This article was originally published in the Texas Bank Lawyer in 2015.
I. A NEW PROPOSED UNIFORM LAW
The National Conference of Commissioners on Uniform State Laws (NCCUSL) recently drafted and approved the Uniform Voidable Transactions Act (UVTA), the replacement of the Uniform Fraudulent Transfer Act (UFTA). Other than amending the current sections of the UFTA, the proposed Act contains two completely new sections: section 10 and section 11. The purpose of the new sections is to clarify the choice of law and series LLCs in fraudulent transfers in preparation of a bankruptcy or protection of assets.
The Texas Legislature will likely consider the new proposal in the next session in 2017 in order to keep up with the other states that have proposed and enacted the law. Maintaining Texas’s status of a “debtor-state” is important for both predictability and economic reasons; diverging too much from Texas’s jurisprudence will do more harm than good. The new proposal will mainly codify what many courts have already established regarding series LLCs. However, the adoption of case law as statute will reduce litigation in certain areas. Although the amendments create, delete, or change more than four aspects of the UFTA, the article will focus on choice of law, series LLCs, burden of proof, and defenses.
First, the article will discuss the language and reason for creating the new sections and amendments. Second, Texas’s history of being a “debtor-state” will be expounded. Next, the article will discuss the economics of asset protection and bankruptcy. Finally, the new sections and amendments will be evaluated on five criteria: whether (1) the Act clarifies ambiguity; (2) the Act causes no significant divergence from case law; (3) the Act is fair to both the debtor and creditor; (4) the Act is in the spirit and tradition of Texas’s status as a “debtor-state”; and (5) the Act makes economic sense.
A. Choice of Law
The UVTA’s first additional section deals with choice of law. The new portion states:
(a) In this section, the following rules determine a debtor’s location:
(1) A debtor who is an individual is located at the individual’s principal residence.
(2) A debtor that is an organization and has only one place of business is located at its place of business.
(3) A debtor that is an organization and has more than one place of business is located at its chief executive office.
(b) A claim in the nature of a claim under this [Act] is governed by the local law of the jurisdiction in which the debtor is located when the transfer is made or the obligation is incurred.
The UVTA’s comments illuminate the purpose of the additions.
[The new section] is a simple and predictable choice of law rule for claims of the nature governed by the Act. It provides that a claim in the nature of a claim under the Act is governed by the local law of the jurisdiction in which the debtor is “located” at the time the challenged transfer is made or the challenged obligation is incurred. “Local law” means the substantive law of the referenced jurisdiction, and not its choice of law rules.
Section 6 determines where the transfer takes place, and the NCCUSL intended the amendment to function like U.C.C. § 9-307 (2014), which is usually the domicile of the debtor. The debtor’s location must be a place of “authentic and sustained activity,” to prevent the debtor from creating false or short-term principal locations as a workaround the law by preventing the debtors moving from a creditor-friendly state to a debtor-friendly state.
B. Series LLCs
Series LLCs are new, and the proposed Act attempts to remedy the uncertainty new entities create. Section 11 states the following:
(a) In this section:
(1) “Protected series” means an arrangement, however denominated, by a series organization that, pursuant to the law under which the series organization is organized, has the characteristics set forth in paragraph (2).
(2) “Series organization” means an organization that, pursuant to the law under which it is organized, has the following characteristics:
(i) The organic record of the organization provides for creation by the organization of one or more protected series, however denominated, with respect to specified property of the organization and for records to be maintained for each protected series that identify the property of or associated with the protected series.
(ii) Debt incurred or existing with respect to the activities of, or property of or associated with, a particular protected series is enforceable against the property of or associated with the protected series only, and not against the property of or associated with the protected series of the organization.
(iii) Debt incurred or existing with respect to the activities or property of the organization is enforceable against the property of the organization only, and not against the property of or associated with a protected series of the organization.
(b) A series organization and each protected series of the organization is a separate person for purposes of this [Act], even if for other purposes a protected series is not a person separate from the organization or other protected series of the organization.
