A Fraudulent Transfer Suit May Commence More Than 4 Years After the Transfer Under CUVTA
Ninth Circuit BAP Decision: Period Can Be Triggered by Date of Transfer or by Date Judgment Is Entered on Underlying Debt Obligation – Even When Transfer Occurs Before Lawsuit Is Filed
- In a recent opinion in In re: Momentum Development, LLC, the U.S. Bankruptcy Appellate Panel of the Ninth Circuit held that under Cortez v. Vogt, the four-year period for commencing an action against a third-party transferee to avoid a fraudulent transfer may be counted either from the date of the transfer or from the date that judgment is entered in a suit by the creditor on the underlying debt, even when the transfer occurred before the lawsuit was filed.
- If an action under the California Uniform Voidable Transactions Act (CUVTA) is not brought within seven years after an asset was transferred, California's statute of repose extinguishes the creditor's cause of action for fraudulent transfer.
- Cortez has been criticized by scholars and courts in some jurisdictions, but praised by others. This Holland & Knight alert discusses the split of authority concerning the date from which courts have found the limitations period for commencing an action to avoid a fraudulent transfer is triggered and how that split can impact the transferee.
In its 1997 decision Cortez v. Vogt, the California Court of Appeal ruled that the limitations period during which an action to avoid a fraudulent or voidable transfer begins to run either on the date of the transfer or on the date a judgment is entered in an action by the creditor against the debtor with respect to the underlying debt.1 Relying on California's then-Uniform Fraudulent Transfer Act – now California's Uniform Voidable Transactions Act (CUVTA or Act) – the legislative history behind the Act and previous California caselaw, the Cortez court ruled that "where an alleged fraudulent transfer occurs while an action seeking to establish the underlying liability is pending, and where a judgment establishing the liability later becomes final, [the statute of limitations period] does not commence to run until the judgment in the underlying action becomes final."2 Cases from the California Courts of Appeal and the U.S. Bankruptcy Appellate Panel of the Ninth Circuit (Ninth Circuit BAP) have since applied Cortez to find that a creditor action effectively tolls the running of the limitations period for commencing an action under the CUVTA to avoid a transfer that occurred while the case was pending until the date that judgment is entered.
In its recent decision in In re Momentum, the Ninth Circuit BAP went even further, finding that the limitations period for commencing an action to avoid a fraudulent transfer may be triggered either by the date of the transfer itself or by the date that judgment is entered in the underlying action, even when the fraudulent transfer at issue did not occur during the pendency of the action.3
In Momentum, the Debtor hired DCA Drilling & Construction (DCA) in 2010 to work on 200 acres of property that the Debtor owned. In 2012, the Debtor transferred the land to Pyramid Center Inc. (Transferee) for a purchase price of 55 cents. Two years after the transfer, in 2014, the Debtor sued DCA for breach of contract. The Debtor lost at trial, and a judgment was entered against the Debtor in favor of DCA for attorney fees in 2018.
The Debtor filed for bankruptcy in 2018 without satisfying the DCA judgment. Section 544(b)(1) of the Bankruptcy Code (11 U.S.C. § 101 et seq.) allows a trustee or a debtor in possession (DIP) under Section 1107(a) to commence an action to avoid a transfer or obligation that is "voidable under applicable law," including state fraudulent transfer law, so long as there exists at least one creditor who could have asserted such an action as of the petition date. Under Section 546, the trustee or DIP generally has until two years after the petition date to commence an action under Section 544(b)(1).
In 2019, the Debtor's bankruptcy Trustee filed a complaint against the Transferee seeking to avoid the 2012 transfer of the Debtor's 200 acres as a fraudulent transfer. Given that the transfer occurred more than four years before the petition date, the Transferee argued that the Trustee's claims were barred by the statute of limitations, but the Trustee claimed that the action was timely because the trigger date for the four-year statute of limitations could be keyed as of the date the judgment was entered in favor of DCA, which happened within four years of the date the Trustee filed the avoidance action.
In Cortez, the transfer occurred during the creditor's action. However, in In re Momentum, the transfer occurred two years prior to the commencement of the action giving rise to the claim, and almost six years before the judgment was entered. Yet, the Ninth Circuit BAP held that such difference was irrelevant:
Defendant has argued that Cortez is inapplicable because it involved a transfer that was made during the pendency of the proceeding that was seeking to establish the underlying liability. Here, the transfer occurred before the lawsuit was commenced. Cortez cannot be read so narrowly. Its rule that the obligation triggers the running of the statute has been followed in numerous contexts.4
Following this logic, the Ninth Circuit BAP found that 1) DCA, the qualifying creditor, could have commenced an action to avoid the transfer at any time during the four years after judgment was entered in its favor in 2018; 2) the Trustee has two years from the petition date (June 19, 2018, to June 19, 2020) to commence a Section 544(b) action; and 3) the Trustee can step into the shoes of any "qualifying creditor" to commence the avoidance action. As such, the Ninth Circuit BAP found that Trustee's action was timely even though it was commenced almost seven years after the transfer took place.
How Does Momentum (and California law) Differ from Cases in Other Jurisdictions?
