Knowing that their Brentwood, California, home suffered extensively from mold and structural damage caused by water, Tracy Westen and Linda Lawson sold it anyway without informing the buyer, Nicole Nagel. In the subsequent arbitration Nagel was warded $4.5 in damages and attorney’s fees.
When the arbitration was not looking good for them, Westen and Lawson had two attorneys, who were also Westen’s brother being Derek Westen and Peter Westen, develop an “Asset Protection plan” which did three things:
First, Westen and Lawson converted a California LLC called Westen Family Group, LLC (“WFG”), in which Westen and Lawson held a 20.7% interest, into a Nevada LLC.
Second, Westen and Lawson placed a portion of the Brentwood home sale proceeds into an annuity.
Third, Westen and Lawson purchased a house in Texas with the proceeds from the sale of the Brentwood home and then later moved there (Texas has an unlimited homestead exemption).
Upon learning of all this, Nagel brought an action for fraudulent transfer, civil conspiracy, and aiding and abetting, which involved Weston, Lawson, WFG, attorneys Derek Westen and Peter Westen, and certain Westen family trusts. While this fraudulent transfer case percolated towards trial, Westen and Lawson declared bankruptcy in Texas and Nagel was able to collect against Westen’s and Lawson’s annuity in Minnesota.
When the time for the trial of the fraudulent transfer case drew near, the California trial court made a number of rulings — which I will discuss below — that had the effect of gutting Nagel’s case and ultimately it was dismissed in its entirety on July 9, 2019, and Nagel appealed.
The California Court of Appeals first noted that the California assembly adopted the Uniform Voidable Transactions Act (UVTA) in 2016 and changed the title from the older Uniform Fraudulent Transfers Act with the end of reducing misconceptions that fraudulent transfer law requires proof of fraudulent intent (it does not). Moreover, the UVTA’s so-called Badges of Fraud work to delineate “the often blurry line between legitimate asset protection planning and voidable maneuvering.”
The salient issue in this case was whether a voidable transaction occurred when Westen and Lawson converted the non-exempt proceeds from the sale of their Brentwood home into exempt property in Texas. Westen and Lawson argued that it was not a voidable transaction since, they argued, there was no transferee involved and thus there could be no “transfer” as contemplated by the UVTA. The Court of Appeals agreed that the UVTA requires a transfer, but noted that the UVTA never defines the term “transferee” — which meant that the UVTA does not foreclose the possibility that the debtor and the transferee could essentially be one-and-the-same. Thus:
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We hold that under the UVTA, physically relocating personal property and transmitting or transporting sale proceeds out of state, then transmuting them into a different legal form, may constitute a direct or indirect mode of parting with assets or one’s interest in those assets.
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The Court of Appeals went on to note that nothing in the UVTA can be interpreted to prevent the debtor from being, essentially, the transferee of herself. This, the Court felt, furthered the public purposes of the UVTA which was to keep debtors from doing things to diminish the rights of their creditors or to “devise new and more creative ways to circumvent valid obligations.”
Thus, the Court of Appeals reversed the trial court and remanded the case back to trial on all of Nagel’s causes of action.
There is a lot to unpack here, but let’s start with the issue of whether the UVTA requires a transferee.
The two operative sections of the UVTA are sections 4 and 5, both of which begin: “A transfer made or obligation incurred by a debtor is voidable as to a creditor”. Setting aside the alternative analysis of obligation incurred for another day, this language unequivocally requires the existence of a transfer, which is defined by the UVTA as “every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with an asset or an interest in an asset, and includes payment of money, release, lease, license, and creation of a lien or other encumbrance.” But, as the Court of Appeals pointed out, there is no definition of what constitutes a transferee.
The question then becomes whether the debtor who makes the transfer can also be the transferee who receives the asset. The Court of Appeals also correctly points out that the UVTA does not preclude this result (the UVTA’s predecessor, the UFTA, did not preclude this result either). The reasoning of the Court of Appeals was that because the purpose of the UVTA was to protect creditors against transfers that diminished the debtor’s estate, and because a transfer — such as, as here, from a non-exempt type of asset to a non-exempt type of asset — from the debtor to herself has that diminishing effect, it was appropriate that the UVTA would operate to avoid such transfers to, effectively, oneself.
In the opinion of your humble writer, who was an American Bar Association advisor to the drafting of the UVTA, the reliance of the Court of Appeals upon this public policy of the UVTA is correct and provides a good ground for the conclusion ultimately drawn. Importantly, the UVTA attempts to reach that result another way, which is also found in the re-titling of the Act from the Uniform Fraudulent Transfer Act to the Uniform Voidable Transaction Act, since the term transaction connotes an even wider array of activity than the broadly-defined term transfer. Of course, it would be preferable if the state legislatures adopted so-called fraudulent conversion laws that reached this result explicitly, but few states have done that, and perhaps that is not necessary so long as the court continue to recognize that the ambit of the UVTA is meant to reach basically all transactions that have the effect of diminishing the debtor’s estate whether or not they easily fit into certain recognized legal cubbyholes.
But the UVTA is not perfect by any means, and we were constrained in the drafting of the UVTA not to entirely overhaul the UFTA as arguably should have been done. The UVTA does not define the term transaction and the courts are thus left to guess at the meaning of the phrase and its import as to the substance of the Act. However, it was certainly intended by the drafting committee to reach other sorts of activity that might not fit neatly into the definition of transfer, such as the conversion of a corporation to a limited liability company for the purpose of defeating the rights to a creditor to collect on the judgment.
An alternative approach to this matter is to expansively construe the term transfer such that when a person converts non-exempt property into exempt property, that is essentially a transfer from the debtor’s non-exempt estate (the classic debtor) to the debtor’s exempt estate (the classic transferee). This involves the creation of a legal fiction, but the law is chock-full of such fictions, and such an approach makes complete sense commensurate with the creditor-protective purposes of the UVTA and its predecessors.
This case now heads to trial, but even if Nagel wins at trial (who knows) then the litigants will face the same issue as came in the Lapides case that have written about previously, which is whether Texas (where Westen and Lawson now apparently reside) will recognize a judgment entered under California’s UVTA as trumping the unlimited homestead protection which exists under Texas law. It is entirely possible that this case may require a ruling by the Texas Supreme Court as to whether the Texas homestead, as enshrined in the Texas Constitution, is susceptible to a fraudulent transfer challenge that is based on a mere statute (which is normally trumped by a state constitution), but may also take into account the application of Full Faith & Credit as to the California judgment (which can itself trump a state constitution).
But there is a possible quirk that may distinguish Lapides. If the judgment that was entered in favor of Nagel and against Westen and Lawson was based on fraud (this opinion does not state), then Nagel might attempt to assert the remedy of a constructive trust upon the proceeds of the sale, and that might circumvent the Texas homestead protection. For those not familiar, a constructive trust works like this: Say somebody robs a bank and then runs across the street and deposits the money into their IRA account which is an exempt asset in that state; in such a case, it is irrelevant whether the IRA account is exempt or not, since the court say something like “That was not your own money in the first place” and impose a constructive trust over the money such that it would be clawed back. Constructive trusts often arise in fraud cases, but, again, I don’t know if that was part of the underlying judgment here.
Certainly, this will be a case worth watching going forward.
Nagel v. Westen, 2021 WL 58119 (Cal.App., Distr. 2, Jan. 7, 2021). https://voidabletransactions.com/2021-nagel-california-opinion-voidable-transactions-and-fraudulent-transfers.html