Transferring Exempt Property May Not be a Fraudulent Transfer Under California Law
It is not uncommon for debtors to want to maximize the amount of property they get to keep to avoid creditor collection efforts, especially efforts to collect their personal residence. Generally, the California Uniform Voidable Transactions Act (UVTA) prohibits debtors from transferring ownership of their assets to family, friends, or legal entities so their creditors cannot collect.
However, the laws create a specific, statutory exclusion from fraudulent transfer claims for property that has no equity beyond an exemption, including transferring a personal residence subject to California’s homestead exemption. Such transfers may be entirely exempt from an attack as a fraudulent transfer in California court, also known as fraudulent conveyance, or voidable transaction. A skilled debtor and creditor rights attorney can help maximize exemptions while avoiding the disastrous consequences of a failed transfer of property.
The Language of California’s Uniform Voidable Transactions Act Excludes Exempt Property, Including a Personal Residence Subject to a Homestead Exemption
Under the California California Uniform Voidable Transactions Act (UVTA), creditors can attack as an actually fraudulent transfer a “transfer” made “With actual intent to hinder, delay, or defraud any creditor of the debtor” or “Without receiving a reasonably equivalent value in exchange for the transfer or obligation….” California Civil Code § 3439.04. Creditors can also seek to avoid as a constructively fraudulent transfer any “transfer” made “without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent at that time or the debtor became insolvent as a result of the transfer or obligation.” California Civil Code § 3439.05.
In turn, the definitions under the California Uniform Voidable Transactions Act provides that “‘Transfer‘ means every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with an asset or an interest in an asset, and includes payment of money, release, lease, license, and creation of a lien or other encumbrance.” California Civil Code § 3439.01(m).
Related thereto, the definitions under the California Uniform Voidable Transactions Act also provide that: “‘Asset’ means property of a debtor, but the term does not include the following: (1) Property to the extent it is encumbered by a valid lien. (2) Property to the extent it is generally exempt under nonbankruptcy law.” California Civil Code, § 3439.01(a).
What this means is that property exempted under California’s exemption laws is also generally excluded from the definition of an asset that can be subject to a claim that of being a fraudulent transfer.
Case Law Further Suggests that Transfers of Exempt Property are Excluded from the Laws on Fraudulent Transfers
As this exemption has been explained by one California court in 2019, “the [California] UVTA defines an asset as the ‘property of a debtor,’ excluding property ‘to the extent it is encumbered by a valid lien[,]’ and ‘to the extent it is generally exempt under nonbankruptcy law.’ ([California Civil Code] § 3439.01, subd. (a).) As noted by the Legislative Committee Comments, the definition of asset ‘requires a determination that the property is subject to enforcement of a money judgment. Under Section 704.210 of the Code of Civil Procedure, property that is not subject to enforcement of a money judgment is exempt.’ (Legis. Com. com., 12A pt. 2 West’s Ann. Civ. Code (2016 ed.) foll. § 3439.01, p. 253.)” Potter v. Alliance United Ins. Co. (2019) 37 Cal.App.5th 894, 906.
This decision follows a 1994 California court of appeal opinion: “It has long been the rule that a gift, sale, or pledge of any part of a homestead cannot, under any circumstances, be with intent to defraud a creditor not having a lien upon the premises, for a creditor is not entitled to complain of the transfer by the debtor of an asset which he could not have reached, had the debtor retained it. If the homestead is valid, no attempted disposition or conveyance of the property, however fraudulent, injures the creditor. For such act, whether effective or not, leaves the creditor in the same position in which he would have been before it was done. While defendant’s attempt to defeat his creditors is not commendable, such conduct neither enlarges plaintiff’s rights nor gives him benefits as punishment of defendant. In such circumstances the defendant’s motives are immaterial.” Tassone v. Tovar (1994) 28 Cal.App.4th 765, 768 (quoting Oppenheim v. Goodley (1957) 148 Cal.App.2d 325, 328).
“Mehrtash [v. Mehrtash (2001) 93 Cal.App.4th 75, 80] rightly affirmed the longstanding principle that injury-in-fact is an essential element of a claim under the UFTA [Uniform Fraudulent Transfer Act] , and we follow that principle in the present case. A creditor has not been injured unless the transfer puts beyond reach property the creditor could subject to payment of his or her debt.” Fidelity National Title Ins. Co. v. Schroeder (2009) 179 Cal.App.4th 834, 845.
The Fidelity court continued that: “Rather, we reiterate and adopt the following language of the Mehrtash opinion: ‘Even assuming the allegedly fraudulent conveyance were set aside and the property were hypothetically available to enforce the plaintiff’s money judgment, it could not be sold without a court order because it is the debtor’s dwelling, and could not be sold without a minimum bid equal to all encumbrances and senior liens plus the homestead exemption. The plaintiff produced no evidence that the value of the property could support any net recovery for her in the event the conveyance were set aside.’ (Mehrtash, supra, 93 Cal.App.4th at p. 81) Here, likewise, the evidence at trial showed that Fidelity could not have obtained any net recovery if the transfer were set aside and a forced sale of the property was sought.” Fidelity National Title Ins. Co. v. Schroeder (2009) 179 Cal.App.4th 834, 847.
