Salahi: Virginia Self-Settled Trust In Bankruptcy

[Riser Adkisson LLP]

In re Salahi, 2012 WL 1438213 (Bkrtcy.E.D.Va., April 25, 2012), as found at http://goo.gl/yqUDD

United States Bankruptcy Court, E.D. Virginia,

Alexandria Division.

In re Corinne Alice SALAHI, Debtor.

No. 11–16621–BFK.

April 25, 2012.

MEMORANDUM OPINION

BRIAN F. KENNEY, Bankruptcy Judge.

*1 This matter comes before the Court on the Motion of the Chapter 7 Trustee, Ms. Meiburger, for turnover of assets pursuant to 11 U.S.C. sec. 542(a) from the Debtor, Corinne Salahi, (Docket No. 33), and the Debtor's Response (Docket No. 39). The Court heard evidence on April 13, 2012. For the reasons stated below, the Court will grant the Trustee's Motion.

Findings of Fact

1. On June 28, 2010, Corinne Salahi ("the Debtor" or "Ms. Salahi"), entered into the Dirgham Salahi Trust ("the Trust") as the Settlor. Trustee's Exh. 1.

2. Ms. Salahi was the sole settlor of the Trust. Id.

3. The sole asset of the Trust is a Promissory Note dated October 8, 2010 ("the Note"), in the principal amount of $166,872.22, executed by the Montessori School of Alexandria. Trustee's Exh. 2.

4. The Note is made payable to the Trust. Id. As consideration, the Note recites that: "[i]t is understood by the current Board of Directors that Dirgham and Corinne Salahi are owed back wages from the early years of the school." Trustee's Exh. 2. The Note also references an "attached detailed accounting" of the unpaid wages and interest, but no accounting was attached to the Note.

5. The Debtor produced an accounting, showing that the Note was the product of wages owed to Mr. Salahi. Debtor's Exh. B.

6. Dirgham Salahi ("Mr.Salahi") is the Debtor's late husband. He passed away on October 6, 2010 (two days before the Note was executed).

7. The Trust names Mr. Salahi as the initial beneficiary. Trustee's Exh. 1, Article II.

8. The Trust further provides that, upon the death of Mr. Salahi, if the Debtor survives her husband, then the Trustee shall continue to hold and administer the Trust estate for the benefit of the Debtor. Id. at Article IV(A).

9. The School Building Fund of the Montessori School of Alexandria is named as a contingent beneficiary of the Trust, to which the trust estate is to be distributed in the event of the deaths of both Mr. and Ms. Salahi. Id. at Article IV(B).

10. The Debtor is the initially named, and sole, Trustee of the Trust. Id. at Article VI(A).

11. Article IV(A) of the Trust provides:

Trustee shall distribute the Trust income and principal to or for the benefit of Corinne Salahi, as she so directs, either verbally or in writing.

Trustee's Exh. 1, Article IV(A).

12. The Trust states that it is irrevocable. Id. at Article IX.

13. The Trust also contains a spendthrift clause. Id. at Article XI(B).

14. The payments made on the Note initially were deposited into an account at United Bank denominated "Estate of Dirgham Salahi." Trustee's Exh. 4. After the Debtor filed her bankruptcy petition, the funds were deposited to an account designated "Dirgham Salahi Trust." Trustee's Exh. 5. The Debtor was the sole signatory on these accounts, and had complete control over disbursements from the two accounts.

15. The Debtor filed her voluntary petition in bankruptcy, under Chapter 7 of the Bankruptcy Code, on September 8, 2011. Docket No. 1.

*2 16. Ms. Meiburger is the duly appointed Chapter 7 Trustee. Docket No. 22.

Conclusions of Law

The Court has jurisdiction over this matter pursuant to 28 U.S.C. sec. 1334 and the Order of Reference entered by the U.S. District Court for the Eastern District of Virginia on August 15, 1984. This is a core proceeding under 28 U.S.C. sec. 157(b)(2)(E) (orders to turn over property of the estate), for which this Court has the authority to enter final orders. See 28 U.S.C. sec. 157(b) ( "Bankruptcy judges may hear and determine all cases under title 11 and all core proceedings arising under title 11 ... and may enter appropriate orders and judgments, subject to review under section 158 of this title").

This case presents the intersection of Bankruptcy Code Section 541 (property of the estate) and applicable State law regarding self-settled trusts. Happily, in this case, the interests of the Bankruptcy Code and applicable State law are not in conflict.

A. Bankruptcy Code Sections 542(a) and 541.

Bankruptcy Code Section 542(a) provides:

Except as provided in subsection (c) or (d) of this section, an entity, other than a custodian, in possession, custody, or control, during the case, of property that the trustee may use, sell, or lease under section 363 of this title, or that the debtor may exempt under section 522 of this title, shall deliver to the trustee, and account for, such property or the value of such property, unless such property is of inconsequential value or benefit to the estate.

11 U.S.C. sec. 542(a).

Both Sections 363(b)(1) and (c)(1) use the term "property of the estate." Thus, in order to determine what must be turned over under Section 542(a), the Court must turn to Section 541 of the Code .FN1

FN1. Bankruptcy Rule 7001 generally requires an adversary proceeding to compel the turnover of property from third parties. However, the Rule contains an exception applicable here: "... other than a proceeding to compel the debtor to deliver property to the trustee." The Trustee, therefore, is not required to bring an adversary proceeding for the turnover of property from the Debtor.