The section is written in anticipation of another Uniform Act concerning series LLC. For many states, the section will not apply; however, Texas has series LLC statutes, thus, this section applies.
C. Allocation of Burden of Proof
A major problem with bankruptcy or asset protection issues is that many debtors disappear. With the debtor missing, creditors and third-parties are left to figure out what happened. The UVTA attempts to remedy such events by allocating the burden in a fair way. The NCCUSL added the following: “A creditor making a claim under subsection (a) has the burden of proving the elements of the claim by preponderance of the evidence.” Many courts imposed the incorrect burden upon the creditor or third-party. Apparently, many courts confused the different meanings of “fraud” and “fraudulent.” The correct burden is “preponderance of the evidence.” Thus, the UVTA clarifies that fraudulent transfers are not “fraud” in the misrepresentation sense. Now, the new amendment will state the burden of proof clearly, instead of relying on similar terms and misapplied cases. The UVTA has the new language in several locations to ensure proper application for the burden of proof. The new change requires the transferee to show that the debtor was solvent at the time of transfer by preponderance of the evidence. In addition, the UVTA also states that the creditor must prove the elements of the fraudulent transfer under the preponderance of the evidence.
The UVTA does little to address the inconsistency of how courts evaluate the current factors:
(1) The transfer or obligation was to an insider; (2) the debtor retained possession or control of the property transferred after the transfer; (3) The transfer or obligation was disclosed or concealed; (4) before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit; (5) The transfer was of substantially all the debtor’s assets; (6) the debtor absconded; (7) the debtor removed or concealed assets; (8) the value of the consideration received by the debtor was the equivalent value to the value of the assets transferred or the amount of obligation incurred; (9) the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation incurred; (10) the transfer occurred shortly before or shortly after a substantial debt was incurred; and (11) the debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.
However, the official comments refer to certain cases as to what the desired outcome would be, and does attempt to address the final factor. The problem is an old one, but the NCCUSL attempts to change the wording in hopes of adding more clarity and preventing injury to unsecured creditors.
D. Defense
The UVTA adds a new requirement to the defense in order to prevail. “A transfer or obligation is not voidable under Section 4(a)(1) against a person that took in good faith and for a reasonably equivalent value given the debtor or against subsequent transferee or oblige.” The addition states that the value must actually be given to the debtor, rather than to someone else. By creating an additional hurdle to the defense, the NCCUSL hopes to have a different outcome than In re Chapman Lumber.
In the case of In re Chapman Lumber, the plaintiff, Quad City Bank, sued the defendant, Rebeka Berstler. The defendant performed hair removal services on Chapman, the president of Chapman Lumber Co., the debtor. Chapman paid the defendant with company checks, which the defendant stated was usual among customers that owned their own businesses. The debtor, the company, received no benefit from the transaction between the defendant and its president. However, the court could not find enough evidence to show that the defendant knew the debtor company had paid for Chapman, or that the transaction was unacceptable; therefore, the court found the defendant accepted the money in good faith even though the defendant had given equivalent value to the debtor’s president, and not to the debtor itself.
In addition, the UVTA does away with “strict foreclosure,” even though permitted under article 9 of the UCC. The amendment means that acceptance of collateral in full or partial satisfaction is now excluded from the defense, eliminating safe harbors. The amendment follows what California and Pennsylvania have already done.
II. TEXAS’S DEBTOR-STATE STATUS
A. Texas’s Asset Protection Law History
Texas is well known for its status as a debtor state. The primary reason for being debtor-friendly is the history of settlement. When Texas needed to be settled in its early years, the government enticed entrepreneurs by giving them favorable treatment in the event of a bankruptcy. In addition, Spanish influence also caused laws to be debtor friendly due to community property laws, otherwise widows would be left looted.
Texas has considered protection of debtors so important that it placed asset protection provisions in the constitution. The constitution lays out generous protections for the homestead, forced sales, mortgages, trust deeds, and liens. Other parts of the constitution even prevent garnishment of wages.
