Last year, the National Conference of Commissioners on Uniform State Laws (“NCCUSL”) rolled out one of its latest projects, the Uniform Voidable Transactions Act (“UVTA”).[I] According to NCCUSL’s website,[ii] the model statute has already been enacted in eight states, including California (where it takes effect on January 1, 2016), and has been introduced in four others, including Massachusetts.
The first thing to know about the UVTA is that it is the Uniform Fraudulent Transfer Act (“UFTA”)[iii] with a new name and the legal equivalent of a fresh coat of paint. In a lengthy article about the drafting of the model statute[iv], the reporter for the NCCUSL drafting committee, Professor Kenneth C. Kettering, describes the model statute as “the UFTA, renamed and lightly amended.” As light as the amendments may be, however, Kettering notes that they are “significant enough to warrant attention”[v]—significant enough, at least, to justify his publishing a 57-page law review article on the subject. The extensive “Official Comments” that were promulgated by NCCUSL along with the model statute also provide some insight into the thinking of the drafters, but Professor Kettering’s article is far more forthcoming about the reasoning behind the proposed statutory changes. Anyone who wants the full story should, therefore, consult Professor Kettering’s article. We will try here instead simply to describe the most significant provisions in the new or, at least, improved model statute.
New Nomenclature
Throughout the model statute, not just in the name, the term “fraudulent transfer” is replaced with the term “voidable transaction.” The drafters felt that the continued use of the word “fraudulent” in connection with the statute was misleading since the kinds of transactions that are commonly described as involving “constructive fraud” (those in which an insolvent debtor makes a transfer or incurs an obligation for less than reasonably equivalent value) do not involve any kind of fraud and even transactions described as being “actual fraudulent transfers” (those made “with intent to hinder, delay or defraud” creditors) do not necessarily involve fraudulent intent.
This mislabeling has had some real consequences. On occasion, for example, courts mistakenly applied the heightened pleading requirement for “fraud” to complaints alleging the existence of a fraudulent transfer or have required the plaintiff to prove its case by a stricter standard of proof than would ordinarily apply in civil actions. To try to prevent such errors, the drafters effectively eliminated the words “fraud” and “fraudulent” from the statute.
New Choice of Law Rule
Courts have almost literally been all over the map in their attempts to discern which jurisdiction’s law to apply under the UFTA. According to Professor Kettering, “[i]nability to predict which jurisdiction’s voidable transfer law will apply” adds to the transaction costs and, if the matter ever goes to court, the litigation costs. [vi]
Accordingly, in its Section 10, the UVTA sets forth a choice of law rule to be applied in all cases under the statute. It instructs that a voidable transaction claim is governed by the law of the jurisdiction in which the debtor is “located” when the challenged transfer was made or the challenged obligation incurred. For this purpose, a debtor that is an individual is “located” at the individual’s principal residence, and a debtor that is an organization is “located” at it place of business if it has only one and, if it has more than one place of business, at its chief executive office.
This rule, while helpful, will not dispose of all potential disputes about the debtor’s location. (Similar rules relating to the location of the debtor under Article 9 of the Uniform Commercial Code have, over the years, engendered considerable litigation.) Still, it narrows the area of potential dispute if the parties get into litigation and gives transactional lawyers considerable guidance, if not always a definitive answer to choice of law issues.
The chief import of this choice of law rule is that, when the UVTA applies, those who transact business with a debtor need to be prepared to analyze the potential voidability of the transaction under the laws of the jurisdiction where the debtor is located—not, for example, the jurisdiction where the property transferred is located.
Another import of this choice of law rule is that in a jurisdiction that has adopted the UVTA the courts will look to the avoidance law of the debtor’s location whether that happens to be another state or even another country. According to Professor Kettering, that is the case even if the law of the debtor’s location has “debased” or effectively eliminated its avoidance laws in order to promote “asset protection trusts” or “asset tourism”[vii]
New Variations on Definition of Insolvency
Whether or not the transferor was “insolvent” at the time of the transfer is not an essential element in cases where the transfer is made with “intent to hinder, delay or defraud” creditors, but many, perhaps most cases, under the fraudulent transfer law have not involved allegations of intent to hinder, delay or defraud. Instead those cases turn on a combination of two factors: one, absence of reasonably equivalent value (or, in older parlance, fair consideration) and, two, some form of insolvency.
