A Tale of Two Participations

It was the best of times. Or was it the worst of times? Depends on which side you are on.

This article will address two decisions concerning loan participations. The decisions were issued on the same day but by different courts (the Third Circuit of Appeals and the Bankruptcy Court for the Eastern District of New York). The facts are not so different, yet the decisions are.

The first case concerns a motion brought by two individuals (the Movants) seeking to compel the bankruptcy trustee (the Trustee) to abandon property that they claimed was not property of the bankrupt estate. The Debtor was a provider of merchant cash advances and purportedly sold participations in its advances to third parties including the Movants. The Movants argued that certain accounts (the Account Funds) were established for their benefit in accordance with the terms of a so-called Syndication Participation Agreement (the Agreement). The Trustee opposed the motion on the grounds that the Agreement was not a true participation agreement but rather a disguised loan, or alternatively a security, and as a result, the Movants did not have a legal or equitable right to the Account Funds.

The Court stated:

In a traditional participation agreement the Account Funds would constitute the proceeds of loans originated by the Debtor but in which the [Movants] owned a fractional share. This is so because a true loan participation would have resulted in a sale to the [Movants] of a fractional interest in specific loans originated by the Debtor. However, the Court finds the [Movants] did not in fact purchase a participating interest in the underlying loans. Rather the[y] acquired a right as set forth in the Agreement to share not directly in the underlying loans but rather in the economic gain or loss of the Debtor.

In determining that the Agreement was not a true participation, it expressed two alternatives to its nature – either a loan or a security. However, inasmuch as neither of these alternatives would exclude the Account Funds from being property of the estate, the Court ruled that they were not subject to abandonment.

The Agreement provided that the Debtor was to make merchant cash advances with some unknown proportion of principal coming from the Movants. The Movants were to be repaid proportionately based on funds they provided to the Debtor and based on the Debtor’s estimates of and adjustments to payment amounts from its merchants. The Agreement indicates that the Movants were to provide funds to the Debtor, and that the Debtor was to determine how to advance the Movants money with “sole discretion” in credit underwriting and origination decisions. The Movants did not introduce any evidence from which the purported participations could be traced to specific merchant advances or to the Account Funds. The Court said:

When it comes to analyzing the true nature of a financial arrangement this Court may look past form and into substance, disregarding what the parties may call the transaction and inquiring into its true economic realities. . . .

Courts have articulated four factors . . . for finding a true loan participation, asking whether: (1) money is advanced by participant to a lead lender; (2) a participant’s right to repayment only arises when a lead lender is paid; (3) only the lead lender can seek legal recourse against the borrower; and (4) the document evidences the parties’ true intentions. . . . For purposes of a[n]. . . equitable interest analysis, a loan participation is one in which a lead lender originates a loan and then sells an equitable right to payment from that loan while retaining legal title.

The Court identified two factual predicates to finding true participations: either (1) the purported participation is entered into to facilitate a specific credit transaction, or (2) the purported participation is entered into to facilitate general lending operations, but loan proceeds are segregated and traceable to the underlying loans. The Court noted that in cases where courts have found a true participation to exist, the facts reflect that there is a known and specific borrower and loan in which the participation is sold.

The true loan participation test is commonly a test for determining whether a credit investment is in fact a disguised loan. A financial arrangement that passes the true loan participation test might be found to be a disguised loan if the weight of the following factors is answered in the affirmative: (1) whether there is a guarantee of repayment by the lead lender to a participant; (2) whether the participation lasts for a shorter or longer term than the underlying obligation; (3) whether there are different payment arrangements between the borrower and the lead lender and the lead lender and the participant; and (4) whether there is a discrepancy between the interest rate due on the underlying note and the interest rate specified in the participation. The Court stated:

The first factor is the most significant as it would evidence payment to the investor based solely on the credit risk of the lead lender rather than of the borrowers in whose credit transactions the investor is purportedly participating.