B. Economics of Asset Protection and Bankruptcy
Dr. Ben Powell, director of the Free Market Institute and professor at Rawls College of Business at Texas Tech University, states the best asset protection and bankruptcy laws are ones that are predictable and quickly frees-up assets. Therefore, the clearer the legislature writes the law and the court releases the assets for use, the better the economy. Some have argued that Texas’s predictable pro-debtor laws have created great economic benefits. Because of the generous protections, banks are cautious in lending, which allows them to weather major economic problems, such as the Great Recession. Also, the protections have allowed entrepreneurs to go through multiple bankruptcies, leaving much of their assets intact, until they start a successful business. The successful business usually more than makes up for the harm caused by the bankruptcy; therefore, the economy as a whole is better off.
Another economic aspect to consider is value. A critical part of evaluating whether a court should set aside the transfer for the benefit of the creditor is the value of the asset. Professor Ludwig von Mises wrote extensively about how an asset is valued:
It is customary to say that acting man has a scale of wants or values in his mind when he arranges his actions. On the basis of such a scale he satisfies what is of higher value, i.e., his more urgent wants [such as converting illiquid assets to liquid cash], and leaves unsatisfied what is of lower value, i.e., what is a less urgent want [such as the opportunities of holding illiquid assets]. . . However, one must not forget that the scale of values or wants manifests itself only in the reality of action. These scales have no independent existence apart from the actual behavior of individuals. The only source from which our knowledge concerning these scales is derived is the observation of a man’s actions. Every action is always in perfect agreement with the scale of values or wants because these scales are nothing but an instrument for the interpretation of man’s acting.
Ethical doctrines are intent upon establishing scales for value according to which man should act but does not necessarily always act. They claim for themselves the vocation of telling right from wrong and of advising man concerning what he should aim at as the supreme good. They are normative disciplines aiming at the cognition of what ought to be. They are not neutral with regard to facts; they judge them from the point of view of freely adopted standards.
This is not the attitude of praxeology and economics. They are fully aware of the fact that the ultimate ends of human action are not open to examination from any absolute standard. Ultimate ends are ultimately given, they are purely subjective, they differ with various people and with the same people at various moments in their lives. . . .
. . . .
Value is not intrinsic, it is not in things. It is with us; it is the way in which man reacts to the conditions of his environment.
Neither is value in words and in doctrines. It is reflected in human conduct. It is not what a man or groups of men say about value that counts, but how they act.
The value of the consideration is simply the invention of the parties, made up to meet their goals. The court simply comes up with what an unrelated person, a witness, who is not a member of the market participated in by the debtor and purchaser, would pay for the asset. This means the court makes up a value and compares that value with the made-up value of the debtor and purchaser.
The question of equivalent value obviously creates a problem when trying to find constructive fraud, but it is necessary as a factor of intent. An additional problem, however, is that the analysis may be based on a faulty premise.
An inveterate fallacy asserted that things and services exchanged are of equal value. Value was considered as objective, as an intrinsic quality inherent in things and not merely as the expression of various people’s eagerness to acquire them. People, it was assumed, first established the magnitude of value proper to goods and services by an act of measurement and then proceeded to barter them against quantities of goods and services of the same amount of value . . . . People buy and sell only because they appraise the things given up less than those received. Thus the notion of a measurement of value is vain. An act of exchange is neither preceded nor accompanied by any process which could be called a measuring of value. An individual may attach the same value to two things; but then no exchange can result. But if there is a diversity in valuation, all that can be asserted with regard to it is that one a is valued higher, that it is preferred to one b. Values and valuations are intensive quantities and not extensive quantities . . . .
