The Second Circuit wouldn’t allow a fraudster to use her own fraud to avoid a judicial lien on her home.
Rather than rely on the notion of unclean hands, the appeals court based its conclusion on the idea that fraudulent transfers are voidable, not void.
The Constructively Fraudulent Transfer
A woman owned a home worth about $800,000. In financial trouble, she transferred the home to her daughter and son-in-law for about $500,000. Later, a creditor obtained a judgment for some $480,000 and recorded the judgment in the county where the home was located.
The judgment creditor sued in state court to set aside the transfer as a fraudulent transfer under New York law. The daughter and son-in-law retransferred the home to the woman for no consideration. Six months later, she filed bankruptcy.
In bankruptcy, the woman moved to avoid the $480,000 judgment lien under Section 522(f). The section allows a debtor to “avoid the fixing of a [judicial] lien on an interest of the debtor in property to the extent that such lien impairs an exemption to which the debtor would have been entitled . . . .”
The judgment lien was seemingly voidable as an impairment on her homestead exemption because mortgages on the property and the homestead exemption exceeded the value of the property. However, Bankruptcy Judge Alan S. Trust of Central Islip, N.Y., denied the motion and was upheld on appeal.
Judicial Liens Must Attach to Property the Debtor Already Owns
The debtor appealed a second time, to lose again in the Second Circuit’s nonprecedential, per curiam opinion on February 25.
The appeals court was able to rest its opinion on venerable authority, not simply notions of equity.
By referring to the “fixing” of a lien, the Supreme Court reasoned in Farrey v. Sanderfoot, 500 U.S. 291 (1991), that a lien on a homestead can be avoided under Section 522(f) only if the lien attached after the debtor acquired the property.
Building on Farry six years later, the Second Circuit dealt with a case where the creditor had docketed a judgment before the debtor had acquired the property. When the debtor bought the property, the judgment lien attached simultaneously. The Second Circuit held that the judicial lien could not be avoided if the lien attached simultaneously with the debtor’s acquisition of an interest in the property. In re Scarpino, 113 F.3d 338 (2d Cir. 1997).
The Second Circuit said that the lower courts properly relied on Scarpino in denying the motion to avoid the judicial lien. The debtor, however, raised a clever argument.
No Benefit from Your Own Fraud
The debtor contended that she retained an equitable interest in the property after the fraudulent transfer. In substance, the debtor argued that her transfer was void ab initio, not merely voidable.
The Second Circuit called the argument “specious.”
“Although there is language in some older decisions” supporting the idea that a fraudulent transfer is void ab initio, the Second Circuit said that “the weight of modern decisions indicates fraudulent conveyances in New York are voidable, not void.”
Given that the debtor’s constructively fraudulent transfer was not void ab initio, the appeals court upheld the lower courts because the judicial lien attached simultaneously with the debtor’s acquisition of an interest in the home.
The Second Circuit wouldn’t allow a fraudster to use her own fraud to avoid a judicial lien on her home.
Rather than rely on the notion of unclean hands, the appeals court based its conclusion on the idea that fraudulent transfers are voidable, not void.
The Constructively Fraudulent Transfer
A woman owned a home worth about $800,000. In financial trouble, she transferred the home to her daughter and son-in-law for about $500,000. Later, a creditor obtained a judgment for some $480,000 and recorded the judgment in the county where the home was located.
The judgment creditor sued in state court to set aside the transfer as a fraudulent transfer under New York law. The daughter and son-in-law retransferred the home to the woman for no consideration. Six months later, she filed bankruptcy.
In bankruptcy, the woman moved to avoid the $480,000 judgment lien under Section 522(f). The section allows a debtor to “avoid the fixing of a [judicial] lien on an interest of the debtor in property to the extent that such lien impairs an exemption to which the debtor would have been entitled . . . .”