The Court also considered whether the Agreement was actually a note or a security but declined to reach a conclusion. It was sufficient to conclude that it was not a participation and, thus, the Account Funds remained property of the estate and not subject to abandonment.

By contrast, the Third Circuit case concerned an intercreditor agreement between the secured lender in a lender finance transaction and a claimed participant in loans made by the secured lender. It is interesting that the parties and the courts (including the lower court and the court in the borrower-finance company’s bankruptcy proceedings) never focused on whether the participation agreement was a true participation or a disguised loan. Instead, they focused on various theories to either support or undermine the workings of the intercreditor agreement. The court below and the Third Circuit each ruled in favor of the participant solely on the terms and conditions of the intercreditor agreement. However, had the secured lender challenged the true participation and succeeded on that theory, the outcome would likely have been different. If the participation was not true, the participation agreement would have been deemed a disguised loan (as described by the first case discussed) and the participant would have been deemed an unsecured creditor, leaving the proceeds held by the secured lender available to reduce the indebtedness owed by its borrower.

The take-away is when dealing with participations, understand what rights you are receiving and what risks you are taking. The Movants invested over a million dollars but did not obtain an undivided interested in the Debtor’s merchant cash advances and, as a result, their investments remained property of the Debtor’s estate. Instead of being a participant, it was a lender to the Debtor or a beneficiary of a security. Similarly, the secured lender by not scrutinizing the participant’s interest, may have missed its opportunity to prevail in the intercreditor dispute. True sale issues need to remain a focus in these types of transactions.

In re: SRS Capital Funds, Inc. et al, 2022WL1110557 (Bankr. EDNY 2022)
CoFund II LLC v. Hitachi Capital America Corp., 2022WL1101576 (3d Cir. 2022)

Another MCA: This Time Enjoined

Readers of WurstCaseScenario tell me that they never tire of MCA stories. This case is from one of the most well-respected Federal District Court Judges, Jed Rakoff (the judge in the Madoff cases, for example), and has the potential of getting ugly. Read on.

This action was brought as a putative class action but has not yet been certified. The claims allege fraudulent and usurious loans and abusive collection tactics employed by merchant cash advance (MCA) defendants GoFund Advance, LLC, Funding 123, LLC, Merchant Capital LLC and Alpha Recovery Partners, LLC and certain individuals. The plaintiffs are two small businesses, a North Carolina urgent care facility and a Texas construction contractor, that entered into MCA agreements with the defendants.

Judge Rakoff described MCAs as:

financial products, often marketed to small businesses through allegedly high-pressure sales operations resembling “boiler rooms,” that purport to purchase at a discount a portion of a business’s future receivables.

This decision determines the plaintiffs’ motion to convert a temporary restraining order granted at the start of the action to a preliminary injunction. The Court summarized the legal standard:

A party seeking a preliminary injunction must ordinarily establish (1) irreparable harm; (2) either (a) a likelihood of success on the merits, or (b) sufficiently serious questions going to the merits of its claims to make them fair ground for litigation, plus a balance of the hardships tipping decidedly in favor of the moving party; and (3) that a preliminary injunction is in the public interest.

It is important to note that in order to secure the preliminary injunction, the party only needs to demonstrate likelihood of success on one claim against each defendant. Here, the plaintiffs’ claims were for breach of contract and for RICO. The Court concluded that the plaintiffs demonstrated their likelihood of success on their breach of contract claims but not on their RICO claims.

Plaintiffs’ primary argument at this stage was that, assuming that the MCA agreements were valid as MCA transactions rather than as loans, the defendants breached them by failing to timely pay the purportedly agreed-upon purchase price, having withheld some $400,000 of the $1 million purchase price. Under the agreement, the defendants were to advance $1 million as a “purchase price” in exchange for the purported purchase of all of the plaintiffs’ receipts until the plaintiffs had repaid $1.499 million through daily ACH withdrawals of $60,000. On its face, the repayment should have been completed in approximately 25 days. However, the defendants initially provided the plaintiffs with only $400,000, after supposedly subtracting $100,000 in fees. After the plaintiffs had made approximately $785,000 in payments to the defendants (a little more than two weeks), the defendants deposited an additional $400,000, supposedly reflecting a deduction of another $100,000 in fees.