A hypothetical of two transactions concerning the same asset can demonstrate how people value assets. Suppose the asset in question is a jet. A farmer, who has no real need or even desire to own a jet, enters into a contract to purchase the jet. However, the farmer does not look to the asset itself to determine its value, but rather the opportunities the farmer gives up, and the opportunities gained. The farmer would see the jet as little use in farming operations. Therefore, the farmer would pay very little for the jet because the farmer has limited opportunities to use the jet in a profitable manner. The seller’s opportunities would be different and incomparable to the farmer’s. Depending on the seller’s opportunities, the seller may settle at a value that is detrimental to profit because the seller views opportunities for the transaction differently than the farmer. However, no one can successfully compare the opportunities of the two parties because they are significantly different. On the other hand, an airline company would have enormous opportunities with a jet because it is in the business of jet flights. The airline company may be willing to pay a premium for the jet because of major opportunities that are profitable. This price, however, may be above what the seller expected to receive because the seller did not seek the same opportunities as the airlines, as the two entities are in two different lines of business. The measurement of the asset is different in both transactions for all the parties involved. None of the parties viewed the exchange as the same amount of value since value is purely subjective.
As Professor Mises points out, no one can look at value or consideration objectively, since the invention of it is purely subjective. The law and courts have evaluated equivalent value based on an objective test, which in turn is based on evidence formulated by witnesses who are not subjectively invested in the transaction, imposing a post hoc judgment, with additional knowledge not possessed by the debtor, and perhaps not by the third-party purchaser. Courts should have a better guide for determining the subjective intent, while using the value from a subjective view as evidence to determine the adequacy of the value exchanged. The analysis proposed in the new Act would not fall in a category of fairness and reality of the market place.
III. THE UVTA—AN ANALYSIS
A. The Five Factors of Evaluation
This article evaluates the new Act on five factors: (1) the Act clarifies ambiguity; (2) the Act causes no significant divergence from case law; (3) the Act is fair to both the debtor and creditor; (4) the Act is in the spirit and tradition of Texas’s status as a “debtor-state”; and (5) the Act makes economic sense.
An important aspect of the law is clarity. Clarity allows for rapid litigation, reduced litigation, and sound expectations. Governments, and their citizens, have long strove for this goal, and any good law should uphold clear policy.
Courts have long followed the doctrine of stare decisis in deciding cases to prevent turbulent legal regimes. The doctrine is good for a variety of reasons, including sound expectations, reduced confusion, and stable economy. Although legislatures usually do not follow such a doctrine, nor should they in many cases, when companies and corporations have created an entire market—lending—based on a presumptive legal regime, the legislature should not create laws that diverge significantly from the previous law to prevent shocking the system.
The UVTA should have an equitable solution; the Act should not be a device to punish the debtor and reward the creditor. Equitable solutions should be fair to both the debtor and creditor, meeting the intentions and expectations of both parties to the best of the law’s ability.
The legislature should maintain Texas’s long and rich history of being debtor-friendly. The state’s policy has contributed to the economy being ranked fourteenth in the world.
Since Texas has one of the world’s largest economies, it should try its best to remain so by having a law that makes economic sense. Creditors create an enormous portion of the economy; creditors include both professional lenders and private businesses that sell on credit. On the other hand, debtors are businesses and entrepreneurs, who are essential to a healthy economy. Therefore, the law should consider their needs to function and prosper.
B. Evaluating Choice of Law
1. Clarifying Ambiguity
Principles of common law and statutes have laid out the choice of law. Many times the choice of law is one of the hardest questions to answer in a case. In fact, some commentators have called the current status of voidable transfers as “chaotic.” Since not all states have adopted the new versions of voidable transactions laws, the outcomes can be significantly different. Adopting the UVTA will allow courts to figure out which law to apply.
2. Divergence from Case Law
The courts over the years have not been consistent. Many courts stated that the situs or location of the property should dictate the choice of law. However, later, although still based on the location of the property, courts would at times use the laws of its own jurisdiction, even though the location of the property may be foreign. The hope is to create equitable and just outcomes, despite the confusion as to what the court would ultimately rule. Since the courts have been inconsistent, the divergence will be insignificant, as the Act finally sides with the domicile of the debtor.
