The prevailing purposes for the UVTA amendments appear to be codification of a choice of law rule and to ameliorate divergent interpretations of the Act among the courts. The divergence has led to varying outcomes of similar claims under UFTA (which failed to create the uniformity desired). See UVTA. §4, cmt. 10 (2014). The changes also bring the uniform act into compliance with the UCC and Bankruptcy Code. UVTA offers some welcome clarity to an all too often misunderstood body of law.
The alterations to UFTA include a few definitional changes that modernize the Act. Updates also include a codified choice of law rule, an exception for UCC Article 9 security interests, the elimination of the separate insolvency definition for partnerships, clarity as to which party carries the burden of proof, and a defined evidentiary standard for seeking a remedy under the Act. Furthermore, the Commission updated and added comments to influence the application of UVTA, as adopted by the States. Some of the comments are worth noting, and (if adopted by the courts) the comments have the potential to change the avoidance analysis in some jurisdictions.
The most noticeable change made in the UVTA is the absence of the word fraudulent from the title and body of the act. In UFTA, “fraudulent” and “voidable” are used inconsistently to refer to transactions for which the act provided a remedy. UVTA replaces “fraudulent” with “voidable” to clear up the inconsistency. Another purpose of the change is to discourage the “oxymoronic usage” of the phrase “constructive fraud” and the misleading phrase “actual fraud”. UVTA §14, cmt. 1 (2014). The use of these phrases perpetuates the confusion and inconsistent application of the act among the courts. The prior language is also inappropriate because “constructive fraud” is confusing, and what is deemed actual fraud (under subsection 4(a)(1)), does not actually require proof of fraudulent intent. See UVTA, §4, cmt. 10 (2014).
Confusion caused some courts seeking collection to latch on to the word “fraudulent.” This led to applications of UFTA inconsistent with its original intent. Some courts applied and continue to apply higher (fraud) pleading standards, and higher evidentiary burdens. The application of a heightened pleading standard most commonly occurs in Bankruptcy Courts applying the Federal Rules of Civil Procedure. For instance in In re: Sharp Int’l Corp, the second circuit, in affirming a decision by a bankruptcy court, held that when
“actual intent to defraud creditors is proven, the conveyance will be set aside regardless of the adequacy of consideration given.” McCombs, 30 F.3d at 328. As “actual intent to hinder, delay, or defraud” constitutes fraud, Atlanta Shipping, 818 F.2d at 251, it must be pled with specificity, as required by Fed.R.Civ.P. 9(b). Moreover, “[t]he burden of proving ‘actual intent’ is on the party seeking to set aside the conveyance.” In re Sharp Int’l Corp., 043 f.3d 43, 56 (2d. Cir 2005) (citations omitted)
The court’s imposition of a heightened pleading standard reflects how the court confused the creditor’s remedy of avoidance with the elements of common-law fraud. A higher pleading standard improperly limits creditor claims.
The confusion has also led several courts to impose a higher evidentiary burden than was intended by the UFTA. The California Sixth District Court of Appeals held in Reddy v. Gonzalez that, to avoid a transfer, a creditor must prove the actual intent to hinder, delay, or defraud “by clear and convincing evidence.” Reddy v. Gonzales, 8 Cal. App 4th 118, 123 (1992); see also Parker v. Parker, 681 N.W.2d 735, 7432 (Neb. 2004) (court applied “clear and convincing” standard to the fraudulent transfer claim under the section of the Nebraska statute that correlates to UFTA section 4(a)(1)). The imposition of a higher standard hinders creditors who would otherwise have a valid claim of avoidance under the UFTA “preponderance of the evidence” standard.
The change in terminology itself is not designed to have any substantive impact. The Commission states in the preface that “[n]o change in meaning is intended”. UVTA, Prefatory Note (2014). However, the change seems motivated by the Commission’s desire to deter the misinterpretation of “shorthand tag[s]” “constructive fraud” and “actual fraud.” UVTA §4, cmt. 1 (2014). In addition, the change in terminology is aimed at reducing the confusion caused by the word “fraud” in applying UFTA. See U.V.T.A. §4, Comment 8. The Commission handled some of these issues directly and indirectly. They did so, by adding new subsections and amending and adding comments.
Defining the Party that Bears the Burden of Proof
The Commission took direct measures to correct the differing evidentiary standards, and burdens of proof. For example, some courts have applied the “clear and convincing” evidence standard to actions under UFTA subsection 4(a), instead of the “preponderance of the evidence” standard that was intended. The Commission added the subsections 2(b),4(c),5(c),8(g), and 8(h) which together create “uniform rules on burdens and standards of proof relating to the operation of the [UVTA].” UVTA §4, cmt. 10 (2014). If adopted by the states, these additions will create the intended uniformity in application. Adoption will also create more certainty for creditors (no longer subject to higher evidentiary standards in jurisdictions that adopt the UVTA). The following is an overview of such subsections.
