The U.S. Bankruptcy Appellate Panel of the Ninth Circuit (BAP) has held that a recorded abstract of judgment attached to the proceeds from the sale of a debtor’s residence even though the abstract was recorded after the debtor’s fraudulent transfer of her interest in the residence to her daughter. Daff v. Wallace (In re Cass), BAP No. CC-12-1513-KiPaTa (9th Cir. BAP, Apr. 11, 2013)(unpublished).
Facts and Procedural Background
Creditors sued the Debtor for nuisance and defamation. To prevent the potential seizure of her half million dollar home, the Debtor transferred her residence to her daughter for no consideration and reserved a life estate therein. The Debtor and her daughter then entered into a separate agreement where the daughter promised to reconvey the home ("Residence") back to the Debtor upon the Debtor’s request (the "Fraudulent Transfer"). The Fraudulent Transfer gave rise to further litigation, as Creditors then filed a second action alleging that the Debtor fraudulent transferred the Residence to her daughter. Creditors obtained a judgment in the nuisance lawsuit, including an award of punitive damages, from which the Debtor appealed. Judgment Creditors then recorded an abstract of judgment against the Debtor (although the Debtor had already transferred title to her Residence).
While the fraudulent transfer litigation progressed, the Debtor filed a chapter 7 petition. The chapter 7 trustee ("Trustee") substituted into the fraudulent transfer action, removed it to the bankruptcy court, and subsequently obtained a stipulated judgment avoiding the Fraudulent Transfer of the Residence. The Debtor opposed the stipulated judgment but her death rendered both her objections and appeals moot.
The Judgment Creditors and the Trustee agreed to sell the Residence. However, the parties disputed whether the Judgment Creditors’ lien attached to the sale proceeds. The Trustee argued that the lien was invalid because the Debtor transferred title to her daughter before the Judgment Creditors perfected their lien. The Judgment Creditors took the position that the Fraudulent Transfer was void such that it never occurred. As a result, the Judgment Creditors argued, title and ownership in the Residence remained in the Debtor and their judgment was superior to any interest held by the Trustee. The bankruptcy court ruled in favor of the Judgment Creditors. On appeal, the Trustee argued, among other things, that the stipulated judgment avoiding the Fraudulent Transfer also avoided the Judgment Creditors’ lien.
Holding and Analysis
The BAP began its analysis by reviewing the California Uniform Fraudulent Transfer Act ("CUFTA"), which law permits defrauded creditors to reach property in the hands of a transferee. The transferee holds only nominal or bare title while the transferor retains a beneficial and equitable interest. A perfected judgment lien therefore attaches to all of a debtor’s interests in real property, including equitable interests.
Both the bankruptcy court and the BAP focused on the daughter’s agreement to reconvey the Residence back to the Debtor at the Debtor’s request. The daughter’s promise to transfer the Residence back meant that the Debtor did not relinquish all of her interests in the Residence; the Debtor retained an equitable interest. Because the Debtor retained an equitable interest, the BAP concluded that the Judgment Creditors’ judgment lien attached to that equitable interest. As a result, the Judgment Creditors’ lien was valid and attached to the Residence and its sale proceeds.
In reaching its determination, the BAP rejected the Trustee’s argument that the stipulated judgment avoiding the Fraudulent Transfer extinguished the judgment lien. According to the BAP, under California law perfected judgment liens are extinguished only by satisfaction of the underlying judgment or a release. Judgment liens are not extinguished through sections 550 and 551 of the Bankruptcy Code.
The BAP also affirmed the rulings of the bankruptcy court that issue preclusion and judicial estoppel did not prevent the Judgment Creditors from enjoying the status of perfected secured creditors as to the sale proceeds of the Residence.
Commentary
A chapter 7 trustee generally seeks to avoid liens in order to take property that is otherwise another creditor’s collateral and allow the funds to be used to pay administrative expenses and unsecured creditors. In this case, the opinion mentions but does not discuss the fact that the Trustee was unable to avoid the lien but nevertheless was permitted to pay administrative expenses from the sale proceeds. The administrative expenses were incurred in significant part fighting with the judgment creditor, so a surcharge theory would not seem to apply; nor does it appear that the judgment creditors agreed to the payment. Thus, the Cass opinion seems to split the baby in the sense that the court held that the sale proceeds were collateral of the wronged judgment creditors, but at the same time apparently available to pay administrative expenses.
To read the full decision, click (Cass) http://cdn.ca9.uscourts.gov/datastore/bap/2013/04/11/Cass%20Memo%2012-1513.pdf
Prepared by the Insolvency Law Committee – Business Law Section of the State Bar of California