3. Fairness
Many parties do not think to add a choice of law clause in the agreement. Various jurisdictions have interpreted the uniform language differently, allowing some debtors to migrate to different jurisdictions until they find a preferable interpretation of the law. When the creditor believes the laws that govern is of State A, when in reality, the law of State B apply because of a loophole the debtor found, the creditor may be hurt. Although the creditor should not be protected because of a lack of due diligence, the creditor should not be hurt because of the loopholes the debtor found.
An entity that extends credit to a debtor should be able to assess the extent to which future dispositions by the debtor of its assets may increase its credit risk; a transferee who receives a transfer of property from a debtor should be able to assess the extent to which he may be at risk of having the transaction avoided at the behest of a disgruntled creditor of the debtor.
However, the UVTA will treat the debtor fairly as well by ensuring the debtor knows which law applies in planning a transaction, and not subject the courts to a guessing-game of applicable law. In addition, the debtor would not hoodwink the creditor by travelling to favorable jurisdictions at the drop of a hat, since the amendment requires the court to apply the law of the debtor’s domicile or principal place of business.
4. Debtor State
The amendments establish that the choice of law is the jurisdiction in which the business is located or the debtor is domiciled. Therefore, the law will simply be Texas’s pro-debtor laws, assuming the debtor is in Texas. Obviously, this would maintain the debtor-status of the state, and may even promote the status.
5. Economic Sense
If the legislature has clear indications as to what rule of law will govern a particular transaction, the better informed the litigants will be. The parties involved or affected by the transaction may plan their loans and business based on those particular laws. Adding such clarity will allow the economic laws to take over and increase reasonable risk-taking and wealth production.
6. Conclusion
The Act’s amendment does not diverge from case law, or favor the debtor or creditor. The Texas legislature should adopt the choice of law amendments. “The provisions are clear and workable in litigation.” Due to their clarity, debtors can better plan in their debtor-friendly state.
C. Evaluating Series LCCs Provision
1. Clarifying Ambiguity
The ambiguity that exists arises from the fact that series LLCs are a new breed of business entities. Therefore, ambiguity primarily comes from the unknown. “The biggest problem with series LLC is that they are fraught with question marks.” Considering each series LLC as a “person” is the logical position to take. However, creditors are likely to be harmed, though not because of the UVTA’s position. Creditors are likely to be harmed because of the series LLCs statutory structure of the over-protection of each series. Even though one common goal connects all the series LLCs, the law considers each independent. Therefore, unintended creditors, such as those injured and winners of a tort claim, cannot collect from the overall business, but only from that particular series. The UVTA makes no mention of an equitable solution to the problem. The new Act simply clarifies what many already believed: each series LLC is a separate and independent “person.” This answer will prevent future questions the court will have to answer.
2. Divergence from Case Law
Currently, little or no case law exists with the question of series LLCs and their relation to voidable transactions. This is because series LLCs are a very new form of business entities, and the problem has not arisen much. Therefore, the amendment will cause no divergence since no body exists to diverge from.
3. Fairness
One instance where the law may unfairly disadvantage a creditor is in the case of an unsecured creditor whose claim arose involuntarily. For example, if a plaintiff had been seriously injured by an employee of a company, the plaintiff would expect to have various medical bills paid off by a lawsuit judgment would be an unsecured creditor in a bankruptcy; thus, these plaintiffs would not have priority over secured creditors, which would likely be professional banks. However, series LLCs have a potential to upset the intentions of the order of the priority claims. Series LLCs will likely lead to a de facto elimination of unsecured creditor collections. The amendment, by treating each series as an individual, will not increase the likelihood of recovering assets for the creditor. However, this unfair preference to the debtor is not the fault of the UVTA, but of the series LLC statutes. Therefore, the proposed Act cannot be assessed for fairness, since it merely points out that series LLCs exist, codified in a different set of laws.
4. Debtor State
The amendment likely remains in favor of debtors, while assisting creditors. Since series LLC statutes create liability protection for owners, and even protecting subparts of owners, debtor-state status will remain intact. In fact, due to the broad protections of the series LLCs, the Act may extend the debtor-state status.
