Congratulations, You Hold A Judgment! But Have You Taken the Steps Necessary To Enforce It Should Your Judgment Debtor File Bankruptcy?

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When you take the trouble and expense to file a lawsuit, you hope to be paid after you obtain a judgment in your favor. However, the individual or entity against whom you obtained a judgment may have transferred assets to relatives or others before or during your litigation to try to shield those assets from your judgment lien. Even if you seek to recover those transfers, what happens if your judgment debtor files bankruptcy before you can collect on your judgment? After all, your lawsuit can often lead to your judgment debtor filing a bankruptcy case rather than paying your judgment. A judgment results in a lien in most states, and this lien gives a judgment creditor rights in property, much like a creditor who has a mortgage or a consensual security agreement with respect to specified types of collateral. Creditors with pre-existing consensual liens or security interests will generally have priority over your judgment lien. So, it is often the case that a judgment lien does not attach to any property without equity. Are you certain to get a distribution in a bankruptcy case when the trustee in the bankruptcy case obtains a recovery from the trustee’s own litigation efforts? Not necessarily.

Judgment Liens on Recoveries Obtained by a Bankruptcy Trustee and Choses in Action

In Matter of Hardin, 2021 WL 4484875 (Bankr. N.D. Ga. September 30, 2021), the Bankruptcy Court addressed a case in which the Debtor filed a Chapter 7 case after three of his creditors (collectively “Zurich”) obtained an $18 million judgment against him, and then filed suit to avoid the transfer of his home to his wife. The transfer of the home occurred after litigation with Zurich had commenced but before Zurich obtained a judgment. The Debtor had also transferred a farmhouse to his wife and an interest in a lake house. The Debtor also owned an 80% interest in a company (the “Executive Stock”) that obtained a contract to sell its office building after the judgment obtained by Zurich. Zurich had not sought a charging order (explained below) to attach its judgment lien to the Executive Stock. In the bankruptcy case, the Chapter 7 trustee subsequently filed a complaint against Zurich to seek a determination of the extent, validity, and priority of its judgment lien.

Before the bankruptcy filing, Zurich had sued to avoid the Debtor’s transfer of the home to his wife and also filed a motion to amend its complaint to include the transfers of the farmhouse and the lake house, but the Debtor filed bankruptcy while Zurich’s motion to amend was pending.

Long after the bankruptcy case was filed, while the trustee’s suit against Zurich was pending, the trustee settled the estate’s avoidance claims against the Debtor’s wife for $897,500. The Chapter 7 trustee’s claims against the wife were substantially similar to the causes of action that Zurich had sought to litigate individually prior to the bankruptcy case.

In the trustee’s suit against Zurich, the Bankruptcy Court addressed the Chapter 7 trustee’s request for a determination of the extent, validity, and priority of liens with respect to the Executive Stock, any proceeds realized upon the sale of the office building, and the settlement proceeds that the trustee had recovered on the Debtor’s transfers of the home, the farmhouse, and the lake house.

Under Georgia law, as in other states, “[a]ll judgments obtained in the … courts of this state … shall bind all the property of the defendant in judgment, both real and personal, from the date of such judgments except as otherwise provided in this Code.” O.C.G.A. § 9-12-80. However, judgments in Georgia do not automatically attach to choses in action, such as the right of a creditor to be paid on a debt, proceeds from contract performance, partnership interests or corporate stock.  See Prodigy Centers/Atlanta No. 1 L.P. v. T-C Assocs., Ltd., 269 Ga. 522, 501 S.E.2d 209 (1998); Fourth Nat. Bank v. Swift & Co., 160 Ga. 372, 127 S.E. 729 (1925)). Rather, a judgment creditor must take additional steps for a judgment lien to attach to a chose in action. In Georgia, a judgment creditor must commence a garnishment or similar collateral proceeding to attach a judgment lien to a chose in action. Before such a proceeding is filed, the judgment debtor is not prohibited from transferring a chose in action.

In Hardin, therefore, Zurich’s judgment lien did not attach to the Executive Stock. The Bankruptcy Court held: “Plaintiff correctly argues that Defendants’ judicial lien did not automatically attach to the Executive Stock or the proceeds from the sale of the office building… Hardin at *5.