Subsection 2(b) deals with the presumption of insolvency. It states:
“a debtor that is generally not paying the debtor’s debts as they become due, other than as a result of a bona fide dispute, is presumed to be insolvent. The presumption imposes on the party against which the presumption is directed the burden of proving that the nonexistence of insolvency is more probable than its existence”. (emphasis added) UVTA §2(b) (2014).
This subsection revises the UFTA in two ways. First, it clarifies that debts subject to “a bona fide dispute” are not to be considered when determining whether the debtor is failing to pay his debts as they become due. Id. Second, the statute places on the debtor the burden of rebutting the presumption of insolvency by proving the “nonexistence of insolvency is more probable than its existence.” Id.
The addition of the “bona fide debts” language is simply a matter of clarification, as this was “the intended meaning of the language before the…[UVTA]”. UVTA §2(b), cmt. 2 (2014). This also brings the definition of insolvent in subsection 2(b) in line with that of the Universal Commercial Code (UCC), and the Bankruptcy Code. Id.
UVTA subsection 4(c) is another new addition. It provides the evidentiary standard for a claim under section 4 “TRANSFER OR OBLIGATION VOIDABLE AS TO PRESENT OR FUTURE CREDITORS,” and defines the party that bears the burden of proof under the section. The significance is similar to that of subsection 2(b). The addition is designed to clarify the act and prevent disparate interpretations. In states that apply the evidentiary standard of “clear and convincing evidence”, adoption of this provision would change the evidentiary standard to “preponderance of the evidence” standard. UVTA §4(c) (2014). The effect, in those jurisdictions, would be to make it easier for creditors to proceed with claims for avoidance under UVTA section 4. In addition, it is likely that heightened pleading standards would no longer be applied in states that adopt the UVTA for claims under section 4.
UVTA subsection 5(c) provides the evidentiary standard and allocates the burden of proof for a claim under UVTA section 5 “TRANSFER OF OBLIGATION VOIDABLE AS TO PRESENT CREDITORS”. UVTA subsection 5(c) places the burden proof on the creditor, except to the extent the burden is limited by subsection 2(b) (which shifts the burden to the debtor to show they are not insolvent if a creditor has proven the debtor is not paying his debts as they become due). UVTA §5(c) (2014). Subsection 5(c) establishes the evidentiary standard as a preponderance of the evidence. Id. Defining which party bears the burden of proof is likely most significant when added to this section because judicial presumptions have been applied that shift the burden to the transferee to show section 5 is inapplicable. For example, in In Re M. Fabrikant & Sons, Inc., the bankruptcy court applying New York’s UFCA stated that New York law “presumes that the debtor who transfers property without fair consideration is insolvent, and the burden shifts to the transferee to rebut it.” In Re M. Fabrikant & Sons, Inc. 447 B.R. 170, 195 (2011). The addition of subsection 5(c), and its brethren should override judicial presumptions such as those in In Re M. Fabrikant & Sons, Inc.
Subsection §8(g) was added to the UVTA to establish the party with the burden of proving each subsection of section 8 “Defenses, Liability, and Protection of Transferee or Obligee.” The party asserting one of the following defenses bears the burden of proving its applicability:
- That a transfer is not voidable under subsection 4(a)(1) because the transferee took in good faith and for reasonably equivalent value to the debtor;
- A good faith transferee or oblige is entitled, to the extent of the value given to the debtor, to a lien or a right to retain an interest in the asset transferred, an enforcement of an obligation incurred, or a reduction in the amount of the judgment;
- A transfer is not voidable by subsection 4(a)(2) or subsection 5 if the transfer results from the termination of a lease upon default by the debtor, or it is an enforcement of a security interest in compliance with article 9 of the UCC, except if the acceptance of the collateral is in full or partial satisfaction of the obligation it secures; or
- A transfer is not voidable under subsection 5(b) to the extent (i) the insider gave new value to or for the benefit of the debtor after the transfer was made (except to the extent the new value was secured by a lien), (ii) it was made in the ordinary course of business of the debtor and the insider, or (iii) it was made pursuant to a good-faith attempt to rehabilitate the debtor and the transfer secured present value given for that purpose as well as an antecedent debt. UVTA 8 (2014).
