Take-Away: In a period of large federal gift tax exemptions, it should not come as a surprise that many individuals are encouraged to take advantage of those large transfer tax exemptions by making substantial lifetime gifts. That said, behind those lifetime gifts is the need to have a working understanding of Michigan’s Voidable Transactions Act which might be used to set-aside those lifetime transfers as voidable. The same understanding also applies to the extent that an individual seriously considers making lifetime transfers to a Michigan Qualified Dispositions in Trust, aka a self-settled domestic asset protection trust. Michigan’s law was fairly recently updated to reflect changes made to the Uniform Voidable Transaction Act.

Background: For many years Michigan had followed the Uniform Fraudulent Transfer Act (UFTA.) In April 2017, Michigan adopted amendments to that Act to reflect, in part, the new Uniform Voidable Transactions Act. [2016 Act 552, MCL 566.31 to 566.45.] The Uniform Voidable Transactions Act was adopted in Michigan with only a few differences. The Michigan Voidable Transactions Act permits a creditor to negate transfers, e.g. gifts,  that were made for the purpose of hindering, delaying, or defrauding the transferor’s creditors. Twenty other states have now adopted some form of the Uniform Voidable Transactions Act.

Michigan Changes: Some of the key changes to the now known as-Michigan Voidable Transactions Act (the Act) are that it:

  • Name Change: Changes the formal name to the Michigan Uniform Voidable Transactions Act; [use of fraudulent in the old law was misleading; this is a civil statute, not a criminal statute]
  • Constructive Fraud: Clarifies that with regard to the concept of constructive fraud, a transfer can be set-aside, or an obligation incurred by an insolvent debtor in exchange for less than reasonably equivalent value can be set aside, without any showing of the transferor’s fraud; [this eliminates the application of some Michigan Court Rules that require certain specificity when pleading a claim based on fraud]
  • Parallel Language Used: Uses language that conforms the Act’s provisions with other relevant statutes that deal with debtors, such as the federal Bankruptcy Code or the Uniform Commercial Code;
  • Debtor’s Location Controls Choice of Law: Adds a choice of law provision which adopts the Uniform Commercial Code’s place of business (or place of chief executive office if its business is conducted over several jurisdictions) definition, in order to identify to the appropriate applicable law; [a claim for relief under the Act will thus be governed by the law of the jurisdiction in which the debtor is located when the challenged transfer is made, or the challenged debt is incurred which is the subject of the ‘set-aside’ litigation]
  • Lower Burden of Proof: Changes the burden of proof placed on the judgment creditor to a preponderance of the evidence, [not the higher clear and convincing standard burden of proof;]
  • Strict Foreclosures: Narrows the exception from voidable transfers for what are known as strict foreclosures; [a strict foreclosure is consented to by the debtor, post-default, and involves the secured party accepting collateral in full or partial satisfaction of the obligation secured by the collateral, without a public sale or judicial foreclosure of the collateral; the secured creditor can prevent an avoidance of that voluntary asset transfer by showing that the foreclosure sale was conducted in good faith and a commercially reasonable manner];  and
  • Nonpayment in a Dispute: Clarifies the rebuttable presumption under the prior Michigan statute that a debtor is deemed to be insolvent if the debtor fails to pay debts as they mature. [consistent with the federal Bankruptcy Code, nonpayment of debts that are the subject of a bona fide dispute are not presumptive of the debtor’s insolvency; the burden to rebut this insolvency presumption now rests with the debtor.]

Deviation from the Uniform Voidable Transactions Act: While most of the provisions of the Uniform Voidable Transactions Act were adopted in Michigan,  a few of its provisions were not included in the Michigan Voidable Transactions Act:

  • Trust Exemption: The formal definition of a transfer differs slightly from the Uniform Act. Back in 2009, the former Michigan Fraudulent Transfer Act was amended to create trust-related exceptions to the definition of transfer, which exceptions were retained in Michigan’s version of the Act; and
  • Longer Statute of Limitations: The Michigan statute of limitations in which to bring an action to set-aside a transfer is different from the Uniform Act. The Uniform Act uses (i) a one year limitations period for what are called insider preferential payments; (ii) four years for any other voidable transaction, and (iii) a ‘discovery rule’ that is applicable to cases of an actual intent by the debtor to hinder, delay or defraud, which allows a lawsuit to be filed within one year after the transfer or obligation was, or could reasonably have been, discovered by the claimant.  Michigan’s statute of limitations retains a general six-year statute of limitations for the avoidance of fraudulent or voidable transfers [MCL 600.5813], and a one-year limitations period for the avoidance of ‘insider’ preferential payments. As a generalization, Michigan’s Act may strengthen the remedy for creditors, as Michigan already has a statute that addresses the ‘discovery rule’ by allowing a fraudulently concealed claim by the debtor to be brought within two years of its discovery. [MCL 600.5855.]

