Bankruptcy practitioners will tell you that, when a company files bankruptcy, the representative of the estate—be it the debtor in possession or a trustee—has the right to pursue fraudulent transfer actions. They will also tell you that a creditor cannot pursue a state law fraudulent transfer action that relates to property previously transferred by the debtor-company during the pendency of the bankruptcy, even if it was filed before bankruptcy. What they don’t often articulate, however, is why the creditor cannot pursue its state law fraudulent transfer rights against a non-debtor. As we will see, the underlying reasoning for this proposition is subject to some disagreement, and can lead to some interesting questions.
Let’s use a simple hypothetical to set up the issue. Assume that Creditor has a judgment against Company for $1 million. Company doesn’t have nearly enough money to pay that judgment, primarily because it transferred almost all of its cash—say, $2 million—to its sole Shareholder for no consideration. Creditor thus files a fraudulent transfer action against Shareholder.