Under section 8, a creditor carries the burden of proving that the transfer is avoidable under subsection 7(a)(1). UVTA §8(b) (2014). By proving a transfer is avoidable under subsection 7(a)(1), a creditor may recover the value of the asset transferred or the amount necessary to satisfy the creditor’s claims. UVTA §7(a) (2014).
Subsection 8(b) provides a defense to an avoidance action for an “immediate or mediate transferee of the first transferee” if they took in good faith and for value. UVTA §8(b)(1). Subsection 8(b) also provides a defense to a person who took in good faith that is a subsequent transferee of a person that took in good faith and for value. Id. A party raising either of these defenses carries the burden of proof. UVTA §8(g)(3). A party seeking adjustment to the value of the asset based “on the equities” of the transfer subject to avoidance has the burden of proving the equities. UVTA §8(c) (2014).
These subsections (like the other additions allocating the burden) are not designed to enact substantial change, but instead to clarify the law as originally intended by the UFTA. The defined burdens of proof will likely curb judicially crafted presumptions, and create more predictability when an action is brought under the UVTA. See UVTA, §4, cmt. 11 (2014).
The final addition to subsection 8(h), provides the evidentiary standard for all of section 8. UVTA §8(h) (2014). Consistent with the rest of the UVTA, it applies the “preponderance of the evidence” standard. Id.
Shifting the Focus from “Fraud” in Section 4(a)(1) Avoidance Actions
As stated above, the UVTA Commission was concerned about the misapplication of the act caused by the word “fraud”. The focus on “fraud” was primarily by courts applying the test under subsection 4(a)(1). Under subsection 4(a)(1), to determine if a transfer or obligation is avoidable, a court must determine whether the transfer or obligation was made with “actual intent to hinder, delay, or defraud a creditor.” UVTA §4(a)(1) (2014). Oftentimes the focus devolved to whether there was an “actual intent” to “defraud”. See General Electric Corp. v. Chuly Int’., LLC, 1, 4 (Fla. App. 2013), (“Because the determination of actual fraudulent intent can be difficult, courts look to certain ‘badges of fraud’ to determine whether the transfer was made with the intent to defraud creditors.”) (emphasis added). As noted, courts continue to confuse fraudulent transfer with common law fraud. The Commission sought to clarify how subsection 4(a)(1) should be applied, by the addition of a comment to section 4.
In the comment, the Commission emphasizes that the phrase “hinder, delay, or defraud” is a term of art. UVTA §4, cmt. 8 (2014). It should be applied as a whole, and not parsed out, nor should the focus solely be on “defraud.” The inquiry is not to be left to the subjective intent of the debtor. See In re Sentinel Management Group Inc., 728 F3d. 660 (7th Cir. 2013). Instead, whether a debtor is found to actually “hinder, delay, or defraud” a creditor depends upon whether “the transaction unacceptably contravenes norms of creditor’s rights”. UVTA §4, cmt. 8 (2014). Such norms are to be analyzed in light of “the devices legislators and courts have allowed debtors that may interfere with those rights.” Id.
This comment has the potential to properly recast the analysis courts conduct when weighing the so-called “badges of fraud” of subsection 4(b). The Comment appears to propose a test for determining whether there has been an attempt to “hinder, delay, or defraud”. The proposed test is whether the conduct “contravenes norms of creditor’s rights”, broadening the test which had devolved, in some cases, to whether the conduct was to defraud. UVTA §4, cmt. 8 (2014). In addition, emphasis on debtor conduct should minimize focus on the malicious intent of the debtor. The comment also cautions against avoiding transfers of legal means, such as transfers to a self-settled spendthrift trust which is permissible in some states. Such transfers should not be avoided in all cases because statutory authorization supplants what would otherwise almost always be an avoidable transfer.
Choice of Law
The driving force behind the revision of the UFTA appears to be the inclusion of a choice of law rule, which has the potential to eliminate much of the litigation in an avoidance action. The new choice of law rule is embodied in section 10 of the UVTA. The rule is similar to that of the UCC. See UVTA §10. Cmt 1 (2014). UVTA section 10 utilizes the debtor’s location to determine the local law that governs the avoidance action. UVTA §19)b) (2014). The test is the debtor’s location at the time of the transfer or incurrence of the obligation. Id. The debtor’s location is defined as:
- The debtor’s principal residence if the debtor is an individual
- The debtor’s place of business if the debtor is an organization and has one place of business, or
- The debtor’s chief executive office if the debtor is an organization and has more than one place of business. UVTA 10(b) (2014).
The rule is simple, clear and easily applicable. The choice of law can have profound consequences. For instance, even among states that enacted the UFTA there are variations in the statute of limitations period, the treatment of an insider transfer, and the treatment of foreclosure sales and other involuntary transfers, among others. The choice of law rule does not alter these changes, and some are likely to persist. Instead, it affords creditors predictability as to which law will govern an avoidance action.
