In re Johnson  – After Fraudulent Gift Deed is Nullified by Court Order Just Before Bankruptcy, Judgment Liens Reattach to Debtor’s Property and Are Deemed Outside of 90 Day Preference Period. 

The following is a case update prepared by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, analyzing a recent decision of interest:

SUMMARY:

A bankruptcy court in Georgia has held that after a fraudulent gift deed was nullified by a court order just before a bankruptcy petition was filed, judgment liens held by the bankrupt’s creditors reattached to his property interest and were therefore transfers that took place outside of the 90 day preference period. [In re Johnson, 2018 Westlaw 3869602 (Bankr. N.D. Ga.).]

Facts: A debtor and his spouse co-owned a parcel of real property. He fraudulently executed a gift deed to her, conveying his interest. That deed was recorded. Subsequently, three creditors obtained liens against him, totaling several million dollars. Two of the liens were judgment liens; the third was a federal tax lien. All were recorded.

The second of the three creditors brought a fraudulent transfer action against the debtor and his wife. The court in that action entered an order declaring that the gift deed was null and void ab initio. Less than 90 days later, the debtor filed a Chapter 7 petition. The property was ultimately sold by the bankruptcy trustee

All three creditors claimed an interest in the proceeds of the sale. The trustee claimed that all three of those creditors’ liens were preferential, since the liens did not attach to the property until the entry of the order declaring the gift deed to be null and void. The creditors, while still jockeying for priority amongst themselves, all argued that the liens attached long before bankruptcy, since the gift deed was a nullity from the outset.

Reasoning: Treating the complex procedural posture as if this were a group of cross-motion for summary judgment, the court ruled in favor of the first judgment lien creditor and against the trustee. The trustee argued that the gift deed was merely voidable, and not void, until the trial court in the fraudulent transfer action had declared it to be void. Accordingly, that moment (which was within 90 days of bankruptcy) was the moment that the debtor acquired “rights” in the collateral for purposes of 11 U.S.C.A. §547(e)(3), which states that “a transfer is not made until the debtor has acquired rights in the property transferred.”

The court disagreed, holding that because the gift deed was a nullity under the trial court’s order, “the Property remained an asset of the Debtor subject to the rights of his creditors.”

Author’s Comment: This is an interesting and difficult question, and there is almost no authority on point. I think the court reached the wrong result. The court is right that a lien against a judgment debtor reattaches to after-acquired property upon the nullification of a fraudulent deed. The court is also right that the priorities among competing lien creditors are not altered when the debtor fraudulently alienates his property and then re-acquires it, either voluntarily or by virtue of a court order. Those are matters of state law.

But §547(e)(3) is a federal statute, and it is pretty clear: there can be no transfer of an asset to a creditor until the debtor acquires rights in that asset. Here, until the entry of the order nullifying the gift deed, the debtor had no rights in the property transferred. He could not have voluntarily alienated that property until the nullification took place. Therefore, the involuntary transfer to his creditors must have occurred when the nullification occurred, which was within 90 days of bankruptcy.

To hold otherwise is simply sophistry. The result in fraudulent transfer cases would depend upon clever drafting: instead of simply characterizing the fraudulent deed as invalid, the trial court (prompted by the judgment creditor) could alter the outcome by additionally declaring the fraudulent deed to have been null and void ab initio, as happened in this case.

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