The plaintiffs were required to provide the defendants with 24 hours prior notice if any of the daily $60,000 ACH withdrawals would result in insufficient funds. The failure to provide notice was identified in the contract as an event of default. Several of the plaintiffs’ remittances resulted in ACH payments being returned for insufficient funds, but the plaintiffs did not notify the defendants as required.

The plaintiffs argued that the defendants breached the MCA agreement by initially depositing $400,000 of the $1 million, by withdrawing excessive fees and withholding until later the second $400,000 payment. The defendants were unable to demonstrate where in the MCA agreements they were entitled to the fees or where they were entitled to withhold portions of the purchase price. The Court then concluded that the plaintiffs were likely to prove that the defendants breached the contract by failing to send the full purchase price, minus applicable and appropriately disclosed fees.

The Court also accepted the plaintiffs’ argument that their own breach (tripping ACH payments) occurred as a result of the defendants’ failure to fully fund the purchase price and that the breach in ACH payment occurred after the defendants’ default.

Indeed, the payment may not have failed had the account been fully funded from the outset.

The defendants alleged a litany of harms that supposedly resulted from their default in payment. They argued that their default was clearly hastened because the defendants failed to timely deposit the cash advance in the plaintiffs’ account. Thus, the Court concluded:

Therefore, [the defendants are] likely to succeed in proving contract damages and, by extension, in prevailing on its breach of contract claim.

The Court went on to find that the plaintiffs had not demonstrated likelihood of success on each element of their RICO claim and, as a result, denied the preliminary injunction on that claim.

Next, the Court considered the other requirements to issue a preliminary injunction – irreparable harm and the public interest.

The papers establish that defendants’ issuance of UCC lien letters has frozen its bank and health insurance accounts, effectively locking up the urgent care center’s finances. If the urgent care center is unable to collect insurance reimbursements, and thus cannot make payroll or purchase medical supplies, there is a material risk of the business’s collapse. That would constitute an irreparable harm for which later payment of money damages would be inadequate.

The urgent care center’s inability to continue as a going concern would also disserve the public interest, because it would eliminate a source of medical care to the people of Fayetteville, N.C. To withdraw medical resources from any community would seriously harm the public interest at any time, but the implications are particularly serious in light of the continuing COVID-19 pandemic . . .

The Court granted the preliminary injunction and ordered:

During the pendency of this case, [defendants are] enjoined from continuing to debit unauthorized monetary amounts from bank accounts belonging to [plaintiffs] and from freezing bank accounts, health insurance accounts, assets and receivables belonging to [plaintiffs]. [Defendant] is further enjoined to withdraw and retract any UCC Lien Letters sent to third parties and to direct any other person or entity acting on its behalf to do the same.

So, what does this all mean? Yes, it is a victory for the plaintiffs and those who have been affected by the conduct of irreputable MCA providers. But that is not the end of the road. Plaintiffs still have a great burden ahead. Likelihood of success on the merits is not success on the merits. That will only come after trial. New York State Courts have, in numerous decisions to date, upheld MCA agreements. These facts may differ from the state court cases, and keep in mind that this federal judge is likely to look at this case with a fresh set of eyes.

 

Even if the case proceeds to trial, the next burden for the plaintiffs will be to succeed in getting certified as a class. That will not be easy. The defendants will likely be looking to settle this short of trial. A significant difference between this case and the New York State Court cases is the amount at issue. The New York State Court cases tended to revolve around small claims (under $50,000). Here the parties have more at risk. Are the plaintiffs looking to win a cause? If yes, then the class certification is important. If not, and the defendants are willing to walk away, then the plaintiffs will have won but without a precedent. If the defendants intend to stand their ground, then the issues will get flushed out and this will be a case to watch as it goes to trial and on to appeals that will certainly get the attention of the MCA industry.