The significance of the rule is magnified when analyzing an example of a possible avoidable transfer. Absent a choice of law rule, it is difficult to determine which law will apply in the following scenario. A creditor located in California extends credit to a debtor individual residing in Florida. The debtor in Florida later transfers an asset located in Georgia to a charity transferee in Alabama with the intent to hinder, delay, or defraud the creditor. If the creditor were to try and avoid this transfer there would certainly be an argument over the applicable law.
If the court hearing this action determines that Florida law is applicable, the transferee may have a defense that the transfer is exempt from avoidance because Florida has a provision in its version of the UFTA which exempts some contributions to charity from avoidance. Fla. Stat. 726.109(7) (2013). The other three states California, Georgia, and Alabama do not have this exception. Assuming that the charity exception in Florida applies, the creditor would have a strong interest in trying to invoke the laws of one of the other jurisdictions with a connection to the transfer.
Under this scenario, a jurisdictions operating under the First Restatement of Conflict of Laws would apply the “situs” rule. The “situs” rule provides that the governing law is the law of the state where the asset was located, when it was transferred. This rule is rarely followed, and now most courts apply the Second Restatement to an avoidance of a transfer. The Second Restatement approach for Torts is to analyze the conflicting interests of the jurisdictions. The Second Restatement takes into account four different forms of contact, and seven different factors. The existence alone of a total of 11 variables (none of which is afforded any particular weight), determine which jurisdiction has the most interest in having its law be determinative in the dispute. Second Restatement, Conflict of Laws §145. This, by its very nature, is unpredictable and invariably leads to disparate results in different jurisdictions (or the same jurisdiction). Therefore, under the Second Restatement it is not possible to know which State’s law would be applied. If section 10 of the UVTA is applied, the answer is clear. The applicable law is Florida law.
The UVTA improves on both the Second Restatement and the First Restatement in two respects. First, it creates clarity for the creditor. The Second Restatement creates uncertainty for the creditor because it cannot be known before litigation which law will apply. This makes it more difficult for the creditor to gage the risk when extending credit. Second, section 10 of the UVTA does not appear to be as subject to abuse or manipulation (as is the “situs” rule of the First Restatement). An asset, particularly an intangible asset, or chattel, could be moved prior to the transfer to take advantage of more favorable fraudulent transfer law. Section 10 does a better job of preventing abuse by using more certain locations which are more difficult to manipulate.
Section 10 of the UVTA is not, however, immune to abuse. For example, an organization with multiple places of business could potentially manipulate the location of its chief executive office, or a business or resident could move prior to making the transfer. However, courts are able to look beyond the nominal place of residence, or chief executive office, and determine the true location based on activities of the debtor. UVTA §10, cmt. 3 (2014). The Commission states that a court should not fall suspect for an artificial location which has been achieved by manipulation. Instead the courts should look to “authentic and sustained activity”. Id.
Section 10 has the ability to diffuse disputes over the choice of law and give more certainty to creditors when extending credit. Note that it will, however, not alter the uncertainty of the choice of law in a Bankruptcy proceeding. In determining applicable state law, Bankruptcy Courts often take one of three approaches: (i) apply the choice of law created by federal common law, (ii) apply a uniform choice of law rule of the state in which they site, or (iii) apply the choice of law rule of the state in which they sit unless a federal interest requires the use of the federal choice of law rule. Section 10 cannot remedy this, as it is only applicable to state law (where adopted).
Other Changes Adopted in the UVTA
8(e)(2) Removing Strict Foreclosures from The Exemption for Article 9 Security Interests
There were a few other minor changes to the UVTA. The first one, of some significance, is the alteration of subsection 8(e)(2) which exempts transfers from avoidance, if the transfer is made pursuant to the enforcement of a security interest made in compliance with UCC Article 9. The Commission added a new clause to subsection 8(e)(2). The new clause excludes from such exemption transfers made pursuant to an Article 9 security interest when the creditor accepts collateral for partial or full satisfaction of the obligation it secures. UVTA §8(e)(2). This means that §8(e)(2) no longer gives an exemption to strict foreclosures of Article 9 security interests. The significance is that creditors with an Article 9 security interest can no longer foreclose on the property and retain it, without risking the transfer being avoided. The creditor can, however, still conduct a foreclosure sale under Article 9 and be immunized from the transfer being avoided.