As to the settlement proceeds on the Debtor’s pre-bankruptcy transfers of real property (effectively the same claims that Zurich was pursuing before the bankruptcy case was filed), while the Bankruptcy Court did not grant summary judgment to the Trustee, the Bankruptcy Court’s conclusions were very unfriendly to judgment creditors.

First, the Bankruptcy Court noted that a creditor’s action to avoid a prepetition transfer of a debtor’s property as fraudulent is stayed when a bankruptcy petition is filed. See In re Van Diepen, P.A., 236 F. App’x. 498, 503 (11th Cir. 2007) (citing In re Saunders, 101 B.R. 303 (Bankr. N.D. Fla. 1989) for the proposition that suits to recover fraudulent conveyances are stayed, and the trustee steps into the shoes of all creditors to pursue the property for their benefit, not just creditors who have won the race to judgment).

Next, in addressing the question of whether the judgment lien remains attached to property recovered by a trustee in a bankruptcy case, the Bankruptcy Court explained the trustee has the exclusive authority to recover fraudulent transfers, but the trustee will take the recovered property into the estate subject to any valid lien held on the property recovered as a result of the trustee’s avoidance action. Hardin at *5.

Because of Zurich’s assertion of an equitable lien, the Bankruptcy Court declined to grant summary judgment to the trustee. Zurich asserted that, because the Debtor’s fraud was the sole reason that Zurich was unable to perfect a statutory lien, an equitable lien was warranted. The key issue with respect to Zurich’s assertion of an equitable lien was whether some states’ laws allow a creditor who first found an alleged voidable transfer, and who sued pre-bankruptcy to avoid that transfer, has an “equitable lien” on any recovery of that transfer.

Although the Bankruptcy Court acknowledged that no party had fully addressed this argument and suggested that the existing case law would not support an argument that an equitable lien would arise as a result of one creditor being the first creditor (in a “race to the courthouse”) to seek avoidance of a transfer, the Bankruptcy Court ultimately decided not to rule on the issue of a possible equitable lien at the summary judgment phase of the proceedings.

In reaching its conclusion in Hardin, the Bankruptcy Court mentioned in dicta a similar case in which the Court had ruled against a judgment creditor, finding that it had not obtained a lien on transferred property.

In that case, In re Patel, 607 B.R. 765 (Bankr. N.D. Ga. 2019), a creditor, State Bank of Texas (“SBOT”) had obtained a judgment against Rajesh C. Patel (and two other co-defendants) in the amount of nearly $7 million and also obtained a judgment lien. When SBOT subsequently discovered that Patel was allegedly transferring his assets to friends and family to shield them from creditors, SBOT filed supplemental pleadings in the same federal court that had entered the money judgment, seeking to avoid Patel’s transfers under Georgia’s Uniform Fraudulent Transfers Act, O.C.G.A. § 18-2-70 et seq. (the “UFTA Claim”). However, before the district court could rule on the supplemental pleadings, Patel filed for bankruptcy. Id. at 767-68.

In Patel’s bankruptcy case, the Chapter 7 trustee filed a complaint seeking to avoid some of the same transfers by the debtor that had been challenged in SBOT’s pre-bankruptcy lawsuit. After extensive litigation and mediation, the Chapter 7 trustee reached a settlement of numerous causes of action against the alleged recipients of the transfers involved in SBOT’s UFTA Claim, and received $900,000.00 in settlement funds. The bankruptcy court concluded, however, that SBOT’s judgment lien did not attach to the settlement funds because SBOT’s UFTA Claim was tantamount to a chose in action that would have required SBOT to initiate a garnishment or other collateral proceeding in order to perfect a lien in SBOT’s favor.

Conclusion

The key takeaway from the Bankruptcy Court’s analysis in Hardin, and from the other cases analyzed in the opinion, is that creditors that have obtained judgments must take careful steps to obtain liens on not only hard assets of their judgment debtors, but also causes of action used to enforce those liens, or risk the possibility that any recovery on account of those actions by a trustee or creditors’ committee in bankruptcy will inure to the benefit of the bankruptcy estate and creditors generally, rather than to the judgment creditor.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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