Congratulations! The Court Entered A Judgment In Your Favor, But The Defendant Refuses To Pay, So Now What? Answer: “The Secret Weapon” Of The Uniform Fraudulent Transfer Act

October 18, 2016 Publications

by Craig Penrose

Litigation is time consuming, disruptive, and expensive. But after years of anguish, you have finally prevailed. Your business finally achieved success and you hold in your hand an order from the court for a final judgment with a specific amount of money damages the defendant must pay. You believe that all the hard work is done, and that you can finally return to “business as usual” as you eagerly await the for check to arrive in the mail.

You then receive a call from your attorney indicating that he or she believes the defendant/debtor will not voluntary pay the judgment; but not to worry you are told, your attorney will soon be “ramping up” the post-judgment proceedings with a Citation to Discover Assets, and possibly a secret weapon: the fraudulent conveyance. You vaguely recall your first meeting with your attorney discussing these possibilities, but now they are a reality. It is not unusual for a defendant who loses a lawsuit and has a money judgment entered against it to simply carry on as if nothing has happened, and simply not pay. However, the law has procedures in place to assist a plaintiff, now a judgment creditor, in dealing with this situation.

The Citation to Discover Assets, 735 ILCS 5/2-1402, is a mechanism that allows a judgment creditor to obtain documents and depositions from the defendant/judgment debtor to locate its assets. Simply put, the law requires the judgment debtor to “open its books” to the judgment creditor to find out where the money is. The discovery and the resulting remedies are broad, allowing the judgment creditor to garnish bank accounts the debtor may have, to seek a court-ordered turn over of certain non-exempt property a judgment debtor may own, or more typically, allow the judgment creditor to simply have the court assign any receivable that is owed to the judgment debtor   to be sent directly to the judgment creditor to begin satisfying the debt. Once served, the Citation to Discover Assets also functions as a lien on all debtor assets. Finally, the creditor can also register the judgment against property the debtor may own.

But what if this same discovery reveals a judgment debtor with very little assets currently, but with numerous, earlier transfers of money or other assets to various parties that appear rather suspicious? Rather than simply “give up” and assume that the judgment debtor is broke and your judgment will never be paid, the secret weapon, the Uniform Fraudulent Transfer Act, 740 ILCS 160/1 et. seq., can possibly be used to “unwind” any improper transfers.

Fraudulent transfer laws have been a part of debtor-creditor relations since 1571 when the Statute of Elizabeth was enacted in England. Such laws were enacted to allow creditors to unwind transactions entered into by a judgment debtor who attempted to hide its assets from creditors. The intent was to protect the creditors of an insolvent judgment debtor by recapturing all property of the debtor improperly transferred away, thus ensuring that creditors were paid before the debtor.

Surprisingly, in the over 400 years since such laws were first enacted, the fraudulent conveyance laws have remained essentially unchanged.   Modern fraudulent conveyance law includes both traditional actual fraud, or fraud in fact, where the judgment debtor acts with the intent to hinder, delay or defraud its creditors, and a broader concept of constructive fraud, or fraud in law, where the financially strapped company engages in transactions that result in a transfer of assets in exchange for something less than the reasonably equivalent value of those assets leaving the debtor in an insolvent state.

Actual fraud requires the person challenging the transfer to prove intent. While intent must be determined on a case-by-case basis, the statute outlines eleven specific circumstances or “badges of fraud” that may be satisfied in various combinations to determine whether the transfer was to hinder the judgment creditor. 740 ILCS 160/5(a)(1).

Constructive fraud is conceptually much easier to grasp and requires only two conditions. First, the exchange for the transfer must have been for less than reasonably equivalent value. Second, the debtor is unable to pay its debts either at the time of the transfer or as a result of the transfer. It is an easy determination when nothing is given in exchange for the transfer. However, when something of value is given, the question becomes whether the value was really adequate for the property transferred. 740 ILCS 160/5(a)(2).

