2017
May 05

Uniform Voidable Transactions Act As Adopted in Arkansas

Background

The Uniform Voidable Transactions Act (“UVTA”) is the successor to the Uniform Fraudulent Transfer Act (“UFTA”). In Arkansas, the UFTA was found at Ark. Code Ann. § 4-59-201 et seq. So far, the UVTA has only been adopted in twelve states, with ten other states under pending legislation.[1] The UVTA was part of the Arkansas Bar Association’s 2017 Bar Package as passed in April of 2017,[2] making the chapter at Ark. Code Ann. § 4-59-201 et seq. the Arkansas Voidable Transfers Act as of ninety days after the sine die adjournment of the session.[3]

The UVTA’s replacement of the UFTA is intended to resolve some uncertainty among variations of the UFTA and bring the uniform rules into compliance with the UCC and the Bankruptcy Code. It is further intended to reduce confusion caused by the words “fraud” and “fraudulent” which appear throughout the UFTA. Dissemination into the legal community has shown proponents to claim the UVTA is just a renamed and lightly amended UFTA, while critics claim that the UVTA creates a litany of issues for practitioners and potentially increases uncertainty.

Notable Amendments in the UVTA

Definitional Changes

A change which is immediately apparent is the omission of the word “fraudulent” from the title of the act. It has been replaced with the word “voidable.” This is intended to discourage the “oxymoronic usage” of the concepts of “constructive fraud” and “actual fraud.”[4] Such confusion caused inconsistent application of the UFTA throughout the nation. However, the change in terminology is not intended to change the meaning of the act.[5]

Certain defined terms have been updated for globalization and e-commerce. For example, the term “writing” from the UFTA was replaced with the term “record” in the UVTA. A “record” includes electronic media.[6]  Additionally, the term “person” has now been split into “individuals” and “organizations,” although no operational differentiation exists from the UFTA.[7]

Elimination of the Separate Insolvency Definition for Partnerships

Under the UFTA, partnerships were insolvent if the sum of all partnership debts was greater than the aggregate of partnership assets and general partner net worth.[8] Under the UVTA, partnerships are treated the same as other debtors.[9] This is a significant development because the partnership may not now take into account assets which the partnership might not have access to in the event of an insolvency claim. An example might include a general partner’s outside interests in an LLC. 

Codified Choice of Law

Previously, there was substantial confusion among the states as to how to apply choice of law provisions for the UFTA. Now, a debtor’s location at the time of a transfer in question determines the local law governing an avoidance action.[10] A debtor’s location is his residence (individual), place of business (organization), or headquarters (organization with multiple locations).[11] This approach is much more rigid than the approach taken under the UFTA and is intended to create a more stable lending environment and reduce litigation.

Exception for UCC Article 9 Security Interests

The UVTA exempts transfers from avoidance if the transfer is made under the enforcement of a security interest in compliance with UCC Article 9.[12] Such exemption does not include strict foreclosure (whether partial or full satisfaction).[13] This prevents an Article 9 creditor from foreclosing and retaining property without risk of later avoidance. However, a foreclosure sale can be conducted with immunity from avoidance. This provision also helps prevent the stealing of equity by a creditor.

Clarity on Burdens of Proof

When applying the UFTA, some courts used a higher standard than the preponderance of the evidence standard required by the UFTA. Now, as to insolvency under the UVTA, a debtor is insolvent if it does not pay debts when due, except as a result of a bona fide dispute.[14] The UVTA clarifies that the burden lies on claimed insolvent to prove by preponderance of evidence that it is not insolvent.[15]  The addition of the “bona fide” language brings the UVTA into compliance with UCC and Bankruptcy Code.

 As to transfers voidable in favor of present or future creditors, there is now a listed party (creditor) that holds a burden of proof.[16] The standard is expressly a preponderance of the evidence, paring down the opportunity for states to use a heightened standard.[17]  Regarding transfers voidable only to present creditors, the UVTA places the burden on the creditor except when the debtor might be insolvent.[18] The burden is the preponderance of the evidence. Finally, the UVTA provides that persons raising defenses such as being a bona fide purchaser, a secured creditor, or otherwise carry the burden of proof of preponderance of the evidence.[19]

Series Organizations

Series organizations are a new wave of entity which allow small protected cells within an entity structure. For visualization purposes, consider a limited liability company (a “series organization”) that contains four more limited liability companies (a “series” within the “series organization”) that are not legally distinct, but are legally separated. Arkansas has not adopted a series organization statutory regime, but the UVTA provisions regarding series organizations were adopted in the package. The UVTA as adopted by Arkansas applies voidable transfer law to series organizations and protected series organizations.[20] This ensures that an action can be brought in Arkansas to avoid transfers to or from a series or series organization, potentially out of state.