Section 541(a)(1) of the Code provides that property of the estate consists of "all legal or equitable interests of the debtor in property as of the commencement of the case." 11 U.S.C. sec. 541(a)(1). Section 541(c)(2) provides that: "[a] restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title." 11 U.S.C. sec. 541(c)(2). This provision of the Code recognizes the enforceability of spendthrift provisions in trusts where the debtor is a beneficiary of a spendthrift trust. See Patterson v. Shumate, 504 U.S. 753, 758 (1992) ("The natural reading of the provision entitles a debtor to exclude from property of the estate any interest in a plan or trust that contains a transfer restriction enforceable under any relevant nonbankruptcy law"); Levin v. Wachovia Bank, 436 Fed.Appx. 175, 179 (4th Cir.2011) (indicating that Section 541(c)(2) "excludes from the property of the bankruptcy estate interests in trust that are protected under a spendthrift clause that is enforceable under applicable state law").

Section 541(d) excludes from the estate property to which the debtor holds bare legal title in trust for another. 11 U.S.C. sec. 541(d). Old Republic Nat'l Title Ins. Co. v. Tyler ( In re Dameron), 155 F.3d 718, 721 (4th Cir.1998). Finally, Section 541(b)(1) provides that the estate does not include:

*3 any power that the debtor may exercise solely for the benefit of an entity other than the debtor.

11 U.S.C. sec. 541(b)(1) (emphasis added). The Court looks to applicable nonbankruptcy law to determine the interests of the bankruptcy estate in the Trust. Butner v. U.S., 440 U.S. 48, 54 (1979).

B. Applicable Nonbankruptcy Law.

The Trust provides that it is governed by the laws of the Commonwealth of Virginia. Trustee's Exh. 1, Article XI(A). Ms. Salahi, who is the settlor, beneficiary, and Trustee of the Trust, is a Virginia resident. Accordingly, the Court will apply the laws of the Commonwealth of Virginia as the applicable non-bankruptcy law in this case.

Virginia adopted the Uniform Trust Code in 2005. Va.Code sec. 55–541.01, et seq. Virginia recognizes the enforceability of spendthrift trust provisions. Va.Code secs. 55–545.01–55–545.03.FN2 There are limitations on the enforceability of spendthrift provisions, however, notably, where the trust is a self-settled trust. Va.Code Section 55–545.05(A) ("Creditor's claim against settlor") provides as follows:

FN2. Virginia recognized the enforceability of spendthrift trusts in 1919, when it enacted Section 5157 of the Code of Virginia, the statute that later became Va.Code sec. 55–19. Sheridan v. Krause, 161 Va. 873, 891 (1934). The enactment of Section 5157 legislatively overruled the case of Hutchinson v. Maxwell, 100 Va. 169 (1902).

Whether or not the terms of a trust contain a spendthrift provision, the following rules apply:

1. During the lifetime of the settlor, the property of a revocable trust is subject to claims of the settlor's creditors.

2. With respect to an irrevocable trust, a creditor or assignee of the settlor may reach the maximum amount that can be distributed to or for the settlor's benefit. If a trust has more than one settlor, the amount the creditor or assignee of a particular settlor may reach may not exceed the settlor's interest in the portion of the trust attributable to that settlor's contribution.

Va.Code sec. 55–545.05(A) (emphasis added).

Further, Section (B)(1) provides that:

During the period the power may be exercised, the holder of a power of withdrawal is treated in the same manner as the settlor of a revocable trust to the extent of the property subject to the power ...

Va.Code sec. 55–545.05(B)(1). Thus, where the beneficiary retains control over the use and disposition of the trust assets (in statutory terms, a "power of withdrawal"), the trust is treated as a revocable trust, despite the fact that, as here, the trust by its terms appears to be an irrevocable trust. Id. For revocable trusts, the property of the trust is subject to claims of the settlor's creditors, at least during the lifetime of the settlor. Va.Code sec. 55–545.05(A)(1).

In this regard, the Uniform Trust Code is consistent with Virginia trust law going back at least to 1910. In the case of Petty v. Moore's Brook Sanitarium, Harry S. Langhorne, described by the Virginia Supreme Court as "an improvident young man," "created a 'spendthrift trust' for his own benefit." 110 Va. 815, 815, 67 S.E. 355, 355 (1910). He conveyed valuable property to the trust. Id. The debt in question was contracted for after the deed to the trust was executed and recorded. Id. at 815, 67 S.E. at 356. The Court noted that "it [was] manifest from the deed that Harry S. Langhorne was to have the sole beneficial use of the property conveyed, certainly during his life, with power to dispose of what remained at his death by will." Id. at 815, 67 S.E. at 356. The Court noted that a number of States had, by then, departed from the English rule that spendthrift trusts were not enforceable as against the beneficiaries' creditors (though it was not until 1919 that Virginia formally recognized the enforceability of spendthrift trusts, see supra note 2). Id. at 818–20, 67 S.E. at 356–357.