The definition of “insolvency” has always, therefore, been one of the cornerstones of fraudulent transfer law. Not surprisingly, the UVTA leaves the UFTA’s definition of “insolvency” largely intact, but it does tweak it in a number of ways.
First, in Section 2(a), the definition is reworded to make it clear that, if the case for insolvency turns on the debtor’s having more liabilities than assets, both the liabilities and the assets must be subject to “fair valuation.” According to the Official Comments to Section 2, “[n]o change in meaning is intended.”
Second, in Section 2(b), the UVTA changes the wording of the provision that deals with insolvency based on the failure to pay debts as they come due. In the UFTA, insolvency is rebuttably presumed based upon such failure. The UVTA makes clear that, for purposes of applying this presumption, a court should disregard debts that are subject to a bona fide dispute. According to the Official Comments to Section 2, “[t]hat was the intended meaning of the language” in the prior model statute. (The presumption, it is worth noting, imposes on the defendant the burden of proving that the nonexistence of insolvency is more probable than its existence.)
Finally, and most substantively, while both the UFTA and the Bankruptcy Code contain special definitions for “insolvent” in the case of partnerships, the UVTA eliminates that special treatment and subjects partnerships to same test of insolvency as other debtors. (For the determination of insolvency, the UFTA and the Bankruptcy Code add to the value of the partnership assets the aggregate net worth of the partnership’s general partners; the UVTA does not.)
New Allocation of Burden of Proof
The UFTA says nothing about which party must carry the burden of proof in fraudulent transfer cases or what standard of proof a court is supposed to require. The UVTA fills in the gaps on these issues.
With regard to the burden of proof, Section 8(g) of the UVTA allocates to the plaintiff creditor the burden of proof on the following issues:
- With respect to Section 8(b):
- Proof of the value of the asset transferred or of the amount of the creditor’s claim, whichever is less.
- Proof that the defendant was the first transferee (the “Initial Transferee”) or the person for whose benefit the transfer was made or was an immediate or mediate transferee of the Initial Transferee (a “Subsequent Transferee”).
- With respect to Section 8(c), if the judgment is based on the value of the asset transferred, proof of the value of the asset as of the time of the transfer (subject to adjustment as the equities might require).
With regard to the burden of proof, Section 8(g) of the UVTA allocates to the defendant transferee (or, where applicable, obligee) the burden of proof on the following issues:
- With respect to Section 8(a), proof that the Initial Transferee (or obligee) took in good faith and for a reasonably equivalent value given to the debtor. (Note: the qualification that the value be given specifically “to the debtor” is added by the UVTA.)
- With respect to Section 8(b)(ii)(A) or (B), if the defendant was a Subsequent Transferee, proof that such Subsequent Transferee was either a good faith transferee who took for value (a “Good Faith Subsequent Transferee”) or an immediate or mediate transferee of a Good Faith Subsequent Transferee.
- With respect to section 8(d), proof that the transferee (or obligee) is a “good faith transferee or obligee” entitled, to the extent of the value given the debtor, to (1) a lien or a right to retain an interest in the asset transferred, (2) enforcement of an obligation incurred, or (3) a reduction in the amount of liability on the judgment.
- With respect to Section 8(e), proof that a transfer that is allegedly voidable as what we used to call a “constructively fraudulent transfer” or as a voidable insider transfer is, in fact, not voidable because it results from (1) certain types of lease termination or (2) enforcement of security interest under Article 9 (other than by way of acceptance of all or part of the collateral).
- With respect to 8(f), proof that a transfer to an insider that would otherwise be voidable is rendered not voidable because (1) the insider gave new value to the debtor after receiving the transfer (and only not voidable to the extent of such new value), (2) the transfer was made in the ordinary course of business or financial affairs of the debtor and of the insider, or (3) the transfer was made “pursuant to a good-faith effort to rehabilitate the debtor and the transfer secured present value given for that purpose as well as an antecedent debt of the debtor.”
New Statutory Standard of Proof
Section 8(h) establishes that the “standard of proof required to establish matters referred to in this section s preponderance of the evidence.” This is intended to override judicial decisions that have applied a stricter evidentiary standard to cases involving “actual fraud” or even, in a few cases, “constructive fraud.”
