Bank That Was Financially Involved With Debtor Gets Caught Up In Fraudulent Transfer Case In Wilson

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Amanda Wilson won a judgment of nearly $4.2 million against Jon Pauling for sexual assault, which award was entered in the District Court for Denver, Colorado. With Jon Pauling asserting that he had no assets, Wilson obtained a charging order against his interest in a general partnership called Two Mile Ranch, which owned a variety of farming and ranching operations.

The 1986 general partnership agreement of Two Mile Ranch stated that Jon Pauling and his brother Mark Pauling were 50%-50% co-owners. The agreement also at that time stated that:

"The affairs of the partnership shall be conducted by all of the partners. In case of a difference of opinion among the partners with respect to the management and policies of the partnership, the decision made by Jonathan M. Pauling shall prevail."

According to the Paulings, in 2014, with Jon Pauling's misconduct known to both of the Paulings, the partnership agreement for Two Mile Ranch was amended so that Jon Pauling's interest was reduced to only 10% and Mark Pauling's interest was increased to 90%. The partnership agreement was also amended to state that Mark Pauling was the Manager of the partnership. Importantly, for what the Court would decide later, Jon Pauling was paid no consideration for the 40% interest that he gave up in the partnership.

Wilson later claimed that the 2014 partnership agreement had been backdated, based on a several facts. First, the 2014 IRS Schedule K-1 from the partnership which reflects that Jon and Mark Pauling were still 50%-50% owners of Two Mile Ranch. Second, when the Paulings signed a document to sell Two Mile Ranch in 2015, they did not disclose any amendments to the partnership agreement. Third, and also in 2015, Jon Pauling alone caused the partnership to loan Mark Pauling $275,000 even though Jon Pauling ostensibly had no legal power to do so by that time.

On July 1, 2016, Two Mile Ranch filed for Chapter 11 bankruptcy relief in the U.S. Bankruptcy Court for the District of Colorado. In that action, Farmers State Bank filed a Proof of Claim which stated that Two Mile Ranch owed Farmers a little over $9.5 million while Two Mile Ranch's assets were just less than $9 million. Later, Two Mile Ranch moved to dismiss its own bankruptcy case, on the grounds that all of Two Mile Ranch's assets were fully secured to Farmers and that Farmers did not support the proposed reorganization. Thus, the bankruptcy action was dismissed.

Farmers obtained its security interests in Two Mile Ranch after extending millions in loans to Two Mile Ranch in 2014 and 2015, all based on Jon Pauling's signature (including in 2015 when he ostensibly had no more management rights for Two Mile Ranch).

Enter stage left Ms. Elyce York. According to the Court:

"In deciding to increase the jury’s punitive damage award, Judge Buchanan noted that Jon Pauling continued to engage in the same pattern of grooming behavior with other vulnerable young women he met at adult entertainment clubs, including during the pendency of the state case. Judge Buchanan specifically cited evidence concerning Jon Pauling’s grooming of defendant Ms. York. He noted that just as Jon Pauling had met Ms. Wilson, Jon Pauling met Ms. York at an adult entertainment club where she works as a dancer. Jon Pauling repeatedly paid for Ms. York to be 'taken off the list' at the club so that she could sit and talk with him instead of dance; took her out to dinner and to go shopping; gave her expensive gifts; and assisted her financially in a variety of ways. Jon Pauling continues to have a close relationship with Ms. York, as discussed below." [Internal citations omitted.]

In 2016, York created a Nebraska limited liability company called Lardyn Consulting LLC through the use of the Paulings's long time attorney Brian Bates. Although York's experience in business was apparently limited to lap and pole dances, she signed numerous documents to transact business on behalf of Lardyn. According to Wilson's allegations, York was paid compensation for her services, whatever they were, through a company called Redtail Resources LLC, and she had lived rent-free at a Colorado property owned by Two Mile Ranch.

