Debtor May Prefer a Creditor, Even Out of Spite

A debtor with multiple creditors is allowed to “prefer one creditor over another by way of sale, mortgage, or the giving of security to others even if the debtor’s intentions toward the nonpreferred creditor are spiteful and the action will delay or prevent the nonpreferred creditor from obtaining judgment.” The Iowa Court of Appeals recently affirmed this conclusion in Travelers Indemnity Co. v. D&L Resources, LLC, No. 15-0083 (Sept. 28, 2016), citing authority over twenty years old, Benson v. Richardson, 537 N.W.2d 748, 757 (Iowa 1995).

In Travelers, debtor Franzen Inc. obtained a judgment against Travelers in an amount over $500,000. Travelers attempted to execute the judgment by using Iowa Code section 630.16, which allows a creditor to subject the debtor’s property to satisfy a judgment, including adding persons indebted to the debtor as defendants. Travelers sought to prove that Franzen Inc. engaged in fraudulent conveyances and still owned property that had purportedly been transferred.

To establish a fraudulent conveyance, Travelers had to, with clear and convincing evidence, prove the debtor’s transfer of property without consideration, and prove that the transfer prejudiced Travelers.

The trial court held, and the appellate court agreed, that Travelers had not met its burden. Although there had been a series of complicated transfers among related entities which left Franzen without assets, Travelers failed to prove that the transfers were made without consideration. The appellate court specifically addressed a $3 million transfer from Franzen Inc. to a related entity.  The transfer was not a fraudulent conveyance, because there was “no dispute” that the related entity was a creditor, and had been a creditor before Traveler obtained its judgment. A debtor is allowed to “prefer one creditor over another … even if the debtor’s intentions … are spiteful.” Moreover, Travelers failed to establish prejudice from the transfer, because Franzen had actually been insolvent at the time Travelers started its relationship with Franzen, and Franzen was insolvent when the judgment was entered. Thus, Travelers would not have been able to satisfy its judgment, even if the transfer had not been made.

As for additional transfers to another entity, Travelers suggested that transfers in exchange for promissory notes rendered the transfers fraudulent. The appellate court, however, first held that “promissory notes themselves constitute consideration.”  Moreover, it was not enough for Travelers to suggest with circumstantial evidence that the promissory notes were illusory; Travelers had to meet its burden and prove with clear and convincing evidence that the notes were a sham. Having failed to do so, the Court of Appeals affirmed the judgment of the trial court.

Travelers demonstrates the difficulty of meeting the evidentiary burden required to prove a fraudulent conveyance, even in light of multiple transfers among related entities. For further information regarding collections actions, contact Mollie Pawlosky.

The material in this blog is not intended, nor should it be construed or relied upon, as legal advice. Please consult with an attorney if specific legal information is needed.

- Mollie Pawlosky