*4 Assuming that a spendthrift trust would be enforceable as against the beneficiaries' interest generally, the Court held that the assets of a spendthrift trust were subject to the claims of the settlor's creditors. Petty, 110 Va. at 821, 67 S.E. at 357. The Court cited a number of cases from Pennsylvania and Massachusetts in support of its holding, summing up as follows:

A donor or settlor cannot, even in jurisdictions where spendthrift trusts are allowed, so dispose of his property for his own use, benefit, or support, as to put it beyond the reach of liabilty for his future debts. If such donor continues sui juris, and if there appears to be no reason for such disposition, except to withdraw his property from such liability, he cannot through the medium of a trust thus retain the temporal ownership without its usual incidents.

Id. at 820–21, 67 S.E. at 357 (quoting 26 Am. & Eng. Ency. of Law 147 (2d ed.)).

This long-held view is consistent with that of the great weight of authority from other jurisdictions involving self-settled trusts. See, i.e., Cutter v. Seror ( In re Cutter), 398 B.R. 6 (B.A.P. 9th Cir.2008) (applying California law, and quoting the Restatement (Third) of Trusts sec. 58(2) (2003): "A restraint on the voluntary and involuntary alienation of a beneficial interest retained by the settlor of a trust is invalid"); In re Robbins, 826 F.2d 293 (4th Cir.1987) (applying Maryland law, and relying on the Restatement (Second) of Trusts sec. 156(2)); United States v. Ritter, 558 F.2d 1165, 1167–1168 (4th Cir.1977) (applying West Virginia law, and noting: "[b]y the great weight of authority it is held that (where the settlor himself has a general power of appointment) the settlor is substantially the owner of the property, and that his creditors can reach it whether he exercises the power or fails to exercise it ..." (quoting A.W. Scott, The Efects of a Power to Revoke a Trust, 57 Harv. L.Rev. 362, 364 (1944))); Riley v. Tougas (In re Tougas), 338 B.R. 164 (Bankr.D.Mass.2006) (Massachusetts law); Johnson v. McCoy (In re McCoy), 274 B.R. 751 (Bankr.N.D.Ill.2002) (Illinois law); Lindquist v. Mack (In re Mack), 269 B.R. 392, 400 (Bankr.D.Minn.2001) (applying Minnesota common law, and relying, in part, on Restatement (Second) of Trusts sec. 156); In re O'Brien, 50 B.R. 67 (Bankr.E.D.Va.1985) (Virginia law).FN3

FN3. The portion of the O'Brien case holding that the phrase "applicable nonbankruptcy law" under Section 541(c)(2) involved only State law, and not federal statutes like ERISA, was overruled in the Supreme Court's decision in Patterson v. Shumate, 504 U.S. 753, 758 (1992). In re O'Brien, 50 B.R., at 74. The portion of the opinion holding that "a settlor cannot create a spendthrift trust for himself to the detriment of his creditors," remains good law. Id., 50 B.R. at 75.

The Debtor in this case was the settlor of the Trust. She is its sole beneficiary. She is the Trustee. She retained complete control over the use and disposition of the assets. See supra Finding of Fact Nos. 11 and 14. The Court holds that, consistent with the above authorities, the assets of the Trust must be turned over to the bankruptcy Trustee.FN4

FN4. The Court notes that the Virginia legislature has enacted a new Asset Protection Trust (APT) statute, Va.Code secs. 55–545.03:2 and 55–545.03:03, effective July 1, 2012. The Virginia statute follows the enactment of APT statutes in a number of other States, such as Alaska, Delaware, Nevada, Rhode Island and Utah. The statute contains a five year "lookback" period for creditors. It is equally noteworthy that in 2005, as a part of the BAPCPA Amendments, Congress enacted what is now Bankruptcy Code Section 548(e), providing the Trustee with the ability to avoid transfers to self-settled trusts or similar devices if made within 10 years of the petition date. 11 U.S.C. sec. 548(e). Section 548(e) was a response to the enactment of the APT statutes by the State legislatures. Collier on Bankruptcy para. 548.07[1] ("Section 548(e) 'closes the self-settled trust loophole' " (quoting H.R.Rep. No. 109–31, 109th Cong., 1st Sess. 449 (2005))).

C. Mr. Salahi's Contribution to the Trust.

The Debtor argues that the property was contributed by Mr. Salahi to the Trust, and therefore, should be exempted from the Trustee's reach. The Debtor's Exhibit B indicates, and the Court accepts, that the Note was the product of Mr. Salahi's wages, and not Ms. Salahi's earnings (despite the fact that the Note recites that it is for wages owed to Mr. and Mrs. Salahi).

*5 The Debtor's argument is not without support. The Fifth Circuit, applying Texas law, has held that the interests of a beneficiary of a self-settled trust can only be reached to the extent of the beneficiary's contributions to the trust, and not as to property contributed by others. Shurley v. Texas Commerce Bank—Austin, N.A. (In re Shurley), 115 F.3d 333, 338 (5th Cir.1997). This is consistent with the Uniform Trust Code's provision that defines a settlor as "a person, including a testator, who creates, or contributes property to, a trust." Va.Code sec. 55–541.03. This Section goes on to provide:

If more than one person creates or contributes property to a trust, each person is a settlor of the portion of the trust property attributable to that person's contribution except to the extent another person has the power to revoke or withdraw that portion.

Id. That is, each person who contributes property to the trust is considered to be a settlor, as to that party's contribution to the trust. Therefore, the trust is not a "self-settled" trust, as to contributions from other settlors. Shurley, 115 F.3d at 337 ("Allowing creditors to reach only the self-settled portion of the trust is consistent with the other long-standing rule of Texas law that a settlor should be allowed to create a spendthrift trust that shields trust assets from the beneficiary's creditors").