Wilson further alleged that in 2017, Two Mile Ranch sold two large tracts of property in Colorado for $4.27 million to Lardyn, although Lardyn did not have the financial resources to actually pay that amount. This is where Farmers comes back into the picture, since Farmers recorded Deeds of Trust against the properties, and also recorded a UCC filing statement against all the livestock, crops and farming equipment of Lardyn. In 2019, Farmers also recorded a Deed of Trust against other Lardyn real property to secure an SBA loan for $3.375 million.

According to Wilson, Lardyn sought certification from the State of Colorado to operate a feedlot at essentially the same place where Two Mile Ranch had its operations, and that Jon Pauling continues to work at this location.

Wilson brought a Complaint in the U.S. District Court for the District of Colorado against Jon and Mark Pauling, Two Mile Ranch, York, Lardyn, and Farmers. The Complaint sought relief under the Colorado Uniform Fraudulent Transfers Act ("CUFTA") for:

· Jon Pauling's transfer of 40% of his interest in Two Mile Ranch to Mark Pauling;

· Two Mile Ranch's transfer of property to Lardyn; and

· A conspiracy to violate the CUFTA by all defendants.

The defendants moved to dismiss the second and third claims of Wilson's Complaint, and that motion lead to the opinion which I shall now relate.

Wilson's second claim was that Two Mile Ranch transferred property to Lardyn in violation of the CUFTA. The defendants made three arguments in response.

Defendants' first argument that that Two Mile Ranch was not a "debtor" of Wilson under the definition of that term as found in the CUFTA, since Two Mile Ranch itself did not owe Wilson on any claim. Instead, Wilson held only a judgment against Jon Pauling, and all she could get was a charging order lien against Jon Pauling's interest in Two Mile Ranch, but not the assets of Two Mile Ranch itself. Thus, defendants argued, Two Mile Ranch, not being a "debtor" was free to transfer its assets to whomever it wanted.

In support of this argument, the defendants cited to the 2016 Georgia Court of Appeals opinion in Merrill Ranch to the effect that a charging order lien does not create any creditor-debtor relationship between the holder of that lien and the entity whose interest is being charged, and thus the entity itself could not be liable for a transfer of its property made in defraud of the holder of the charging order lien.

The Court rejected this argument:

"I will not follow in the Austell court’s footsteps. The Austell court took a formalist approach to interpreting Georgia’s equivalent of CUFTA. Yet CUFTA is broadly written, seemingly to encompass a variety of novel and creative means by which debtors attempt to hinder, delay, or defraud creditors. [] 'Transfer' is 'every mode, direct or indirect, ... of disposing of or parting with an asset or an interest in an asset.' [] An asset is 'the property of a debtor,' and 'property' is 'anything that may be the subject of ownership.' [] Jon Pauling indirectly 'dispos[ed] of' his interest in Two Mile Ranch by causing Two Mile Ranch to destroy the value of that interest.

"The fact that Two Mile Ranch is not itself a judgment debtor of Ms. Wilson’s does not hide this transaction from the eyes of the law. Ms. Wilson’s complaint sufficiently alleges that a debtor caused the transfer of property from Two Mile Ranch to Lardyn."

[Internal citations omitted and emphasis in original.]

The defendants' next argument was that the property of Two Mile Ranch was not an "asset" under the CUFTA, since the definition of that term specifically excludes "property to the extent that it is encumbered by a valid lien", and noting that the lien of Farmers covered the property that was transferred to Lardyn.

The problem here was that the defendants relied on certain public documents to prove their point, which sounds good at first glance, but as the Court noted, "[t]he mere fact that documents have been entered into the public record does not render their contents conclusively truthful." To the contrary, there were opposing facts that showed the Jon Pauling had abused the bankruptcy process to delay his trial, there were allegations that Jon Pauling had backdated certain documents, and there were also allegations that Famers was in cahoots with Jon Pauling to help him transfer his assets away in defraud of Wilson.

This now brings us to the most interesting part of the Court's opinion, which relates to Wilson's conspiracy allegations and the attempts by Farmers to get out from under the litigation as a party defendant.

