NJ Supreme Court Decision Imposes Further Burdens on Lenders in Troubled Loan Situations
In SASCO 1997 NI, LLC v. Zudkewich (A-94-99), a recent decision by the New Jersey Supreme Court, it was held that the four year statute of limitations under the New Jersey version of the Uniform Fraudulent Transfer Act (the "Act") begins to run when the property is transferred and not on the date upon which the creditor obtains a judgment. In addition, the Court held that in order for a creditor to be eligible for the one year "tolling" provision of the Act, the creditor will need to have judgment searches run on the defaulting obligors at the time of default so as to meet the requirement that the action be brought within one year after the transfer "could reasonably have been discovered" by the claimant. The case represents a new interpretation of the Act which is likely at odds with existing industry practice in the commercial lending field. Because of that fact, the Court held that the decision should be prospective in application only and would not be applied retroactively.
The facts of the case are straightforward. In 1989, Midlantic Bank, N.A. extended a $2,900,000 mortgage loan to Gateway 195, which was a New Jersey general partnership formed to develop commercial real estate. All of the general partners including Arik Zudkewich, guaranteed the loan. Midlantic subsequently assigned the loan to ALI, Inc. In December 1994, ALI gave Gateway formal notice that it considered the loan in default and accelerated payment. Also in December 1994, ALI filed a complaint in the Law Division against Gateway and eight of the general partners, including Zudkewich. In March 1995, Gateway filed for bankruptcy and thereafter, ALI, Gateway and five of the eight general partners entered into a settlement agreement. Zudkewich was not a party to the settlement. Under the settlement, Gateway agreed to transfer certain real estate to ALI and sell other properties so as to reduce the outstanding balance of the loan. Because the outstanding balance of the loan was not paid in full after that transfer and sales, ALI continued its Law Division action against Zudkewich and the other partners who did not settle. When it appeared that ALI was about to obtain a default judgment against Zudkewich, ALI ordered an asset search on Zudkewich. In August, 1997, ALI obtained judgment against Zudkewich and about that time ALI transferred its interest in the case to SASCO 1997 NI, LLC ("SASCO").
The 1997 asset search disclosed that in May 1990, a few months after Zudkewich personally guaranteed the loan, he transferred his interest in his marital residence to his wife for $1.00. That home was sold in 1992 for $1,200,000 and the Zudkewichs moved into a new home, which was later sold for a profit of $1,500,000. Zudkewich's spouse alone held title to the newly purchased home.
In April, 1998, SASCO filed a complaint against Zudkewich and his spouse, alleging that the 1990 transfer of the home was a violation of the Act. The lower courts dismissed the action under the Act as being barred by the various statutes of limitation and the New Jersey Supreme Court agreed to hear the case.
Under the Act, a cause of action with respect to a transfer with intent to defraud is extinguished unless the action is brought either (i) within four years after the transfer was made or the obligation was incurred or, (ii) if later, within one year after the transfer was or could reasonably have been discovered by the claimant. N.J.S.A. 25:2-31(a). These time limitations are applicable to transfers which were made with "actual intent to hinder, delay or defraud." Constructive fraudulent transfers are handled by other sections of the Act.
The Court first considered whether the four year statute of limitations begins to run from the time of transfer or the date judgment was obtained. The Court had little difficulty concluding that the plain language of the Act established that the four year period begins to run from the time of transfer rather than the date of judgment. Courts in other jurisdictions have concluded that the statute begins to run from the time of judgment, but the New Jersey Supreme Court refused to adopt that view.
Under the Act, even if a creditor fails to bring an action within four years of the transfer, it may still bring an action at a later date so long as that action is brought "within one year after the transfer. . . was or could reasonably have been discovered by the claimant." The initial question was whether the obligation to act diligently to reasonably discover a transfer would be imposed upon the particular claimant (in this case SASCO) or whether it refers to any claimant in the chain of the transaction. It was held that the "critical question" is when a reasonable commercial creditor would have known about the transfer, rather than whether SASCO could, using reasonable means, have discovered the transfer. In the Court's mind, at the time of the default and acceleration in 1994, a reasonable commercial creditor (which was then ALI) should have conducted asset searches which would have revealed the transfer of the residence to Mrs. Zudkewich.
SASCO and various trade organizations who filed "friend of the court" briefs submitted evidence that commercial creditors would not perform an asset search on a guarantor until after the creditor obtained a judgment. The Court rejected this contention and noted that the industry standard is not necessarily determinative of how a reasonable creditor would behave. The Court felt that the industry position, which would encourage a creditor to file suit against a guarantor before determining whether the guarantor had any assets, simply encouraged potentially meaningless litigation. To go through the entire process of obtaining judgment against a guarantor which might be worthless, made no sense to the Court. It seemed reasonable to the Court that a creditor which had the full scope of information about the assets of a guarantor or other obligor would make an informed decision about how to proceed prior to bringing its litigation. If the obligor was "judgment proof," there might be no reason to bring the litigation. On the other hand, if there were substantial assets or if a potentially fraudulent transfer had occurred, the litigation would be brought accordingly.
Based on this analysis, the Court concluded that the underlying loan was in default in December 1994 and that a reasonable commercial creditor would have conducted an asset search at that time thus requiring that any complaint be filed alleging a fraudulent transfer by no later than December 1995. SASCO was several years late.
Because the case was one of "first impression" and because SASCO also reasonably relied on a practice which was apparently the dominant practice in the commercial lending industry, the Court concluded that it would be unfair to SASCO to apply its ruling retroactively. Thus, the holding of the Court is prospective only.
The effect of this decision may well be to impose additional financial and other burdens upon creditors in defaulted loan situations. Asset searches may be expensive but in order to protect themselves against being time barred under the Act, a prudent creditor will conduct asset searches on the obligated parties at the time of default. The Court was not clear whether the trigger for the one-year window is any default or whether there must be a default, acceleration of the loan and demand for payment. Under the facts of the SASCO case, there was a default, acceleration and demand for payment. Given the frequency of "technical" defaults which do not result in acceleration and the potential high cost of assets searches, it would truly be an unreasonable imposition upon creditors if the one year statute begins to run from the date of "technical defaults." However, the decision of the Court is not crystal clear on this point and leaves creditors in a quandary as to how to proceed. If the stakes are high enough, asset searches may be justified to protect against the possible running of the one-year time frame of the Act. Asset search firms may be the primary beneficiaries of the Court's holding.