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Let’s Continue Discussing the Michigan Uniform Fraudulent Transfer Act

Last month, we started discussing a scenario involving a plaintiff with a judgment against the now defunct Darn Debtor, Inc. (“Debtor”). The judgment debtor’s majority shareholder, Ina Insider (“Insider”), received cash and equipment from Debtor when it liquidated its assets. The plaintiff has decided to bring a claim against Insider under MCL 566.35(2) of the Michigan Uniform Fraudulent Transfer Act (“MUFTA”) on the theory that the debtor made a transfer to an “insider” for an antecedent debt, at a time when Debtor was insolvent and Insider had reasonable cause to believe Debtor was insolvent.

To recap the facts, Insider kept Debtor alive with loans secured by the company’s assets. Insider perfected her security interest after she began making loans to Debtor but at a time when Debtor was paying all of its operating expenses and debts (other than Insider’s loans). When Debtor failed, Insider assumed the company’s other liabilities, whose value far exceeded the value of the assets transferred to Insider. In addition, although the plaintiff obtained its judgment after Debtor transferred the cash and equipment to Insider, the judgment was based on Debtor’s breach of contract that occurred before Insider’s security interest was perfected.

Where will the battle lines be drawn on the plaintiff’s MUFTA claim? First, let’s examine why the plaintiff will feel confident of prevailing.  Insider is an “insider” because of her majority shareholder status in Debtor. See MCL 566.31(g)(ii)(C). Insider’s loans to Debtor predated the perfection of her security interest and receipt of the cash and equipment, making the transfers on account of antecedent debt. See MCL 566.33(1). Debtor was technically insolvent at the time of the transfer because its debts, including Insider’s loans, exceeded the fair value of the company’s assets, which Insider had reasonable cause to know as the majority shareholder. See MCL 566.32(1). Finally, the plaintiff’s claim against Debtor arose before the fraudulent transfer, because Debtor breached its contract with the plaintiff before Insider perfected her security interest and received the cash and equipment. See MCL 566.31(c).

Insider tells her attorney she must have a valid defense to the plaintiff’s claim because she gave value to Debtor by virtue of her loans and assumption of Debtor’s liabilities after liquidation, the value of which far exceeded the value of the cash and equipment she received. Unfortunately for Insider, one of the advantages of bringing a claim under MCL 566.35(2) is that it does not matter if the insider provided the debtor with “reasonably equivalent value,” as that is only a defense to other claims under other sections of MUFTA.

Insider’s attorney has more bad news. Insider wants to argue there was no “transfer” because that requires an act of disposing of an “asset,” which by definition does not include “property to the extent that it is encumbered by a valid lien.” See MCL 566.31(l) and MCL 566.31(b)(i). However, this argument will likely fail because MCL 566.31(l) provides that there is a “transfer for value” because Insider’s antecedent debt was later secured.

Insider would also appear to be out of luck under MCL 566.38(6), which provides that a transfer is not voidable under MCL 566.35(2) if the “insider gave new value to the debtor after the transfer was made unless the new value was secured by a valid lien.” Insider’s problem here is that while she continued to loan money to Debtor after perfection of her security interest, those new loans were also secured by that lien. Insider can try to argue that by assuming the company’s other liabilities after the liquidation she gave new value that was not secured by a lien. While this argument makes logical sense, the problem is that the “transfer” took place when Insider’s security interest was perfected, not when she received Debtor’s cash and equipment after liquidation.

It is looking bleak for Insider, however, she is not down for the count just yet. Insider can argue Debtor was not insolvent when she perfected her security interest, because the company was servicing all of its debts (other than her loan) at that time. See MCL 566.32(2)(which provides another definition of insolvency as a “debtor who is generally not paying his or her debts as they become due …”) If Insider’s loans were evidenced by a demand note, with no fixed payments of principal and interest, under this statutory provision Debtor was arguably not insolvent when Insider’s security interest was perfected. This argument would be further bolstered if (i) Debtor’s balance sheet also shows that when Insider’s secured loan is omitted from Debtor’s liabilities, its assets exceeded its liabilities, and (ii) if Insider could truthfully say that Debtor appeared to be on the verge of landing new business that would have improved its bottom line. Those facts would also support an argument that Insider did not have a reasonable belief that Debtor was insolvent when she perfected her security interest.

The prospect of these arguments preventing the plaintiff from obtaining summary disposition on her MCL 566.35(2) claim could give Insider (and the Court) some settlement leverage.

In our December blog, we noted that the claim above is one of four that the plaintiff could bring under MUFTA. We will analyze the other three potential MUFTA claims in future blogs.

For more information regarding the Michigan Uniform Fraudulent Transfer Act, please contact Kenneth Neuman directly at Kneuman@neumananderson.com.