Even assuming that Mr. Salahi did contribute the entire amount to the Trust, however, the Trust is still subject to the claims of Ms. Salahi's creditors. The Trust provides that, upon Mr. Salahi's death, Ms. Salahi is the sole beneficiary. Trustee's Exh. 1, Article IV(A). Ms. Salahi was the sole beneficiary on the date of the filing of her bankruptcy petition. Immediately upon becoming the sole beneficiary, Ms. Salahi acquired complete control over all of the assets of the Trust estate. Id. ("Trustee shall distribute the Trust income and principal to or for the benefit of Corinne Salahi, as she so directs, either verbally or in writing") (emphasis added). The entire Trust is subject to the claims of Ms. Salahi's creditors under the plain meaning of the exception contained in Va.Code sec. 55–541.03: " except to the extent another person has the power to revoke or withdraw that portion." (Emphasis added). See also Cutter v. Seror (In re Cutter), 398 B.R. 6, 21 (B.A.P. 9th Cir.2008) ( "Ordinarily, if only a portion of a spendthrift trust's corpus is contributed by a beneficiary-debtor, only that portion becomes property of the beneficiary-debtor's estate. If, however, the trust agreement allows the debtor-beneficiary to exercise control over and reach trust property contributed by others, the estate is entitled to the maximum amount that the trust could pay or distribute to the debtor-beneficiary") (citations omitted); Osherow v. Porras (In re Porras), 312 B.R. 81, 131 n. 30 (Bankr.W.D.Tex.2004) ("In addition, the general rule is that, if the court declares a trust to be self-settled, the creditors can reach not only the settlor's express interest, but also the maximum amount that the trust (through its trustee) could pay the beneficiary or apply for his benefit under the terms of the Trust" (citing Shurley, 115 F.3d at 339–40)).

*6 The critical difference between the Shurley case and this case is that, in Shurley, there were beneficiaries still living who had contributed property to the trust. Shurley, 115 F.3d at 336. Their interests were protected as co-settlors of the trust. Here, the Debtor is the sole beneficiary of the Trust, with complete control over the disposition of its assets. Accordingly, it makes no difference at this point whether Mr. Salahi or Ms. Salahi contributed the assets to the Trust. The Court will order a turnover of the Trust assets to the bankruptcy Trustee.

Conclusion

For the foregoing reasons, the Court finds that the assets of the Trust are property of the bankruptcy estate under 11 U.S.C. sec. 541(a)(1). The Court will order a turnover of the Trust assets—the Note and its proceeds—to the bankruptcy Trustee, pursuant to 11 U.S .C. sec. 542(a). A separate Order will issue.


= = = = = = = A S S E T P R O T E C T I O N = = = = = = = =

Posted by Jay D. Adkisson, a co-author along with Chris Riser of Asset Protection: Concepts & Strategies (McGraw-Hill 2003) with main website http://www.assetprotectionbook.com and blog at http://www.assetprotectionblog.com see also http://www.jayadkisson.com and http://www.risad.com

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In re Salahi, 2012 WL 3249550 (Bkrtcy.E.D.Va., Slip Copy, Aug. 7, 2012).

United States Bankruptcy Court, E.D. Virginia, Alexandria Division.

In re Corrine Alice SALAHI, Debtor

Robert D. Burke, Trustee, Plaintiff

v.

Corrine Alice Salahi, et al., Defendant.

Bankruptcy No. 11–16621–BFK.

Adversary No. 12–01195.

Aug. 7, 2012.

Julian Karpoff, Arlington, VA, for Plaintiff.

Thomas O. Murphy, Manasas, VA, for Defendant.

MEMORANDUM OPINION

BRIAN F. KENNEY, United States Bankruptcy Judge.

*1 This case involves the contours—and the limits—of the Trustee's strong-arm powers under Section 544 of the Bankruptcy Code. On April 25, 2012, the Court granted the Chapter 7 Trustee's Motion to Compel the Debtor to turn over certain property, specifically, a Promissory Note made by the Montessori School of Alexandria. In re Salahi, No. 11–16621, 2012 WL 1438213 (Bankr.E.D. Va. April 25, 2012). The Court ruled that the Note, which was held in a self-settled trust created by the Debtor, was property of the estate under Section 541(a) of the Bankruptcy Code. Id. at *6. Roughly two weeks later, on May 9, 2012, Robert D. Burke, Trustee of the Robert D. Burke CPA, P.C., Profit Sharing Plan, filed this adversary proceeding. Mr. Burke, as Trustee, claims to be a creditor of Mr. Salahi, and further asserts that the Note was fraudulently transferred to the Dirgham Salahi Trust, to the detriment of Mr. Salahi's creditors.

Burke, Trustee, claims to be a creditor of Dirgham Salahi, by virtue of a guaranty given by Mr. Salahi for the debts of Oasis Vineyard, Inc. and The Salahi Limited Partnership. Complaint, para. 2. The Complaint further alleges that the Montessori School owed Mr. Salahi $166,872.22. Id. at para. 3. The Complaint alleges that the Note was made payable to the Dirgham Salahi Trust "with the object and intent to prevent the Plaintiff from realizing anything from Dirgham Salahi's receivable from the Montessori School of Alexandria." Id. Further, the Complaint alleges that the Dirgham Salahi Trust gave no consideration for the Note, and that Mr. Salahi was insolvent at the time of the transfer. Id. The Complaint seeks to avoid the transfer of the Note to the Trust as a fraudulent transfer under Virginia law. Complaint, Count I.FN1

FN1. Count II alleges that a transfer of a limited partnership interest in The Salahi Family Limited Partnership to the Debtor likewise was a fraudulent transfer. At oral argument, counsel for Burke, Trustee, acknowledged that this Count is now moot.