We will be watching and reporting issues of significance.

Haymount Urgent Care PC; Robert A. Clinton, Jr.; et al v. Gofund Advance, LLC; Funding 123, LLC; Merchant Capital LLC; Alpha Recovery Partners, LLC; et al. 2022 WL 836743 (SDNY 3/21/2022)

Federal Court Usury Claim Against MCA Dismissed and Court Declined to Compel Arbitration

Readers will recognize a few recurring themes in WurstCaseScenario: Merchant Cash Advance (highlighting both abuse and where MCAs are responsible high-risk financing sources) and promoting the use of arbitration in commercial finance disputes. A recent decision from the New Jersey Federal Court brings these two topics together. Note that the law, when applied to a specific set of facts, may not result in a fair treatment, despite the fact that the law itself is fair. Here, the judge apparently regretted making a correct decision.

Gold Lion Steel LLC (Gold Lion) and its guarantors (the plaintiffs) brought an action alleging that Global Merchant Cash, Inc., d/b/a Wall Street Funding (Global Merchant), willfully entered into two usurious loan agreements in violation of the criminal usury statutes well as the New Jersey Consumer Fraud Act. Global Merchant moved to dismiss and compel arbitration.

The financing was structured as a merchant cash advance pursuant to which Gold Lion agreed to repay the loans within 180 days at a 143% interest rate (for the first of two financings) and within 164 days at a 164% interest rate for the second. The loans were to be repaid in fixed daily payments of $270.28.

The individuals gave “validity guaranties” whereby they guarantied against the breach of any “representation, warranty, and/or covenant” under the loan agreements. This apparently included any breach of a covenant to make payments. (Sounds more like a full unconditional guaranty, doesn’t it?)

The agreement also included a broad binding arbitration clause for the resolution of any disputes. It also included a choice of law provision where the parties agreed that New York law would apply and that the arbitration would be held in New York. Notwithstanding, the plaintiffs argued that New Jersey law should apply, and the court addressed that first:

[A] district court must apply the choice of law rules of the forum state to determine what law will govern each of the issues of a case. . . . . Under New Jersey’s choice-of-law rules, effect is given to contracting parties’ private choice of law clauses unless they conflict with New Jersey public policy.

The Court recognized that New Jersey and New York each has a strong public policy against usury but that the cases presented by the plaintiffs did not support overruling the parties’ choice of New York law. It also noted that New York’s anti-usury policy was so strong that it made usury violations criminal.

The Court then turned to the enforceability of the arbitration clause, finding:

. . . the [Federal Arbitration Act] requires courts to compel arbitration in accordance with the terms of an arbitration agreement, upon the motion of either party to the agreement, provided that there is no issue regarding its creation. . . . . To that end, courts must determine: (i) whether the parties have executed a valid agreement to arbitrate and, if so (ii) whether the dispute at issue falls within the scope of the agreement.

The Court reasoned that the parties agreed that the dispute fell within the scope of the agreement and went on to find that the parties had agreed to arbitrate the dispute in New York. However, citing significant case law, the New Jersey Federal Court determined that it could not compel parties to arbitration outside of its jurisdiction, in what it described as a “perplexing dilemma”:

When faced with this dilemma, courts in this Circuit have denied the motions to compel arbitration and either dismissed or transferred to the appropriate district.

While recognizing its decision to be “somewhat paradoxical,” it held that it was required to follow this practice and deny Global Merchant’s motion to compel and grant its motion to dismiss.

So what does this all mean?

First, it does not mean that the MCA won the war, albeit it won the battle. The plaintiffs had an expensive lesson and should have followed the jurisdiction provisions of the contract. That difference would mean that the New York court, had there been one, could have compelled arbitration in New York, as provided for in the agreement, or better (albeit unlikely), could have determined that the strong anti-usury public policy required it to rule that the agreement was not subject to arbitration and that the MCA was subject to penalties.