Criticisms of the UVTA

The estate planning and commercial bars state that overall the revisions provided by the UVTA are good in that debtors will be less able to avoid legitimate debts, but some estate planning techniques may be caught up in the broad net. Scholars are in uproar about the effect of the official comments to the UVTA—some say that the negative effects will be very detrimental to tax and estate planning bar, while others say that there is no effect because the law hasn’t changed (in most regards), and the comments are not binding.

While Arkansas noted in its adopting legislation that the comments are only comments and certain comments “should not be considered” when interpreting Arkansas’s UVTA, the notation was not codified into law nor were the comments disregarded or preempted by Arkansas-specific commentary.[21] Thus, it remains to be seen how courts will utilize official comments to the UVTA that “do not represent Arkansas law.”[22]

Asset Substitution Under Comment 8

 a. Issue– The UVTA Official Comment 8 to Ark. Code Ann. § 4-59-204(a)(1) states that “simple exchange by a debtor of an asset for a less liquid asset, or disposition of liquid assets while retaining illiquid assets, may be voidable.”[23]

b. Example– John Doe exchanges an asset into or from a trust, such as cash for a long-term installment note or an interest in an LLC. The exchange is intended to make it more difficult for creditors to reach the cash.

c. Criticism– Application of the comment substantially favors creditors and goes beyond the intended scope of the UVTA because there is no “intent” provision included in the comment. It appears to be a de facto allowance for a set aside and places a burden of proof initially on the debtor, which contravenes the UVTA.

d. Response to Criticism– This comment (and the law itself) only apply when the transfer was in fact intended to lessen the rights of creditors. The UVTA amendments to the UFTA on the matter do not change this outcome. Furthermore, Ark. Code Ann. § 4-59-204(c) clearly places the burden of proving the debtor’s intent upon the creditor, regardless of what the comments state. 

Entity Formation Under Comment 8

a. Issue– The UVTA Official Comment 8 to Ark. Code Ann. § 4-59-204(a) also discusses the situation in which a business is capitalized by its members when no reason to anticipate personal liability or financial distress exists.[24] However, the UVTA aims to pre-empt state LLC statutes when “the clouds of personal liability or financial distress” have gathered over the members prior to the capitalization.[25]

b. Example– In a state that prevents execution upon LLC interests, the formation and capitalization of an LLC may be set-aside. This might potentially affect members of the LLC who had no issue with solvency prior to the capitalization.

c. Criticism– Mere business planning to protect business operations should not satisfy the intent element of the UVTA. As an extreme example, what if a five percent equity holder in an LLC was subjected to an avoidance action? What becomes of the ninety-five percent of the remaining equity holders? This places their rights at substantial odds with a potentially miniscule claim of a third party.

d. Response to Criticism– Nothing in the UVTA amendments to the UFTA changes the existing law on this fact. If a person forms a business and has no creditors, he is not a debtor within the Act. Even if they are a debtor, the transferee may be able to claim the “good faith” defense.

Entity Conversion Under Comment 8 

a. Issue– Another issue presented by Official Comment 8 to the UVTA discusses that an entity conversion may be voidable, regardless of the benefits associated, if any intent to hinder, delay, or defraud creditors exists.[26]

b. Example– Dad and two sons own a corporation. Dad decides to recapitalize the entity with sons becoming majority holders. Sons then decide to convert the corporation to an LLC to receive charging order protection. Dad then is sued by a third-party. The comments appear to promote a rescinding of the recapitalization.

c. Criticism– Such action eviscerates free choice in planning and can create substantially inequitable results.

d. Response to Criticism– If the debtor had the intent to defeat creditors, then the Act is working as it was intended. Furthermore, the law on that issue has not changed as a result of the UVTA. There is already much case law on this particular issue.

Domestic Asset Protection Trusts (“DAPTs”) Under Comments 2 and 8

a. Issue– UVTA Official Comments 2 and 8 to Ark. Code Ann. § 4-59-204, in conjunction with Ark. Code Ann. § (the new choice of law 4-59-210 (the governing choice of law provision) creates an issue for planners when interstate transactions are at play. Irrevocable trusts which can pay principal and income back to the settlor may no longer offer as much protection. This has the potential for an out-of-state party to override state legislative authority governing domestic asset protection trusts.

b. Example– Debtor in State Y, which does not recognize DAPTs, transfers assets to a DAPT in State X, which has specific legislation permitting DAPTs. Based upon the official comments, the transaction may be voidable.