New Provisions Regarding Series Organizations
Arguably, the greatest innovation in the UVTA is Section 11, which deals with a relatively new type of business known as a “series organization.” A series organization is an entity whose organizational documents authorize it to create special obligations that can be satisfied only out of certain assets of the entity and whose other obligations cannot be satisfied out of those protected assets. According to Professor Kettering, twelve states, the District of Columbia and Puerto Rico have enacted statutes that permit the creation of a series organization (although not all such statutes employ the term “series organization”), and most of those apply to limited liability companies or LLCs, but, in theory, any type of business organization could be a series organization.[viii]
Under the current state of the law, it is not clear whether a protected series created by a series organization is to be treated as a separate legal entity (analogous to a corporate subsidiary) or is to be treated as part of the organization as a whole (analogous to a corporate division).[ix] This creates some interesting issues in the context of a fraudulent transfer or voidable transactions statute. As Professor Kettering has noted, if “a series is not a legal person, then no disposition of the property allocated to it to another series or to the ‘mother ship’ can possibly be a voidable transfer under the UFTA.”[x]
To address these issues, the UVTA specifies, in Section 11(b), that a “series organization and each protected series of the organization is a separate person for purposes of this [Act], even if for other purposes a protected series is not a person separate from the organization or other protected series of the organization.”
NCCUSL notes that this provision should be enacted even in states that do not authorize the creation of protected series on the ground that, under choice of law rules, a court may have to apply the law of another jurisdiction that does enable the creation of protected series.
A Note on California and Uniformity
It is significant that California, the nation’s largest state, has enacted the UVTA.[xi] The statute goes into effect, in place of the UFTA, on January 1, 2016, as Sections 3439 et. seq. of the California Civil Code.
It is, however, equally significant that California did not enact the UVTA in its entirety. It did not, for example, adopt Section 11 regarding series organizations, nor did it enact the UVTA’s “insider preference” avoidance provisions that were carried over, virtually verbatim, from the UFTA (California did not adopt those UFTA provisions, either)[xii], and it retained certain non-uniform provisions that had been previously been inserted into California’s version of the UFTA.[xiii]
Still, California did enact the UVTA’s choice of law rules in new Cal. Civil Code section 3439.10, as a result of which, depending on the jurisdiction in which the debtor is deemed located, California courts and California creditors may find themselves looking to the laws of a jurisdiction like Delaware (that still has the UFTA but also authorizes the creation of protected series) or New York (that still employs the pre-UFTA model statute, the Uniform Fraudulent Conveyance Act, promulgated in 1918). In that regard, whether the Uniform Voidable Transactions Act actually turns out to be a step toward further uniformity remains an open question.
[i] http://www.uniformlaws.org/shared/docs/Fraudulent%20Transfer/2014_AUVTA_Final%20Act.pdf
[ii] http://www.uniformlaws.org/Act.aspx?title=Voidable Transactions Act Amendments (2014) – Formerly Fraudulent Transfer Act
[iii] http://www.uniformlaws.org/Act.aspx?title=Fraudulent Transfer Act – now known as Voidable Transactions Act
[iv] Kettering, “The Uniform Voidable Transactions Act; or, the 2014 Amendments to the Uniform Fraudulent Transfer Act,” 70 Bus. Law. 777 (2015) (hereinafter, cited as “Kettering”).
[v] Kettering at 779.
[vi] Kettering at 795.
[vii] Kettering at 801.
[viii] Kettering at 828-829.
[ix] Routledge, “Again, For the Want of a Theory: The Challenge of the ‘Series’ to Business Organization Law,” 46 Am. Bus. L.J. 311 (2009).
[x] Kettering at 830.
[xi] Cal. SB No. 161, filed with the California Secretary of State on July 2, 2015.
[xii] Compare UFTA Section 5(b) and UVTA Section 5(b) with Cal Civil Code Section 3439.05.
[xiii] Compare, for example, UVTA Section 7 (Remedies of Creditor) with Section 3439.07 of the California Civil Code (both in its current UFTA-inspired version and in its future UVTA-inspired version).