Residence Underwater Due To Liens Not An Asset That Could Be Fraudulently Transferred In Tootian
Article 2022 California Asset ValidLien Art211021ResidenceUnderwaterDueLiensNotAssetFraudulentlyTransferredTootian
Sometimes debtors will engage in a lot of shady transactions to save a property, but those transactions still do not rise to the level of a voidable transaction for the reason that there just isn't equity in the property. Such is the case of In re Tootian (Goldman v. Dardashti), 2021 WL 4558290 (Bk.C.D.Cal., Oct. 5, 2021), where husband and wife debtors engaged in a long line of hinky transactions with relatives and others to try to save their Encino property from being taken by creditors. Among these transactions were apparently bogus foreclosures which were started and then stopped by friendly creditors to try to thwart the unfriendly creditors, numerous liens placed on the property by relatives, an apparently bogus short sale attempt, and even a lease to a college student relative who apparently had no ability to pay the $10,825 per month rental.
In other words, just the sort of junk that I and other creditor rights lawyers have to deal with daily. But, if nothing else, this opinion is a good read as an example of all the hijinx that debtors will do when they are in deep distress. But at the end of it all, the debtors were not successful in being able to keep their property and instead were forced to part with it in a short sale to one of their lenders. Two years after that sale, the debtors voluntarily filed for bankruptcy in the Southern District of California, and the Bankruptcy Trustee moved to set aside the sale.
The bankruptcy court first noted that the UVTA definition of "asset" excludes both property that is encumbered by a valid lien and exempt property. As an aside, California recently raised the homestead exemption to a minimum of $300,000 and as much as $600,000 depending on the average property values in a given county — which would mean $600,000 for Los Angeles County where the debtors' residence was located.
The key issue was this: The determination of whether something is an asset per UVTA, and the value of that asset, is made at the time of the transfer. The trustee argued something like that the court should consider the value after the transfer when various of the liens on the property disappeared following the short sale to their lender. But of course whatever happened subsequent to the transfer is not relevant to the value of the residence at the time of the transfer, and the bankruptcy court pounced on this point. Here, the debtors simply had no equity in the residence at the time of the transfer, and therefore the residence was not an "asset" that even could be fraudulently transferred. The court also noted that the junior lienholders had to surrender their liens so that the short sale could go through. Thus, the bankruptcy court:
"Here, Plaintiff has not presented any other evidence that she would have been able to recover any equity at the time of the transfer. Plaintiff’s argument that the equity has increased over time and the home is a current asset is irrelevant."
The bankruptcy court also gave a lengthy discussion on the trustee's argument that a resulting trust should be imposed on the residence, but this largely failed because the trustee was unable to come up with evidence that any significant portion of the creditor's money was used by the debtor's to purchase the residence in the first place, which failure was ultimately fatal to the trustee's claim. Since this is beyond the scope of what I want to focus on here, being the definition of "asset" under the UVTA, I will simply direct readers to that discussion if it is of interest to them.
ANALYSIS
Creditors will often go for the debtor's residence first, because it is all of inherently immobile, very difficult to adequately protect, and usually has the debtor's greatest remaining wealth. The problem is, as this case illustrates, that a creditor can only get at the debtor's equity in the property, less any homestead exemption. Where the value of the residence, plus the amount of homestead, is exceeded by bona fide loans against the property, there just isn't any equity remaining for the creditor to get.
However, and as apparently happened here, residences will often appreciate in value such that equity in excess of loans + homestead begins to appear. Where that happens, the new equity created by the appreciation becomes fair game for the creditor. This is something that is often not adequately taken into account in asset protection planning.
The problem for the creditor is how to get at that equity, and if the residence has been sold then the creditor is usually left (as here) with a fraudulent transfer action against the transferee. But as the court here correctly notes, the time for valuing the residence ⸺ or any asset ⸺ is at the time of the transfer, and not at any later time. If the property later appreciated in the transferee's favor, too bad for the creditor as that simply doesn't matter.
Where it seems the trustee fell short here was in its proof that the liens on the property were not bona fide liens, but instead were in the nature of shams extended largely by insiders of the debtors. Also, for whatever reason, the trustee did not have an appraisal done of the property at the time of the transfer to demonstrate that there was equity in the property at that time. Instead, the trustee made the common creditor's mistake of simply trying to show the court something like the debtors are bad people and the people that the debtors were dealing with were bad people too, thinking that would get the trustee over the evidentiary hump. It did not.
Certainly, there was no shortage of hinky transactions precipitated by the debtors who were intent on protecting their residence as long as possible. But proof of that is somewhat different than a lien-by-lien unwinding on the basis that each lien was not a "valid lien", and then a final showing that there was indeed equity in the property at the time of the transfer, and it was that showing where the trustee fell short.
The opinion of the bankruptcy court here is very clear on the substantive issues, but the recitation of the facts — and particularly which liens were valid and which were not — will never be nominated as a model of drafting clarity. One definitely gets the impression that instead of methodically peeling back the layers of the onion, lien by lien, the court simply cut straight through to the issue that caused the dismissal of the trustee's case. That is not without grounds for criticism, especially in a case where it is obvious that the debtors had set out to encumber their residence with bogus liens to try to prevent its foreclosure by any legitimate creditor.
AI Synopsis
♦ Key Takeaways: (1) UVTA and Asset Definition: The case highlights the importance of the timing of asset valuation under the Uniform Voidable Transactions Act (UVTA). The value of an asset is determined at the time of the transfer, not at a later date. This means that any appreciation in value after the transfer is irrelevant for purposes of determining whether a fraudulent transfer occurred. (2) Equity and Homestead Exemption: Creditors can only recover the debtor's equity in a property, less any homestead exemption. If the value of the property, plus the homestead exemption, is less than the amount of bona fide loans against the property, there is no equity for the creditor to recover. (3) Proof of Fraudulent Transfer: The trustee in this case failed to prove that the liens on the property were not bona fide. They also failed to provide an appraisal of the property at the time of the transfer to demonstrate that there was equity in the property at that time. (4) Importance of Evidence: The case emphasizes the importance of gathering and presenting strong evidence in fraudulent transfer cases. Simply showing that the debtors engaged in shady transactions is not enough. The trustee must prove that the transactions were fraudulent and that the debtor had equity in the property at the time of the transfer. (5) Asset Protection Planning: Asset protection planning should take into account the potential for appreciation in value. If a property is likely to appreciate, it may be necessary to take steps to protect the equity that will be created. (6) Debtor's Tactics: The debtors in this case engaged in a number of questionable transactions in an attempt to protect their property. This highlights the need for creditors to be vigilant in identifying and challenging such tactics. (7) Court's Approach: The court's decision was clear on the substantive issues but lacked clarity in its recitation of the facts. This raises questions about the court's approach to complex cases involving multiple transactions and parties. ♦