Business Law
Lariat Company, Inc. v. Wigley (In re Wigley)
Dear constituency list members of the Insolvency Law Committee, the following is a case update by Kit Gardner analyzing a recent case of interest:
SUMMARY
The Eighth Circuit Court of Appeals has held that the recipient of a fraudulent transfer may have committed “actual fraud” for purposes of non-dischargeability. Lariat Company, Inc. v. Wigley (In re Wigley), 15 F.4th 1208 (8th Cir. 2021).
To read the full published decision, click here.
FACTS
In connection with his failing restaurant, Michael Wigley was sued by his landlord for past due and future accruing rent which he had personally guaranteed. While that action was pending, Michael transferred assets to his wife, Barbara, which the state court later found to have been transferred with actual intent to hinder, delay, or defraud the landlord. As a result, judgment was entered in favor of the landlord and against Michael and Barbara, jointly and severally, in the amount of the $780,000 in fraudulently transferred assets.
Michael (but not Barbara) thereafter filed for bankruptcy. Pursuant to Section 502(b)(6) of the Bankruptcy Code, the landlord’s claim was capped in an amount less than the judgment amount, which Michael eventually satisfied. [Author’s note: The Ninth Circuit also holds that the cap applies to claims against a guarantor. Arden v. Motel Partners (In re Arden), 176 F.3d 1226 (9th Cir. 1999).] Once the landlord’s capped claim was satisfied, Barbara sought to have the state court judgment against her vacated, which was denied. Barbara then filed her own Chapter 11 petition, and the landlord again filed a claim, this time in the amount of more than $1 million, representing the unsatisfied portion of the judgment plus accrued interest. Again, the landlord’s claim was capped in Barbara’s bankruptcy case pursuant to Section 502(b)(6) and again the capped claim was satisfied in full. Even though Barbara had not personally guaranteed the lease and even though the landlord’s claim against Barbara derived solely from the fraudulent transfer judgment, the bankruptcy court still held that the cap applied because it arose from a lease termination.
In the meantime, though, the landlord sought to have the uncapped portion excepted from discharge in Barbara’s bankruptcy case. After a trial, the Bankruptcy Court entered judgment in favor of the landlord, finding that Michael had transferred assets with actual intent to hinder, delay, or defraud his creditors, and that Barbara had participated in the scheme, possessing “actual fraudulent intent when receiving the transfers.” The Eighth Circuit Court of Appeals affirmed.
PROCEDURE
The Debtor filed her voluntary Chapter 11 petition on June 3, 2021, identifying herself as a small business debtor and electing to proceed under Subchapter V. Within 30 days of the filing, NLI filed a Motion to Dismiss Chapter 11, Subchapter V Bankruptcy Case, and the United States Trustee filed a Motion to Strike Designation of Chapter 11 Case as Subchapter V under 11 U.S.C. § 1182. NLI requested dismissal or the case or conversion to a “conventional” Chapter 11 case. The U.S. Trustee requested that the Subchapter V designation be stricken. The motions were granted in part: the Debtor’s designation of the case as being under Subchapter V of Chapter 11 was stricken, and the case was allowed to proceed as one under Chapter 11, but not under Subchapter V.
REASONING
The Court of Appeals had no trouble dispensing with Barbara’s argument that the landlord cap set forth in Section 502(b)(6) capped the creditor’s substantive claim. The Court cited precedence (from the Ninth Circuit) holding that a cap on claims merely establishes a limit on what will be allowed to be paid from the bankruptcy estate, and is neither a substantive damages remedy nor a limit on substantive damages. In re Condor Systems, Inc., 296 B.R. 5, 12. (B.A.P. 9th Cir. 2003) (construing the Section 502(b)(7) employee compensation cap).
Next, the Court found that Barbara committed “actual fraud” by receiving the transfers from Michael. The Court held that, “A transferee who receives a fraudulent transfer with the requisite wrongful intent commits ‘actual fraud,’ and any debts traceable to the fraudulent transfer are excepted from discharge” citing the Supreme Court’s decision in Husky Int’l Electronics., Inc. v. Ritz, 578 U.S. 356 (2016). The Court of Appeals found sufficient evidence of Barbara’s wrongful intent and held that the Bankruptcy Court did not err in analyzing the various “badges of fraud” in connection with Barbara’s receipt of the transferred property.
AUTHOR’S COMMENTS
The Eight Circuit’s analysis of the interplay between the landlord’s cap on damages and the dischargeability of the amount in excess of the cap should not be surprising insofar as the purpose of the cap has been said to be designed to fairly compensate a landlord while not unduly diluting the claims of other unsecured creditors; in other words, the cap was ostensibly never enacted for the protection of debtors.
It might also be no surprise that the recipient of a fraudulent transfer may be found liable under Section 523(a)(2) for a debt that originated with another (the transferor), given the Supreme Court’s decision in Husky compelling precisely that outcome. In Husky, the Supreme Court held that a fraudulent transfer scheme can be a type of “actual fraud” within the meaning of that section. Husky, 578 U.S. at 361 – 362. The Supreme Court also determined that a debt can be “obtained by” the fraud when the transferee receives the property that is the subject of the scheme. Id. at 365. That a transferee of a fraudulent transfer may have such a debt excepted from discharge under Section 523(a)(2) complements a growing line of cases holding that the transferor of a fraudulent transfer commits “actual fraud” within the meaning of that section. See e.g., DZ Bank, AG v. Meyer, 869 F.3d 839, 843-44 (9th Cir. 2017).
These materials were written by Kit James Gardner of the Law Offices of Kit J. Gardner in San Diego (kgardner@gardnerlegal.com). Editorial contributions were provided by Ed Hays of Marshack Hays LLP in Irvine.