In DZ Bank AG Deutsche Zentral-Genossenschaft Bank v. Meyer, 869 F.3d 839 (9th Cir. 2017) (“DZ Bank”), the Ninth Circuit Court of Appeals held that a nondischargeable debt resulting from a fraudulent transfer included the full amount that a bank-creditor would have recovered if the creditor had been able to execute against the debtor’s ownership interests in a closely-held corporation. The Ninth Circuit disagreed with the bankruptcy court and the district court in limiting the nondischargeable debt to the original amount of the collateralized debt ($123,200), versus the full market value of the assets at the time of the fraudulent transfer ($385,000).
To read the full published decision, click here: http://cdn.ca9.uscourts.gov/datastore/opinions/2017/08/24/15-35086.pdf
In 2008, Louis Meyer (“Meyer”), a sole member and manager of Choice Cash Advance LLC (“Choice”), obtained a third-party financed loan of over $1.77 million. DZ Bank AG Deutsche Zentral-Genossenschaftsbank (“DZ Bank”) was the agent for the third-party, and held a security interest in the loan. DZ Bank later acquired the Note and a personal guaranty by Meyer and his wife (together, the “Meyers”). Over the next two years, Choice and DZ Bank entered into several forbearance agreements.
During this time, the Meyers engaged in a series of transactions to transfer assets from one closely-held corporation to another. In 2008, Meyer caused Choice to transfer $123,200 to a closely-held corporation, Meyer Insurance (“MI”) (“2008 Transfer”), and then, in 2010, he caused MI to transfer those assets to another closely-held corporation, Insurance Choices 4 U, Inc. (“IC4U”), for no consideration (the “2010 Transfer”). IC4U further promised to pay back that money to Meyer, personally, over time. At the time of the 2010 Transfer, MI’s assets had a fair market value of $385,000, of which $123,200 was attributable to the originally transferred funds in 2008.
In 2011, IC4U transferred its assets to Connect Insurance Agency, Inc. (“Connect”), leaving all of Meyer’s closely-held corporations (Choice, MI, and IC4U) insolvent. Within a few months, Choice and the Meyers defaulted on the loan and personal guarantee, and, after DZ Bank filed suit, the Meyers filed for bankruptcy.
DZ Bank filed a nondischargeability adversary proceeding against the Meyers under § 523(a)(2)(A). Relying on the Supreme Court’s recent decision in Husky Intern. Electronics, Inc. v. Ritz, which held that the term “actual fraud” under § 523(a)(2)(A) encompasses fraudulent transfers, DZ Bank alleged that the 2010 Transfer was a fraudulent transfer under the Washington Uniform Fraudulent Transfer Act (“WUFTA”).
The bankruptcy court ruled in favor of DZ Bank on its fraudulent transfer claim, but limited the nondischargeable debt to $123,200 (the amount of DZ Bank’s security interest in the assets at the time of the 2008 Transfer from Choice to MI). The district court affirmed, reasoning that the nondischargeable debt was limited to assets titled in the Meyers’ name as property of the estate ($123,200), not assets titled in a non-debtor entity’s name (i.e., MI). The district court required DZ Bank to prove that MI was the alter ego of the Meyers to recover the fair market value of the property ($385,000) at the time of the 2010 Transfer, which DZ Bank failed to do. (Presumably, though unclear from the opinion, the district court found that the $123,200 was legally titled in the Meyers’ name, or that Choice was the alter ego of the Meyers, when Choice transferred the $123,200 to MI in 2008.) The Ninth Circuit disagreed with both courts, reversing and remanding the case to allow DZ Bank to recover the fair market value of the assets at the time of the 2010 Transfer ($385,000) as nondischargeable debt.