Proving a Voidable Transaction: For a transfer, like a lifetime gift, to be set-aside as voidable, a creditor must prove the debtor’s (i) specific intent to ‘hinder, delay, or defraud’ a specific creditor’s collection efforts, a subjective test, often called the actual intent test; or (ii) a constructively voidable transfer, which is a more objective test that is based upon proof of values before and after the challenged transfer. A constructively voidable transfer is one where the transfer is: (a) for less than fair market value; and (b) the debtor is insolvent at the time of the transfer, or because of the transfer, the debtor is rendered insolvent, where a proof of the debtor’s bad intent is not required.

Actual Intent Test: Under the actual intent test, the judgment creditor must demonstrate the debtor’s intent underlying the transfer of the debtor’s assets, which entails a subjective analysis by the court. Other than lawyer-arguments, there are few objective factors to consider to prove the debtor’s actual intent to hinder, delay or defraud specific creditors.  Accordingly, most judgment creditors prefer to establish constructive fraud, which is a purely objective determination through what are called badges of fraud.

  • Actual intent must be shown that without receiving a reasonably equivalent value in exchange for the transfer or obligation,  the debtor did either of the following: (i) was engaged or about to engage in a transaction for which the remaining assets of the debtor were unreasonably small in relation to the transfer; or (ii) intended to incur, or believed, or reasonably should have believed that the debtor would incur debts beyond the debtor’s ability to pay as those debts became due. [MCL 566.34 (1) (b).]

Badges of Fraud: Very seldom will a debtor admit to his/her fraudulent intentions. Consequently, when a creditor is unable to prove the debtor-transferor’s actual intent to hinder, delay or defraud, the creditor will be forced to resort to identifying multiple badges of fraud to prove the debtor’s constructive fraud sufficient to set aside the debtor’s transfer. Some of the well-known badges of fraud, which arguably could be present in implementing many basic estate planning strategies, include:

  • Insolvency: If the lifetime transfer/gift causes the debtor to become insolvent, that is a red flag, e.g. parent funds a dynasty trust with $11 million in assets, leaving the parent with $40,000 of assets to pay for the parent’s day-to-day living expenses [from which it is easy to infer a prior arrangement where the dynasty trust will make its assets and income indirectly available to the parent];
  • Retention of Possession or Benefit: When the debtor retains possession or continues to enjoy the benefits that stem from the transferred assets, e.g. mother gifts family cottage to her children using her lifetime federal gift tax exemption, yet mother continues to use the cottage without paying any rent for her exclusive use of the cottage;
  • Lack of Adequate Consideration: An asset is sold for what appears to be much less than its normal market value, e.g. a hard-to-value parcel of commercial real estate is sold by a father to an intentionally defective trust (IDGT) established for the father’s children at less than the real estate’s fair market value, in exchange for an interest-only promissory note that balloons and comes due after the father’s normal life expectancy;
  • Insider Relationships: Transfers between relatives are always highly suspect, e.g. father sells his Florida condo to his children in exchange for an interest-only promissory note;
  • Threat of Litigation: If there is a threat of litigation or a lawsuit is already filed, that again increases the risk of a finding of a constructive fraud leading to a voidable transaction, e.g. parent receives notice of an IRS audit with regard to his prior income tax returns, and he promptly makes a large gift of all of his marketable security portfolio to a family limited liability company, and then promptly transfers 99% of the LLC units to his children using his currently large federal gift tax exemption; and
  • Other Factors: Other badges of fraud include the debtor-transferor’s financial condition, the cumulative effect of a number of lifetime transfers, the chronology of events, the degree of secrecy attached to the lifetime transfers, and substantial deviations from the transferor’s normal behavior.

All of these badges of fraud can be used, often in combination, to prove a constructive fraud in order to set aside the lifetime transfer, even one that occurs as a result of an attorney’s estate planning recommendation .

Conclusion: Many of the badges of fraud  appear in federal Tax Court litigation where the IRS attempts to include the value of the lifetime-transferred asset back into the transferor’s taxable estate under either IRC 2036 or IRC 2038 as a lifetime transfer with an implied retained interest in either the asset or the income generated by the transferred asset. While Michigan’s Voidable Transactions Act will probably not be a large consideration in lifetime gifts by individuals, it is something to become familiar with if an individual, based on a professional recommendation, decides to take the plunge and either make a large lifetime gift to use his/her temporary bonus federal gift tax exemption, or he/she decides to fund a Michigan Qualified Dispositions in Trust instrument with a retained beneficial interest in that trust.