The Impact of a Fraudulent Transfer on a Mortgage Lien and How to Minimize or Avoid the Consequences
It is not uncommon for a lender to fund a loan to property owned by one spouse. There exist many plausible reasons why one spouse only would be in title, including but not limited to estate planning, taxes, divorce, and protection against future creditors of the nontitled spouse. This article addresses the concerns a lender might have where the underlying transaction between the spouses constitute a fraudulent transfer under either state law or under section 548 of the Bankruptcy Code. Additionally, this article will explore the preventive measures a lender should take to avoid the impact a fraudulent transfer may have upon its lien.
Essentially, a fraudulent transfer occurs where there has been an inadequate conveyance of consideration for the transfer of one spouse’s interest in real property to another. Although this is not limited to transactions involving real property or for transactions as between spouses, for the purposes of this article, we will use a transfer of real property as between a husband and a wife as our example. An action to set aside a fraudulent transfer is generally brought by a creditor seeking to enforce its judgment against the nontitled spouse. The judicial remedy for a fraudulent transfer is an order that would set aside the transfer, which places title to the property back into the names of the husband and wife. The effect is that the rights of the judgment creditor to effectuate its lien to the judgment debtor’s interest has been restored. A tell-tail sign that a fraudulent transfer may have occurred is when the deed or related tax documents cite no consideration or nominal consideration.
The law of fraudulent transfer affect not only the rights of the immediate transferee, but also those of subsequent transferees and lien holders. This is best illustrated by a bankruptcy case entitled In re: Sandra Altmeyer, 268 BR 349 (W.D.N.Y., 2001). Frank and Sandra Altmeyer were the joint owners of certain real property by tenancy-by-the-entirety (the property). While owners of the property, both Frank and Sandra were encountering financial and marital difficulties. Sandra moved out of the property and Frank applied for a loan to refinance the property for the purpose of paying down his debts. The property appraised for $92,000, and the lender issued a commitment for $73,600. Prior to closing, a quit claim deed was prepared and executed by Sandra, which cited consideration of “one and no more dollars.” Of the $73,600 loaned, approximately $32,000 went to satisfy the previously existing mortgage, with the balance used to pay debts, approximately $17,000 of which were joint debts. At the time Sandra executed the quit claim deed, she was insolvent. Subsequently, Sandra filed for relief under Chapter 7 of the Bankruptcy Code. The Chapter 7 trustee appointed to the case commenced an adversary proceeding seeking an order: (1) to set aside the transfer of the property as between husband and wife; and (2) to set aside the mortgage lien on the property as against the wife’s equity interest in the property. After careful analysis and consideration, the court granted the trustee’s motion. As a result of this determination, the mortgage lien of the lender was voided to the extent it impaired the equity Sandra conveyed by execution of the quit claim deed. The court did not, however, impair the mortgage lien so far as it encumbered the original half interest of Frank. Although the court proceedings did not include the sale of the property, it seems likely that the lender did not get paid in full on its mortgage lien.
The court considered several factors in reaching its conclusion. In this case, New York law imposed a requirement of inquiry regarding real estate transactions that cite nominal consideration. The lender must make a reasonable inquiry into the solvency of the transferor at the time of the transfer. Additionally, the lender’s attorney prepared the quit claim deed. His knowledge as to the examination of title is attributed to the lender. Although nominal or no consideration might be indicative of a fraudulent transfer, it is not determinative of the issue. A transfer by a solvent transferor without consideration might not constitute a fraudulent transfer. As best stated by the court, “Prospective mortgagees are asked not to avoid all lending to those who acquire title for nominal consideration, but to make prior inquiry about its fraudulent character.”
The court proposes a practical solution for lenders to avoid this potential problem. To demonstrate good faith or to negate a suggestion of knowledge of a voidable transfer, the lender should first obtain an appropriate affidavit from the nontitled spouse confirming his or her solvency, that he or she have assets which are reasonably adequate as capital for any anticipated transactions or businesses, that he or she do not anticipate incurring debts beyond their ability to pay, and that he or she has no intent to hinder, delay, or defraud any person or entity to which he or she was or would become indebted.
A lender, by implementing a few simple procedures, may limit its entanglement with a fraudulent transfer situation. Ownership by only one spouse should raise a red flag to inquire as to the consideration paid for transfer of title. If the consideration for transfer of title between spouses is nominal, the lender should seek to obtain an affidavit from the nontitled spouse as to his or her solvency at the time of the transfer. For further protection, documentation to show solvency should be obtained and annexed. Additionally, lenders should advise their counsel to avoid the preparation of quit claim or other deeds as between the spouses unless an appropriate affidavit has first been obtained. Perhaps lender’s counsel should seek to oversee this procedure rather than chance having the borrower’s counsel prepare documentation that may later be determined as inadequate. A small amount of prevention will minimize the risk of having the mortgage lien voided.
Richard G. Gertler is a partner of the firm Thaler & Gertler, LLP, located in Westbury, New York, and concentrates his practice in the areas of real estate, commercial litigation, bankruptcy, and business law. His firm’s website is www.ThalerGertler.com.
© Copyright 2008, American Bar Association.