Contrary to the district court’s reasoning, the Ninth Circuit determined that whether assets are titled in a debtor’s name or that of the debtor’s closely-held corporation is irrelevant for the purpose of fraudulent transfers. What matters is that the assets could have been applied to payment of the debt. The Ninth Circuit reached this determination after looking to the purpose of WUFTA – to provide relief to creditors whose collection efforts are frustrated by debtors – and comparable case law where courts refused to allow debtors to hide behind their corporate entities to commit fraudulent transfers. See Wiand v. Lee, 753 F.3d 1194, 1203 (11th Cir. 2014), Reilly v. Antonello, 852 N.W.2d 694, 701 (Minn. Ct. App. 2014), and In re Nickeson, Adv. No. 14-1004, 2014 WL 6686524, at *11 (Bankr. D.S.D. Nov. 25, 2014).
The Ninth Circuit also disagreed with the district court and the bankruptcy court’s limitations on the amount of the nondischargeable debt. Such limitations deprive creditors of the full execution amount to which they would be entitled but for the fraudulent transfer (namely, by executing against the 100% ownership interests of the debtor to satisfy the debt). Thus, the proper relief is the full amount that a creditor would have recovered if the fraudulent transfer had not occurred, which in this case was “the full $385,000 that DZ Bank would have recovered if it had been able to execute against Louis Meyer’s ownership interest in MI.”
This decision helps to answer a question left open in Husky International Electronics v. Ritz, 136 S. Ct. 1581 (2016) (“Husky”): what amount of a debt is nondischargeable as a result of a fraudulent transfer? In Husky, the Supreme Court, in dicta, explained that “any debts ‘traceable to’ the fraudulent conveyance will be nondischargeable under § 523(a)(2)(A),” but it did not clarify what that meant, leaving it open to interpretation. Does “traceable to” narrowly mean that a lender can only recover the original value of its collateralized debt? Or does it more broadly mean that a creditor can recover the full value of the collateral at the time of the fraudulent transfer, as if the creditor had been able to execute against it just prior to the transfer?
The Ninth Circuit adopted the broader approach, which seems to be the only reasonable interpretation that does not reward a debtor for bad behavior. Limiting the amount of nondischargeable debt that a creditor can recover purely because a debtor unlawfully transfers it to evade collection efforts does not relieve creditors of the burden of the transfer – the creditor not only is out of pocket from having to chase the debtor and the creditor’s collateral, but it would lose any increase in value that it otherwise would have rightfully obtained from executing against it. Such a limitation would merely incentivize a debtor to transfer property to closely-held companies to preserve any increase in value for the debtor’s benefit. Although this result would be appealing to a debtor, it would run contrary to the intent of state legislatures in enacting UFTAs and basic contract law. When a creditor bargains for collateral, the creditor bargains for the full value of the collateral, whatever that value might be at the time of execution. In some security agreements and financing statements, this arguably might be explicitly included in the definition of collateral – e.g., “whether now existing or hereafter arising”; “whether now owned or hereafter acquired”; “all products and proceeds of or relating to the foregoing property.” In other cases, a creditor implicitly would have in mind its ability to collect the full value of its collateral at the time of collection. In no case would a creditor bargain for a shell game that limits the collateral’s value or the creditor’s ability to collect on that value at any time.
Moreover, the Ninth Circuit correctly disagreed with the district court’s rationale that a creditor can only recover the value of assets that are legally titled in the debtor’s name, regardless of fraud or fraudulent transfers. Although the district court’s rationale makes sense in many situations – if an asset is not titled in the debtor’s name, it may not be property of the estate – it does not fit situations where legal title is intentionally distorted to hide assets from collection efforts. By this logic, a debtor could “protect” itself by illegally transferring property to a non-debtor entity (thereby removing legal title from the debtor and preventing the property from being property of the estate), shielding the debtor’s losses at the expense of creditors. Simply put, by engaging in fraudulent transfers, a debtor would benefit from limiting a creditor’s ability to collect on any “increase” in value as part of the nondischargeable debt, which the creditor otherwise would have been entitled to collect. This surely would not coincide with the purpose of fraudulent transfer laws.
These materials were written by Jessica Mickelsen Simon of Hemar, Rousso & Heald, LLP in Encino, California (firstname.lastname@example.org). Editorial contributions were provided by Christopher Hughes of Nossaman LLP in Sacramento.