A number of secondary sources have also discussed this requirement of an of an “injury” to creditor required to attack a transfer as fraudulent under California law. See Requirement of Injury to Creditor., 8 Witkin, Cal. Proc. 5th Enf Judgm § 497 (2020); 16A Cal. Jur. 3d Creditors’ Rights and Remedies § 406 (“A creditor has not been injured unless the transfer puts beyond the creditor’s reach property that he or she otherwise would be able to subject to the payment of his or her or her debt”); Prelawsuit Considerations, Cal. Prac. Guide Enf. J. & Debt (Rutter Group 2020) Ch. 3-C, 3:318.1 (“Mehrtash v. Mehrtash (2001) 93 CA4th 75, 81, 112 CR2d 802, 806—real property conveyance not fraudulent where plaintiff not injured (no evidence that value of property could support net recovery with mortgages, senior liens and homestead exemption)”).
Transferring a Home with No Equity May be Excluded from California’s Fraudulent Transfer Laws
The law is that: “A transfer in fraud of creditors may be attacked only by one who is injured by the transfer. A creditor does not sustain injury unless the transfer puts beyond his reach property which he otherwise would be able to subject to the payment of his debt.” Haskins v. Certified Escrow & Mortg. Co., (1950) 96 Cal. App. 2d 688, 691. Since a creditor would not have benefited from collecting on a debtor’s property with no equity, transferring such property should generally not be considered a fraudulent conveyance.
Transferring a Home After a 522(f) Motion to Avoid a Lien as Impairing an Exception in Bankruptcy Appears to be Excluded from Attack as a Fraudulent Transfer
One common strategy for debtors to address a recorded abstract of judgment that encumbers their house is to file a bankruptcy, followed by a motion to avoid the judgment lien as impairing their homestead exemption under 11 U.S.C. 522(f). In fact, various cases throughout the country establish that a homestead is protected under 522(f) despite the potential nondischargeability of a judgment lien recorded on the home. Related to this concept, a motion to avoid a lien under 522(f) is seemingly akin to a finding that a debtor’s personal residence has no equity for the creditor beyond the homestead exemption. Upon such a finding, a debtor may be entitled to transfer the property on the basis that it has no equity available for creditors without being subject to a state court attack by the creditor.
Note that research has yet to reveal whether bankruptcy courts in California would reach the same conclusion if a bankruptcy were filed after such a transfer. However, federal courts in California have cited Mehrtash with approval. See Avila v. Bank of America (N.D. Cal., Sept. 20, 2017, No. 17-CV-00222-HSG) 2017 WL 4168534, at *3 (“In order to state a claim, however, it is not enough to plead ‘[m]ere intent to delay or defraud.’ Mehrtash v. Mehrtash, 93 Cal. App. 4th 75, 80 (Cal. Ct. App. 2001). Rather, ‘injury to the creditor must be shown affirmatively. In other words, prejudice to the plaintiff is essential.’ Id. Injury in this context means ‘the transfer puts beyond [Plaintiff’s] reach property [he] otherwise would be able to subject to the payment of [his] debt.’ Id.”).
Transferring Homestead With No Equity Beyond an Exception to a Spouse May Not Be a Fraudulent Transfer under California Law
Related to this concept, sometimes, one spouse in a marriage may have a judgment against them or creditors seeking to collect from them. As a result, the spouses may decide to transfer the family home with no equity beyond the homestead exemption to the spouse without creditors. In turn, a creditor may challenge this transfer as a fraud. Thereafter, the spouse receiving the transfer would raise the defense that the transfer was lawful on the basis that the creditor cannot prove any injury as a result of the transfer. As Mehrtash v. Mehrtash, (2001) 93 Cal.App.4th 75, 79–80 explained: “Under some circumstances a creditor may sue to set aside a transfer of property by a debtor, where the transfer defrauds that creditor.” (Civ.Code, § 3439 et seq., the Uniform Fraudulent Transfer Act.) A well-established principle of the law of fraudulent transfers is, ‘A transfer in fraud of creditors may be attacked only by one who is injured thereby.’” Nonetheless, creditors can attack a transmutation as a fraudulent transfer pursuant to Mejia v. Reed.
Consult a Debtor and Creditor Rights Attorney to Understand the Lead on Transfers of Exempt Property
Even an innocent misstep in such a complex area of law can lead to disastrous consequences. Indeed, this blog post describes general principles that may vary in application to your matter. We highly recommend contacting a California real estate lawyer with experience in creditor’s rights and debtor’s rights to understand how to handle your situation.