Posting for

Monday, July 15, 2002

 

by:  Bert Rush

brush@firstam.com

 

 

CREDITORS' RIGHTS/MARITAL PROPERTY DIVISIONS/FRAUDULENT TRANSFERS/FRAUDULENT CONVEYANCES

 

Hey!  Time to play, "You Be The Judge!"

 

Danilo and Violeta were married in 1970.

 

By 1994, Danilo fathered a child in an extramarital relationship with Rhina.  The child was born in February 1995.  Rhina filed a paternity suit and, in April 1995, paternity was established through genetic testing, and Danilo was ordered to pay child support.

 

Weeks later, in May 1995, Violeta filed for divorce.  The day after her petition was filed, Danilo and Violeta entered into a marital settlement agreement.  Among other things, this agreement provided that Violeta would get the couple's various real properties, and Danilo would get his medical practice, a car, and a pension plan.  The agreement also provided that Danilo's extramarital support obligations would be borne by him, solely.

 

In August 1995, a divorce judgment was entered, incorporating provisions of the marital settlement agreement.

 

By 1997, Danilo abandoned his medical practice and, "living on a shoestring," moved in with his mother.

 

In November 1997, Rhina filed suit to set aside the marital property agreement, and related provisions of the divorce judgment, claiming that transfers of the former couple's real properties to Violeta were fraudulent.  Rhina's complaint was based on California's version of the Uniform Fraudulent Transfer Act ("UFTA"), promulgated by the National Conference of Commissioners on Uniform State Laws in 1984.

 

Under UFTA (and the version of UFTA enacted in California in 1986), a transfer may be set aside if it was made with actual intent to hinder, delay, or defraud any creditor of the debtor (transferor); or if the debtor/transferor did not receive a reasonably equivalent value in exchange for the transfer and the debtor was insolvent at that time or the debtor became insolvent as a result of the transfer.

 

On his motion for summary judgment, the trial court ruled in favor of Danilo, finding no evidence of "actual intent to defraud," and also finding Danilo was not made insolvent by the transfers.

 

On appeal, the Court of Appeals quickly concluded the case was unsuitable for summary judgment, because there were questions of fact (such as, value of Danilo's medical practice) that would have to be decided by a full trial.

 

But the knottier issue was whether the court-ordered marital property division could, as a matter of law, be subject to fraudulent transfer law.  Danilo argued it could not, citing California law promoting finality of marital property division’s incident to divorce, and public policy for protection of innocent ex-spouses. Rhina argued to the contrary, saying that where fraudulent transfer law was in conflict with family law (or, divorce law), fraudulent transfer law should prevail.

 

You've just been appointed to the Court of Appeals, how would you decide?

 

The Court held that a court-ordered marital property division may be subject to fraudulent transfer law, and remanded the case for Rhina to go after Violeta's properties.

 

In so holding, the Court was somewhat influenced by out-of-state cases from Oklahoma, Oregon, Illinois, the Seventh Circuit federal court of appeals, and Massachusetts.

 

The Court also said that its reading of California statutes suggests the legislature intended fraudulent transfer law to be read "expansively" (i.e., affecting rights of present and future creditors), while family law is more limited in scope (addressing issues between spouses and their immediate families).

 

Otherwise, the Court found little guidance in pertinent statutes, legislative history, and California case law.  In the end, the Court based its decision on "policy considerations."  The Court noted that marital property divisions have not, historically, been considered absolutely sacrosanct.  For example, even when merged into a divorce judgment, marital settlement agreements have been subject to attack on grounds of fraud, and they are also vulnerable to challenge under federal bankruptcy laws.  Therefore, the Court concluded fraudulent transfer law may trump a marital property division.

 

The case is Mejia v. Reed, 97 Cal.App.4th 277 (2002).

 

Comment:  If you guessed wrong, you still may be right!  In another recent case, a different California appeals court reached the opposite conclusion.  That case is Gagan v. Gouyd, 73 Cal.App.4th 835 (1999).

 

On June 12, 2002, the California Supreme Court agreed to hear an appeal from the Mejia decision.  Stay tuned.

 

This case is a reminder, if we needed one, that creditors' rights issues may be lurking in any transaction.  We're frequently asked to remove our policy exclusion for creditors' rights in commercial transactions, but the same issues may be present when there's been a transfer for "no consideration," a marital property division, or collusion.  And, in the latter case, how would you know?

 

A reminder, if we needed one.

 

**********

 

Following Monday's posting, Alan Rubin (Manhattan) writes:

 

In a September, 2001 decision, the United States bankruptcy Court, Western District of New York, in the case In re John B. Kraeling, ruled on a case with substantially similar facts.

 

In that case, the Trustee sought to recover monies, paid to the wife, as a fraudulent conveyance under section 548(a) of the Bankruptcy Code [under the second subdivision of 548(a) a trustee may avoid transfers where a debtor received "less than a reasonably equivalent value in exchange for transfer"].  The trustee moved for summary judgment seeking to set aside the transfer to the wife.

 

The court found that the payments made to the wife were a property settlement pursuant to a separation agreement between the parties; that the distributions to the wife were in consideration "for a settlement of marital and related property rights"; and, in light of all of the facts, the court was satisfied that "the debtor received a reasonably equivalent value in exchange for the distribution", and therefore, that the trustee lacked any basis for a fraudulent conveyance.

