Effect Of Bankruptcy Discharge On Creditor’s Standing To Sue Transferee Under New Jersey’s Fraudulent Transfer Act

Picture this scenario: A debtor transfers his assets to his wife to avoid a creditor’s judgment.  The debtor then discharges the creditor’s judgment in a chapter 7 Bankruptcy.  Can the creditor independently sue the debtor’s wife under New Jersey’s Fraudulent Transfer Act (“NJUFTA”), N.J.S.A. 25:2-20 et seq., to avoid the asset transfer even though the creditor’s judgment against the debtor was discharged?  The answer to this question remains unclear. image-fraudulent-transfer

The goal of the NJUFTA is to “prevent [] a debtor from placing his or her property beyond a creditor’s reach.” Barsotti v. Merced, 346 N.J. Super. 504, 515 (App. Div. 2002) (quoting Gilchinsky v. Nat’l Westminster Bank N.J., 159 N.J. 463, 475 (1999)). Fraudulent transfer actions are necessarily derivative; authority to sustain them depends entirely upon the plaintiff’s status as a creditor and defendant’s status as a debtor with respect to a claim, which serves as the predicate for maintenance of the action. But if the predicate claim has been extinguished and/or satisfied, the derivative NJUFTA action ceases to constitute a justiciable controversy. Where, in short, a debt is extinguished, the right to challenge the debtor’s transactions as fraudulent is extinguished. Presumably, this logic would also extend to claims against the transferee of the alleged fraudulent conveyance.

In Robert Lewis Rosen Assocs. v. Webb, 2009 N.J. Super. Unpub. LEXIS 1464 (App. Div. 2009), the Appellate Division held that a plaintiff must be a “creditor” with a “claim,” as defined under the NJUFTA, to maintain a cause of action against a transferor and transferee of an alleged fraudulent transfer. In the underlying Chancery case, the court found that the plaintiff was not a creditor under the NJUFTA because the defendants William Webb and Cynthia Webb, husband and wife, were no longer indebted to the plaintiff, negating the creditor/debtor relationship necessary to trigger the applicability of the NJUFTA. Plaintiff appealed arguing that it still held a claim against the defendants.

In 1986, Mr. Webb, then a director of sports broadcasting, hired plaintiff, a sports agency, to represent him. On April 18, 2001, a dispute arose between the parties resulting in plaintiff filing a demand for arbitration. In 2002, while the arbitration was pending, Mr. Webb filed a separate ancillary action in the United States District Court for the Southern District of New York, alleging various claims against plaintiff. On July 31, 2003, plaintiff obtained an arbitration award against Mr. Webb for $355,084.32 plus interest and attorneys fees. Although the award included attorneys’ fees and costs incurred by plaintiff during the arbitration, the arbitrator explicitly refused to award and fees relating to suits filed in a court of law.

A few weeks after the issuance of the arbitrator award, Mr. Webb conveyed his interest in his marital home to his wife. The deed reflected a purchase price of $47,667 whereas the assessed value of the property was $495,400. In January 2004, plaintiff filed a complaint against Mr. and Mrs. Webb in the Superior Court of New Jersey, Chancery Division, alleging that the transfer of the marital residence was a fraudulent conveyance in violation of the NJUFTA. In 2007, Mr. Webb paid off plaintiff’s judgment in full and requested that plaintiff dismiss its NJUFTA action because plaintiff no longer had a “claim” against him. Plaintiff acknowledged that its debt had been satisfied but maintained it still had a “claim” against Mr. Webb, as defined under the UFTA, for its legal fees.

On March 2, 2007, the Webbs filed a motion for summary judgment seeking to dismiss plaintiff’s NJUFTA claims, arguing that plaintiff was no longer a creditor of Mr. Webb. On March 19, 2007, plaintiff filed a second demand for arbitration seeking to recover the legal fees and expenses it spent while enforcing and defending the arbitration award. The arbitrator dismissed plaintiff’s claim for fees. In December 2007, the Chancery Court granted the Webbs’ motion for summary judgment and dismissed plaintiff’s NJUFTA action. In so doing, the Court found that the creditor/debtor relationship between plaintiff and Mr. Webb ceased to exist upon Mr. Webb’s payment of the arbitration judgment and the arbitrator’s denial of plaintiff’s claim for attorneys’ fees. Accordingly, the Court held that plaintiff no longer had a “claim” against Mr. Webb as defined under the NJUFTA, requiring the dismissal of the action against the Webbs.

