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.