Wisconsin Court of Appeals Clarifies Discovery Rule for Fraudulent Transfers

By: Attorney William E. Wallo– Weld Riley, S.C.

Creditors chasing payment from defaulting companies often find there simply aren’t enough assets to go around. On occasion, however, assets have been transferred to third parties within the months (or years) prior to the debtor’s ultimate financial failure. Wisconsin law, like the law of most states, allows creditors to potentially recover those assets under the Uniform Fraudulent Transfer Act (“UFTA”) if they were either (i) transferred with the “actual intent” to hinder, delay, or defraud creditors or (ii) transferred for less than “reasonably equivalent value” at a time when the debtor was either insolvent or lacked sufficient remaining assets to carry on its business.

When a defaulting debtor transfers assets, one question for both creditors and potential purchasers is the relevant window of time in which a complaining creditor of the seller/transferor can try to avoid the transfer – in other words, calculating when the limitations period for initiating a fraudulent transfer claim actually ends.

In that regard, Wis. Stat. § 893.425 provides that a fraudulent transfer action under Wis. Stat. § 242.04(1)(a) – which relate to transfers “with actual intent to hinder, delay, or defraud” creditors – must be commenced “within 4 years after the transfer is made or the obligation is incurred or, if later, within one year after the transfer or obligation is or could reasonably have been discovered by the claimant.” In contrast, actions for “constructively fraudulent transfers,” or transfers where the only issue is the reasonable value of what the debtor received, are subject to a hard deadline and must be brought within four years of the transfer.

A recent decision by the Wisconsin Court of Appeals highlights the importance of the “discovery rule” contained in § 893.425 as to “actual fraud” actions under § 242.04(1)(a). In Official Committee of Unsecured Creditors of Great Lakes Quick Lube LP v. Theisen, 2018 WI App 70, 384 Wis.2d 5480, 920 N.W. 2d 356, the unsecured creditors committee of a bankrupt entity brought an action alleging that two transactions related to a leveraged buyout constituted fraudulent transfers under Wisconsin law.

According to the complaint, the defendants sold a company in a leveraged buyout to an entity that later filed for bankruptcy. The committee contended that two transactions – the issuance of notes to the individual sellers and the subsequent satisfaction of the notes while the debtor’s financial condition was deteriorating – ran afoul of Wisconsin’s fraudulent transfer provisions, and it sought to recoup approximately $3 million received by the sellers. Notably, the original sale occurred in late 2004, more than eight years before litigation was commenced challenging the transaction.

In response, the defendants sought summary judgment on the grounds that the statute of limitations had run. In order to defeat the motion, the plaintiff needed to show that at least one creditor could not have reasonably discovered the “transfer or obligation” by April 2, 2011 – the date the debtor entity filed for bankruptcy.

Citing various canons of statutory construction, the defendants argued the phrase “within one year after the transfer or obligation … could reasonably have been discovered” meant the limitations period commenced as soon as a claimant could reasonably have discovered the transfer, even if there was no indication whatsoever that the transfer might be fraudulent. The plaintiff, in contrast, argued that the statutory text provided the timeline with respect to a fraudulent transfer or obligation and the limitations period did not commence until the claimant had notice of something fishy. The trial court agreed with the defendants and construed the statute to be based upon the creditor’s ability to discover the transfer itself, rather than the fraudulent nature of the transfer.

On appeal, the Court of Appeals reversed and adopted the majority view of other jurisdictions which have enacted the UFTA. According to the court, the correct interpretation of the statute “sets a one-year statute of limitations from the point at which the claimant discovers or reasonably could have discovered the fraudulent nature of the transfer or obligation.” 2018 WI App. 70 at ¶ 20.

In general, it more difficult to prove that a transfer was the result of “actual fraud” than it is to prove a transfer is constructively fraudulent, as the latter considers only what the debtor received in exchange for what it gave up. However, actual intent to defraud can still be proven by circumstantial evidence, or what are called “the badges of fraud.” Courts are told they can consider factors such as whether (i) the transfers were to “insiders,” or family members or management of the business; (ii) the debtor retained possession of the property; (iii) the transfer was disclosed or concealed; (iv) the transfer was of substantially all the debtor’s assets; (v) the debtor received reasonably equivalent value; or (vi) the debtor was or became insolvent. See Wis. Stat. § 242.04(2).

By establishing that the a creditor has one year from when it reasonably can be held to have discovered sufficient information as to the fraudulent nature of the transfer, the Court of Appeals expanded the timeline for such actions and arguably made it more difficult for defendants to succeed at the summary judgment stage.

It will no longer be enough for a defendant to simply show when the creditor learned of the transfer. Instead, the commencement of the discovery period will hinge upon what else the creditor knew about the transfer, and whether those facts should have reasonably led to suspicion about the nature of the transaction itself. Potential defendants won’t be able to start the clock by a simple notice to creditors that a transfer has occurred. They may want to provide more detail about the underlying transactions, while simultaneously avoiding issuance of something that could be regarded as an invitation to file suit – a delicate balancing act, to say the least.