So you have finally triumphed after a long legal battle and obtained a judgment in favor of your client against the defendant Darn Debtor, Inc. (“Debtor”). However, no sooner do you have your judgment then the defendant’s counsel informs you that their client is judgment proof and won’t even bother with an appeal. What is likely to happen next?
The plaintiff’s attorney will very likely conduct an debator’s examination of the judgment debtor. The attorney will thoroughly review the debtor’s financial records, keeping a close eye out for any transfers of money or other assets from Debtor. Hypothetically, let’s suppose that the plaintiff’s attorney finds evidence that when Debtor went out of business, it transferred proceeds from the liquidation of its assets and some equipment to its majority shareholder, Ina Insider (“Insider”), in partial satisfaction of secured loans made to the company that exceeded the value of the transferred assets. In other words, we have a plaintiff with a hard earned judgment who has every reason to believe that he/she is being cheated by Debtor’s majority shareholder. But Insider can say that she kept the company alive with her loans and that when Debtor failed, she wound up with the company’s liabilities (besides the judgment) that far outweigh the value of what she got from the liquidation.
Let’s make several other assumptions. First, without continuous infusions of cash from the majority shareholder, Debtor would have failed long before it contracted with the plaintiff. However, when Insider’s security interest was perfected, Debtor was paying all of its operating expenses and debts other than hers. Second, like many, if not most, shareholders of a small closely held corporation, Insider didn’t ask Debtor’s attorney to draft the security agreement granting her a security interest in the company’s assets and to file a UCC-1 perfecting that interest until several years had passed since she started making loans to Debtor to keep it afloat. Third, while the plaintiff obtained its judgment after the now defunct Debtor transferred the cash and equipment to Insider, the judgment was based on Debtor’s breach of a contract with the plaintiff that occurred before the security interest was perfected. Fourth, the amount of the judgment is less than the value of the cash and assets transferred to Insider. It may sound complicated, but this scenario is actually quite realistic.
Now it’s time to get ready for Round #2 of the litigation in which the plaintiff will try to get a judgment against Insider by claiming that she received a fraudulent transfer from Debtor in violation of the Michigan Uniform Fraudulent Transfer Act (“MUFTA”), MCL 566.31 et seq. The plaintiff’s attorney will potentially have four types of claims under MUFTA, but let’s focus on the one that he/she will probably view as the key to a quick judgment against Insider. That would be MCL 566.35(2), which states that a transfer made by a debtor is fraudulent as to an “insider” whose claim arose before the transfer was made if the transfer was made to an insider for an antecedent debt, the debtor was insolvent at that time, and the insider had reasonable cause to believe the debtor was insolvent.
You might be inclined to think that the plaintiff has an easy road to a judgment against Insider. After all, she is clearly an “insider” because of her majority shareholder status in Debtor and her loans to the company clearly predated the perfection of her security interest and receipt of the cash and equipment. Moreover, Debtor was clearly insolvent in an accounting sense at those times because its debts, including the one owed to Insider, exceeded the value of the company’s assets, which she knew. Debtor also signed the contract under which the plaintiff’s claim long before conveying the cash and equipment to Insider.
However, there are a number of issues that the parties and the Court will have to sift through in order to see if the plaintiff is entitled to a judgment against Insider. They include (1) whether there was a “transfer” to an “insider”, as defined by the MUFTA, and if so, when it occurred; (2) whether Insider can claim that her receipt of cash and equipment from Debtor didn’t violate MCL 566.35(2) because it resulted from a foreclosure of her security interest; (3) whether Insider can credibly say she didn’t have reasonable cause to believe that Debtor was insolvent at the time of transfer; and (4) whether an argument can be made that Debtor was not insolvent at that time.
We will analyze those issues next month.
For more information regarding the Michigan Uniform Fraudulent Transfer Act, please contact Kenneth Neuman directly at Kneuman@neumananderson.com.