Farmers argued that Wilson had failed to make out a case of conspiracy which included the bank, because Wilson had not established any "meeting of the minds" Farmers and the Paulings to shield Jon Pauling's assets from collection. Wilson had alleged that Farmers knew that Jon Pauling was being sued for sexual assault, Farmers later knew that Wilson was trying to collect her judgment against Jon Pauling, that Farmers had a longstanding business relationship with the both Jon and Mark Pauling, that Farmers knew that Lardyn was simply a shell company and that York was the straw man (or straw stripper in this case), and that Farmers had required Mark Pauling to co-sign on behalf of Lardyn. Thus:

"Based on these allegations, Ms. Wilson argues that it is plausible that Farmers 'agreed to help Jon Pauling continue his business through Lardyn as a sham to avoid Plaintiff’s judgment because they had a longstanding and profitable relationship, they regarded Plaintiff’s judgment collection activities as a threat to their business relationship, and they concluded that it was in their mutual interests to collaborate in the subterfuge of running Jon Pauling’s business through Lardyn with Elyce York as a straw woman.' I agree that these allegations suffice to bring Ms. Wilson’s claim against Farmers for civil conspiracy across 'the line from conceivable to plausible.' "

[Internal citations omitted.]

Farmers also tried to argue that the limitations period for Wilson's civil conspiracy claim was only one year, and that she was beyond that one year when she filed her lawsuit. The Court did not agree with this defense either. The Court pointed out that in Colorado, the statute of limitations for civil conspiracy is the same period as the underlying tort on which it is based, and in this case Wilson's CUFTA claims had a four year extinguishment period such that her Complaint was timely.

Thus, the defendants' Motion to Dismiss failed, and all of them ⸺ including Farmers ⸺ had to face Wilson's continued litigation.

ANALYSIS

This opinion presents several juicy issues, the most delicious of which is the civil conspiracy claim that survived against Farmers.

It is important to understand that the 1984 Uniform Fraudulent Transfers Act (UFTA), or its latest iteration the 2014 Uniform Voidable Transactions Act (UVTA), does not attempt to set forth the entire law relating to fraudulent transfers. The Reporter's Comment states plainly: "This Act is not an exclusive law on the subject of voidable transfers and obligations." Comment to § 4 at ¶ 9. Instead, § 10 of the UFTA and § 12 of the UVTA provide that:

"SUPPLEMENTARY PROVISIONS. Unless displaced by the provisions of this [Act], the principles of law and equity, including the law merchant and the law relating to principal and agent, estoppel, laches, fraud, misrepresentation, duress, coercion, mistake, insolvency, or other validating or invalidating cause, supplement its provisions."

The effect of this Supplementary Provisions section is to basically say that the UFTA/UVTA sits as an overlay on top of existing law, and that if some issue is not covered by the UFTA/UVTA then one should apply other law to resolve the issue.

There are in fact myriad issues that the UFTA/UVTA does not address, with probably the issues of whether attorneys fees may be awarded in a fraudulent transfer lawsuit and whether a fraudulent transfer claim may support a civil conspiracy being the most important of these. To resolve such issues, the Court must look outside the UFTA/UVTA to other law as it did in this case.

The thing to remember here is that this "other law" will usually be non-uniform, i.e., it may substantially vary between the states, unlike Uniform Acts which are designed for the very purpose of being nearly identical across state borders. Thus, issues of attorney fees, civil conspiracy, etc., can be decided very differently depending on which side of the state line that one stands. Some states allow attorneys fees to be awarded in fraudulent transfer cases; some don't. Likewise, some states allow civil conspiracy actions to be based on a fraudulent transfer claim; some don't.

Here, Colorado has been ruled to be a state that recognizes that a civil conspiracy action based upon a fraudulent transfer claim. Most classically stated, a civil conspiracy exists when at least two parties agree to accomplish an illegal purpose or to accomplish a legal purpose by illegal means. Whether an agreement existed between those parties depends on whether they reached a "meeting of the minds" to accomplish the illegal purpose or to use illegal means.

In practice, and I've litigated a bunch of these cases over the decades, civil conspiracy is an amorphous concept that is often subject to the hay test, i.e., "I don't know how many stands make up a bale of hay, but I know a bale of hay when I see one." This impreciseness makes civil conspiracy particularly dangerous for defendants, so long as the plaintiff has (as here) just enough facts to avoid an early dismissal.

