Sunday, September 17, 2017

FYI: 9th Cir Holds Creditor in Fraudulent Transfer Action May Recover Amounts Above Collateralized Debt

The U.S. Court of Appeals for the Ninth Circuit recently held that, where husband and wife debtors fraudulently transferred assets, the creditor was entitled to the full sum the creditor would have recovered and was not limited to the amount of the collateralized debt. 


In so ruling, the Ninth Circuit reversed a bankruptcy court and trial court judgment in the creditor's favor that the debt was non-dischargeable due to the debtor's fraud, but improperly limiting the non-dischargeable debt to only the collateralized amount.


A copy of the opinion is available at:  Link to Opinion


A bank (Lending Bank) made a commercial loan to husband and wife borrowers. The husband borrower was the sole member and manager of a cash advance business, which purchased five insurance agencies with the $1.7 million loan from the Lending Bank,


The cash advance business executed a promissory note for the loan and gave the Lending Bank a blanket security interest in all of its assets, including intangibles, and the debtors personally guaranteed the note.  The Lending Bank in turn financed the loan under a credit and security agreement with another bank (Financing Bank) in which the Financing Bank was granted a security interest in the loan to the business.


Ten months later, the Lending Bank defaulted on the security agreement with the Financing Bank and filed for bankruptcy. The Financing Bank and the Lending Bank agreed to transfer the cash advance business's note and the personal guarantee to the Financing Bank.  The cash advance business formally acknowledged the assignment and agreed to pay the balance on the note to the Financing Bank.


Over the next several years the cash advance business repeatedly requested loan modifications and entered into several forbearance agreements with the Financing Bank. The cash advance business also executed an elaborate series of transfers and sales to place their assets beyond their creditors' reach.


The cash advance business transferred $123,200 of assets to a closely-held business of which the husband owned 100% of the shares. The husband and wife created a family trust, of which they were the beneficiaries. The closely-held business then transferred its total assets, valued at $385,000, to another company that the husband purchased from a friend for $200. The trust then purchased that company and the company agreed to pay its $385,000 in assets to the husband. The result left all of the businesses and the trust insolvent.


The cash advance business defaulted on the loan and the debtors defaulted on the guarantee.


The Financing Bank filed a lawsuit against the cash advance business and husband and wife. The husband and wife then filed for bankruptcy. The Financing Bank's lawsuit against the husband and wife was stayed but the lawsuit against the cash advance business proceeded and resulted in a judgment of $1.7million.  The Financing Bank could not collect, however, because the cash advance business was insolvent.


The Financing Bank then filed an adversary action against the husband and wife in bankruptcy court alleging that they had fraudulently transferred assets under the Washington Uniform Fraudulent Transfer Act, Wash. Rev. Code § 19.40.041 ("WUFTA"), and thus the debt was non-dischargeable under 11 U.S.C. §523(a). As you may recall, section 523(a) excepts from discharge debts obtained by actual fraud, which includes fraudulent conveyance. 11 U.S.C. § 523(a)(2)(A).


The bankruptcy court ruled in favor of the Financing Bank on the fraudulent transfer claim but limited the judgment to $123,200, which was the amount that was traceable to the Financing Bank's security interest in the cash advance business's assets.


The Financing Bank appealed and the trial court affirmed on different grounds, explaining that the Financing Bank could not maintain a fraudulent transfer claim on "non-collateral assets" because the Financing Bank could only recover assets that were the property of the debtors, meaning legally titled in the debtors' name.


Thus, the lower court held, the Financing Bank could not recover any assets from the family trust or the closely-held businesses involved in the fraudulent transfers, and, do to so under WUFTA, the Financing Bank would have had to obtain a ruling that those entities were the alter egos of the debtors, which it had failed to do.


The Financing Bank appealed.


On appeal, the Ninth Circuit reversed explaining that the purpose of WUFTA is "to provide relief for creditors whose collection on a debt is frustrated by the actions of a debtor to place the putatively satisfying assets beyond the reach of the creditor," which is also known as fraud.


The Court compared the facts of this case to others around the country under identical or similar fraud laws and concluded that, through the series of transfers, the husband "depleted the value of his assets to the detriment of his creditors" while he continued to receive payments from the trust even after he filed for bankruptcy, thereby preventing the Financing Bank from collecting the debt he owed. Thus, the Ninth Circuit agreed with the bankruptcy court's finding that the debtors had engaged in actual fraud.


The Ninth Circuit reversed on the issue of the amount the Financing Bank could recover because it was only the fraudulent transfers that prevented the Financing Bank from being able to collect.


Based on 11 U.S.C. §523(a)(2)(A), if the husband had not fraudulently transferred the assets from the closely-held company, the Financing Bank would have been able to recover against it because a non-dischargeability claim based on a fraudulent transfer scheme between closely-held companies intended to defeat collection of a debt is actual fraud. 


Thus, the Ninth Circuit held, the amount of the non-dischargeable debt was not merely the $123,200 in assets from the cash advance business, but included the $385,000 in fraudulently transferred assets.


Accordingly, the lower court's judgment was reversed and the matter remanded.




Ralph T. Wutscher
Maurice Wutscher LLP
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Chicago, Illinois 60602
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