The matter comes before the Court on the Bankruptcy Trustee's Motion to Dismiss Mr. Burke's Complaint, pursuant to Bankruptcy Rule 7012 (incorporating Fed.R.Civ.P. 12(b)(6)). Docket No. 6. For the reasons stated below, the Bankruptcy Trustee's Motion will be denied.

The Court has jurisdiction over this matter pursuant to 28 U.S.C. sec. 1334 and the Order of Reference of the U.S. District Court for the Eastern District of Virginia dated August 15, 1984. This is a core proceeding, under 28 U.S.C. sec. 157(b)(2)(A) (matters concerning the administration of the estate) and (O) (other matters affecting the liquidation of the assets of the estate).

I. The Standard on a Motion to Dismiss: Twombly and Iqbal.

Under the Supreme Court's decisions in Twombly and Iqbal, to survive a motion to dismiss under Rule 12(b)(6), the complaint must state a claim that is plausible on its face. See Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007); Ashcroft v. Iqbal, 556 U.S. 662 (2009). A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged. Twombly, 550 U.S. at 556.

*2 In Iqbal, the Court held that only a complaint that states a plausible claim for relief will survive a motion to dismiss. 556 U.S. at 679 ("[W]hether a complaint states a plausible claim for relief will ... be a context specific task that requires the reviewing court to draw on its judicial experience and common sense").FN2

FN2. At the same time, it must be remembered that Bankruptcy Rule 7008 (incorporating Fed.R.Civ.P. 8(a)(2)) still only requires a "short and plain statement of the claim showing that the pleader is entitled to relief." Iqbal and Twombly together do not constitute an invitation to resolve factual disputes on a motion to dismiss.

The Court accepts as true all well-pleaded facts in the Complaint, but is not required to accept allegations that are legal conclusions. Walters v. McMahen, ––– F.3d ––––, No. 11–1796, 2012 WL 2589229 (4th Cir. July 5, 2012) ("[A]lthough a court must accept as true all factual allegations contained in a complaint, such deference is not accorded to legal conclusions stated therein. The mere recital of elements of a cause of action, supported only by conclusory statements, is not sufficient to survive a motion made pursuant to Rule 12(b)(6)" (citing Iqbal, 556 U.S. at 678)).

II. The Court Looks to Applicable NonBankruptcy Law, To Determine the Property Rights of the Parties.

As a general proposition, the Court looks to applicable non-bankruptcy law to determine the property rights and interests of the parties. Butner v. United States, 440 U.S. 48, 55 (1979); Lee v. Anasti (In re Lee), 461 Fed.Appx. 227, 233 (4th Cir.2012). Here, there is no dispute that the applicable non-bankruptcy law is that of Virginia.

Further, as a general matter, the interest of the bankruptcy estate in property rises no higher than that of the debtor, when the petition is filed. Lee, 461 Fed.Appx. at 233; Old Republic Nat'l Title Ins. Co. v. Tyler ( In re Dameron), 155 F.3d 718, 721 (4th Cir.1998). As noted by the Fourth Circuit in Lee, the rights of the Trustee and the Debtor are the same, for purposes of determining the parties' respective property rights, and " 'there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding.' " Lee, 461 Fed.Appx. at 233 (quoting Butner v. United States, 440 U.S. 48, 55 (1979)).

III. The Interplay of Virginia Code Sections 55–80 and 55–82 and Bankruptcy Code Sections 544(a)(1) and (2).

Virginia Code Section 55–80, the Virginia fraudulent transfer statute, provides as follows:

Every gift, conveyance, assignment or transfer of, or charge upon, any estate, real or personal, every suit commenced or decree, judgment or execution suffered or obtained and every bond or other writing given with intent to delay, hinder or defraud creditors, purchasers or other persons of or from what they are or may be lawfully entitled to shall, as to such creditors, purchasers or other persons, their representatives or assigns, be void. This section shall not affect the title of a purchaser for valuable consideration, unless it appear that he had notice of the fraudulent intent of his immediate grantor or of the fraud rendering void the title of such grantor.FN3

FN3. Virginia has not adopted the Uniform Fraudulent Transfer Act (UFTA).

*3 Section 55–82 of the Virginia Code provides for creditors' suits to avoid transfers alleged to be fraudulent under Section 55–80 (and under Section 55–81, Virginia's voluntary conveyance statute). Section 55–82 provides as follows:

A creditor before obtaining a judgment or decree for his claim may, whether such claim be due and payable or not, institute any suit which he might institute after obtaining such judgment or decree to avoid a gift, conveyance, assignment or transfer of, or charge upon, the estate of his debtor declared void by either sec. 55–80 or 55–81; and he may in such suit have all the relief in respect to such estate to which he would be entitled after obtaining a judgment or decree for the claim which he may be entitled to recover. A creditor availing himself of this section shall have a lien from the time of bringing his suit on all the estate, real and personal, hereinbefore mentioned, and a petitioning creditor shall be entitled to a like lien from the time of filing his petition in the court or in the clerk's office of the court in which the suit is brought. If the proceeds of sale be insufficient to satisfy the claims of all the creditors whose liens were acquired at the same time they shall be applied ratably to such claims and the court may make a personal decree against the debtor for any deficiency remaining on the claim of any creditor after applying thereto his share of the proceeds of sale, or, if any creditor be not entitled to share in such proceeds, may render a personal decree against the debtor for the full amount of the creditor's claim. This section is subject to the provisions of secs. 8.01–268 and 8.01–269.

