Fraudulent Transfers a/k/a Avoidable TransactionsJDA
In a community property state, there are essentially three types of property: His, Hers, and Ours. His property is the property that he brings into the marriage, that he inherits, or that the marital parties agree will be his sole and separate property. Likewise, her property is the property that she brings into the marriage, that she inherits, or that the marital parties agree will be her sole and separate property. All other property that is earned or acquired during the marriage is considered community property. The marital parties can agree, through either a premarital agreement (“prenupt”) or a postmarital agreement (“transmutation agreement” or “partition agreement”) that certain things will be or not be community property.
While a community property system has dramatic implications when a spouse dies, there are also implications during their lifetimes when it comes to creditors. His sole and separate property is only available to his creditors. Her sole and separate property is only available to her creditors. Their community property is available to the creditors of either spouse. Thus, it makes complete and practical sense for couples about to be married to enter into prenuptial agreements so as to reduce the universe of their potential creditors by 50%.
Robert Sturm won a $600,000 non-dischargeable judgment against Todd Moyer in 2005. In 2014, Todd Moyer and Jessica Schell entered into a premarital agreement which provided, as most agreements typically do, that their respective income and earnings, and any property acquired by them individually during the marriage, would remain each spouse’s sole and separate property, and that they would keep their liabilities (including pre-existing liabilities) as their own.
Todd had not just Sturm’s $600,000 judgment handing over his head, but he had other debts and liens held by other creditors. These were listed in Exhibit A to the premarital agreement. That premarital agreement also had a “sunset provision” which stated that if all of Todd’s debts and liens became unenforceable for any reason, then the couple’s earnings, income and property acquired during the marriage would be community property.
Todd and Jessica were married in 2014, after their premarital agreement had been inked. Two years later, in 2016, Todd appeared at a debtor’s exam noticed by Sturm and there Todd testified that he had no assets and desired never to work again so that he would never have to pay on Sturm’s judgment against him (which is an amazingly stupid thing to say at a debtor’s exam, but let’s move on). At that debtor’s exam, Sturm learned of the Todd/Jessica marriage and their premarital agreement.
Sturm then brought an action for fraudulent transfer against Todd under the California Uniform Voidable Transactions Act (UVTA), although the judge who wrote this opinion for whatever reason that cannot be discerned refers to it incorrectly by its old name, the California Uniform Fraudulent Transfers Act (UFTA). Sturm’s fraudulent transfer action was based on the premarital agreement, and the Exhibit A to that agreement was attached to Sturm’s complaint. The gist of Sturm’s lawsuit is that, through the premarital agreement, Todd had given up, without consideration and with the intent to defraud his creditors, his right to Jessica’s income and earnings as community property.
The California Superior Court dismissed the lawsuit on the basis that the California Family Code allows couples who are about to be married to divvy up their property so that it never becomes community property in the first place, and so there was nothing that could be fraudulently transferred.
Sturm appealed the dismissal, and the California Court of Appeals issued the following opinion.
The Court of Appeals first noted that the UFTA defines the term “transfer” broadly and to encompass pretty much every way that a debtor could part with an asset. Against this, the California Family Code allows a couple to keep their income, earnings, property and liabilities separate from each other by way of a premarital agreement entered into before the marriage or a transmutation agreement entered afterwards. Notably, a transmutation agreement is subject to the fraudulent transfer laws.
There were two possible ways to look at this issue, thought the Court. One could argue (as did Todd and Jessica) that no transfer ever took place because the premarital agreement operated prior to the marriage and thus neither ever had a community property interest that was available to creditors. Conversely, it could be argued that the premarital agreement did not become effective until the marriage, and then by agreement (transmutation) the couple divided their property.
Noting that a premarital agreement by its very nature (and the Family Code) does not become effective until the marriage, the Court posited:
This suggests that at the moment of marriage, each spouse acquires rights to community property that are (if the premarital agreement calls for it) immediately transferred.
This lead the Court of Appeals down the rabbit hole of trying to discern the legislative intent behind the California UFTA, which the Court found to be “enlightening, but not dispositive”, namely because the legislative history does not address whether property is transferred upon marriage by a premarital agreement.
