Policyholder’s Release of Bad Faith Failure to Settle Claim Held Voidable as a Fraudulent Conveyance

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In Potter v. Alliance United Ins. Co. (No. B287614; filed 7/23/19), a California appeals court held that an insolvent policyholder’s judgment creditor could void a release of bad faith claims given by the policyholder to his insurer as a fraudulent conveyance under the Uniform Voidable Transactions Act (UVTA). (Civ. Code, §§ 3439 et seq.)

Potter was injured by Alliance United Insurance Company’s (AUIC) insured Jesus Tovar in an auto accident. Potter offered to settle for Tovar’s $15,000 policy limit, but AUIC did not respond to the offer. Potter obtained a jury verdict of nearly one million dollars, which was vacated on a motion for a new trial. Before retrial, AUIC entered a confidential settlement with Tovar for $75,000 to release any bad faith claim for failure to accept the settlement offer. At trial, Potter prevailed again, this time obtaining a judgment in excess of one million dollars. AUIC paid Potter the $15,000 limit, but refused any further payment. Because Tovar was insolvent, Potter sued AUIC alleging that the release it procured from Tovar was a fraudulent conveyance under statutory and common law. The trial court sustained a demurrer by AUIC and dismissed the case on the ground that the suit failed to state a proper fraudulent conveyance claim.

The appeals court reversed. Potter’s lawsuit against AUIC alleged that the settlement agreement and release constituted a fraudulent conveyance under both common law and the Uniform Voidable Transactions Act (UVTA, Civ. Code, §§ 3439 et seq.), on a theory that Tovar was insolvent up to the time of the release, but that Tovar had a viable claim for breach of the implied covenant of good faith and fair dealing against AUIC, which was an “asset” that he could have used to pay down his civil liability. Further, that AUIC participated in a fraudulent transfer of that asset by entering into the release—which prevented Potter from collecting all or a greater share of the judgment in his favor.

The appeals court agreed that this stated a cause of action under the UVTA. The court traced the history of the UVTA going back to Queen Elizabeth I, and defining a fraudulent transfer as “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.” The Act makes a fraudulent transfer voidable, and the creditor can recover against either “[t]he first transferee of the asset or the person for whose benefit the transfer was made.” That does not include, however, “a person that took in good faith and for a reasonably equivalent value given the debtor or against any subsequent transferee or obligee.”

The statute allows recovery on proof of either actual or constructive fraud, the latter of which is shown where a debtor makes a transfer or incurs an obligation “[w]ithout receiving a reasonably equivalent value in exchange for the transfer or obligation,” and the debtor either engaged in a transaction without sufficient assets or would reasonably have believed he would incur debts beyond his ability to pay.

In finding that Potter had stated a claim, the appeals court held that a cause of action for bad faith is an “asset.” The court pointed out that a cause of action to recover money damages is a “chose in action,” which is considered a form of personal property. Although an exception exists for personal property that is not assignable, the court pointed out that ”[a]n insured may, however, assign a cause of action for bad faith failure to settle in exchange for the plaintiff’s covenant not to execute an excess judgment against the insured’s personal assets. (Citing Hamilton v. Maryland Cas. Co. (2002) 27 Cal.4th 718, 732; and 21st Century Ins. Co. v. Superior Court (2015) 240 Cal.App.4th 322, 327.) Thus, “[b]ecause it was assignable, and because it does not appear to be otherwise exempted, the potential cause of action [for bad faith failure to settle] is property subject to a money judgment and therefore an asset under the UVTA.”

The Potter court went on to note that although a cause of action for bad faith failure to settle does not accrue until a final excess judgment is entered “Safeco and the other cases we have cited recognize a bad faith cause of action may be assigned to the claimant before trial in the underlying action.” (Citing Safeco Ins. Co. of Am. v. Superior Court (1999) 71 Cal.App.4th 782.)

The Potter court also rejected the argument that a release is not a “transfer” stating that: “‘[T]ransfer’ under the UVTA has a broad meaning. [] It includes ‘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.’ [] Under the plain language of the UVTA, a release qualifies as a ‘transfer.’” The court further stated that a judgment was not required, since the UVTA only requires the creditor to have a “claim.”

The court finally found that Potter had alleged sufficient injury, and that AUIC was a proper defendant for a fraudulent conveyance cause of action being a “person for whose benefit the transfer was made” as required under the UVTA. Having found that the claim stated a cause of action under the UVTA, the Potter court declined to address common law fraudulent conveyances, deeming the issue to have been waived on appeal.

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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