The Statute of Limitations Under the Uniform Fraudulent Transfer Act: New Jersey’s View

Title:
The Statute of Limitations Under the Uniform Fraudulent Transfer Act: New Jersey’s View
Publication:
The Banking Law Journal
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Although New Jersey adopted its version of the Uniform Fraudulent Transfer Act (the "Act") in 1988, it was not until March, 2001 that New Jersey courts were called upon to interpret the important statute of limitations provisions of the Act. Beginning with the decision of the Supreme Court of New Jersey in Sasco 1997 NI, LLC v. Zudkewich, ("Sasco")1, the New Jersey courts, in rapid fire succession, addressed this or similar issues in three separate cases. The decisions, in particular Sasco, interpreted the one year "tolling" provision of N.J.S.A. 25:2-25 in a manner which imposes heavy burdens on creditors in order for them to take advantage of that window of opportunity. It will take some time for New Jersey creditors to fully sort out the long term impact to these decisions but, in the short run, certain changes in day-to-day practices may be necessary.

Fraudulent Conveyance Law

In adopting the Act in 1988, New Jersey replaced the previously existing Uniform Fraudulent Conveyance Law. The Act was intended to prevent a debtor from placing his or her property beyond a creditor's reach. Gilchinski v. National Westminster Bank.2 Under the Act, fraudulent conveyance claims are permitted to allow creditors to undo transactions which are deemed "wrongful" so as to bring transferred property within the "ambit of collection."3 The Act has been adopted by at least 39 states and the District of Columbia and was in response to perceived deficiencies in the predecessor statute, the Uniform Fraudulent Conveyance Law, under which there were great discrepancies in interpretation nationwide as to statutes of limitations applicable to the avoidance of fraudulent transfers. To remedy those inconsistencies, the National Conference of Commissioners on Uniform State Laws recommended a uniform statute of limitations and such was included in the Act. The Act defines two categories of fraudulent transfer. There are those transfers made by a debtor with actual intent to "hinder, delay or defraud" any creditor of the debtor.4 This action is the so-called "actual" fraud provision. The Act also characterizes as fraudulent those transfers made where the debtor does not receive reasonably equivalent value in exchange if at the time of the transfer the debtor is effectively insolvent.5 This section is often referred to as the "constructive" fraud provision. There are limits on the amount of time creditors have under the Act to institute an action to set aside an alleged fraudulent transfer and N.J.S.A. 25:2-31 sets forth the Act's statutes of limitation. The time periods vary depending upon whether the allegation is that the transfer was made with actual intent to defraud or whether the transfer is alleged to be constructively fraudulent as a result of the inadequacy of consideration and the debtor's poor financial condition at the time of the transfer. As to transfers involving allegations of actual fraud, a cause of action with respect to such a transfer is "extinguished" unless the action is brought within "four (4) years after the transfer was made or the obligation was incurred, or, if later, within one (1) year after the transfer or obligation was or could reasonably have been discovered by the claimant."6 It is this "tolling" provision which was a major focal point of the recent New Jersey cases.

Sasco

In this case, the New Jersey Supreme Court interpreted for the first time the statute of limitations provisions of the Act. 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 trial court 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 trial court 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. 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. 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.7 The Court next turned to whether Sasco may still bring its action because it was brought within one year after the transfer "was or could reasonably have been discovered by" Sasco. 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 New Jersey 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.

Other Recent New Jersey Fraudulent Transfer Cases

Since the March 1, 2001 opinion of the New Jersey Supreme Court in Sasco, the courts have had two other occasions to further consider the various time frames under New Jersey law for bringing actions established by the Act.