It should be noted that in the event the matter proceeds to arbitration and the arbitrator rules that the MCA agreement was not usurious (as many New York courts have ruled in similar situations), it is unlikely that a court would vacate such an award on public policy grounds.

So, here is the takeaway: in addition to the confidentiality assurances of the process, arbitration remains a strong tool to protect lenders – whether right or wrong.

Gold Lion Steel LLC v. Global Merchant Cash, Inc., 2022 WL 596997

Bad Facts Make Bad Law: Lender Liability Is Back on the Rise

The area of lender liability has been reasonably dormant for many years. An entire generation has grown up since this was a hot topic amongst lenders and, as a result, many of the lessons learned years ago have not been learned by at least some of the present generation of lenders. Generally, lender liability claims succeed when a lender has exercised management controls.

Christmas came a day early for a factor who woke up on Dec. 23 with a lump of coal (well, maybe a mountain of coal) in its stocking by a searing, 145-page decision issued by a Dallas Bankruptcy Court at the request of a Chapter 7 trustee that should be of concern to every lender.

This case involves: (a) a decades-old metal fabricating business; (b) its long-time owner; and (c) a factoring company. There was a short-lived financing arrangement among the parties that went terribly wrong. The bankruptcy trustee and former owner of the business alleged that:

(a) improper conduct of the factoring company ultimately destroyed the business enterprise which—although experiencing financial distress—had prestigious customers and a hopeful future; and (b) the factoring company unlawfully put a lien on and coerced the former owner to sell his exempt homestead and pay over the sale proceeds to the factoring company (based on a broken promise to resume factoring, if he did). The bankruptcy trustee and former owner allege[d] more than a dozen torts against the factoring company, in addition to breach of contract.

Specifically, the trustee alleged that the factor:

refused to advance funds under the applicable factoring and inventory loan agreements in good faith and in the manner promised—in fact, almost immediately taking a stance that the businesses were in an “over-advanced” position, which was not only not a defined concept in the agreements, but was problematic in light of several weeks of due diligence and awareness regarding certain slow-paying accounts and inventory status; (ii) charged fees, expenses, penalties and other items against “reserves” (contributing to the alleged “over-advanced” position), without any transparency; (iii) exercised excessive control over the businesses, by controlling what vendors, employees, and expenses got paid, and insisting on direct payments to them by the factoring company rather than funding to the businesses as contemplated by the underlying agreements (i.e., the argument being that this was an improper exertion of control; there were no amendments of documents or forbearance agreements to justify deviating from the underlying agreements). This, collectively, is argued to have caused the businesses’ failure. (emphasis added)

In addition, the business owner alleged that the factoring company: (a) wrongfully coerced him to transfer to it his equity from his exempt homestead in violation of the Texas Constitution and Texas Property Code; (b) misrepresented in the process that the factoring company would resume making advances on accounts receivable if he did so; (c) but had no intention of doing so and, in fact, never did so; (d) took a termination fee of $75,000 immediately after receiving $225,000 of sale proceeds from the home, without disclosing the termination fee; and (e) thereafter continued to accept accounts receivable collections but extended no funding.

The Court stated:

This was an excruciatingly difficult case but, on balance, the court has determined that the factoring company breached its agreements in certain ways and committed various torts. While the factoring company has essentially argued that the businesses involved here were dead-on-arrival and it did not cause their demise, the court strongly believes this is an incorrect assessment.

The Debtor companies were engaged in metal fabrication, product engineering and design, and provided products to suppliers for automotive manufacturers in the U.S. and Mexico. They suffered downturns during the 2008-9 recession but later developed additional sophisticated components for rocket engines used by Elon Musk and SpaceX. They also developed new technology to manufacture bullets for the military, replacing machines built during World War II, which remain in use to this day.