5. Economic Sense
Series LLCs are important to industries that are risky, such as insurance and reinsurance arrangements. Treating them as individuals is essentially the purpose of their existence. In order for entrepreneurs take that risk willfully, the law needs to give a level of consistent protection, even in the event of bankruptcy. Since each series operates as separate entities and separate ownership in the real world, the economic consequence is that each series is a separate person in business interactions.
6. Conclusion
The Texas legislature should adopt this section to prevent future confusion. Since Texas has series LLC provisions, the legislature should take proactive measures for the benefit of the courts and the future litigants. Although the fairness factor is in serious question, the economic benefits of entrepreneurship may outweigh the costs.
D. Evaluating the Allocation of Burden of Proof
1. Clarifying Ambiguity
The amendments absolutely clarify some ambiguity by explicitly stating that the burden of proof is preponderance of the evidence, rather than clear and convincing evidence. Since some of the courts have struggled understanding which standard applies by confusing fraud with fraudulent transfers, the amendment will be a welcomed guide for confused lawyers and judges.
In addition, the name, being changed from “fraudulent” to “voidable,” will likely help clarify that “fraudulent transfers” are not “misrepresentations.” An example of possible confusion is demonstrated in cases like Nwokedi v. United Restoration Specialists, Inc. In this case, not only did the defendants commit actual fraud, they also engaged in a fraudulent transfer. Confusion can arise since the case uses the term “fraud” interchangeably to describe two different acts despite the fact the definition of the term is different.
2. Divergence from Case Law
The NCCUSL originally intended the UFTA to have a preponderance of the evidence standard. However, since a small number of cases have accidentally used the wrong standard, the amendment does not change the case law any, if at all. The UVTA will only improve the case law since previously there was accidental divergence with a few courts. Therefore, the amendments do not diverge from the intended reality.
3. Fairness
The UVTA initially creates a presumption in favor of the creditor. The presumption is a fair one because the creditor is the party least likely to know the circumstances of the transaction. On the other hand, the debtor, or third-party, has more access to evidence that indicates the transaction is not voidable. In addition, the creditor’s favorable presumption allows the court to carry on with a lawsuit if the debtor is uncooperative or inclined to lie. “[The fact that] debtors often tell outrageous lies, destroy key evidence, and disappear to parts unknown is simply a reality of debt collection. . . . Thus, presumptions and burdens of proof often become very important in fraudulent transfer cases.” Presuming the debtor is insolvent when the debtor fails to pay the debt when due is a logical and fair assumption, and the debtor can easily rebut this presumption by claiming lack of notice or mistake. However, since this presumption can change, the creditor may have to present evidence to shift the burden back on the debtor. In addition, the new language means the burden adds that the debtors or creditors must show that the debtors were more likely solvent than insolvent, depending on whether the burden has shifted. The UVTA balances the burden by requiring the plaintiff to prove the elements of the claim while the defendant must prove the defense.
4. Debtor State
Burdens of proof can affect the debtor-state status; however, the preponderance of the evidence standard does not significantly change the debtor-state status since the UVTA is unlikely change the substantive rights of either party to the lawsuit. Rather, the UVTA will cause the debtor or creditor to admit evidence that the debtor was solvent or insolvent, which means the substantive law, though perhaps not procedurally, will remain in the debtors favor. The preferential debtor treatment can be shown by the fact the UVTA requires to creditor to prove the elements of the claim.
5. Economic Sense
As Professor Powell mentions, the faster the court and litigants know the procedures—thus, a quicker trial—the better the overall economy works. The amendments’ clarity will allow the court proceedings to move quicker, reducing the amount of time the court freezes the use of the assets at issue. The UVTA will allow the assets to pass for a more beneficial use.
6. Conclusion
The burden of proof section of the UVTA provides great guidance for Texas courts, lawyers, and litigants. The Act clarifies the appropriate standard used in proving a voidable transaction, rather than fraud, causing confusion for many lawyers and judges, and anyone researching the subject. Therefore, the legislature should adopt the new amendment, word-for-word.
