Sid DeLong, Caveat Donee

BEWARE OF BITCOIN GEEKS BEARING GIFTS: FRAUDULENT TRANSFERS FROM INSOLVENT DEBTORS MAY BE CLAWED BACK
Sidney DeLong

A few weeks ago, it was reported that the principals of the bankrupt crypto firm FTX made political donations to both parties totaling tens of millions of dollars in the last election cycle. 

When FTX went into bankruptcy, some of the politicians who received the “tainted” donations announced that they intended to donate the funds to charity. Those who did so may by now have discovered that their virtuous gesture proved to be quite costly. Under Bankruptcy Code 11 U.S.C. § 548, the trustee can avoid (i.e., reverse) any transfer of funds made by the debtor within one year of the petition if the transfer was made at a time when the debtor was insolvent and if the transfer is made for less than reasonable value. Insolvency is determined on an assets basis at the time of the transfer. 11 U.S.C. § 101 (32). In other words, if FTX made a political contribution at a moment in time when it was later found to have been technically insolvent, then the trustee can claw back the amount of the contribution and the politician who received it is personally liable for its return. A transferee’s duty to turn over such property to the trustee is set forth in 11 U.S.C. § 543.  Limited exceptions for gifts to charitable or religious donees are set forth in 11 U.S.C. 548 (a) (2).

Readers familiar with the common law should note that a fraudulent transfer under §548 differs from a fraudulent conveyance in several ways that are relevant to a donee. A person who conveys property with the intention to hinder, delay or defraud their creditors has made a fraudulent conveyance. The recipient of a fraudulent conveyance must, upon demand, disgorge the amount of the conveyance to any creditor of the debtor who establishes that the conveyance when made. There is no indication that FTX made the political contributions as fraudulent conveyances.

By contrast, a fraudulent transfer under the Bankruptcy Act has no intent requirement. It is established purely by the financial facts of the debtor’s insolvency and inadequate consideration paid by the transferee, matters that may be unknown to either party at the time of the transfer. Nor need the transferee be able to foresee that the transferor will declare bankruptcy within a year of the transfer.

Unfortunately for those politicians who may have spent the FTX contributions or donated them to charity, they remain liable to return the transferred funds to the trustee. As expected, the trustee of FTX has indeed announced that it will seek the return of $92 million in funds from the politicians who received contributions from the debtor. The trustee may also trace the funds into the hands of the charities to which they were donated.

Although we all should be aware of the fraudulent transfer risk, this is a risk that really cannot be minimized by careful planning or precautionary record searches. It is impossible for an institution that depends on gifts for its income to eliminate the possibility that a donor may end up in bankruptcy, leaving the institution on the hook for the amount of the gift. And it is certainly impossible to minimize the possibility that a donation may be traceable to an earlier fraudulent transfer to the donor. For wealthy institutions, perhaps it would be prudent to wait for 12 months before spending donated funds if the institution can afford to do so. Otherwise, Caveat Donee.

One might minimize a donee’s complaint at a clawback by the well-known legal principle “easy come, easy go,” even creditors who have been paid valid debts by someone who later files for bankruptcy may be required to return the payment to the trustee if it is held to be a preference under § 547. Law students who plan to practice business, financial, or commercial law are well-advised to take the law school course in bankruptcy whether or not they anticipate practicing in bankruptcy court, if only to help their clients minimize the risk of serious disasters like this one.