In 2014, the Debtor companies’ bank lender asked them to find a new lender. Another bank was interested but suggested that the companies temporarily transition via an interim factoring arrangement. The factor conducted due diligence from October 2014 through February 2015. During this period, the factor described the company as a “strong deal” although the companies were in arrears in paying ad valorem taxes. In addition, their accounts payable were in arrears with some 50% aged over a year and certain future business opportunities to be paid on a “milestone” basis.

Notwithstanding the “issues” the factor and the company entered into a factoring agreement as well as a revolving inventory loan agreement. In reciting the facts, the Court appeared to be critical of a number of provisions in these agreements including common ABL and factoring loan provisions such as cross-default provisions, general insecurity clauses, using availability under one facility to satisfy the unpaid fees in the other facility, and 15 categories of fees and expenses to be charged under the factoring agreement.

Almost immediately after closing and funding the financing and factoring agreements, the companies fell into an over-advance situation.

The Court cited destructive acts by the factor as:

  • refusing to make advances in good faith;
  • making payments directly to third-party vendors and employees of factor’s choosing;
  • exercising excessive control over the Debtor’s business;
  • misleading the Debtor about availability;
  • wrongfully placing a lien on the Guarantor’s exempt homestead;
  • declaring a default without a reasonable basis; and
  • taking a termination fee.

The Court concluded that the factor’s actions destroyed the business.

The court fully recognizes that the Agreements (the Factoring Agreements as well as the Inventory Loan Agreements) were quite replete with rights, fees, and other provisions that heavily favored [the factor] . . . ). In fact, the Agreements were shockingly one-sided in favor of [the factor]. And, generally, a contract is a contract. Be that as it may, the following are non-exclusive examples that the court finds demonstrated [the factor]’s bad faith and, at times, even malice toward [the Debtors], especially from July 1, 2015 forward.

. . . .

While this court believes that [the factor]’s conduct was in many ways tortious (and shocking), the breach of contract analysis here is actually quite vexing. As alluded to earlier, the Agreements are amazingly one-sided. In fact, they are so one-sided (i.e., providing a smorgasbord of rights, remedies, and discretion in favor of [the factor], with very few rights in favor of Debtors) that there seem to be very few breaches of contract. In other words, many of the alleged bad acts articulated by the Trustee were seemingly permitted by the terms of the Agreements.

The Court went on to find the factor liable for:

  1. breach of contract;
  2. breach of the duty of good faith and fair dealing;
  3. lender liability (which it described as a broad umbrella of tort liability);
  4. fraud;
  5. tortious interference with contractual and business relations;
  6. violations of the bankruptcy automatic stay; and
  7. attorneys’ fees.

The Court ultimately awarded the Trustee $17 million in damages ($13 million of which was for breach of contract, breach of duty of good faith and fair dealing, fraudulent misrepresentation); plus $2 million for separate tort of contractual and business interference; plus $2 million for willful automatic stay violations (including some $1.5 million in punitive damages); plus in excess of $1 million to the Guarantor. And this is before the attorneys’ fees have been assessed.

The key takeaway is to exercise care when involved in a workout. Most critical is to secure releases at every stage to better ensure that you will not be a victim of an ugly lawsuit such as this one. A valuable lesson may be learned from this case. In a case I defended years ago where the lenders’ conduct was not nearly as bad, but where we secured releases at every opportunity, the result was significantly different. Read that decision from the Second Circuit Court of Appeals.

The Value of Spousal Waivers

Generally, a creditor may not require the signature of an applicant’s spouse (or any other person other than a joint applicant) on any loan if the applicant qualifies for the credit requested under the lender’s standards of creditworthiness. If an applicant does not meet the lender’s standards of creditworthiness, then the lender may (among other things) condition approval of the credit upon the applicant furnishing the signature of another person (e.g., guarantor), but the creditor may not require that person to be the applicant’s spouse. If a creditor routinely requires spousal guarantees, for example, without first ascertaining whether an applicant is creditworthy, then the conditioning of the loan on the spousal guarantee violates Federal Reserve Board Regulation B.

