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Fraudulent Transfer Into Retirement Account Exempt in NY? The Morra decisions

Is a 401(k) retirement plan exempt in bankruptcy under New York law? Does it make a difference if the funds were transferred into the retirement account when the debtor was insolvent (a constructive fraudulent conveyance)? What about funds transferred into the account within 90 days of filing bankruptcy? These were the issues presented in a long, torturous Eastern District of New York bankruptcy case, In re Morra, resulting in four court decisions from 2006 to 2009. To be precise, the 90 day transfer issue was not present in Morra, but the analysis reached would apply to that issue as well. These decisions came out a while ago, but I have not seen any other on-line analysis of their significance.

Ms. Morra filed her bankruptcy case on Long Island February 23, 2004 (EDNY Bk #04-81042.) She had a Verizon 401(k) with $23,000 in it. The trustee objected to her exemption of the asset, arguing that she could only exempt the right to receive benefits from the fund, not the fund itself. Bankruptcy Judge Stan Bernstein issued a decision Oct. 26, 2006 that the 401(k) account was exempt, based on the Supreme Court decision Rousey v. Jacoway, 544 U.S. 320, interpreting a federal exemption identical to New York's, as well as Dubroff v. First Nat'l Bank of Glens Falls (In re Dubroff), 119 F.3d 75, 79 (2d Cir. 1997) and In re Ruffo, 261 B.R. 580 (Bankr. E.D.N.Y. 2001).

The trustee appealed Judge Bernstein's decision to the District Court. In the appeal, the trustee argued that funds in the account could not be exempt under New York law if they were fraudulently transferred into the account. NY CPLR 5205(c)(5)(ii) states that additions to an exempt retirement account "shall not be exempt from application to the satisfaction of a money judgment if . . . deemed to be fraudulent conveyances under article ten of the debtor and creditor law". The District Court, in a decision September 10, 2007, punted on the issue, saying Judge Bernstein had not discussed the fraudulent conveyance argument in his 2006 decision, and so bankruptcy court should reconsider the whole matter.

A fraudulent conveyance under New York law is described in Debtor and Creditor (D&C) Law Sections 270-279. In essence it is a transfer that denies creditors the opportunity to seize unexempt assets to satisfy their claims. After the District Court returned the case to the bankruptcy court, the trustee examined the debtor, concluded that she was insolvent when she funded her 401(k) plan (that is, her debts exceeded her unexempt assets) and, therefore, any transfers into her retirement account while insolvent would be a 'constructive fraudulent conveyance' under NY D&C Sect. 273 ('constructive' means the transfer was fraudulent whether or not the debtor intended to defraud anyone.)

On September 5, 2009, a bankruptcy judge, Carla E. Craig, issued a new decision disallowing the trustee's exemptions. The CPLR 5205(c) argument was something of a red herring (my words, not the judge's), because a bankruptcy debtor can claim an exemption on the entirely independent grounds of D&C 282(iii)(2)(e). In other words, the limitations on the exemption as against state court judgment creditors contained in CPLR 5205 (c) do not apply to a bankruptcy debtor's right to exempt the same asset under D&C 282(iii)(2)(e).

The trustee's exemption argument in Murra was based on the argument that funds were fraudulently transferred into the account, an exemption limitation contained in CPLR 5205(c)(5)(ii). But the court's reasoning would equally apply to the "90 day" limitation of CPLR 5205(c)(5)(i), which states that additions to retirement accounts "shall not be exempt from application to the satisfaction of a money judgment if made after the date that is ninety days before the interposition of the claim on which such judgment was entered." If the limitation of CPLR 5205(c)(5)(ii) doesn't apply to a bankruptcy exemption under D&C 282(iii)(2)(e), then a limitation under 5205(c)(5)(i) wouldn't apply either.

But the Murra trustee was not done yet. In 2006, he had filed an adversary proceeding (EDNY Bankruptcy AP #06-08099) against the debtor, seeking to avoid as a fraudulent conveyance funds transferred into the account, and the bankruptcy court's September 2008 decision said that the AP could go forward. The trustee argued that the transfers into the 401(k) account were fraudulent conveyances under NY law because:

1) They were transferred into an account that was into a 'separate juridical entity'
2) The debtor was insolvent when she made all the transfers;
3) Therefore, the transfers were a constructive fraudulent conveyance, avoidable by the trustee

The debtor's position was that there were no transfers at all, that the debtor simply moved money from one of her accounts to another; that the funds were not delivered to a third party.

