Judgment Creditor and Debtor’s Lawyers Duke It Out Over Equity in Home – ND IL

A law firm’s failure to scrutinize its client’s transfer of property to a land trust backfired in Radiance v. Accurate Steel, 2018 WL 1394036.

The case presents a priority fight between the plaintiff judgment creditor and the law firm who defended the debtor in post-judgment proceedings.

The Relevant Chronology

August 2013 – Defendant debtor transferred the Property to an irrevocable trust;

March 2014 – Plaintiff’s predecessor recorded its money judgment against defendant;

June 2014 – The law firm agrees to represent defendant if she mortgaged the Property to secure payment of attorney fees.

June 2015 – The law firm records a mortgage against the Property;

March 2018 – The court voids the 2013 transfer of the Property into a land trust as a fraudulent transfer.

The Trial Court’s Decision

The court ruled that the Property reverted back to the debtor and was no longer protected from its creditors. The court also found the law firm lacked actual or constructive notice that the creditor’s prior judgment lien could wipe out the firm’s mortgage.

As a result, the Court found the law firm met the criteria for a bona fide purchaser – someone who gives value for something without notice of a competing claimant’s right to the same property.

Reversing itself on plaintiff’s motion to reconsider, the Court first noted that recording a judgment gives the creditor a lien on all real estate owned in a given county by a debtor. 735 ILCS 5/12-101.

Illinois follows the venerable “first-in-time, first-in-right” rule which confers priority status on the party who first records its lien.  An exception to the first-in-time priority rule is where a competing claimant is a bona fide purchaser (BFP). A BFP is someone who provides value for something without notice of a prior lien on it.

Here, the law firm unquestionably provided value – legal services – and lacked notice of the bank’s judgment lien since at the time the firm recorded its mortgage, the title to the real estate was held in trust. Where a creditor records a judgment against property held in a land trust, the judgment is not a lien on the real estate. Instead, it only liens the debtor’s beneficial interest in the trust. (See here  and here.) These factors led the Court originally to find that the Firm met the BFP test under the law.

Reversing itself, the Court found the law firm was on inquiry notice that it’s mortgage could be trumped by the plaintiff’s judgment lien.

Inquiry notice means “facts or circumstances are present that create doubt, raise suspicions, or engender uncertainty about the true state of title to real estate.” In re Thorpe, 546 B.R. 172, 185 (Bankr. C.D. Ill. 2016)(citing Illinois state court case authorities).

A mortgagee has a responsibility not only to check for prior liens and encumbrances in the chain-of-title, but also to consider “circumstances reasonably engendering suspicions as to title.” Id.

In its reconsideration order, the Court noted as badges of fraud the plaintiff’s recording its judgment lien more than a year before the law firm’s mortgage and the ample proof of the debtor’s pre-transfer financial struggles.

The Court found the law firm was apprised of facts – namely, debtor’s financial problems, aggressive creditors, and gratuitous transfer of the Property into a land trust – that obligated it to dig deeper into the circumstances surrounding the transfer.

Afterwords:

Radiance and the various briefing that culminated in the Court’s reconsideration order provide an interesting discussion of creditor priority rules, law firm retainer agreements, trust law fundamentals and fraudulent transfer basics, all in a complex fact pattern.

The case reaffirms the proposition that where property is held in trust, a judgment lien against a trust beneficiary will not trump a later recorded judgment against the trust property.

However, where real estate is fraudulently transferred – either intentionally or constructively (no value is received, transferor incurs debts beyond her ability to pay, e.g.) – a creditor of the transferee should think twice before it transacts business with a debtor and delve deeper into whether a given property transfer is legitimate.

 

 

Plaintiff Shows Actual and Constructive Fraud in Fraudulent Transfer Suit – IL Court

The plaintiff mortgage lender in Summitbridge Credit Investments II, LLC v. Ahn, 2017 IL App (1st) 162480-U sued the husband and wife borrower defendants for breach of a mortgage loan on two commercial properties in Chicago

Two days after the plaintiff obtained a $360K-plus default judgment, the defendants deeded a third commercial property they owned to their adult children.

