCA) in and of themselves do not contain any specific language which creates a creditor's remedy for money damages against third parties and are not otherwise applicable against persons who are neither transferees of the assets nor beneficiaries of the conveyance. The transfer of freely alienable property is not unlawful, nor is it tortious. The underlying theory or premise of the fraudulent conveyance remedy is recession of the transfer, not the creation of liability.

The exact formulation defining fraud and the number of elements employed in the definition show a fair amount of variation in the case law, having to do more often with how the elements are separated and counted.

Professor Prosser, in his treatise Prosser on Torts, criticized indiscriminate use of the word "fraud" which makes its use so vague as to require definition in nearly every case and settled on the following essential elements of common law fraud: (1) a false representation of tact; (2) knowledge or belief that the representation is false; (3) an intention to induce another to act or refrain from action in reliance on the representation; (4) justifiable reliance by such person; and (5) damage resulting from such reliance. Some states have resorted to statutory definition, typically codifying the common law.

Fraudulent transfer law is not concerned with the relationship of the parties or righting a wrong but is remedial. It is a tool for collecting money or for executing on a judgment. It is not a procedure for determining the liability of a debtor. Thus, the focus on solvency is the debtor's financial ability to satisfy claimants who have already proved their debt.

In fact, the transfers in question are "fraudulent" to third parties outside of the particular transaction in question, and the "wronged" parties may not even be ascertainable at the time of the transfer. The "badges of fraud" primarily indicate that a transaction caused the transferor to become unable to pay current or future creditors.

Conversely, an action to set aside a transfer as fraudulent against creditors is likely to fail despite a showing of intent to hinder, delay, or defraud a creditor (the badges of fraud) if the transfer has left the debtor with sufficient assets to cover the claims against him or her. Consistent with its remedial purpose, fraudulent transfer law seeks to extend a creditor's reach to assets no longer in the debtor's possession and can offer numerous specific remedies which may operate against strangers to the creditor-debtor dispute.

Fraudulent transfer law affects the rights and liabilities of parties outside of the transactions in question. The statutes and current well-reasoned case law (as opposed to some older case decision and ethical opinion) are clear that it is a remedial legal device whose purpose is to furnish creditors with enhanced powers by which to collect judgments.

A "fraudulent transfer" is not an equitable action arising out of a misrepresentation to the creditor and detrimental reliance by the creditor being the proximate cause of damage. Thus, it cannot be a tort under the American legal system. Since a transfer of good title to property is the prerequisite to triggering the right of a creditor to avail himself or herself of the statutory remedy, the transfer cannot be unlawful. If the transfer was not of good title, then a further remedy by statute would not be needed.

Fraudulent concealment or transfer of property can carry criminal penalties for attorneys as well as clients and third parties under the bankruptcy code. Practitioners who collaborate with a client in criminal activity may risk criminal prosecution under an assortment of other federal statutes. Certain states, notably California, do have criminal fraudulent conveyance law.

The litigation process as an adversarial proceeding not only may result in financial injury to the other or "adverse" party, but financial economic injury to the other party is the anticipated direct result of the process. Litigation is a win-lose situation, not a win-win scenario. Nonetheless, the lawyer's ethical obligation is to assist the client and not to avoid the infliction of economic harm on adversaries.

This is not to say that an attorney by other conduct may become a participant with his or her client by acting outside the scope of his or her representation. However, where the attorney is acting within the scope of his or her representation of the client, such as in preparation of documents and instruments, providing legal advice, and acting as the client's representative which accompanies that representation (representation essentially is listening, speaking, reading, and writing), there is no ethical liability to a non-client.

Specifically, as to the transfer or conveyance of property, there is no ethical obligation to a non-client arising from the client's lawful conduct in the transfer of the client's freely alienable property. The lawyer representing the client in such lawful transaction is acting ethically within the Model Rules.

In summary, the term "fraud" for purposes of Model Rule 1.2(d) and 8.4(c) does not include conduct under the statutory remedy commonly known as fraudulent conveyance or transfer law. Perhaps the ethical resolution of these issues has been best summed up by Professor Wolfram in his treatise Modern Legal Ethics:

To this point, the focus has been upon client conduct that is criminal, fraudulent or contrary to a direct rule of a court. Are the considerations different if the client's conduct is not of this description but violates other law? For example, what if the client wishes to pursue a course of conduct which is unconscionable under applicable law but is not criminal, fraudulent or in violation of a court order? What if client conduct violates the law of torts, contracts, property or some other noncriminal law that does not deal with fraud?...Under the Model Rules a lawyer who assists the conduct described definitely commits no professional offense.