 

In a discussion of the first subdivision of section 548(a) [providing for the avoidance of a transfer made with "actual intent to hinder, delay or defraud"], the court recognized that it could avoid matrimonial settlements that are "inappropriately collusive or made with an intent to hinder, delay, or defraud creditors".  In this case, however, the separation agreement was negotiated at arm's length and in a "hostile environment" without evidence or a plan to avoid the repayment of debt.  In fact, the stipulation of facts filed in conjunction with the parties motions recited that the parties "at no time" had reason to believe that the husband would file for bankruptcy.  As a result, the court was satisfied that the parties, in negotiating a settlement, sought to achieve an equitable distribution of property.

 

 

Jack Milkis (Marlton, NJ) writes:

 

I believe that the courts should not (under most circumstances) upset the marital settlement agreement.  That agreement was strictly between the parties to a marriage, in the process of being dissolved.  Unless the ex-wife knowingly partook in an uneven distribution of the marital assets to inhibit her ex-husband's future support obligations for this new child, I see no reason for a judge to penalize the innocent ex-wife.  She had absolutely no culpability to the paramour, nor any obligation for the support of this child fathered by her ex-husband.  If the paramour had a child with a "dud" father, she made the bed she now finds herself in.  Why take anything away from the alleged innocent victim, the ex-wife??

 

Keith Pearson writes:

 

A great case to remind us that just because a court ordered it, it does not bind non-parties to the action.  I am frequently asked to insure based on a court judgment or order that purports to affect a non-party to the action and have steadfastly refused to do so invoking the ire of many PRACTICING ATTORNEYS who find it incredible that their court order cannot be used to bind someone else who was not a party to the action.  When asked to explain my reasoning for my position, my stock reply is "because this is the United States of America and therefore someone cannot have their rights or property interests affected without notice and a hearing as required by the Constitution (with accompanying God Bless America music in the background whenever possible)."  This reply usually evokes snorts of indignation and occasionally words that are unprintable on Landsakes, but it is the end of the discussion.

 

The principal rule of this case is true not only in creditors rights issues but all issues wherein we are asked to insure in reliance on a judgment that purports to affect someone who was not named in the action.

 

**********

 

Following Monday's posting, and replies, Bill Hart (Title Law Associates/Philadelphia, PA) writes:

 

With regard to Mr. Rubin's post readers may also want to review In re Altmeyer, 268 B.R. 349 (Bankr. W.D. N.Y. 2001) 2002 ALTA Title Counsel Exh. 19 and compare this with Mejia v. Reed, Santa Clara Co. Super. Ct. No. CV 769375 (March 29, 2002) 2002 ALTA Title Counsel Exh. 49.

 

Comment by Bert Rush:  Bill makes reference to Exhibits handed out with materials at the last ALTA Title Counsel meeting.

 

Anyhow, I'd forgotten about Altmeyer.  In that case, a husband and wife owned a home as tenants by the entirety.  They had marital problems, and wife left.  Husband applied for a mortgage loan.  Lender approved the loan, subject to requirement that wife give husband a quitclaim deed to convey her interest.  Wife had lots of debt, but she agreed and gave husband a quitclaim deed reciting consideration of $1.  New mortgage loan closes, and husband gets loan proceeds of about $60,000.  Later, wife files Chapter 7 bankruptcy.  Trustee in bankruptcy files adversary proceeding to set aside quitclaim deed as fraudulent conveyance, and avoid new mortgage as to wife's (former) one-half interest in property.  (There was no divorce, and no court-ordered marital property division.)  Get this, HELD:  (1)  Quitclaim deed avoided as fraudulent conveyance, per Bankruptcy Code section 548(a)(1).  Husband bound by deed recital that consideration was $1, and by Real Property Transfer Report (required to calculate transfer tax), signed

under oath by husband, to same effect.  Court would not consider evidence that husband paid other debts of wife in consideration for quitclaim deed.  (2)  New lender not entitled to "safe harbor" protection of Bankruptcy Code section 550(b)(1) (i.e., for "good faith" transferee) because new lender failed to inquire about suspicious circumstances behind quitclaim deed for nominal consideration.  Therefore, new lender not in "good faith," as defined by NY state law, sufficient to qualify for protection of section 550(b)(1).

 

Now, as Bill suggests, compare that to Mejia (the subject of our posting) and the Kraeling case (described by Alan).

 

Meanwhile, Jim Dondero (Grand Rapids, MI) writes:

 

Keith makes an excellent point to remember when we are asked to insure based on a court order purportedly affecting the rights of non-parties, or at least those without notice and opportunity to be heard. And, in the reported case, how does this lady have standing to bring the action in the first place? On the merits, I also struggle with the concept that an inequitable property division can be characterized as a "fraudulent transfer", and will be very much interested to learn the position of the California Supreme

Court on the subject. Please let us know.

 

Comment by Bert Rush:  The Uniform Fraudulent Transfer Act, or what we sometimes call "fraudulent conveyance laws," provide a cause of action for any creditor who believes his debtor's assets have been transferred to defeat (unfairly) the creditor's rights to execute upon them, and get paid. So that gives the paramour "standing" to sue the ex-wife.