c. Criticism– Under the new choice of law provision (debtor’s location at time of transfer), the voidable transfer law of the domicile state can be used to override another state’s protection scheme. This further creates the issue of whether the DAPT state is subject to the other state’s UVTA provisions or whether a generic conflicts of law approach is required (i.e. it puts voidable transfer law and trust law at odds). Critics also claim that other estate planning tools are affected and that the drafters did not even consider the issues that the UVTA might create for planning methods like qualified terminable interest property trusts (“QTIP Trusts”) or incomplete non-grantor trusts (“ING Trusts”).

d. Response to Criticism– States have made their own choices as to which laws to adopt,[27] and citizens make their own choices as to state of residence. The lobbying industry is strong should a person choose to utilize it, and planners should not attempt to otherwise circumvent their state laws.

Homestead

a. Issue– Ark. Code Ann. § 4-59-210, the new choice of law provision, will affect other states’ homestead laws.

b. Example– Dr. John Doe retires from State A (minimal homestead) to State B (extraordinary homestead). After establishing domicile, Doe is sued by former patient from State A. The patient wants a lien on Doe’s home, pursuant to State A’s UVTA, claiming the home was purchased while Doe was “located” in State A.

c. Criticism– Critics state that this creates an absurd result that Doe and Doe’s neighbor, identically situated, could be subjected to very different and inequitable results merely because the purchase occurred while Doe was living in State A instead of State B.

d. Response to Criticism– Respondents state that the above claim is unfounded because a fraudulent transfer action is against the transferee and not the debtor. Such a property sale is unlikely to create personal jurisdiction over the transferee who was always located in State B. Moreover, any judgment of State A would have to be domesticated in State B, which would then be subject to State B’s homestead exemptions.            

Now that the UVTA will become law in Arkansas soon, it remains to be seen how the Official Comments will play into the interpretation of the Act. Potentially, the critics of the Act will be vindicated through the effect of the published sentiment of the legislature that interpreters of the Act stay within established Arkansas law. However, there is always the risk that it becomes a windfall for creditors and substantially affects myriad areas of law in ways that were unintended by the official drafters of the UVTA. While it is certain that the UVTA does in fact make some critical changes to the UFTA, only time will tell whether the effect will be a net positive. If you have any questions about the changes, you should contact competent counsel to guide you.

[1] http://www.uniformlaws.org/Act.aspx?title=Voidable%20Transactions%20Act%20Amendments%20(2014)%20-%20Formerly%20Fraudulent%20Transfer%20Act.

[2] See 2017 Ark. Acts 1086.

[3] See Knowles v. Vick Chemical Co., 240 Ark. 125, 398 S.W.2d 204 (1966) (stating that, absent an emergency clause, bills passed during the session do not become effective until ninety days after the close of session).

[4]  http://www.americanbar.org/publications/probate_property_magazine_2012/2015/july_ august_2015/2015_aba_rpte_pp_v29_3_article_foster_boughman_uniform_voidable_transactions_act.html.

[5] See UVTA Prefatory Note (Style).

[6] Ark. Code Ann. § 4-59-201(13) (2017).

[7] Ark. Code Ann. §§ 4-59-201(10); 201(11) (2017).

[8] Ark. Code Ann. § 4-59-202(c) (1997).

[9] Ark. Code Ann. § 4-59-202(a) (2017).

[10] Ark. Code Ann. § 4-59-210 (2017).

[11] Ark. Code Ann. § 4-59-210 (2017).

[12] Ark. Code Ann. § 4-59-208(e)(2) (2017).

[13] Ark. Code Ann. § 4-59-208(e)(2) (2017).

[14] Ark. Code Ann. § 4-59-202(b) (2017).

[15] Ark. Code Ann. § 4-59-202(b) (2017).

[16] Ark. Code Ann. § 4-59-204(c) (2017).

[17] Ark. Code Ann. § 4-59-204(c) (2017).

[18] Ark. Code Ann. § 4-59-205(c) (2017).

[19] Ark. Code Ann. § 4-59-208(h) (2017).

[20] Ark. Code Ann. § 4-59-211 (2017).

[21] See § 2 Ark. House Bill 2139, 91st Gen. Assemb. (2017).

[22] See § 2 Ark. House Bill 2139, 91st Gen. Assemb. (2017).

[23] See Official Comment 8 to UVTA.

[24] See Official Comment 8 to UVTA.

[25] See Official Comment 8 to UVTA.

[26] See Official Comment 8 to UVTA.

[27] Arkansas does not have statutory authority permitting the utilization of domestic asset protection trusts.