Caldeira

In State of New Jersey Department of Environmental Protection v. Caldeira,8 the Appellate Division of the New Jersey Superior Court considered whether an action brought by the New Jersey Department of Environmental Protection ("DEP") against former owners and operators of a landfill was timely under the Act. The facts are somewhat complicated but, in essence, they revolve around certain transfers of corporate ownership interests by Joseph J. Caldeira, Sr. to his son, as well as the forgiveness by a corporate affiliate of certain obligations owed to it by the former corporate operator of the landfill. The landfill in question was under supervision for closure by DEP for many years and, as part of that process, the operators, including Caldeira, Sr., filed various reports with the New Jersey Board of Public Utilities ("BPU"), which was the regulatory body initially charged with overseeing such matters. At some point, the regulatory oversight of the closure of landfills was transferred from the BPU to DEP. In various documents provided by the landfill operators, it was clearly disclosed that in 1989 Caldeira., Sr. transferred his ownership interests in the corporate owner of the landfill to his son and there were recitations of the consideration for the transfer. Subsequent sworn statements by Caldeira, Sr. further revealed the transfers to DEP. In 1993, Caldeira, Jr. transferred certain shares of stock he held in a related entity to an unrelated corporate entity which ultimately also acquired certain of the corporate assets of several of the entities originally controlled by Caldeira, Sr. In 1997, DEP commenced enforcement proceedings against the landfill operator and against Caldeira, Sr., individually and as owner. However, it was not until April, 1999, that DEP commenced the fraudulent transfer action which is the underlying basis for the appeal. In addition to naming in that action all of the various related entities owned and controlled by the Caldeira family, the DEP also named as defendant a subsequent unrelated transferee, seeking to compel an accounting by that defendant for any and all property received and for all proceeds arising from the transactions complained of. An initial question considered by the Court was whether DEP, as an agency of the State of New Jersey, was entitled to the benefit of the general ten year statue of limitations which is granted by New Jersey law to the State of New Jersey and any of its political subdivisions rather than the four year period set forth in the Act.9 DEP argued that the statue of limitations provisions of the Act should not apply because it could not be shown that a shorter time limitation "expressly and specifically" applied to DEP, as is required under prior case law considering statute of limitations issues involving the State of New Jersey. The Court considered these prior cases, and easily concluded that the Act "expressly and specifically" provides a four year limitation provision applicable to all fraudulent transfer claims by the DEP, and a one-year tolling provision for certain types of claims. It concluded that DEP is a "creditor" under the Act because it is a "person [with] a claim"10 and a "person" includes the "government or governmental subdivision or agency…."11 Because the New Jersey Legislature adopted the Act before the New Jersey courts and legislature had abrogated the doctrine that "no time runs against the king,"12 the Act was viewed as a specifically intended override of that judicial and legislative doctrine. Accordingly, the Court concluded that there was no indication that a different time limitation should be applicable to the DEP than to any other "person" bringing a claim under the Act. The Court had little sympathy for the DEP's arguments that, due to budgetary constraints, it had no ability to adequately monitor all of the situations under its jurisdiction. Having concluded that certain portions of DEP's actions were time barred by the four year statute of limitations of the Act, the Court next turned to consider whether DEP could take advantage of the one year tolling provision. Relying on Sasco, the Court believed that an aggrieved creditor under the Act, even the DEP, must act with "reasonable diligence" within one year after the transfer "was or could reasonably have been discovered." Given all of the information which DEP had within its files regarding the transfer of the ownership interest by Caldeira, Sr., the Court barred certain portions of the DEP claims as being outside of the one year tolling provision. Certain other transfer claims were allowed to continue and be litigated, as there was no evidence that DEP had any information in its files as to such transfers. A final point considered by the Court was whether the lower court's dismissal of an unrelated third-party transferee of certain assets was proper. The DEP argued that the transferee, as the ultimate holder of the transferred assets subject to the fraudulent transfer claim, was a necessary party to the action because its interest in the transferred assets could well be effected by the outcome of the litigation if the transferee could not demonstrate it paid reasonable value for such assets. The lower court concluded that the transferee was not a proper party. The Appellate Division reversed stating that a cause of action did exist against the transferee and the Act allows the "avoidance" of fraudulent transfers, as well as other remedies, against all transferees subject to any defenses that the transferee may have under the Act.13 The Act provides a transferee with a defense if the transferee took the transferred asset "in good faith and for reasonably equivalent value."14 The burden of proof in establishing that the transferee took the assets subject to this standard, is upon the transferee.15 Accordingly, among other issues remanded for further consideration, was the question of whether the transferee could establish the affirmative defense that it took the transferred assets "in good faith" and "for reasonably equivalent value."

