A secured lender’s efforts to collect a debt can from time to time evolve into a cause of action for fraudulent transfer. As noted by the Indiana Court of Appeals in its May 20, 2008 decision in Hoesman v. Sheffler, 2008 Ind. App. LEXIS 1031 (Ind. Ct. App. 2008), “the purpose of a fraudulent transfer claim is the removal of obstacles which prevent the enforcement of the judgment … [and, if successful,] will subject the [transferred] property to execution….” For secured lenders, normally a fraudulent transfer claim will come into play, if at all, when a lender is attempting to enforce a deficiency judgment.
Underlying judgment. In Hoesman, an individual, acting as a trustee for a family trust, stole about $349,000 from the trust. The trial court entered a judgment against the trustee for about $288,000, which reflected the total damages recoverable under Indiana law minus, among other things, about $300,000 that the trustee put back into the trust after acquiring money from her parents.
The allegedly-fraudulent transfer. The Court’s opinion surrounded the impact of the parents’ payment of the $300,000 that the trustee used to “reimburse” the trust. The potential problem was that, after the trustee acquired the $300,000, she executed a promissory note to her parents for $300,000, together with a security agreement in which the trustee pledged as collateral for the “loan” several vehicles she owned and a mortgage on her residence. The trustee also transferred all of her shares in a closely-held S-Corp (a farm) to her parents. A key question in Hoesman was whether the transfer of the stock and the security interests in the vehicles and the residence should be avoided. If so, then the plaintiff could satisfy the judgment from those assets. If not, then the parents’ lien or interests in those assets could shield them from collection.
Gift vs. loan. The plaintiff contended the transfer of $300,000 from the parents to the trustee was a gift, for which the trustee incurred no legal obligation. Arguably, therefore, the subsequent stock transfer and security agreement were not given for consideration (value). On the other hand, if the $300,000 transfer was a loan, then the stock and security agreement were given to the parents in exchange for value, and the parents were competing creditors of the trustee. The Court summed-up the issue as follows: “the [plaintiff’s] success under a fraudulent transfer theory depends upon whether [the trustee’s] transfers to her parents were made (1) for a bona fide and honest debt; (2) in good faith; and (3) free of fraudulent intent.
Fraudulent intent. As previously documented in this blog, fraudulent intent in Indiana involves a fact-sensitive question and focuses upon certain “badges of fraud,” which include:
1. Transfer of property by the debtor during the pendency of a suit;
2. Transfer of property that renders the debtor insolvent or greatly reduces his estate;
3. A series of contemporaneous transactions which strip a debtor of all property
available for execution;
4. Secret or hurried transactions not in the usual mode of doing business;
5. Any transaction conducted in a manner differing from customary methods;
6. A transaction whereby the debtor retains benefits over the transferred property;
7. Little or no consideration in return for the transfer; and
8. A transfer of property between family members.
The Court noted that “the existence of several of these badges may warrant an inference of fraudulent intent, but no particular badge constitutes fraudulent intent per se.”
Questions deferred for trial. The Court denied summary judgment and concluded that material questions of fact remained as to whether the transfers from the trustee to her parents were made in good faith and free of fraudulent intent:
Here, many of the badges of fraud are arguably present . . .. However, this is not a typical fraudulent transfer case, as the debtor (the trustee) had received (either by gift or by loan) assets that appear to be worth more than those dissipated, and used the received assets to repay the Trust. On the other hand [the trustee’s] transfer of assets and grant of security came well after [her] parents transferred funds to [her]. If the [plaintiff’s] theory that the transfer of funds was a gift is correct, the subsequent transfers and grant of security could be found fraudulent.
The case thus must go to trial to examine and weigh the disputed facts. For more on the elements of a fraudulent claim, please click on the .pdf of the Hoesman opinion, and you can also click on these two statutes – Ind. Code § 32-18-2-14 and § 32-18-2-18 – upon which the plaintiff in Hoesman relied. These are sections from the Uniform Fraudulent Transfer Act.
Lookout. When you’re struggling with a judgment debtor (borrower or guarantor) on the hook for a deficiency judgment, be on the lookout for suspect asset transfers and funny business between family members. The eight badges of fraud outlined above are a good place to start when analyzing the viability of a fraudulent transfer claim.