E. Evaluating the Defense
1. Clarifying Ambiguity
As demonstrated in In re Chapman Lumber, some ambiguity can exist. By clearly identifying to whom the value must be given, the defense becomes much clearer, especially in bizarre fact patterns. Now, the courts will unmistakably know which entity must be involved in the transaction.
2. Divergence from Case Law
The hope is that the amendment will parallel the Bankruptcy Code. This will likely cause significant divergence from case law, as previously the law allowed for strict foreclosures as a defense. However, with the new amendment, the defense is not allowed. Between the absence of the strict foreclosure clause and the “given to the debtor” language, some divergence from case law is likely.
3. Fairness
The current UFTA does not allocate culpability among the parties, but operates against the assumption of innocence. Now the proposed Act adds that value must be given to the debtor. As described above, this will change the outcome of In re Chapman Lumber. The amendments will likely injure innocent third-parties, who are unaware of the financial troubles of the debtor, or believes someone is the debtor, as in the case of In re Chapman Lumber. The UVTA amendments cause an unbalanced preference in favor of the creditor, allows the debtor to pass on liability to a third-party, and the third-party has to pay for the sins of the debtor. The creditor has the luxury of placing contractual limits on the use of assets; thus, creditors can protect themselves by preventing the debtor for making certain transactions once the debtor surpasses the threshold, but the third-party, who is likely a less sophisticated business dealer, cannot foresee the implications of a simple transaction. Therefore, the legislature should not adopt the “to the debtor” language.
In some cases, the current rule seems to be effective and works in a way that creates a fair solution. Altus Brands II, LLC v. Alexander, a Texas case, demonstrates the analysis of fraudulent transfers and equivalent value. Two defendants had significant holdings in a corporation that had an outstanding note. The corporation was insolvent and could not pay the note. The defendants transferred the property to themselves with no consideration. The trial court found that the defendants did not intend to devalue the stock of the corporation, but merely that the transfer was performed without equivalent value. This appears to be a fair solution because the parties received absolutely nothing in return. However, neither the new law, nor the current law, states “no value”; rather, the problem remains with the word “equivalent.”
4. Debtor State
The defenses currently employed in Texas, and the proposed UVTA, do real damage to the asset protection and bankruptcy regime that has greatly enhanced the state’s economic power because it greatly favors creditors. The defenses greatly favor the creditors, restricting the use of the assets. Texas should serious reconsider the UFTA’s and UVTA’s consequences on innocent parties.
5. Economic Sense
The “reasonably equivalent value” requirement already causes much litigation, and it is not economically reasonable. The many problems that face the courts come from two sources: the debtor is trying to hinder or delay the creditor, or no ready market exists for the debtor’s assets. The judge is generally not a qualified economist, much less has all the relevant information to make those economic evaluations. Instead, many judges tend to focus on the harm to the creditor, which is unfair to an innocent debtor and possibly creates more litigation.
In addition, many people are unaware that the two combined elements in the formula prescribed by statute, voluntary conveyance and inadequate value, come from different origins. Initially, fraudulent conveyance focused “on the voluntariness of the transfer, rather than the debtor’s intent.” The value aspect was whether the estate has been significantly and unfairly diminished. This provides evidence of intent and bad faith. Again, the Act uses these legal formulas to focus on the harm caused to creditors, rather than the true intent of the debtor and third-party. In fact in earlier times, for constructive fraud, inadequate value was not a basis for a creditor’s remedy; courts used inadequate value only in cases of actual fraud, or at most a non-dispositive factor to find actual fraud.
Initially, the law considered a transfer for inadequate value a “moral wrong” that the courts should “right.” However, sometimes the premise of inadequate value is wrong. The parties may simply be ignorant to the true value, or the conditions of a particular market. In addition, the third-party purchasing the asset may know that the debtor is nearing insolvency and desperate; therefore, the purchaser drives a hard bargain that the debtor must take. Surely no law or society would consider such reasons for inadequate value morally wrong, especially since the debtor’s actions were for the purpose of actually paying back the creditor. If the law should punish those who are ignorant of the true value of an asset or forced into hard bargains, then “most of us are in trouble.”
