In a Sept. 29, 2020, decision, the Eleventh Circuit Court of Appeals issued a disturbing decision affirming dismissal of a bank’s action to bar a guarantor’s bankruptcy discharge despite the guarantor having transferred substantial assets to a limited liability company he set up for his wife and daughter. The transfer occurred after the default by the borrower.
The non-dischargability action was dismissed by the Bankruptcy Court for the Southern District of Alabama, and was later affirmed by the United States District Court. The bank then appealed to the Eleventh Circuit (the appellate court just below the United States Supreme Court), which covers the states of Georgia, Alabama and Florida.
The guarantor guaranteed two business loans made in 2006 to fund a real estate development project. In 2008, he reaffirmed his guaranty when the loans were increased. A year later, the development project was in financial trouble and the bank sent the guarantor a warning of potential default. Less than two weeks after receiving the warning letter, the guarantor conveyed parcels of real property to a newly formed limited liability company whose members were the guarantor, his wife and daughter. He later conveyed his membership interest to his wife and daughter, fully divesting himself of any interest. This transfer was part of a series of conveyances of personal assets including real property, cash and business interests made to family members over the next five years. In 2010, the bank brought an action against the guarantor resulting in a money judgment in the amount of $9.1 million. The guarantor continued to transfer assets through 2014.
The bank (by its successor) ultimately sued the guarantor, his wife and daughter under the Alabama Uniform Fraudulent Transfer Act resulting in the guarantor filing for bankruptcy. The bank then commenced an adversary proceeding to declare the guarantor exempt from discharge due and allege the fraudulent conveyance. The guarantor answered the complaint and then moved for summary judgment dismissing the complaint by arguing that he did not defraud the bank in guarantying the loans, and because his conveyances did not injure the bank or its property.
The Bankruptcy Court found that the bank’s claim failed because the bank did “not contend that the underlying debt from the guaranties was obtained by fraud or was anything other than a standard contract debt” and because “[t]he underlying debt is the result of personal guaranties, not any willful and malicious injury by [guarantor].” Finally, the Bankruptcy Court found no basis for the bank to amend its complaint to add a claim under the Fraudulent Transfer Act, noting that the bank had “not provided any Alabama law that [a] debtor/transferor who fraudulently transfers property is liable to a creditor for the value of the transferred property.” On appeal, the District Court agreed with the Bankruptcy Court “for all the reasons articulated in [its] order,” and the bank appealed to the Eleventh Circuit.
The Eleventh Circuit stated that the bank
does not—and cannot—argue that [guarantor] or the entity whose debt he guarantied fraudulently obtained money or property from [the bank]. A state court awarded [the bank] a judgment on its ordinary breach of contract claim, and that judgment makes no findings of fraud. The only fraud that [the bank] alleges—[guarantor’s] conveyances of real and personal property—happened years after [guarantor] incurred the debt by signing the guaranties. The money that the bank loaned is obviously not traceable to those later conveyances.
It went on to distinguish the 2016 decision of the United States Supreme Court in Husky International Electronics, which held “[t]he term ‘actual fraud’ in § 523(a)(2)(A) encompasses forms of fraud, like fraudulent conveyance schemes, that can be effected without a false representation.”
However, the Eleventh Circuit claimed that
…the Supreme Court [did not] eliminate[] the requirement that for a debt to be exempt from discharge …, the money or property giving rise to the debt must have been “obtained by” fraud, actual or otherwise. Instead, [it] merely recognized the possibility that fraudulent schemes lacking a misrepresentation—including fraudulent transfers of assets to avoid creditors—can satisfy the “obtained by” requirement in some circumstances.
Readers of WurstCaseScenario likely understand how difficult it is to prove intentin order to succeed in proving “actual fraud.” But a fraudulent conveyance does not need to be done with intent to defraud. It is the action that matters – not the reason for it.
Section 8-9A-4 of the Uniform Fraudulent Transfer Act, as adopted in Alabama, provides:
(a) A transfer made by a debtor is fraudulent as to a creditor, whether the creditor’s claim arose before or after the transfer was made, if the debtor made the transfer with actual intent to hinder, delay, or defraud any creditor of the debtor.
This type of fraudulent transfer does require proof of intent. Although, in its complaint, the bank used some of this language, it did not make any reference to this Alabama state law. Instead, it only referred to Section 523 of the Bankruptcy Code, the section that addresses exemptions to discharge. In addition, Section 8-9A-5 of the Uniform Fraudulent Transfer Act, as adopted in Alabama, provides for certain transfers that do not require proof of intent to defraud:
(a) A transfer made by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made if the debtor made the transfer without receiving 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.
(b) A transfer made by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made if the transfer was made to an insider for an antecedent debt and the debtor was insolvent at that time and the insider had reasonable cause to believe that the debtor was insolvent.
These claims were not included in the complaint although it would appear likely that they could have been proven.
Section 523 of the Bankruptcy Code, which the bank did specifically cite in its complaint, does not provide for fraudulent conveyances. Inasmuch as the bank did not ask to set aside the transfer under Alabama law, the Court did not have to address whether the transfer would be exempted from discharge. It merely needed to deny the relief under Section 523.
Had the Eleventh Circuit stopped there, it might not have been so bad. Instead, it went beyond the failure to prove intent under 523:
The only misconduct alleged by [the bank] pertains to [guarantor’s] fraudulent conveyances of assets. But those conveyances occurred years after [guarantor] became indebted to [the bank] for the [borrower’s] guaranties, and the conveyances are not traceable to that debt, which arose from an ordinary breach of contract.
That is what should concern lenders. This makes it unclear whether Alabama and the Eleventh Circuit will protect lenders against fraudulent transfers by its borrower and guarantors when a well-pled complaint is at issue, instead of the one in this case, which clearly failed to put forth the proper claims.
SE Property Holdings, LLC v. Jerry DeWayne Gaddy, 11th Cir., September 29, 2020 (2020 WL 5793082)