The plaintiff caught wind of the post-judgment transfer during citation proceedings and in 2015 filed a fraudulent transfer suit to undo the property transfer.  The trial court granted summary judgment for the lender and voided the defendants’ transfer of property. The defendants appealed.

Affirming, the First District recited and applied the governing standards for actual fraud (“fraud in fact”) and constructive fraud (“fraud in law”) under Illinois’s fraudulent transfer act, 740 ILCS 160/1 et seq. (the “Act”)

The Act allows claims for two species of fraud under the Act – actual fraud and constructive fraud, premised on Act Sections 5(a)(1) and 5(a)(2) and 6(a), respectively.  (Also, see http://paulporvaznik.com/uniform-fraudulent-transfer-act-actual-fraud-constructive-fraud-transfers-insufficient-value-il-law-basics/5646)

Actual Fraud and ‘Badges’ of Fraud

Actual fraud that impels a court to unwind a transfer of property requires clear and convincing evidence that a debtor made a transfer with actual intent to hinder, delay or defraud creditors.

Eleven badges or indicators of fraud are set forth in Section 5(b) of the Act.  The factor the Summitbridge Court particularly homed in on was whether there was an exchange of reasonably equivalent value.  That is, whether the defendants’ children gave anything in exchange for the transferred commercial property.

In analyzing this factor, courts consider four sub-factors including (1) whether the value of what was transferred is equal to the value of what was received, (2) the fair market value of what was transferred and what was received, (3) whether it was an arm’s length transaction, and (4) good faith of the transferee/recipient.  Reasonably equivalent value is measured at the time of transfer.

In opposing the plaintiff’s summary judgment motion, the defendants made only conclusory assertions they lacked fraudulent intent.  Moreover, they failed to come forward with any evidence showing they received consideration for the transfer.

In summary, because there were so many badges of actual fraud present, and the debtors offered no proof of consideration flowing to them in exchange for quitclaiming the property, the appeals court affirmed the trial court’s actual fraud finding.

Constructive Fraud

Unlike actual fraud, constructive fraud (i.e., fraud in law) does not require proof of an intent to defraud.  A transfer made for less than reasonably equivalent value of the thing transferred that leaves a debtor unable to meet its obligations are presumed fraudulent.  A fraudulent transfer plaintiff alleging constructive fraud must prove it by a preponderance of evidence – a lesser burden that the clear and convincing one governing an actual fraud or fraud in fact claim.

Constructive fraud under Act Section 5(a)(2) is shown where a debtor did not receive a reasonably equivalent value for the transfer and the debtor (a) was engaged or was about to engage in a business or transactions for which the debtor’s remaining assets were unreasonably small in relation to the business or transaction, or (b) intended to incur, or believed or reasonably should have believed he would incur, debts beyond his ability to pay as they came due.

Section 6(a) constructive fraud applies specifically to claims arising before a transfer where a debtor doesn’t receive reasonably equivalent value and was insolvent at the time of or resulting from a transfer.

The First District agreed with the lower court that the plaintiff sufficiently proved defendants’ constructive fraud.  It noted that the plaintiff’s money judgment pre-dated the transfer of the property to defendant’s children and there was no record evidence of the debtors receiving anything in exchange for the transfer.

Take-aways:

Summitbridge provides a useful summary of fraud in fact and fraud in law fraudulent transfer factors in the context of a dispositive motion.

Once again, summary judgment is the ultimate put-up-or-shut-up litigation moment: a party opposing summary judgment must do more than make conclusory assertions in an affidavit.  Instead, he/she must produce specific evidence that reveals a genuine factual dispute.

The defendants’ affidavit testimony that they lacked fraudulent intent and transferred property to their family members for value rang hollow in the face of a lack of tangible evidence in the record to support those statements.

