The following is a case update prepared by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, analyzing a recent decision of interest:
A California appellate court has held that a fraudulent transfer claim attacking a collusive stipulated judgment between a judgment debtor and his brother is not subject to the litigation privilege. [Chen vs. Berenjian, 2019 Westlaw 1397592 (Cal.App.).]
Facts: A purchaser paid approximately $33,000 for goods that were not delivered. The purchaser obtained a judgment against the seller for that amount. Allegedly in an attempt to avoid paying the judgment, the seller and his brother entered into a fraudulent arrangement, under which the brother filed suit against the seller and obtained a phony stipulated judgment against the seller.
The purchaser later filed a second lawsuit against the seller for the nondelivery of another batch of goods; that lawsuit also resulted in a judgment. When the purchaser attempted to enforce his two judgments against the seller, the brother (as a spurious judgment creditor) interposed his own judgment lien to block enforcement of the purchaser’s judgment liens.
The purchaser next filed a complaint against the seller and his brother, asserting a cause of action to avoid the collusive judgment as a fraudulent transfer under the Uniform Voidable Transfer Act, California Civil Code §§ 3439.01 et seq. The trial court sustained a demurrer to the complaint on the ground that the fraudulent transfer cause of action was barred by the litigation privilege of California Civil Code §47(b). The purchaser appealed.
Reasoning: The court held that litigation privilege applies solely to “communicative” acts. Here, by contrast, the heart of the purchaser’s fraudulent transfer claim stemmed from the collusive judgment lien, rather than from the “communicative” aspect of the litigation between the brothers:
[T]he acts causing injury to [the purchaser] were the agreement to defraud him and the transfer of the [assets] from [the seller to his brother] by means of executing on the judgment. The acts of filing the sham complaint and agreeing to the stipulated judgment, though communicative in nature, were not the gravamen of [the purchaser’s] fraudulent transfer cause of action. Chen’s complaint alleged, “when an attempt was made to enforce the . . . claims and judgments by [the purchaser] . . . [the brother of the seller] would levy on the property subject to the claim.” The levy was the allegedly voidable transfer producing the injury and was, therefore, the gravamen of the cause of action for fraudulent conveyance. Levying on property is essentially a taking, a physical act that is not communicative.
The brother of the seller argued that the court’s holding would frustrate the purpose of the litigation privilege. The court sharply disagreed:
The litigation privilege’s purposes are “to encourage open channels of communication and zealous advocacy, to promote complete and truthful testimony,” and “to promote effective judicial proceedings by encouraging full communication.” . . . . Thus, the privilege does not extend to noncommunicative conduct that is not of necessity related to communicative conduct. Levying on property as part of a scheme to defeat a creditor’s rights in violation of the UVTA is not communicative conduct; therefore, extending the litigation privilege to such conduct advances none of the privilege’s purposes.
The UVTA serves the valuable purpose of protecting creditors from schemes to place assets beyond their reach . . . . Were we to extend the litigation privilege to the facts alleged by [the purchaser], we would be providing a road map to circumventing the UVTA and defeating the rights of creditors.
Author’s Comment: This result is exactly right. Note that the collusive judgment satisfies several of the “badges of fraud” articulated in §3439.04(b):
(b) In determining actual intent under paragraph (1) of subdivision (a), consideration may be given, among other factors, to any or all of the following:
(1) Whether the transfer or obligation was to an insider.
(4) Whether before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit.
(8) Whether the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred.
(9) Whether the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred.
(10) Whether the transfer occurred shortly before or shortly after a substantial debt was incurred.
(11) Whether the debtor transferred the essential assets of the business to a lienor that transferred the assets to an insider of the debtor.
Subsection (11) is particularly pertinent. It refers to the familiar “friendly foreclosure” scenario, under which the debtor willingly defaults, a creditor forecloses, and then the assets are resold to an insider. Here, instead of creating a phony mortgage resulting in a phony foreclosure sale, the two brothers created a phony judgment that would have resulted in a phony execution sale.
For a discussion of an analogous issue, see 2013-37 Comm. Fin. News. NL 76, Collusive Foreclosure Allegedly Orchestrated by Senior Creditors May Trigger Successor Liability Claim In Favor of Subordinated Noteholders.
These materials were written by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, for his Commercial Finance Newsletter, published weekly on Westlaw. Westlaw holds the copyright on these materials and has permitted the Insolvency Law Committee to reprint them.