Bankruptcy Code Sections 544(a)(1) and (2) endow the bankruptcy trustee with certain "strong-arm powers." Specifically, these Sections provide as follows:

The trustee shall have, as of the commencement of the case, and without regard to any knowledge of the trustee or of any creditor, the rights and powers of, or may avoid any transfer of property of the debtor or any obligation incurred by the debtor that is voidable by—

(1) a creditor that extends credit to the debtor at the time of the commencement of the case, and that obtains, at such time and with respect to such credit, a judicial lien on all property on which a creditor on a simple contract could have obtained such a judicial lien, whether or not such a creditor exists;

(2) a creditor that extends credit to the debtor at the time of the commencement of the case, and obtains, at such time and with respect to such credit, an execution against the debtor that is returned unsatisfied at such time, whether or not such a creditor exists....

11 U.S.C. sec. 544(a)(1)-(2). The bankruptcy Trustee, therefore, occupies the position of one with an unsatisfied judicial lien, under Sections 544(a)(1) and (2).

A. Virginia Case Law on the Writ of Fieri Facias.

In Virginia, the writ of execution for a judgment creditor historically has been known, and is still known, as a writ of fieri facias. Va.Code sec. 8.01–466, et seq. The Trustee, by virtue of her strong-arm powers under 11 U.S.C. secs. 544(a)(1) and (2), stands in the shoes of one with an unsatisfied writ of fieri facias against the Debtor. The issue is what, precisely, this means under applicable non-bankruptcy law.FN4

FN4. The Court uses the term "unsatisfied" advisedly here. See infra Part III(B) (discussion of Restatement of Restitution, First, secs. 172 & 173).

*4 In Virginia, the writ of fieri facias gives a judgment creditor no greater rights in property than its judgment debtor owns. Int'l Fidelity Ins. Co. v. Ashland Lumber Co., Inc., 250 Va. 507, 463 S.E.2d 664 (1995); Lynch v. Johnson, 196 Va. 516, 521, 84 S.E.2d 419, 422 (1954). In International Fidelity, the Virginia Supreme Court held as follows:

The writ of fieri facias creates a lien in favor of the judgment creditor only to the extent that the judgment debtor has a possessory interest in the intangible property subject to the writ. Lynch v. Johnson, 196 Va. 516, 521, 84 S.E.2d 419, 422 (1954). Accordingly, when the judgment debtor has no interest in the property held by the suggested garnishee, the writ does not create a valid lien on that property, and the suggestion for summons in garnishment must fail.

250 Va. 507 at 511, 463 S.E.2d 664, 666–67. Similarly, in Lynch v. Johnson, the Court held:

[A] proceeding in garnishment is substantially an action at law by the judgment debtor in the name of the judgment creditor against the garnishee, and therefore the judgment creditor stands upon no higher ground than the judgment debtor and can acquire no greater right than such debtor himself possesses.

196 Va. at 521, 84 S.E.2d 419, 422. The proposition that a judgment lienholder has no greater rights than the judgment debtor is well established in Virginia law. In Barnes v. American Fertilizer Co., the Court noted:

"It may therefore be laid down as a universal rule, established by many cases, that a judgment lien is always subject to every possible description of equity held by a third party against the debtor at the time the judgment attached; and that it is immaterial whether the rights of such third party consists of an equitable estate or interest in the judgment debtor's land, an equitable lien on his land, or a mere equity against the debtor which attaches to or affects his land. Nor is it at all material whether the judgment debtor has or has not, when he contracted his debt or obtained his judgment or docketed the same, notice of such equitable estate, equitable lien, or mere equity. If they be prior in time to the judgment, they will always be preferred to the judgment lien. The authorities we have cited abundantly sustain this conclusion; and there is no exception to this universal rule, except where such exception has been made by some statute law."

144 Va. 692, 722, 130 S.E. 902, 911 (1925) (quoting McClanahan's Adm'r v. Norfolk & W.R. Co., 122 Va. 705, 768–69, 96 S.E. 453, 466 (1917)).

Virginia law is entirely consistent with the view of the Fourth Circuit in Dameron and, more recently, in Lee: the bankruptcy Trustee obtains no greater rights than the Debtor had in property, as of the date of the petition.

B. The Restatements of Restitution (First and Third).

Both the Restatement of Restitution (First) (1937) and Restatement of Restitution and Unjust Enrichment (Third) (2011) are consistent with Virginia case law.FN5 The Restatement (First) of Restitution, Sections 172 and 173, state as follows:

FN5. There is no Restatement (Second) of Restitution. The effort apparently was abandoned in 1985 after some controversy within the working group. See Andrew Kull, Restitution Rollout: The Restatement (Third) of Restitution & Unjust Enrichment: Three Restatements of Restitution, 68 Wash. & Lee L.Rev. 867, 867 (2011).