On appeal, the Appellate Division stated that the NJUFTA defines a “creditor” as a “person who has a claim” and a “claim” is broadly defined as a “a right to payment, whether or not the right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured.” See Webb, 2009 N.J. Super. Unpub., supra, *14. Applying a plain reading of this definition, the Appellate Division held that plaintiff was no longer a creditor of the statute because it no longer had a legally recognized right to payment from the Webbs. As such, the Appellate Division affirmed the Chancery Court’s ruling.

Based on the Webb decision, one could make the argument that if a creditor ceases to have a claim against the transferor of a fraudulent conveyance, the creditor does not have independent standing to sue the transferee under the NJUFTA. The question remains whether the Court’s holding in Webb would apply to prevent a creditor from suing a transferee under the NJUFTA when the debt at issue was not paid off in full by the transferor, as was the case in Webb, but rather was discharged in a chapter 7 Bankruptcy proceeding.

A chapter 7 discharge releases the debtor from personal liability for certain specified debts. See 11 U.S.C. 727(b). However, a discharge of a debtor’s debt does not “affect the liability of any other entity on, or the property of any other entity for, such debt.” 11 U.S.C. § 524. The Third Circuit Court of Appeals, have recognized that “discharged” debts continue to exist despite their unenforceability against the debtor on the basis of 11 U.S.C. § 524(e), which states “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.” See e.g. First Fidelity Bank v. McAteer, 985 F.2d 114, 118-19 (3d Cir. 1993) (holding that § 524(e) did not release non-debtor parties from their obligations and liabilities arising from the discharged debt). For example, a debtor’s discharge of a debt would not affect a third-party guarantor of the same debt unless that guarantor also obtained a discharge of his/her personal liability for that debt. Several courts have held that a transferor’s chapter 7 discharge does not affect the liability of a transferee of a fraudulent conveyance in a state court action. See Dixon v. Bennett, 72 Md. App. 620 (1987); Casey Nat’l Bank v. Roan, 282 Ill. App. 3d 55, 62-63 (1996); Rountree v. Nunnery (In re Rountree), 448 B.R. 389, 414 (Bankr. E.D. Va. 2011).

While it is clear that a Bankruptcy discharge does not extinguish or satisfy a debtor’s debt, a strict interpretation of the definition of a “claim” under NJUFTA would seemingly bar a creditor from independently suing a transferee if the transferor has discharged the creditor’s debt. Given the lack of reported decisions by New Jersey courts, the jury is still out on this issue.

Disclaimer: This article is published for informational purposes only, and is not intended to create an attorney client relationship between the reader and the law firm of LoFaro & Reiser, L.L.P.  Further, this article is not intended to be an exhaustive review of its subject matter, and is otherwise limited to the reported and unreported case law citied herein.

© 2016, Eric D. Reiser, LoFaro & Reiser, LLP

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Eric’s varied litigation and transactional experience includes complex commercial/ chancery/federal matters, preliminary injunctions, partnership/corporate shareholder actions, will & probate litigation, guardianships, bankruptcy, bankruptcy court litigation and corporate dissolutions, business transactions & corporate law, asset recovery/repo, debt collection & judgment enforcement, receiverships, foreclosure, fraudulent transfer litigation, attorney & professional ethics, entertainment and intellectual property, internet and website development law, real estate disputes and restrictive covenants, trial & appellate practice in state and federal courts. Eric has also been appointed by the court to serve as counsel to an alleged incapacitated person in a guardianship matter and is a candidate for judicial appointments in complex commercial litigation matters as a special fiscal agent, receiver and provisional director.

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