A Good Faith Defense Exists to a Fraudulent Conveyance Action

The Uniform Fraudulent Transfer Act set forth in California Civil Code § 3439, et seq., has been renamed the Uniform Voidable Transactions Act, but it still makes voidable a fraudulent conveyance of real property, which is a transfer by the debtor of property to a third person undertaken with the intent to prevent a creditor from reaching that interest to satisfy its claim.  If a transferee or obligee took in good faith and for a reasonably equivalent value, however, the transfer or obligation is not voidable. (Civil Code § 3439.08(a), the "good faith defense".)

Whether a transfer is made with fraudulent intent and whether a transferee acted in good faith and gave reasonably equivalent value within the meaning of

§ 3439.08(a) is a question of fact.  The transferee, seeking to assert the good faith defense under § 3439.08(a), has the burden of proving that subdivision's applicability by a preponderance of the evidence (i.e., more likely to be true than not true).

A transferee cannot avail itself of the good faith defense if the transferee:

had fraudulent intent,

colluded with a person who was engaged in a fraudulent conveyance,

or actively participated in a fraudulent conveyance,

or had actual knowledge of facts showing knowledge of the transferor's fraudulent intent.

In the recent case of Nautilus v. Yang, the court of appeal reviewed a trial judgment involving a transfer of real property ("Property") from two brothers to their father with no consideration paid by the father, who then obtained a reverse mortgage from Security One Lending, which subsequently sold the mortgage to Urban Financial.  Unknown to both Security One and Urban Financial, Nautilus had obtained a judgment against one of the brothers, and recorded an abstract of judgment against the Property.  A title company provided a preliminary title report to Security One, but the title company failed to realize that the abstract affected the Property.  The proceeds of the reverse mortgage were used to pay-off the existing liens against the Property in the amount of $308,576.72.

The parties agreed that there was no evidence that Security One or Urban Financial had actual fraudulent intent, actually colluded with the debtor brother to defraud Nautilus, or actively participated in the fraudulent scheme.  The appellate court framed the issue on appeal as whether there is evidence showing Security One or Urban Financial had actual knowledge that the transferor had fraudulent intent.

Constructive knowledge or inquiry notice is not sufficient to defeat the good faith defense.   There must be evidence of actual knowledge of facts by the transferee showing the transferor had fraudulent intent.

In the Nautilus case, the appellate court concluded that Security One and Urban Financial, based on the facts known to them, did not have actual knowledge of the transferor's fraudulent intent when making the reverse mortgage loan because:

a.         They did not know of the abstract of judgment before the reverse mortgage was funded or sold to Urban Financial, as that was the fault of the title company alone;

b.         The transfer from the brothers to their father, a family member, that was not made in exchange for financial consideration, was insufficient to defeat the defense because that is common in many reverse mortgage loan situations;

c.          It was insufficient that the reverse mortgage funds were to be used to pay off a preexisting judgment lien against one of the brothers by a creditor other than Nautilus because Security One and Urban Financial did not have a duty to conduct further inquiry merely because of the brother's previous litigation; and

d.           In our litigious society, commerce quickly would grind to a halt if every buyer had an affirmative duty to conduct an independent inquiry prior to purchasing an asset merely because the seller was involved in litigation or otherwise was accused of wrongdoing.

This case illustrates the value of the good faith defense to a fraudulent conveyance claim, if the transferee can prove it did not have actual knowledge of the transferor's fraudulent intent.

Successor in Interest After Foreclosure Can Evict Tenant With 90 Day Notice

The general rule is that foreclosure of a senior encumbrance terminates subordinate (i.e., filed later in time) liens, including leases.  An exception to the general rule is contained in California Code of Civil Procedure section 1161b.

Section 1161b, subsection (b)(1), provides that tenants in possession of a rental premises under a fixed-term residential lease can remain until the end of the lease term, and all of their rights and obligations under the lease survive the foreclosure sale.

However, it also provides that such tenants can be evicted if they are served with a 90 day written notice to quit by the purchaser at the foreclosure sale, or its successor in interest, if the purchaser or successor intend to occupy the premises as a primary residence.

The question is: Who is included in the term "successor in interest"?  That term is not defined by section 1161b.  There can be differing interpretations because "successor in interest" is not qualified by terms like "immediate", "ultimate", or "eventual".

Recognizing that the legislature did not specifically limit the exception under section 1161b to one specific successor in the chain of title, the court in the recent case of Epps v. Lindsey decided that the term "successor in interest" is not limited to the purchaser's immediate successor in interest, but to "the" ultimate or most significant successor in interest who then-owns the property intending to reside there, and who serves the 90 day notice to quit. 

In Epps v. Lindsey,  Bank of America foreclosed on its loan, and the parents of Joshua Epps purchased the property for Epps who lacked the cash to make a bid himself.  A month later, the parents transferred the property to Epps who intended to use it as his primary residence.

After Epps served the tenant in the property with a 90 day notice to quit, the tenant refused to vacate the property, and an unlawful detainer action was filed by Epps.  The tenant contended he was able to remain in the property for the duration of the lease.  Epps contended he was a successor in interest to the foreclosing Bank of America, even if the property was owned by his parents in the interim.

In ruling that Epps was a "successor in interest" under section 1161b, the Court saw no problem with allowing a successor in interest that is two steps removed from the foreclosure sale from exercising the same rights afforded under section 1161b to the "purchaser" or the purchaser's immediate successor. 

The Court determined that section 1161b was enacted in-part to address the concern that unsuspecting tenants were being evicted despite paying their rent.  The statute's exception for a 90 day notice to quit suggests the legislature intended to give the post-foreclosure owner, who doubles as a would-be resident, preference over a non-defaulting tenant whose interest would have otherwise been extinguished by the foreclosure sale.   

Caveat:  To get the benefit of this statute, none of the owners after the foreclosure sale can accept any rent tendered by the tenant because acceptance of the rent would confirm the owner's consent to the written lease that still had time remaining before it expired.