*5 sec. 172. Bona Fide Purchase.

(1) Where a person acquires title to property under such circumstances that otherwise he would hold it upon a constructive trust or subject to an equitable lien, he does not so hold it if he give value for the property without notice of such circumstances.

(2) In the Restatement of this subject such a transferee is called a bona fide purchaser.

sec. 173. Value.

(1) The rules as to what constitutes value in the Restatement of this Subject are the same as the rules stated in secs. 298–309 in the Restatement of Trusts, except as stated in Subsection (2).

(2) Except in the case of a transfer by an express trustee, a transfer of property other than an interest in land in satisfaction of or as security for a pre-existing debt or other obligation is a transfer for value.

Comments (j) and (k) to Section 173 are particularly instructive on the subject. They provide, in part:

(j) Creditors. Where a person holds property subject to a constructive trust, his creditors are not purchasers for value and are subject to the constructive trust, except as stated in comment k. Thus, if a person who holds property subject to a constructive trust makes an assignment for the benefit of his creditors, the assignee is not a bona fide purchaser of the property (see Restatement of Trusts, sec. 306). So also, if he becomes bankrupt, the trustee in bankruptcy is not a bona fide purchaser of the property (see Restatement of Trusts, sec. 307). So also, a creditor who attaches the property or obtains and records a judgment or levies execution upon the property is not a bona fide purchaser, although he had no notice of the constructive trust (see Restatement of Trusts, sec. 308)....

* * *

(k) Purchaser at execution or judicial sale. If property is held by a person subject to a constructive trust, and is sold on execution upon a judgment against him or at a judicial sale and the purchaser pays the purchase price without notice of the constructive trust, he is a bona fide purchaser. (See Restatement of Trusts, sec. 309). This is true whether the property is purchased by a third person or by the judgment creditor himself. It is true not only in the case of sales on the execution of a judgment but also in the case of sales by a trustee in bankruptcy, receivers' sales, sales under court order by an executor or administrator, tax sales, and partition sales. In all these cases the purchaser is protected, although the sale was not voluntarily made by the transferor.FN6

FN6. The Restatement (First) of Restitution was published in 1937. It is not, therefore, helpful in determining Congressional intent with respect to the meaning of Bankruptcy Code Sections 544(a)(1) and (2). At the same time, a departure from pre-Code practice is not to be lightly inferred. See Maharaj v. Stubbs & Perdue, P.A. ( In re Maharaj), 681 F.3d 558, 571 (4th Cir.2012) ("[W]e are mindful that courts 'will not read the Bankruptcy Code to erode past bankruptcy practice absent a clear indication that Congress intended such a departure' " (quoting Hamilton v. Lanning, 130 S.Ct. 2464, 2467, 177 L.Ed.2d 23 (2010))).

Restatement (First) of Restitution, sec. 173 (1937) (emphasis added).

Bankruptcy Code Section 544(a)(2) is entirely consistent with the above-quoted commentary. Section 544(a)(2) gives the bankruptcy Trustee the rights of a creditor who obtains "an execution against the debtor that is returned unsatisfied at such time." (Emphasis added). That is, the bankruptcy Trustee occupies the position of the creditor with an unsatisfied judicial lien under Comment (j), and not that of the creditor who purchases at a judicial (or other) sale under Comment (k).

*6 The Restatement (Third) of Restitution and Unjust Enrichment (2011) reaches the same result. Section 60 (Priority) provides in part:

(1) Except as otherwise provided by statute and by sec. 61, a right to restitution from identifiable property is superior to the competing rights of a creditor of the recipient who is not a bona fide purchaser or payee of the property in question. Acquisition of a judicial lien (by attachment, garnishment, judgment, execution or the like) does not make the lien creditor a purchaser of the property subject to lien.

Restatement (Third) of Restitution and Unjust Enrichment, sec. 60 (2011). The Comments to Section 60 illustrate the issue with particular clarity:

(f) Restitution in bankruptcy.

* * *

The underlying dispute is not decades but centuries old: it is the contest between the judgment creditor and the holder of a prior equitable interest affecting the judgment debtor's apparent title to property. As a matter of applicable nonbankruptcy law, the outcome of this contest is not in doubt. The holder of the prior equitable interest prevails over the judgment creditor, except insofar as (1) the judgment creditor might qualify as a bona fide purchaser by the rule of sec. 66, or (2) the prior interest might be subordinated or invalidated by statutes requiring that particular transfers be registered or recorded as a condition of their effectiveness against protected third parties.

* * *

This preference for the restitution claimant over the judgment creditor rests on rules of common law and equity of exceptionally long standing. The judicial rationale has always been that the judgment creditor—unlike the purchaser for value—does not change position in reliance on the debtor's apparent title; or not, at least, in a manner sufficient to justify cutting off the claimant's equitable rights.

Id.

The Court notes that the same result would not obtain, with respect to the Trustee's strong-arm rights as to unrecorded interests in real property owned by the Debtor, under Section 544(a)(3). There, the Trustee occupies the position of a bona fide purchaser for value, and takes title to the Debtor's real property free and clear of latent, or unrecorded, interests. See Wells Fargo Funding v. Gold, 432 B.R. 216 (E.D.Va.2009); Mayer v. United States ( In re Reasonover), 236 B.R. 219 (Bankr.E.D.Va.1999).