Bernstein

In re Bernstein,16 a bankruptcy case decided March 13, 2001, considered whether a fraudulent transfer action under the Bankruptcy Code was barred by the statute of limitations of the Act. The case involved a challenge by the trustee in bankruptcy to the transfer by Douglas Bernstein of his interest in the marital residence to his spouse for no consideration. The transfer occurred and the deed was recorded on January 25, 1996, which was approximately four years and one month prior to the filing of the bankruptcy petition by Douglas Bernstein. The bankrupt argued that because the transfer occurred outside of the four year statute of limitations of the Act, the trustee could not bring the action. The trustee responded by contending that, under prior case law, the statue of limitations of the Act was severed from the Act and rendered inoperative as to bankruptcy cases.17 The trustee relied upon the avoidance powers under Section 544(b) of the Bankruptcy Code and urged that irrespective of when the debtor made the transfer to the defendant, an action may be brought by the trustee so long as it was brought within two years of the bankruptcy filing.18 As an alternative argument, the trustee argued that it may avoid any transfer of an interest of the debtor in property that is voidable under applicable state law by a creditor holding an unsecured claim as of the commencement of the case. Because the trustee alleged that there was at least one creditor who had extended credit to the debtor within one year of the bankruptcy filing, as to that creditor, the cause of action was not to be extinguished as of the petition date and, therefore, the trustee could stand in that creditor's shoes under Section 544 of the Bankruptcy Code. The Court began by analyzing a trilogy of New Jersey cases which considered similar questions.19 Based on these cases, the Court rejected the trustee's contention that, under Sections 544(b) and 546(a) of the Bankruptcy Code, an action will be timely by the trustee so long as it is brought within two years of the filing date. Rather, the Bankruptcy Court concluded that the correct interpretation of those sections was that the trustee must have commenced suit within two years of appointment on a cause of action which was, itself, available under applicable law on the date that the bankruptcy petition was filed.20 In this case, the four year statute of limitation under the Act had run prior to the filing of the bankruptcy petition by the debtor. This did not completely dispose of the trustee's argument. The trustee further argued that, based on prior bankruptcy court cases which interpreted the statute of limitations provision of the Act, such provision was preempted and severed from the Act by the limitation provisions of the Bankruptcy Code.21 If such an argument were adopted, the only time limitation on the trustee's bringing of an action would be those set forth in the Bankruptcy Code, i.e., two years of the date of filing of the bankruptcy petition. Again, the Court was not persuaded by the trustee's reasoning. Based on the prior cases which interpreted the statute of limitations provision of the Act, the Court concluded that the Act's statute of limitations is severable once a bankruptcy petition is filed only if that statute of limitation had not previously expired before the bankruptcy filing. Stated differently, if the creditor in whose place the trustee stands under Bankruptcy Code Section 544(b) had no right to sue on the bankruptcy filing date because the cause of action had expired, then the trustee will similarly have no right to sue. Finally, the Court addressed the trustee's argument that even if the four year statute of limitations provisions of the Act had expired before the petition was filed, the trustee may still prosecute the action under the one year tolling provision of the Act. The trustee reasoned that if there was at least one unsecured creditor with a claim that arose within one year of the petition date, that creditor might be in a position to establish that it could take advantage of the tolling provision which provides that a fraudulent transfer action may be brought within one year after a transfer was or could reasonably have been discovered by that claimant. Here the trustee had more success. Relying upon Sasco, the Court reasoned that if there is at least one unsecured creditor with a claim that arose within one year of the petition date and that unsecured creditor could establish that it meets the criteria for the one year tolling provision, then the trustee's complaint could be timely under section 546(a) of the Bankruptcy Code. Therefore, the bankrupt's motion to dismiss the complaint in its entirety was not granted and the trustee was provided with the opportunity to establish that the unsecured creditor referred to in its complaint could have availed itself of the one year tolling provision of the Act to file a timely complaint as of the petition date.

