The following is a case update written by Corey R. Weber, a partner at Brutzkus Gubner Rozansky Seror Weber LLP, analyzing a recent decision of interest:
A bankruptcy court in the Northern District of Texas held that a bankruptcy trustee prevailed on constructive fraudulent transfer claims to avoid and recover a “gift of equity” from the debtor to his adult children as part of a sale of real property prior to the bankruptcy case. Aurzada v. Jenkins (In re Jenkins), 2020 WL 1907534 (Bankr. N.D. Tx. April 17, 2020).
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The bankruptcy trustee for the estate of debtor Stephen Jenkins (the debtor) filed an adversary proceeding including fraudulent transfer claims to avoid and recover transfers to or for the benefit of the debtor’s adult children, including: (1) constructive fraudulent transfer claims pursuant to 11 U.S.C. §§ 548(a)(1)(B) and 550 of the Bankruptcy Code; and (2) actual and constructive fraudulent transfer claims pursuant to the Texas Uniform Fraudulent Transfer Act (TUFTA). The transfers consisted of an $82,266 “gift of equity” in connection with the debtor’s sale of real property to his adult children, cash payments to cover closing costs, and mortgage payments made after the sale closed. The Trustee also asserted an equitable interest in the property and requested the partition and sale of the property under the Texas Property Code.
The debtor was engaged in an unsuccessful “house flipping” business. Although the debtor was married, he purchased residential real property in his name alone on March 30, 2015. The debtor found a lender for a short-term loan to enable him to pay off a previous loan, complete renovations and resell the property. The debtor and his wife (the Jenkinses) executed documents confirming that the property was the non-homestead, commercial property of the debtor, that the Jenkinses would not occupy the property while the short term loan remained unpaid, that the property was not exempt property, and that the loan would be used exclusively for commercial purposes. The debtor’s spouse signed a separate agreement stating that the property was the sole and separate property of the debtor.
Notwithstanding the representations made by the Jenkinses, they moved into the property in December 2015 (the debtor’s spouse admitted to the Jenkinses misrepresenting their intentions to the lender). The debtor attempted to obtain a new lender for the property but was unable to do so. The Jenkinses instead used their adult children to refinance the property by having them purchase the property with financing obtained in their own names. Most of the purchase price was to be financed through the new lender, with the remaining portion to be paid through a “gift of equity” from the debtor to his children. Following the sale, the Jenkinses continued to occupy the property and made the mortgage payments. The debtor thereafter filed a bankruptcy case, but did not disclose the transfers until filing amended statements of financial affairs. After trial the bankruptcy court held that the trustee prevailed on her constructive fraudulent transfer claims to avoid and recover the gift of equity. The court found in favor of the debtor’s adult children on the other claims.
There was no dispute that the transfers were made within two years prior to the debtor’s petition date or that the debtor was insolvent on the date of the transfers. The contested issues revolved around the debtor’s interest in the property transferred and whether the transfers were for a reasonably equivalent value.
The court discussed the claims under the Bankruptcy Code and the claims under TUFTA separately. As to the Bankruptcy Code constructive fraud claims relating to the “gift of equity” that was part of the sale from the debtor to his adult children, the children argued that the gift of equity was not real and not an interest of property of the debtor. The court found that the debtor and the adult children engaged in fraudulent conduct in obtaining the new loan on the property and would not “condone such conduct in disregarding the existence of the Grant of Equity.” The court therefore stated that “a party also may not obtain defensive relief where it is necessary for such party to prove, as a part of the party’s defense, the party’s own illegal conduct.” The court found that the gift of equity was not an interest in the real property itself but instead “was the waiver or release of the contractual right to receive $82,266.00 of the $375,989 Sales Price for the Tremont Property.” The court determined that the contractual rights constituted an interest in property of the estate pursuant to 11 U.S.C. § 548. Citing to In re Trans Texas Gas Corp., 597 F.3d 298, 306 (5th Cir. 2010), the court reiterated that whether value was reasonably equivalent would be determined from the standpoint of creditors, that nothing of value was provided in exchange for the gift of equity, and that the trustee met her burden of proving less than reasonably equivalent value. The court therefore found that the gift of equity was subject to avoidance and that the trustee should be awarded $82,266, the amount of the contractual right.
As to the Bankruptcy Code claims relating to the closing costs, the court found that the testimony was largely “muddled,” but that there was reasonably equivalent value because the closing costs were an obligation of the debtor in the sales transaction. For the Bankruptcy Code claims relating to the mortgage payments, the court found that the Trustee failed to meet her burden of proof because she did not present evidence supporting her calculation of mortgage payments; it also found that the debtor would have incurred expenses for renting or buying a new residence anyway.
For the claims under TUFTA, the court found that “the Trustee has not pursued any relief in this case under section 544(b) of the Bankruptcy Code. Therefore, the Trustee’s direct claims under TUFTA will be denied.” Finally, the court determined that the trustee had no basis to obtain partition relief under the Texas Property Code because the trustee was not a joint owner or claimant of the property, that the trustee did not have any interest in the property, and that such ownership or interest was required for a partition action. The court was able to enter judgment on the partition claims because the parties stipulated to the court’s authority to enter final judgment as to the non-”core” claims.
The court’s determination that the “gift of equity” was not an interest in the real property but was instead a transfer of a contractual right is an interesting issue. The property itself was transferred from the debtor to his adult children, but the trustee apparently did not seek to avoid and recover the property itself or its value (other than seeking partition relief). Given the gift of equity, it seems that the property was likely transferred for less than reasonably equivalent value.
The court determined that the trustee did not pursue relief under 11 U.S.C. § 544(b) and therefore could not pursue claims under TUFTA. However, if the trustee did not include a citation to 11 U.S.C. § 544(b) as part of her TUFTA claims in the complaint, it is unclear how the trustee survived a motion to dismiss (if one was filed) without amending the complaint, or how the TUFTA claims proceeded past the pretrial conference without addressing that issue. Notwithstanding, it is not clear that the TUFTA claims would have provided any additional relief to the Trustee based on the timing of the transfers (the transfers all appeared to take place within the two years prior to the bankruptcy case, and claims brought under the TUFTA usually are included due to longer reach-back periods under state law as compared to under the Bankruptcy Code). One caveat is that the decision references that the TUFTA claims included both actual intent and constructive fraudulent transfer claims, while the section 548 claims included only constructive fraudulent transfer claims. It is possible that the trustee may have been entitled to relief as to a portion of the cash payments for closing and/or the mortgage payments in addition to the value of the gift of equity if the trustee had included section 548(a)(1)(A) actual intent fraudulent transfer claims (the court already determined that the debtor and his adult children engaged in fraudulent conduct), or had pled section 544(b). It is not clear why the trustee did not plead actual intent fraudulent transfer claims under the Bankruptcy Code.
There is no discussion in the decision about what evidence was presented as to the adult childrens’ affirmative defense of good faith and value pursuant to 11 U.S.C. § 548(c). Presumably the children did not meet their burden on their affirmative defense because the court determined that the debtor and the children engaged in fraud, and therefore they did not have an applicable good faith defense.
These materials were written by Corey R. Weber, a partner at Brutzkus Gubner Rozansky Seror Weber LLP, a member of the ad hoc group and the Chair of the CLA Business Law Section, with editorial contributions by the Hon. Meredith Jury (United States Bankruptcy Judge, C.D. Cal, Ret.), also a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.