This case is illustrative of the dangers that face banks, trust companies, and other financial institutions when they deal with clients who have large claims against them, since they can be rather easily dragged into allegations that they were a participant in a civil conspiracy. This puts such banks and similar companies, as here, at grave risk for liability based upon the assistance that they gave to their client and maybe also for punitive damages. What was yesterday's vanilla transaction can be tomorrow's fraudulent transfer with a civil conspiracy kicker. Particularly in a recession, when so many former financial clients are going through extreme financial distress, the exposure for banks and similar companies who attempt to aid such debtors go up exponentially. The reason for this heightened exposure is that, as here, a longstanding relationship with a client, now an underwater or struggling debtor, can be a factor that prove helps to prove the "meeting of the minds" necessary to support a civil conspiracy allegation.

Sure, banks and similar companies feel a natural desire to assist their longtime customers, and they hope that those customers will eventually get back on their feet and be good clients in the future too, but assisting those clients when they are in financial distress and start doing questionable things can be tantamount to buying into a fraudulent transfer and civil conspiracy lawsuit. Here, it is to be remembered that banks and similar companies are soft targets in the sense the debtor may be broke but they are not, and the average jury should not be expected to arrive in the box in these days with much sympathy for them. The careful vetting of transactions involving distressed debtors is therefore a must.

Just take this case as an example. Here, there are allegations that the bank's client committed sexual assault, made improper bankruptcy filings, formed a shell company with a stripper as a figurehead managers, and made fraudulent transfers to try to avoid paying on the judgment. Is that really the client that the Famers wants to sit with as a co-defendant at a jury trial? At the very least, Farmers will now have to be the cost of litigation to defend this case, and there is also the reputational risk to Farmers to be considered. Probably not just a few folks would take a step back and ask, "What on Earth were you smoking Farmers when you got into this crazy deal with the Paulings?" It might have sounded like a good opportunity at the time, but with the passage of time this deal will look increasingly negligent if not outright crazy.

Switching gears, the issue of whether Two Mile Ranch was a "debtor" under the CUFTA is a complex one. The Court reach the right result, but a better rationale would have been that a charging order accomplishes two things: First, the charging order creates a lien on the debtor/member's (Jon Pauling's) interest in the partnership; Second, creates a temporary assignment of the debtor/member's economic right to distributions to the creditor until the judgment has been satisfied in full.

While the lien aspect should not cause Two Mile Ranch to be anything like a "debtor", the assignment aspect probably does. Under the CUFTA, the term "claim" includes a "right to payment", and the term "debt" means liability on a claim. Certainly, Jon Pauling had a "right to payment" of his share of the distributions from Two Mile Ranch, and Two Mile Ranch thereby owed him a "debt" for those distributions. When the charging order temporarily assigned Jon Pauling's rights to Wilson, the "debt" was then owed to her, she became a creditor of Two Mile Ranch and Two Mile Ranch became a debtor to her. Thus, when Two Mile Ranch transferred its assets such that Wilson could not collect the distributions that would have otherwise been made to Jon Pauling, a fraudulent transfer occurred.

But even if Wilson did not hold a charging order, the transfer from Two Mile Ranch was still potentially a fraudulent transfer since Jon Pauling was certainly a debtor, his interest in Two Mile Ranch was certainly an asset, and a transaction undertaken by Jon Pauling through Two Mile Ranch that caused his own asset to diminish in value could very possibly be a fraudulent transfer under the very broad sweep of the UFTA/UVTA.