In oral arguments on July 5, 2009, (transcript available on the court docket), the trustee tried to make a distinction between "merely the change of form of the asset, if I have cash today and I put it into a house tomorrow, I'm not making a transfer and I'm not making a conveyance" (Trustee argument, transcript pg. 8) and "taking it out of [the debtor's bankruptcy] estate, putting it into a separate juridical entity no longer available ton the creditors" (Trustee argument, transcript pg. 7.)

The court didn't accept, or even understand, the trustee's distinction and actually went well beyond the trustee's concept of what constitutes a transfer for fraudulent conveyance purposes. "The definition of transfer is very broad . . . There's case law I read before I came out here to the effect that if you transfer from one bank account to another in your own name that's still a transfer. . ." (Court; transcript pg 5.)

The Court did not cite the case law mentioned, and I suspect it derived from fraudulent transfers under Bankruptcy Code Sect. 548, rather than New York fraudulent conveyances as defined under D&C 270. I would not immediately jump to the conclusion that a 'transfer' under bankruptcy fraudulent transfers is identical to a 'conveyance' under New York's fraudulent conveyances.

In any case, the Court issued its decision in the AP three weeks later, July 21, 2009. On the question of what constitutes a transfer that could be considered fraudulent, the Court concluded that D&C Sect. 270 does not require that the transfer "be made for the benefit of a third party." Decision, pg. 5. In a footnote, the court concluded that payments to the 401(k) plan "do constitute to an entity separate from the Debtor." Decision, footnote 2, pg. 5.

The real question for the court is not whether a transfer took place but rather whether it was for "fair consideration", and on this crucial point the court issued a split decision. D&C Sect. 272 defines 'fair consideration' as an exchange of property or obligation "as a fair equivalent thereof, and in good faith." In fraudulent conveyance cases (and bankruptcy fraudulent transfer cases), the asset is transferred to a third party, and the debtor gets nothing back. But here, where funds are transferred into the debtor's retirement account, the debtor has the same valuable asset after the exchange as before. So the whole argument about whether the transfer was made to another entity or not is mostly irrelevant. Except - - -

Except for the additional phrase in the definition of 'fair consideration' that the exchange be in "good faith" as well as for fair equivalent value. The court acknowledged that under New York law the concept of "good faith" in defining fair consideration is difficult to interpret. Fair consideration is what is exchanged in 'constructive' fraudulent conveyances, and by definition a constructive fraudulent conveyance does not look to the intent of the parties, just a balance sheet analysis of whether the conveyance rendered the debtor insolvent.

The court in its AP decision permitted the trustee to go forward with trial to determine if the fair consideration was exchanged in "good faith." The trustee could also argue, if he wanted, that this was a case of actual fraud, that the debtor actually intended to "hinder, delay or defraud" creditors by transferring money into the retirement account, in violation of D&C Sect. 276. If the debtor intended to defraud, the issue of fair consideration and fair equivalent value would be irrelevant.

I would caution here that all the Morra decisions were based on New York exemptions and New York fraudulent conveyance law, although some federal cases were cited.  Debtors claiming federal exemptions, and trustees pursuing bankruptcy fraudulent transfers, have a different statutory scheme to consider, and different case law interpreting those statutes.  I would note, as one example, that a a constructive fraudulent transfer under Bankruptcy Code Sect. 548(a)(1)(B)(i) looks to "reasonably equivalent value" in the exchange, and not "fair equivalent" property exchanged "in good faith", as in NY D&C Sect. 272.

Even though the Morra court in its AP decision left the fraudulent conveyance door slightly open, I guess the trustee decided enough was enough. After four court decisions, an appeal, an adversary proceeding, and all that, perhaps the burden of proof would have been too great to overcome. The trustee, seeing where the court was going on this one, stated at the end of the July 5, 2009 hearing "we spent a lot of money on this issue, money we'll never recover. So we were quite prepared to to have to accept a substantial loss in the interest of making what we thought was the appropriate arguments under the law" (trustee argument; transcript pg. 24.)

In any case, the AP was voluntarily terminated, and, a month after the AP decision was issued, the trustee filed a "no asset" report, closing the bankruptcy case.

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