 

 

 

Fraudulent Transfer Action Can Be Brought In Post-Judgment Proceedings – No Separate Lawsuit Required – IL Court

Despite its vintage (over two decades), Kennedy v. Four Boys Labor Service, 664 N.E.2d 1088 (2nd Dist.  1996), is still relevant and instructional for its detailed discussion of Illinois’ fraudulent transfer statute and what post-judgment claims do and don’t fall within a supplementary proceeding to collect a judgment in Illinois.

The plaintiff won a $70K breach of contract judgment against his former employer and issued citations to discover assets to collect the judgment.

While plaintiff’s lawsuit was pending, the employer transferred its assets to another entity that had some of the same shareholders as the employer.  The “new” entity did business under the same name (Four Boys Labor Service) as the predecessor.

Plaintiff obtained an $82K judgment against the corporate officer who engineered the employer’s asset sale and the officer appealed.

Held: Judgment for plaintiff affirmed

Rules/reasons:

The Court applied several principles in rejecting the corporate officer’s main argument that a fraudulent transfer suit had to be filed in a separate action and couldn’t be brought within the context of the post-judgment proceeding.  Chief among them:

– Supplementary proceedings can only be initiated after a judgment has entered;

– The purpose of supplementary proceedings is to assist a creditor in discovering assets of the judgment debtor to apply to the judgment;

– Once a creditor discovers assets belonging to a judgment debtor in the hands of a third party, the court can order that third party to deliver up those assets to    satisfy the judgment;

– A court can authorize a creditor to maintain an action against any person or corporation that owes money to the judgment debtor, for recovery of the debt (See 735 ILCS 5/2-1402(c)(6);

– A corporate director who dissolves a company without providing proper notice to known creditors can be held personally liable for corporate debts (805 ILCS 5/8.65, 12.75);

– An action to impose personal liability on a corporate director who fails to give notice of dissolution must be filed as a separate lawsuit and cannot be brought in a post-judgment/supplementary proceeding;

– Where a third party transfers assets of a corporate debtor for consideration and with full knowledge of a creditor’s claim, the creditor may treat the proceeds from the sale of the assets as debtor’s property and recover them under Code Section 2-1402;

– A transfer of assets from one entity to another generally does not make the transferee liable for the transferor’s debts;

– But where the transferee company is a “mere continuation” of the selling entity, the transferee can be held responsible for the seller’s debt.  The key inquiry in determining successor liability under the mere continuation framework is whether there is continuity of shareholder or directors from the first entity to the second one;

– An action brought under the Uniform Fraudulent Transfer Act (FTA), 740 ILCS 160/1, is considered one that directly concerns the assets of the judgment debtor and imposes liability on the recipient/transferee based on the value of the transferred assets;

– A transfer is not voidable against one who takes in good faith and provides reasonably equivalent value.  740 ILCS 160/9;

– A court has discretion to sanction a party that disobeys a court order including by entering a money judgment against the offending party;

(664 N.E.2d at 1091-1093)

Applying these rules, the Court found that plaintiff could properly pursue its FTA claim within the supplementary proceeding and didn’t have to file a separate lawsuit.  This is because an FTA claim does not affix personal liability for a corporate debt (like in a corporate veil piercing or alter ego setting) but instead tries to avoid or undo a transfer and claw back the assets actually transferred.

FTA Section 160/5 sets forth eleven (11) factors that can point to a debtor’s actual intent to hinder, delay or defraud a creditor.   Some of the factors or “badges” of fraud that applied here included the transfer was made to corporate insiders, the failure to inform the plaintiff creditor of the transfer of the defendant’s assets, the transfer occurred after plaintiff filed suit, the transfer rendered defendant insolvent, and all of the defendant’s assets were transferred.  Taken together, this was enough evidence to support the trial court’s summary judgment for the plaintiff on his FTA count.

Take-away: Kennedy’s value lies in its stark lesson that commercial litigators should leave no financial stones unturned when trying to collect judgments.  Kennedy also clarifies that fraudulent transfer actions – where the creditor is trying to undo a transfer to a third party and not hold an individual liable for a corporate debt can be brought within the confines of a supplementary proceeding.