Emerging from that rabbit hole, after a lengthy detour and frolic to consider at length the comments of a law professor which are first seemed helpful but then the Court decided to simply disregard, the Court of Appeals promptly launched itself down another rabbit hole, this one being public policy.
Here, the Court thought that public policy favored creditors like Sturm and disfavored couples like Todd and Jessica, based on an opinion (Mejia v. Reed) that dealt with the wholly-dissimilar situation where a couple attempt to divide up their community property through a transmutation agreement well after a claim had arisen that their community property was obviously at risk for collection. But just when you thought this was over, the Court dropped this last paragraph:
It might be argued that applying the UFTA to a premarital agreement in which the parties agree that each party’s earnings, income, and assets acquired during marriage would be that party’s separate property would discourage marriage in cases, such as the present one, in which one of the parties has significant debts while the other party has substantial income. But the Legislature already has provided protection for the couple in such a case, by enacting Family Code section 911. As noted, under that statute, the non-debtor-spouse’s earnings are sheltered from liability for the debtor-spouse’s premarital debts, so long as those earnings are kept by the non-debtor-spouse in a separate account (to which the debtor-spouse does not have a right of withdrawal) and are not commingled with other property in the community estate. This provision demonstrates, not only an intent to protect the non-debtor-spouse’s earnings, but also a policy judgment — an intent to prevent the debtor-spouse from taking advantage of that protection at the expense of his or her creditors by being allowed access to the protected funds.
In other words, so long as the non-debtor spouse deposits her income and earnings into her sole and separate account to which the debtor spouse has no access, that money is not available to creditors. Thus, practically, the non-debtor spouse can make money all day long, handing cash to the debtor spouse when he needs it, and they simply never acquire any property during the marriage that is community property. This results in a “decision without teeth”.
Thus, the Court of Appeals ended its opinion by holding in favor of Sturm on the dismissal of his complaint:
In light of the suggestions raised by the legislative language and history, and the strong policy — advanced by both the UFTA and section 911 of the Family Code — of protecting the rights of creditors from fraudulent transfers, we conclude that the Legislature must have intended that UFTA can apply to premarital agreements in which the prospective spouses agree that each spouse’s earnings, income, and property acquired during marriage will be that spouse’s separate property. The policy considerations in favor of applicability of the UFTA are especially strong in this case, where the agreement provides that all earnings and income, and property acquired with those earnings and income, dating back to the date of marriage will become community property when certain premarital debts no longer are enforceable, and where the agreement allows the debtor-spouse joint access to the non-debtor-spouse’s earnings and income that are deposited in a joint account.
Having in the end satisfied nobody, but to a degree thrown the otherwise straightforward California community property regime into confusion, the Court of Appeals remanded the case to the California Superior Court to determine whether Todd had the intention of defeating Sturm’s rights be entering into the premarital agreement.
ANALYSIS
Effectively, the Court of Appeals attempts to answer the age-old question: What came first, the chicken or the egg? The answer, sayeth the Court of Appeals, is the chicken but by only a fraction of a millisecond. Under the theory of the opinion, in the first 0.00001 millisecond after the Holy Man’s pronouncement of marriage, their premarital agreement shot into effect ⸺ since the premarital agreement could not be effective before that instant under the California Family Code.
In essence, the Court of Appeals muses that the premarital agreement could become effective either before the marriage, when it was signed, or immediate after the marriage pursuant to the Family Code. But the Court of Appeals misses the third alternative, which is the correct one: The couple were married and the premarital agreement went into effect simultaneously, i.e., neither happened before or after the other. In that event, there was no community property interest which could be transferred, and thus no fraudulent transfer.
But let’s play along with the Court of Appeals’ first fraction of a millisecond theory; there is still no fraudulent transfer.
Sturm’s case arises under the Intent Test of California Civil Code § 3439.04(a)(1):
3439.04. (a) A transfer made or obligation incurred by a debtor is voidable as to a creditor, whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation as follows: (1) With actual intent to hinder, delay, or defraud any creditor of the debtor.
Forgetting the intent element for a moment, let’s focus on the term “transfer” instead. Section 3439.01(m) defines the term “transfer” as:
3439.01(m) “Transfer” means every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with an asset or an interest in an asset, and includes payment of money, release, lease, license, and creation of a lien or other encumbrance.
