Pennsylvania Court Takes Hard-line on Fraudulent Transfers

Mid Penn Bank advanced a $165,000 unsecured line of credit to Zene Farhat, a home builder.  Less than two months later, his parents sold him a lot for $1.00.  Zene built a house on the property.  Meanwhile, for almost eighteen months, Zene made timely interest payments on the loan.  Then, however, a new loan officer asked Zene to make principal payments, suggested that Zene offer the property as collateral, and reminded Zene that Mid Penn could call the entire loan and confess judgment against him if he failed to pay.  Zene explained that his father owned the property and refused.  He then stopped making any payments and sold the property back to his parents for $1.00.  Several months later, Zene's parents sold the property for $275,000.  When Mid Penn confessed judgment against Zene the following month, it discovered that his personal residence was encumbered with mortgages, including a new line of credit, and had little or no equity.  Mid Penn then sued Zene and his parents for the $165,000, plus interest, under Pennsylvania's Uniform Fraudulent Transfer Act.  Zene's father passed away before trial, leaving Zene and his mother as defendants.

After a non-jury trial, a judge found for the Farhats, on the ground that there was insufficient evidence that Zene actually intended to defraud Mid Penn when he transferred the property back to his parents.  Normally, this factual determination by a trial judge would be unassailable.  The Superior Court, however, reversed, and concluded that the transfer was fraudulent even though nothing had been concealed.  The Superior Court emphasized that the sale of the property by Zene to his parents was between insiders, after Mid Penn threatened litigation, and just before Zene obtained the $50,000 line of credit, which was a substantial debt.  Most importantly, the Superior Court stressed that Zene failed to receive "reasonably equivalent value" for the property, which his parents later sold for $275,000, and that Zene was insolvent at the time because he could not pay Mid Penn.  Based upon these factors, the Superior Court concluded that, as a matter of law, the transfer of the property was fraudulent, and that Zene and his mother were liable.

The take-away from the Superior Court's opinion is that Pennsylvania courts will subject transactions by debtors to very significant scrutiny.  Indeed, the concept of a "fraudulent" transfer is a misnomer, in the sense that there need not be anything misleading or any intent to deceive.  Rather, courts will look to whether the circumstances made collection harder for creditors. Mid Penn Bank v. Farhat should encourage lenders to follow the money because those that even passively accept assets from distressed borrowers do so at their peril.