In Momentum, the Transferee argued that the phrase "obligation incurred" refers to the fraudulently incurred obligations, not the obligation from the debtor/transferor to the plaintiff. Although the Ninth Circuit BAP recognized that the provisions of the Uniform Voidable Transactions Act (UVTA) are generally intended to prevent debtors from intentionally making a fraudulent transfer or incurring fraudulent obligations to defraud creditors,5 it refused to follow other courts and held that under Cortez and its progeny, "obligation incurred" refers to the judgment entered against a debtor on the underlying debt that is the underlying basis for the creditor's fraudulent conveyance claim. Hence, even if the transfer had occurred more than four years prior to the debtor's insolvency, a judgment creditor (and thus a bankruptcy trustee or debtor in possession) may still have a valid claim because the limitation period may be deemed to run from the date of the final judgment of the underlying lawsuit that establishes the creditor-debtor relationship.
Outside of California, courts in other jurisdictions do not agree with the Momentum and Cortez courts' interpretation of the relevant language from the Uniform Fraudulent Transfer Act (UFTA) and UVTA.
For example, in K-B Bldg. Co. v. Sheesley Const., Inc., the Superior Court of Pennsylvania rejected the judgment creditor petitioner's reliance on Cortez, holding that the Cortez court's interpretation of UFTA is inconsistent with the express language of 12 Pa.C.S. Section 5109.6 The Pennsylvania court held that "action must be brought within one year of the date the transfer could have been discovered through the exercise of reasonable diligence or within four years of the transfer. The statute does not toll the statute of limitations in instances where the creditor-debtor relationship stems from a judgment obtained in a lawsuit."7
Similarly, in Moore v. Browning, the Arizona Court of Appeals rejected the Cortez court's analysis and held that the Cortez court erred in ruling that the statute of limitations of UFTA is tolled until a creditor obtains judgment against the debtor in the underlying action ("We believe the court misread the legislative material, find no counterpart to the previous decision in Arizona case law, and conclude that analyzing policy is inappropriate in construing the statute of repose.")8
The Supreme Court of New Jersey also rejected Cortez, noting that under the explicit language of UFTA, "the four-year provision runs from the date of transfer rather than the date of judgment."9
Implications of Momentum
Most states have adopted UVTA or UFTA, which generally provide that a creditor must commence an action to avoid a fraudulent or voidable transfer within four years from the date of the transfer or the date the obligation was incurred, subject to a one-year "discovery" rule. Under the majority rule, as exemplified by the Pennsylvania, Arizona and New Jersey cases described above, an avoidance action is timely if it is commenced against the transferee within four years from the date the challenged transfer was made or obligation was incurred, subject to the one-year discovery rule.
By contrast, under the Ninth Circuit BAP's interpretation, a transfer may be subject to collateral attack as a fraudulent or voidable transfer for as long as nine years after a transfer is made or obligation is incurred. For example, assume that a debtor makes a transfer to a transferee in Year 1. At some point thereafter, the debtor becomes involved in a dispute with another party, as a result of which litigation is commenced and, in Year 3, a judgment is entered against the debtor that goes unsatisfied. Then, just under four years after the date the judgment is entered, the debtor commences a bankruptcy case (sometime in Year 7). While there may be other defenses or arguments that would make a fraudulent transfer action commenced so many years after the transfer unlikely to succeed, under the In reMomentum court's view, the bankruptcy trustee or DIP may commence a timely action under Section 544(b)(1) to avoid the transfer within two years after the petition date, so as much as nine years after the actual transfer.
The Ninth Circuit BAP's ruling in Momentum has been appealed to the Ninth Circuit by Pyramid Center Inc. While the outcome of the appeal remains to be determined, transferees should be aware that current California law makes any transfer they received potentially vulnerable to challenge for many years after the date of the transfer.
1 Cortez v. Vogt, 52 Cal. App. 4th 917 (1997).
2 Id. at 920
3 In re Momentum Development, LLC., 2023 WL 2398561 (B.A.P. 9th Cir., Mar. 2, 2023).
4 In re Momentum Development, LLC., 2022 WL 990261 *2 (Bankr. C.D. Cal., Mar. 30, 2022).
5 In particular, the court noted these cases: In re Image Worldwide, Ltd., 139 F.3d 574 (7th Cir. 1998) (obligation incurred was loan guaranty by debtor to affiliated entity); In re Art Unlimited, LLC, 356 B.R. 700 (Bankr. E.D. Wis. 2006) (obligation incurred was payment for sham consulting services that were never performed), aff'd, 2007 WL 2670307 (E.D. Wis. Sept. 6, 2007); In re Strasser, 303 B.R. 841 (Bankr. D. Ariz. 2004) (obligation incurred was debtor's unenforceable promise to repay parents for support); In re Toy King Distribs., Inc., 256 B.R. 1 (Bankr. M.D. Fla. 2000) (obligation incurred was payment of guaranty fees when no guaranty existed).
6 Pennsylvania statute's equivalent to Cal. Civ. Code § 3439.09(a).
7 K-B Bldg. Co. v. Sheesley Const., Inc., 833 A.2d 1132, 1136 (Pa. Super., 2003).
8 Moore v. Browning, 50 P.3d 852, 859 (Ariz. App. 2d Div. 2002).
9 SASCO 1997 NI, LLC v. Zudkewich, 767 A.2d 469, 473 (N.J. 2001).
Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.