In constructive fraud cases, the creditor must prove that reasonably equivalent value was not given. No formula exists for making that determination. Some factors to look for include whether the transfer is at fair market and in good faith. Adequate value can exist in the form of lines of credit. Adequate value does not exist when the transfer made solely benefited a third party, even if such third party is an affiliate or a subsidiary of the debtor.

Once the transfer has been deemed to be fraudulent, the statute gives the power to the court to order that the judgment creditor recover the property or the value of the property directly from the recipient or anyone else to whom the property was subsequently transferred, unless the subsequent transferee acted in good faith to purchase the property without having knowledge of the outstanding rights of the debtor to the property. 740 ILS 160/8(a)(1). In the alternative, the court is also empowered to enter a judgment for the amount fraudulently transferred directly against the recipient. 740 ILCS 160/9(b).

The fraudulent conveyance statute is interpreted broadly, giving a right to the plaintiff even before a judgment is entered to sue the transferee to avoid the fraudulent transfer that the plaintiff may have discovered prior to judgment. The statute allows a plaintiff, with sufficient evidence, to obtain injunctions against the defendant to stop the transfer even before the fraudulent transfer occurs. 740 ILCS 160/8(a)(3)(A). Because the term “transfer” and “asset” as defined under the statute has been interpreted broadly, the fraudulent transfer statute has been applied to numerous types of commercial transactions such as guarantees, stock pledges, and even Ponzi schemes.

The fraudulent transfer statute is a powerful weapon at the disposal of a plaintiff.   It has the power to go “back in time” to set aside and unwind transactions that may have occurred even before the plaintiff’s lawsuit and force the recipient of the funds to give the funds directly to the plaintiff to satisfy a portion of the debt.

The power of this statute was recently demonstrated in the construction case of A.G. Cullen Construction Inc. v Burnham Partners, LLC, 2015 IL App(1st) 122538. In that case, Defendant Westgate Ventures (“Westgate”) hired A.G. Cullen Construction, Inc. (“Plaintiff’) to build a warehouse and distribution facility. Westgate was primarily owned by Burnham Partners, LLC, (“Burnham”) which, in turn, was owned by Robert Halpin (“Halpin”). Following a dispute and an arbitration at the end of the project, A.G. Cullen was awarded $457,416.37 against Westgate. However, before the arbitration award was entered by the court, Burnham, through Robert Halpin, began to liquidate all of Westgate’s assets. The majority of Westgate’s remaining cash was disbursed to Burnham in the form of a $400,000 development fee and to Robert Halpin and his wife, to repay an alleged loan they made to Westgate. This left Westgate with no funds to pay the arbitration award. Plaintiff filed a new lawsuit against defendants Burnham and Halpin and his wife in the circuit court to recover the amount awarded, alleging, among other things, fraudulent conveyance and breach of fiduciary duty.

After a bench trial, the trial court entered judgment in defendants’ favor on all counts, and plaintiff then appealed. At issue on appeal was whether the traditional fraud, or fraud in fact, existed. The appellate court initially noted that all of the transfers were to related parties as “insiders.” The appellate court also noted that the $400,000 was for work that was already required to be performed by Burnham, thus Westgate received no exchange of reasonably equivalent value.   The appellate court further noted there was a complete absence of documentary evidence of what work, if any, was actually performed by Burnham. Next, the appellate court noted that the loan repayment to the Halpins was actually repayment of the Halpins’ capital contribution to Westgate that they were required to make under the agreement, thus Westgate received no exchange of reasonably equivalent value for that payment. As result, the appellate court reversed the court order and went one step further, indicating that a judgment against Burnham and the Halpins should be entered for the amount of the transfers.

The Uniform Fraudulent Transfer Act is a powerful weapon at the plaintiff’s disposal. While it is always preferable to have a debtor willing to pay its debts, for those instances where that is not the case, full examination of a debtor’s books and records may provide fertile ground for a new fraudulent conveyance action.