Not infrequently, a borrower’s loan collateral will fail to fully satisfy a secured debt, particularly after the add-ons of default interest, attorney’s fees and other costs of collection. In such cases, lenders must choose whether to pursue a recovery of the remaining, unsecured debt from either the borrower or a corporate or individual guarantor. Sometimes, a pre-loan and post-judgment comparison of financial statements causes lenders to question whether there may have been fraudulent transfers of assets that could be avoided and become a source of recovery. Guttierrez v. Kennedy, 2010 U.S.Dist. LEXIS 73053 (S.D. Ind. 2010) (.pdf) helps guide a judgment creditor’s decision of whether to incur the time and expense of pursuing suspected fraudulently-transferred assets.
Fact sensitive. No two fraudulent transfer/veil piercing cases are alike, and I’ve concluded that a detailed summary of facts in cases like Guttierrez adds little to the overall message. For more about the assets and relationships at issue, I recommend that you read the opinion.
Negative value. The key asset in Guttierrez involved a contract previously held by the judgment debtor that was transferred (assigned) to a related corporate entity. Indiana’s Uniform Fraudulent Transfer Act (“UFTA”) at Ind. Code § § 32-18-2-1 through 21 permits creditors to obtain avoidance of a fraudulent transfer to the extent needed to satisfy a claim. Guttierrez specifically touched upon the amount of the potential recovery. “The creditor may recover the lesser of the amount necessary to satisfy its claim or the value of the transferred asset.” Valuation is determined at the time of the transfer but can be adjusted “as the equities may require.” To the extent the asset may generate income from use, the liability of the transferee will be “limited in any event to the net income after the deduction of the expense incurred in earning the income.” After an examination of the facts in Guttierrez, the Court concluded that the judgment creditor could not recover under the UFTA because the subject contract had negative value after the deduction of the expenses incurred in earning the income.
Direct continuation. The judgment creditor in Guttierrez also argued that the corporate assignee of the contract was a “direct continuation” of the judgment debtor and, as such, should be liable for the judgment. I discussed this type of veil piercing claim on July 28, 2007. Generally, in Indiana “when a corporation is clearly a direct continuation of the ownership and operations of another corporation, it will be liable to the other corporation’s creditors.” The corporate entities in Guttierrez operated from the same location and performed the same jobs. On the other hand, the targeted entity was not created immediately after the threat of judgment against the judgment debtor and indeed preexisted the judgment by twelve years. Additionally, even though one of the principals of the judgment debtor had a stake in the targeted entity, two of the other principals did not. Moreover, the judgment creditor did not offer evidence of the important factors of undercapitalization, comingling of personal and corporate assets, or corporate payment of personal obligations. But the nail in the coffin was the “negative value” of the asset at issue: “Plaintiffs were not harmed by the transfer because the [contract] turned out to be a losing proposition.”
No harm, no foul. From the perspective of judgment creditors, one lesson of Guttierrez is to ensure that the asset being chased is worth chasing. Guttierrez centered upon the capture of an income-producing asset (a contract) that, on its face, appeared to have significant worth. But the Court concluded that, after deducting operating/overhead costs, the contract had negative value. The judgment creditor’s efforts to seize the contract were for naught. While it may be understandable that a value determination cannot be made before a claim is filed, prompt post-filing discovery and investigation should be undertaken in order to assess what an income-producing asset may be worth. In Guttierrez, the subject transfers and corporate entities were suspect, but in the end those circumstances didn’t matter because the targeted asset turned out to be a liability.