While the UVTA attempts to remedy the ills befallen the victim, the creditor, the Act should also consider another victim, who may be the most innocent: the third-party purchaser. Blindsiding third-party purchasers because they managed to get a great deal makes no economic sense. What makes better sense is for creditors to place restrictions or covenants in their lending and credit agreements, obtain security, or increase the interest to account for the risk. Raising the interest rate not only provides protection, though limited, for the creditor, it also relieves any innocent third-party purchaser caught in the crossfire. A proper solution for those creditors that do not charge interest for their claims, such as employees and tort claimants, is to give them higher priority in bankruptcies. Some courts have imposed interests to the benefit of the third-party purchasers. While this resolution helps an innocent purchaser better than none, it still falls short of preventing harm to an innocent party, especially if they have made additional plans and accommodations for the acquired asset.
Many debtors do not want to enter into bankruptcy; therefore, they try to convert illiquid assets into cash to meet obligation. However, finding a willing buyer immediately that will pay the price the court demands can be very difficult.
In the marketability of the various commodities . . . there prevail[s] considerable differences. There are goods for which it is not difficult to find applicants ready to disburse the highest recompense which, under the given state of affairs, can possibly be obtained, or a recompense only slightly smaller. There are other goods for which it is very hard to find a customer quickly, even if the vendor is ready to be content with a compensation much smaller than he could reap if he could find another aspirant whose demand is more intense.
In addition, the courts inconsistently, and often arbitrarily, define the reasonably equivalent value. Market conditions vary from town to town, or even from block to block. The courts rarely recognize these realities, and place a post hoc judgment on the debtor, assuming the debtor possessed, or should have possessed, more knowledge at the time. The court should not punish the debtor for the current market conditions. In addition, creditors, which are many times professional lenders, are in a better position to protect themselves and have more knowledge about the market conditions.
Although the Act attempts to clarify the law by requiring the reasonably equivalent value be given to the debtor, it does little to alleviate the underlying problem. The new provision will only add some guidance—some improvement—but it is still based on bad law.
6. Conclusion
Texas legislature should not adopt the new defense amendments, even though it clarifies certain ambiguities. In addition, the legislature should seriously reconsider the fundamental problem with the formulation of voluntary transfer and equivalent value for constructive fraud. Reevaluating the fundamental formula, and recognizing that the formula came from two different origins, will likely reduce litigation and allow better predictability that will allow for a better economy.
IV. WHAT SHOULD TEXAS DO?
When Texas considers the Act, probably in 2017, it should adopt most of the UVTA, word-for-word. However, certain parts threaten the principles rooted in Texas’s foundation. The legislature should seriously consider the repercussions of the available defenses. The law should not punish intelligent property planners who work with entrepreneurs, unless the planners intend to defraud the creditors. The new defense regime increases the likelihood the plaintiff can recover assets from innocent third-parties, having an outcome that is different from In re Chapman Lumber. However, the vast majority of the proposal is worth adopting, creating a fair environment that carefully balances the needs of the creditors to increase the sponsorship of enterprise, and the needs of entrepreneurs as they take on risk. As voidable transactions become more prevalent in business and estate planning in economic downturns, lawyers and client should have appropriate asset protections that do not harm the creditor, nor unreasonably benefit the debtor or third-party.
However, should the Texas legislature adopt all the wording of the UVTA, very little substantial change will occur. The Act will clarify some of the issues, but it will not substantially change the currently enacted UFTA.
Finally, other states should adopt the UVTA, allowing states to be more uniform with states already passing it, as well as improving ambiguity. Since most states do not have an economic system based on preferential treatment of debtors, these states should probably adopt it in whole, except for the “to the debtor” language to prevent harming innocent purchasers.