Of course, there are exceptions to this rule. Regulation B expressly permits a spousal guaranty when the spouse’s guaranty is necessary to make property available as collateral to satisfy the debt in the event of a default. Understand that potential borrowers tend to push back on requests for spousal guaranties and waivers, but there are reasons why they are necessary. We will look at a recent case from the Second Circuit Court of Appeals which addressed a fraudulent conveyance action where the spouse transferred her interests in jointly owned property to her daughter.

In May 2015, Husband and Wife conveyed their respective interests in valuable real property to their daughter. Their apparent goal in this conveyance, as in two prior transactions, was to shelter the property from enforcement of a $45 million default judgment entered days earlier against the Husband. In 2017, the U.S. District Court for the Eastern District of New York (EDNY) voided the transfer as fraudulent under New York law. Then in 2020, the EDNY issued an order extinguishing Wife’s right of survivorship in the property, determining that Wife had acted in bad faith by participating in the conveyance to the daughter.

The EDNY analyzed the text of the fraudulent conveyance provisions of the New York Debtor and Creditor Law which provided for two remedies for creditors whose claim has matured:

[h]ave the conveyance set aside or obligation annulled to the extent necessary to satisfy his claim,

or to

[d]isregard the conveyance and attach or levy execution upon the property conveyed.

The judgment creditor and the EDNY recognized that the Debtor and Creditor Law does not state generally that a creditor may seek equitable remedies, much less the specific equitable remedy awarded here: termination of a non-debtor’s right of survivorship to a fraudulently conveyed property.

In considering the issue, the Second Circuit noted:

The New York Court of Appeals has not ruled directly on this question. Our task therefore is ‘carefully to predict how the [state’s] highest court’ would interpret the statute.

Note, that unlike the Second Circuit decision addressed in yesterday’s issue of WurstCaseScenario, the Second Circuit did not certify the question to the New York Court of Appeals but, instead, predicted how it would interpret the statute.

… case law strongly suggests that the New York Court of Appeals would follow [the decision of a New York intermediate appellate court] and find that the remedy the [EDNY] Court ordered is impermissible [under the statute]. The [EDNY]’s first order, voiding the conveyance from [Husband] and [Wife] to [the daughter] as fraudulent, restored the “status quo ante” in this case: under that order, [Judgment Creditor] retains its preexisting lien over [Husband]’s interest in the property, and [Wife] retains her share of the tenancy by the entirety for the [p]roperty, including her right of survivorship. Extinguishing [Wife]’s right of survivorship expands [Judgement Creditor]’s’ rights relative to the status quo ante….

The Second Circuit concluded:

…we predict with confidence that were the New York Court of Appeals to address this issue, it would conclude that the remedy ordered by the District Court was not available under New York’s [Debtor Creditor Law]. Because we conclude that the District Court could not terminate [Wife]’s right of survivorship under that statute, we vacate the District Court’s order and remand for proceedings consistent with the interpretation of New York law described in this Order.

So what does this mean? It means that despite Wife’s dirty hands, she retains her right of survivorship and, assuming Husband predeceases her, she will take the property free and clear of the Judgment Creditor’s judgment lien. It also means that the existence of the joint tenancy will prevent the Judgment Creditor from executing on the property. Understand that there is a 20-year statute of limitations in which an action may be brought on a judgment. The joint tenancy makes it more possible to retain the property until after the statute of limitations has run.

Now – what does all of this mean to you? It means that if you intend to rely on property that is subject to a joint tenancy, you very much need to have a spousal guaranty or spousal waiver. Without it, your judgment will very likely remain in limbo hoping that your judgment creditor’s spouse predeceases him or her prior to the expiration of the applicable statute of limitations.

We recognize that it is unpleasant to require a spousal guaranty or waiver, and many lenders just hope that they won’t need it. But when they do, they will be pleased they have it. Or they will be disappointed that they failed to get it when they should have.

Deerbrook Insurance Company v Mirvis, 2021 WL 4256845 (2d Cir. September 20, 2021)