CONCLUSION

With the three cases described in this article, the New Jersey courts have provided guidance as to their interpretation of the statute of limitations provisions of the Act. The Sasco case will likely lead to further litigation as to, in particular, whether the obligation described by the Court to conduct asset searches will be triggered by any default or whether a default and acceleration will be required. Certainly, the lending community would urge the latter interpretation as otherwise there would be complete uncertainty as to when the limitation period would begin to run. In Caldeira, the Court provided important clarity to the Act's application in situations involving New Jersey state agencies. To the extent there was any confusion as to whether the State of New Jersey was subject to the ten year statute or the Act's specific statute, the Court put such confusion to rest. In Bernstein, the interplay between the statute of limitations provisions of the Act and the time frames for bringing actions by a trustee under the Bankruptcy Code was reconciled and confirmation was provided that the cause of action must be available under the Act at the time of the filing of the bankruptcy petition in order for the trustee to take advantage of these provisions under the Bankruptcy Code. While the ultimate conclusions of the cases are not free from controversy, they do go a long way towards providing direction to New Jersey practitioners.

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1. 166 N.J. 579 (2001). 2. 159 N.J. 463, 475 (1999). 3. Gilchinski, supra, at 475. 4. N.J.S.A. 25:2-25. 5. N.J.S.A. 25:2-25b. The Act requires that, in addition to not receiving reasonably equivalent value for the transfer, at the time of the transfer the debtor:

(i) was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction;
or
(ii) intended to incur, or believed or reasonably should have believed that the debtor would incur, debts beyond the debtor's ability to pay as they came due. N.J.S.A. 25:2-25b.

6. N.J.S.A. 25:2-31a. The limitations period for constructively fraudulent transfers is four years after the transfer was made and there is no further one year tolling period as to such transfers. N.J.S.A. 25:2-31b. 7. See, e.g., Cortez v. Vogt, 60 Cal. Rptr. 2d 841, 843 (Cal Ct. App. 1997); Eskridge v. Nalls, 852 P.2d 818, 820 (Okla. Ct. App. 1993).

8. 338 N.J. Super 203 (App. Div. 2001). 9. N.J.S.A. 2A:14-1.2 provides that except as expressly and specifically set forth in other laws, any civil action commenced by the State of New Jersey must be brought within ten years after the cause of action accrues. 10. N.J.S.A. 25:2-21 11. N.J.S.A. 25:2-22 12. The doctrine of nullum tempus occurit reg. 13. N.J.S.A. 25:2-30 14. N.J.S.A. 25:2-30b(1) and (2). 15. Resolution Trust Corp. v. Spagnoli, 811 F. Supp. 1005, 1016 (D.N.J. 1993) 16. 259 B.R. 555 (Bankr. D.N.J. 2001) 17. Relying on First Union National Bank v. Gibbons (In re Princeton - New York Investors, Inc. ("Princeton III"), 255 B.R. 366 (Bankr. D.N.J. 2000) 18. 11 U.S.C. § 546(a). 19. In re Princeton-New York Investors, Inc., 199 B.R. 285 (Bankr. D.N.J. 1996);
In re Princeton-New York Investors, Inc., 219 B.R. 55 (Bankr. D.N.J. 1998); and
In re Princeton-New York Investors, Inc., 255 B.R. 366 (Bankr. D.N.J. 2000) 20. The Court relied on In re Princeton-New York Investors, Inc., 199 B.R. 285 (Bankr. D.N.J. 1996) which quoted from In re Dry Wall, 111 B.R. 933, 936 (Bankr. D. Colo. 1990) which stated:

[As] long as the state law statute of limitation has not run before the debtor's filing for bankruptcy, the trustee can bring a fraudulent conveyance action as long as he complies with the provisions of Section 546(a).

21. Princeton III, supra; 11 U.S.C. § 546(a).