Under UFTA subsection 8(e)(2), there was no protection afforded other creditors from a creditor with an Article 9 security interest that foreclosed on an asset with built-in equity, and retained the asset. Remaining equity in the asset would have otherwise been available to settle other debts. Now, a creditor with an Article 9 security interest that forecloses may retain the asset, but be left subject to avoidance, or they must conduct a sale of the asset in a “good faith” and “commercially reasonable manner.” See UCC Art. 9 (2014). Both of these scenarios should protect the equity in the asset for other creditors.
Deletion of a the Separate Definition of Insolvency for a Partnership
Subsection 2(c) of the UFTA provides a separate definition for partnership insolvency. Insolvency of a partnership under this subsection is measured by determining if the sum of all of the partnership’s debts is greater than the aggregate of the partnership’s assets and the value of the general partners’ non-partnership assets to the extent they exceed the partners’ non-partnership debt. The Commission deleted UFTA subsection 2(c) to treat partnerships the same as other debtors. The deletion of this provision now treats partnerships the same as other debtors.
This deletion is significant because, when determining partnership insolvency, partnerships may not take into account assets to which the partnership may not have access. Modern business entity statutes permit partnerships to be formed where a (limited) general partner is not personally liable for all or even part of the partnership debts. Assets of general partners not liable for all partnership debts should not count in the solvency determination of the partnership (to prevent insolvency and avoidance of a transfer by the partnership).
The Commission found no reason to retain a rule that effectively gave special treatment to partnerships. See UVTA Prefatory Note (2014). The Commission viewed the liability of a general partner similar to that of a guarantor of a non-partnership debtor because both debts are guaranteed by contract. As a result, there did not seem to be any reason to define insolvency differently for a partnership debtor from that of a non-partnership debtor.
The UVTA adds a new section, section 11, which extends the application of fraudulent transfer law to series organizations and the series that comprise them. UVTA §11 (2014). The new section goes to great length to define a series organization, and a protected series. It defines a protected series as an arrangement by a series organization that has the same characteristics as a series organization. UVTA §11(a) (2014). A series organization is an organization that has the following characteristics:
- An organic record of the organization which provides for the creation of one or more protected series with respect to specified property of the organization, and provides for records to be maintained for each protected series., the records of which identify the property of or associated with the protected series.
- The debt incurred or existing with respect to the activities or property of a particular protected series is enforceable against only the property of or associated with the protected series, and not against other property of or associated with the organization or other protected series of the organization.
- The debt incurred or existing with respect to the activities or property of the organization is only enforceable against the property of the organization and not against the property of or associated with a protected series of the organization.
The act treats each series organization, and each protected series of the organization, as a separate person, regardless of whether they would be treated as separate persons under other areas of the law. UVTA §11(b) (2014). The act extends to series organizations and protected series, “however denominated”, if they meet the characteristics set forth in the UVTA. Id.
This addition (segregating valuable assets between series, to potentially void such transfers and restrict avoidance of insolvency) may become quite significant, if adopted in states where series organizations (or Series LLCs) are permitted by statute. However, the UVTA arguably treats series as they would have been treated under the UFTA, since each series is ordinarily treated as a separate entity by statute. Nevertheless, the revisions ensure that transfers between series, or a series and the organization can be avoided.
Modernizing the UFTA
There are a few other changes made to UFTA which are of note, but likely have no practical significance. The first is the change in the title. The Commission approved the change of “transfer” to “transaction”. UVTA §14 (2014). The Commission made the change to make the title more inclusive. UVTA § 14, cmt. 1 (2014). “Transfer” ignored obligations which are also covered by avoidance law. Id. Second, the Commission took steps to modernize the UFTA, by adopting the terms “electronic” and “record” in place of writing. UVTA §1 (2014). These changes create medium neutrality by incorporating almost any mode of communication which more accurately reflects the manner in which business is conducted today. Third, the definition of “organization” was changed to conform to the UCCs definition; it is now separate from the definition of a person. See UVTA, §1 cmt. 10 (2014). An organization is now any person other than an individual. UVTA §1(10) (2014). The definition of “person” has been changed to remove the word “organization,” but is fundamentally the same. UVTA §1(11) (2014).
UVTA made several improvements to the UFTA. Some of the changes are more significant than others. The inclusion of a choice of law rule at section 10 will limit litigation and likely create a more stable lending environment. The removal of the exclusion from avoidance for Article 9 strict foreclosures also provides needed clarity. The clarification of burdens of proof and evidentiary standards will reduce the improper imposition of common-law fraud standards in avoidance actions. The change of “fraudulent” to “voidable” will also reduce confusion among the courts when applying the UFTA/UVTA. The other minor changes to the language of the UFTA modernize the Act and bring it in line with other uniform laws and the Bankruptcy Code. Overall, the changes are a positive step.