So, to have a “transfer” the debtor must have had an “asset” that he disposed or parted with. That takes us to the definition of “asset” which is found at § 3439.01(a) and says:
3439.01(a) “Asset” means property of a debtor . . ..
This then further leads us to the definition of “property” under § 3439.01(j), which states:
3439.01(j) “Property” means anything that may be the subject of ownership.
So, what was the property that Todd transferred to Jessica that was the “subject of ownership”. The answer is that in that first fraction of a millisecond after their marriage became effect, was nothing. At that particular millisecond in time, Todd and Jessica’s marital estate consisted of nothing — there were simply no assets or income in it, and certainly nothing that could rise to the dignity of being the subject of ownership.
At best, through the premarital agreement Todd transferred away his future rights to whatever in the future might become community property. To say that this “property” is speculative in nature is to grossly understate the matter. As noted, Jessica could keep her future income from becoming community property simply by keeping it in her sole and separate account and segregated away from any money that Todd had. Nor is there any guarantee to Todd that at any future time that Jessica would use her sole and separate money to acquire community property assets ⸺ that is just the purest speculation.
But speaking of speculation, how could one even hope to define a property right in a future hope that community assets might appear? It is impossible, and just as impossible as speculating how long the marriage might last.
The bottom line is that at the critical millisecond identified by the Court of Appeals, there simply was no existing property that could even theoretically be said to “be the subject of ownership”, nor was there more than the purest speculation that such property might exist in the future.
If you want to step away from the theoretical and look at the matter practically, consider what Todd’s interest in his community property was worth in terms of fair market value at the critical millisecond: Absolutely nothing. No reasonable person would offer any more than a nominal amount of money for the little-more-than-a-blind-hope that community property might someday appear. And even if somebody were to offer such a nominal amount, how exactly would they establish ownership in what amounts to at best a speculative expectancy?
Thus, there was either no transfer because their was no property, or else a “transfer” of some ephemeral expectancy that someday some community property might be created ⸺ and expectancy which would fall firmly into the ancient legal doctrine of de minimis no curae lex (“the law deals not with trifles”). Stated otherwise, the Court of Appeals myopically focused on the transfer to the exclusion of what if anything was being transferred, being property which simply didn’t exist at that time and in fact may never exist.
Moreover, in addition to being demonstrably wrong, the Court of Appeal’s opinion does substantial violence to one of the primary purposes of the California Family Code in allowing such premarital agreements, which is that a putative spouse should not by the act of marriage be forced into a creditor-debtor relationship with her new spouse’s creditors. The Court of Appeal’s decision is untenable on that basis alone.
The real problem with this decision is that it appears to be a result-oriented decision. Nobody likes a deadbeat, and they like arrogant deadbeats even less. By taunting in his debtor’s examination that he was not going to pay the judgment to Sturm ever, Todd established himself as a matter of law as an arrogant deadbeat. The Court of Appeals then bent over backwards to find some way to punish Todd for his arrogance, which is laudable in his individual case, but unfortunately this opinion sets a very bad precedent that will affect litigants in much less extreme cases.
But there are ways for a court to deal with an arrogant deadbeat without interfering with the sole and separate property rights of the deadbeat’s spouse, such as through the appointment of a judgment-enforcement receiver under California Code of Civil Procedure § 708.620 and the liberal use of other remedies under the California Enforcement of Judgments Law.
Hopefully, this decision will be appealed and the California Supreme Court will take a hard look at it. If not, hopefully other courts which consider the decision will take a long and deep look as to whether it is correct.
Because I don’t think so. Having lived with the UFTA/UVTA for several years as an American Bar Association adviser to the drafting committee, and having written many dozens of articles on fraudulent transfer law, this decision strikes me as flat wrong for the reasons set forth above.
But then, nobody has seen fitten to give me a black robe.
Oh, and by the way, the answer to “Which came first, the chicken or the egg?” is itself a question, namely “Which chicken, and which egg?”
CITE AS
Sturm v. Moyer, 2019 WL 642708 (Cal.App. Distr. 2, 2/15/2019). Full opinion at https://goo.gl/a68Hg2
This article at https://goo.gl/Pv5pdP