C. A Return to Va.Code sec. 55–80.

Va.Code Section 55–80 provides protection for "a purchaser for valuable consideration, unless it appear that he had notice of the fraudulent intent of his immediate grantor or of the fraud rendering void the title of such grantor." That is, the statute protects only purchasers for value without notice, a position the bankruptcy Trustee does not occupy in this case.

The remedy for a fraudulent transfer claim under Sections 55–80 and 82 is: (a) a declaration that the transfer is void, and (b) a sale of the property. See also Va.Code sec. 55–82.1 (award of attorney's fees); Va.Code sec. 55–82.2 (authority of the court to set aside a transfer under Sections 55–80 and 81 during an action brought by a creditor to execute on a judgment). In fact, an in personam judgment against the transferee is only allowed where the property transferred is money, or something similar. Mills v. Miller Harness Co., Inc., 229 Va. 155, 158, 326 S.E.2d 665, 667 (1985) ("We find nothing in the statute authorizing a court to award an in personam judgment when a fraudulent conveyance is set aside"); Price v. Hawkins, 247 Va. 32, 37 439 S.E.2d 382, 385 (1994) (allowing in personam judgment where subject of the transfer was money).FN7 Thus, a fraudulent transfer claimant has an equitable claim to the property itself, not just a legal claim for money damages.

FN7. Where the bankruptcy Trustee is the Plaintiff, the Trustee not only has avoidance powers under Section 548, but under certain circumstances, the ability to obtain an in personam judgment for the value of the property as well. 11 U.S.C. sec. 550(a).

*7 The bankruptcy Trustee argues that the lien granted to the Plaintiff under Section 55–82 arises, by the terms of the statute, only "from the time of bringing his suit on all the estate." Trustee's Motion to Dismiss, p. 4 (quoting Va.Code sec. 55–82). The Trustee argues that there was no suit pending at the time of the bankruptcy filing in this case, nor as far as she knows, was any claim ever made under Section 55–80 prior to the filing of the bankruptcy. However, the Plaintiff isn't claiming that he is a creditor with a lien under Section 55–82 that trumps the Trustee's judicial lien under Section 544(a)(1) and (2). The Plaintiff is claiming that the Note was fraudulently transferred to the Debtor. In this sense, this is not a question of a race to the courthouse, i.e., which party's lien first attached to the Note; rather, it is a question of the nature of the Trustee's property interest versus the Plaintiff's asserted property interest in the Note. For the reasons stated above, the Court finds that the bankruptcy Trustee takes the Note subject to the Plaintiff's fraudulent transfer claim, whether or not the claimant has asserted a lien under Section 55–82 before the bankruptcy was filed.

The Trustee argues finally that there was no memorandum of lien filed under Section 55–82. But, the filing of a memorandum of lien was unnecessary—the bankruptcy Trustee does not, and cannot, occupy the position of a bona fide purchaser under Va.Code sec. 55–80, by virtue of her strong-arm powers under Sections 544(a)(1) and (2). Further, Section 55–82 provides that the memorandum of lien "is subject to the provisions of secs. 8.01–268 and 8.01–269," the Virginia lis pendens statutes. Virginia Code Section 8.01–268(a), in turn, provides that no lis pendens or attachment "shall bind or affect a subsequent bona fide purchaser of real or personal estate for valuable consideration and without actual notice of such lis pendens or attachment, until and except from the time a memorandum" is filed setting forth the nature of the cause and other matters pertinent to the claim. It is clear, therefore, that Section 55–82, in providing for a notice of lien, is intended to put potential bona fide purchasers on notice of a fraudulent transfer or voluntary conveyance claim, in order to cut off any claim of a bona fide purchase without notice of the claim.

In sum, the Plaintiff has stated a plausible fraudulent transfer claim to the Note. Further, the Plaintiff has stated sufficient facts, in the form of badges of fraud, to state a plausible claim to avoid the transfer of the Note to the Dirgham Salahi Trust as a fraudulent transfer under Va.Code sec. 55–80. See Phillips v. Moazzeni ( In re Tarangelo), 378 B.R. 128, 134 (Bankr.E.D.Va.2007) (badges of fraud include "(1) retention of an interest in the transferred property by the transferor; (2) transfer between family members for allegedly antecedent debt; (3) pursuit of the transferor ... [by creditors] at the time of the transfer; (4) lack of or gross inadequacy of consideration for the conveyance; (5) retention or possession of the property by the transferor; and (6) fraudulent incurrence of indebtedness after the conveyance" (quoting Hyman v.. Porter (In re Porter), 37 B.R. 56, 63 (Bankr.E.D.Va.1984))). See also Hutcheson v. Savings Bank of Richmond, 129 Va. 281, 105 S.E. 677 (1921) (describing badges of fraud under Virginia law). The Motion to Dismiss will be denied.

Conclusion

*8 For the foregoing reasons, the Defendant's Motion to Dismiss will be denied. A separate Order will issue.

= = = = = = = A S S E T P R O T E C T I O N = = = = = = = =

Posted by Jay D. Adkisson, a co-author along with Chris Riser of Asset Protection: Concepts & Strategies (McGraw-Hill 2003) with main website http://www.assetprotectionbook.com and blog at http://www.assetprotectionblog.com see also http://www.jayadkisson.com and http://www.risad.com

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