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:
The Fifth Circuit Court of Appeals held that summary judgment entered by a state court on fraudulent transfer claims, which a district court was required to treat as its own following removal to the bankruptcy court and then withdrawal of the reference, was not appropriate based on disputed issues of material fact and evidentiary objections that were sustained without providing a basis. Matter of Alabama & Dunlavy, Limited, 2020 WL 7349243 (5th Cir. 12/15/20).
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Jay Cohen (Cohen) filed a suit in a Texas state court against Robert Abercrombie (Abercrombie) and the Texas Abercrombie Family Interests, Ltd. (TAFI), including claims under the Texas Uniform Fraudulent Transfer Act (TUFTA), conspiracy to commit fraud, conspiracy to breach a fiduciary duty, and aiding and participating in a breach of fiduciary duty. The claims were based on an allegedly fraudulent land transfer from a limited partnership, Alabama & Dunlavy (A&D), to TAFI. Cohen indirectly held an ownership interest in A&D through control of A&D’s largest limited partner and contended that Abercrombie, who controlled TAFI, was a strawman purchaser in a self-dealing land transfer for the benefit of Abercrombie and the person in control of A&D, Matthew Dilick (Dilick).
The property involved in the lawsuit is a commercial property in Houston, Texas. The history involving the property is complicated and a number of transactions involving the property included questionable circumstances. The property was close to foreclosure and Dilick sought a bridge loan to avoid foreclosure using a financial statement and documentation relating to the eventual purchaser, TAFI. Based on the documents, the lender’s understanding was that Dilick controlled TAFI. In February 2010, Dilick, acting on behalf of A&D, sold the property to TAFI and TAFI closed on the bridge loan using $2 million in funds from Dilick and a personal guaranty from Dilick (the person in control of the seller). Abercrombie did not contribute to the purchase and instead asked Dilick for a loan so that Abercrombie could pay child support obligations. In June 2010, after the sale, TAFI obtained a loan secured by the property and Abercrombie signed the loan documents without reviewing them. The disbursements upon closing of the loan included $2.94 million to TAFI, with $1.06 million of that amount transferred from account to account before going to an entity controlled by Dilick.
In the state court action filed by Cohen, the state court granted a motion for summary judgment in favor of Abercrombie and TAFI. As part of granting summary judgment, the state court sustained evidentiary objections, some without explanation, and expunged a notice of lis pendens on the property. Following a chapter 7 bankruptcy filing by A&D, the state court litigation was removed to the bankruptcy court. Thereafter, the district court withdrew the reference from the bankruptcy court and entered a final judgment. Between the entry of summary judgment by the state court and the entry of final judgment by the district court, Abercrombie passed away and the property was sold. Cohen appealed the district court judgment to the Fifth Circuit. The Fifth Circuit affirmed in part, vacated in part, and remanded, determining that summary judgment was not appropriate due to genuine issues of material fact and because certain evidentiary objections were improperly sustained.
The Fifth Circuit noted that the case “traveled a peculiar path to the Fifth Circuit and has left us in the position of having to review a grant of summary judgment entered in Texas state court some seven years ago.” Citing to In re Meyerland Co., 960 F.2d 512, 520 (5th Cir. 1992) (en banc), the court stated that “[i]n this circuit, when a case is removed from state court to federal court, the federal court takes the case as it finds it and treats the state court rulings as its own” and that “this case is ready for appellate review.” The court determined that the state court improperly granted summary judgment because there were triable issues of fact.
As to the fraudulent transfer claims, the Fifth Circuit found that Cohen qualified as a creditor and thereby had standing because he indirectly had an ownership interest in A&D and a right to payment when A&D sold the property. TUFTA is similar to the Bankruptcy Code in permitting the avoidance of transfers made with the actual intent to hinder, delay or defraud creditors (actual intent fraudulent transfers) and transfers made for less than reasonably equivalent value when one of several insolvency tests are met (constructively fraudulent transfers). Citing to Janvey v. GMAG, 592 S.W.3d 125, 129 (Tex. 2019), the court determined that there were questions of fact regarding actual intent given that “badges of fraud” were present. The court further found that there were questions of fact regarding whether reasonably equivalent value was exchanged as to the constructive fraudulent transfer claims.
The court therefore determined that a jury could find that the land transfer was fraudulent and turned to the defenses under TUFTA as to whether the transfer was accepted in good faith and for value (Tex. Bus. & Comm. Code § 24.009(a)). The court found that there was a question of fact as to whether TAFI received the property in good faith. In examining the good faith defense, the court cited to Janvey, stating that the defense “requires honest and reasonable conduct considering known facts and conduct free from both improper motive and willful ignorance of fraud.” The court further cited to case law providing that there is no applicable good faith defense if a person is on “inquiry notice” of the fraud and had knowledge of red flags that would cause a reasonable person to investigate further. Citizens Nat’l Bank of Tex. v. NXS Constr., Inc., 387 S.W.3d 74, 85 (Tex. App. 2012) and Hahn v. Love, 321 S.W.3d 517, 527 (Tex. App. 2009). The court was skeptical that Abercrombie (as the person in control of TAFI) could have accepted the land transfer in good faith, noting that “it makes no sense for Dilick to risk millions of dollars, have his CPA produce a balance sheet for an entity he had no control over” and where “Abercrombie shouldered none of the financial risk while Dilick put millions of his own dollars at stake as collateral, and Abercrombie claims to have asked no questions about what was happening” and found that, “[a]t minimum, a jury could find that Abercrombie knew of red flags that would have prompted a reasonable person to investigate” and that “willful ignorance” is sufficient for a jury to conclude that a good faith defense does not apply.
As to the common law claims, the court found that the evidence was sufficient to allow a jury to find that the claims had been proven but found that only monetary relief was available because the property had been sold after expungement of the lis pendens. Based on Fed. R. Civ. P. 56(c)(2), the court also found that the state court (and thereby the district court in entering judgment) abused its discretion in sustaining certain evidentiary objections without explanation.
The Fifth Circuit therefore affirmed in part, vacated in part and remanded the case to the district court.
This case has a complicated factual history and an unusual procedural history, but the Fifth Circuit’s holdings are straight-forward. Perhaps the most interesting part of the decision is the question raised by the Fifth Circuit at the outset: “[s]o what happens when, as here, a party appeals a state trial court decision to a federal court of appeals without a federal district judge’s prior consideration?” It seems that the answer is that it results in the unusual situation where a district court’s judgment is vacated based on having made determinations of fact and sustaining evidentiary objections that the state court, rather than the district court, actually made, and which determinations the district court was required to treat as its own under Meyerland.
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 Immediate Past 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.