California Court Finds Fraudulent Transfer to Non-Existent Corporation Shielded by Statute of Repose | Practical Law

California Court Finds Fraudulent Transfer to Non-Existent Corporation Shielded by Statute of Repose | Practical Law

A California appellate court recently held that an individual's attempt to shield his equity in real estate from creditors by fraudulently transferring a deed of trust and promissory note to a non-existent corporation cannot be challenged after the expiration of the statute of repose under the Uniform Fraudulent Transfer Act.

California Court Finds Fraudulent Transfer to Non-Existent Corporation Shielded by Statute of Repose

by Practical Law Real Estate
Published on 21 Aug 2017 • California
A California appellate court recently held that an individual's attempt to shield his equity in real estate from creditors by fraudulently transferring a deed of trust and promissory note to a non-existent corporation cannot be challenged after the expiration of the statute of repose under the Uniform Fraudulent Transfer Act.
On August 9, 2017, the 4th District for the California Court of Appeals issued its opinion in PGA West Residential Ass'n, Inc. v. Hulven Int'l, Inc. The case involved an individual who attempted to shield his equity in real estate assets from creditor claims by transferring a deed of trust and promissory note to a nonexistent corporation. The court held that creditors trying to prevent foreclosure by the sham corporation by claiming an invalid transfer were unable to do so because the Uniform Fraudulent Transfer Act prohibits such claims after expiration of its seven-year statute of repose. (.)

Background

The defendant, Dempsey Mork, purchased a condominium in 2003. In 2004, Mork executed and transferred a deed of trust and promissory note to a sham corporation, Hulven International, Inc., which at the time was not actually incorporated in any state. The deed of trust secured repayment of a fictitious loan with the condominium. Hulven was incorporated in Montana nine months after the transfer and was wholly owned and controlled by Mork. Hulven was involuntarily dissolved two years later.
Mork defaulted on the note by failing to make his first annual payment on January 1, 2005. Hulven never claimed default. The statute of limitations expired for any claim Hulven may have had against Mork in January 2009.
In 2011, PGA West recorded a judgment lien against Mork's condominium, which Mork promptly abandoned.
In 2012, the trustee for the deed of trust benefitting Hulven issued a notice of foreclosure sale of the condominium. The foreclosure sale was scheduled to take place in 2013. PGA West sued to stop the foreclosure sale and for declaratory relief that the deed of trust was invalid and did not create an interest superior to its judgement lien. Hulven claimed that PGA West's lawsuit was barred by the seven-year statute of limitations under the then titled Uniform Fraudulent Transfer Act (UFTA) (Cal. Civ. Code § 3439.09(c) and see Cal. Civ. Code §§ 3439 to 3439.14).
PGA West countered that the transfer of the deed of trust and note were not governed by UFTA because Hulven was a sham corporation that could not be a transferee.
The trial court held that the deed of trust was void and entered judgment for PGA West.
Hulven appealed, arguing that fraudulent transfers to sham entities are transfers under the UFTA governed by its seven-year statute of limitations. Hulven contended that PGA West filed its claim more than seven years after the transfer, and therefore its claim was extinguished. PGA West claimed there was no UFTA transfer because:
  • Hulven never existed and could not be a transferee under the UFTA.
  • Mork and Hulven were one and the same and had no distinguishable interest in the property.
  • The note and deed of trust never imposed a real obligation on Mork.
Accordingly, PGA West claimed UFTA's seven-year statute of limitations did not apply. PGA West further argued that Section 3439.09(c) of the California Civil Code did not implement a statute of limitations because it was not a substantive limit on its right of action.

Outcome

On appeal, the court held that the transfer of the deed of trust and note was a transfer governed by the UFTA, even though the corporation did not exist at the time of the transfer, and never existed as a corporate entity distinct from Mork.
The court found that:
  • The UFTA applies to all transfers, including those to sham corporations.
  • The UFTA creates a statute of repose rather than a statute of limitations.
The court explained the difference between a statute of limitations and a statute of repose:
  • A statute of limitations is a period beyond which actions may not be brought to prevent parties from having to defend against stale claims where the passage of time may obscure facts and create unfair handicaps. Statutes of limitations are procedural limitations that encourage plaintiffs to pursue claims diligently and are subject to statutory or equitable tolling. They begin to run based on the accrual of a cause of action.
  • A statute of repose is a legislative judgment that a defendant should be free from liability after a period of time and begins to run on the date of the last culpable act or omission of the defendant. The injury need not have occurred or have been discovered. A statute of repose does not depend on the accrual of a claim and can prohibit a cause of action from coming into existence. A statute of repose is a substantive limitation, rather than a procedural one, and is not subject to statutory or equitable tolling.
The court found that the UFTA provides an overarching, all-embracing maximum time period within which to contest fraudulent transfers. California Civil Code Section 3439.09(c) is worded so that a cause of action is "extinguished" if not brought within seven years, indicating that it was intended to be a statute of repose rather than a statute of limitations. By comparison, California Civil Code Sections 3439.09(a) and (b) contain no such extinguishing language and provide for a four-year statute of limitations.
The court noted the State Bar Business Law Section's concern that an early draft of the UFTA did not have an absolute termination date for claims of fraudulent transfers. Given that a great deal of time could pass before a creditor might discover the fraud, an absolute limit was necessary to provide creditors and debtors with certainty regarding potential liability. The bar committee recommended a ten year absolute deadline, which the Senate Judiciary Committee later shortened to seven years in the approved version of the legislation that was later signed into law.
The court also found that statutes of repose are not subject to forfeiture, unlike statutes of limitations, the protections of which are subject to forfeiture if not raised as an affirmative defense.
Accordingly, the court ruled that because PGA West's claim was subject to the UFTA, it was barred by the seven-year statute of repose.

Practical Implications

This opinion is significant for real estate lenders in California. Lenders should be aware that all transfers are subject to the seven-year statute of repose under the UFTA. Lenders should pursue all potential claims of fraud under the UFTA diligently.
The California legislature revised the UFTA and renamed it the Uniform Voidable Transfers Act effective January 1, 2016 after judgment was rendered, but this did not substantively affect the provisions of the statute applicable in this case.