The last point of interest in this opinion goes to whether the property transferred by Two Mile Ranch to Lardyn was an "asset" since it was encumbered by the security interest of Farmers. The key here is that to take property out of being an "asset" under the CUFTA, not only does a security interest have to exist, but the security interest must also be bona fide. In this sense, the term bona fide not only means that the security interest is genuine, but also that it must be in "good faith" as that is the literal translation of bona fide from Latin to English. If Farmers took a security interest in Two Mile Ranch's property in something other than good faith ⸺ such as to assist Jon Pauling in dodging Wilson's judgment ⸺ then the security interest would not be bona fide and the exception to that property being an "asset" under the CUFTA would not apply. Here, Wilson was able to cast enough facts to suggest that Farmers was basically in cahoots with the Paulings to cheat Wilson out of collecting her judgment, and so there was at least minimal doubt present that the security interest of Farmers was truly bona fide.

In my own litigation experience, the bulk of fraudulent transfer cases have often turned on parsing the definitions of the UFTA/UVTA, and which is why they should be studied much more closely than they usually are. Folks tend to overlook definitions and go right to the operative meat of statutes, but with the UFTA/UVTA that can be very dangerous as the defined terms often don't match up completely against their common meanings.

CITE AS

Wilson v. Pauling, 2020 WL 2197931 (D.Colo., May 6, 2020), as found at https://chargingorder.com/index.php?n=Site.2020ColoradoWilsonFraudulentTransfer









AI Synopsis


♦ This case revolves around Amanda Wilson's attempt to collect a $4.2 million judgment against Jon Pauling for sexual assault. Jon Pauling, claiming to have no assets, transferred his 40% interest in Two Mile Ranch, a farming and ranching partnership, to his brother Mark. Wilson alleges this transfer was fraudulent and part of a larger conspiracy to shield assets from her judgment. (A) Key Players: (1) Amanda Wilson: Plaintiff, seeking to collect judgment against Jon Pauling. (2) Jon Pauling: Defendant, accused of sexual assault and fraudulent transfer. (3) Mark Pauling: Defendant, brother of Jon Pauling, allegedly benefited from the transfer. (4) Two Mile Ranch: General partnership owned by the Pauling brothers, subject of the fraudulent transfer allegations. (5) Farmers State Bank: Defendant, alleged to have colluded with the Paulings to facilitate the transfer. (6) Elyce York: Defendant, alleged straw woman for a shell company, Lardyn Consulting LLC, which purchased assets from Two Mile Ranch. (B) The Allegations: (1) Fraudulent Transfer: Wilson argues that Jon Pauling's transfer of his interest in Two Mile Ranch to Mark was a fraudulent transfer under the Colorado Uniform Fraudulent Transfers Act (CUFTA). She claims the transfer was made without consideration and with the intent to hinder, delay, or defraud her. (2) Conspiracy: Wilson alleges a conspiracy between Jon Pauling, Mark Pauling, Two Mile Ranch, Farmers State Bank, and Elyce York to violate the CUFTA. She argues that Farmers knew about the fraudulent transfer and facilitated it by providing loans and security interests to the shell company, Lardyn Consulting LLC, which purchased assets from Two Mile Ranch. (C) The Court's Decision: (D) The court denied the defendants' motion to dismiss, finding that Wilson's allegations were plausible and sufficient to proceed to trial. The court rejected the defendants' arguments that: (1) Two Mile Ranch was not a "debtor" under the CUFTA because Wilson only had a charging order against Jon Pauling's interest, not the partnership itself. (2) The property transferred to Lardyn was not an "asset" under the CUFTA because it was encumbered by Farmers' security interest. (3) Wilson's conspiracy claim against Farmers failed because she did not establish a "meeting of the minds" between Farmers and the Paulings. (E) Key Takeaways: (1) Broad Scope of CUFTA: The court emphasized the broad scope of the CUFTA, which aims to encompass various methods used by debtors to defraud creditors. (2) Plausibility Standard: The court applied the plausibility standard, finding that Wilson's allegations, while not conclusive, were sufficient to raise a reasonable inference of fraudulent transfer and conspiracy. (3) Danger for Financial Institutions: The case highlights the risks faced by banks and financial institutions when dealing with clients facing financial distress. Assisting such clients in questionable transactions can lead to liability for fraudulent transfer and conspiracy. (4) Importance of Vetting Transactions: The case underscores the need for financial institutions to carefully vet transactions involving distressed debtors to avoid potential liability. ♦