Statute of Elizabeth case provides important reminders

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Conveyance to an LLC is set aside

A recent South Carolina Court of Appeals case* affirmed a Circuit Court order that set aside a conveyance under the Statute of Elizabeth. This is yet another tale of woe from the economic downturn.

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Kenneth Clifton was a successful real estate developer who commonly purchased investment property in his own name. When he developed property, he transferred his interest to a limited liability company (LLC). He organized more than forty LLCs during his career.

In 1993, Clifton and Linda Whiteman purchased approximately 370 acres in Laurens County in their individual names as tenants in common.

Clifton routinely borrowed money from lenders to finance his developments. At issue in this case were three loans from First Citizens Bank totaling around $4 million. These loans were renewed over the years as Clifton made progress payments.

When the real estate market slowed in 2008, Clifton sought additional extensions for two of the loans. First Citizens asked for a personal financial statement. Clifton’s financial statement claimed a net worth of $50 million with real estate comprising over $48 million. The subject 370 acres in Laurens was included. The statement stated Clifton owned a 50% unencumbered interest valued at approximately $1.5 million. Relying on this financial statement, First Citizens renewed the loans to mature in 2009.

Later in 2008, Clifton requested an extension on the third loan. Just prior to receiving the extension, Clifton and Whiteman transferred their interests in the property to Park at Durbin Creek, LLC (PDC). Clifton testified that he and Whiteman chose to transfer this property to PDC over Whiteman’s concern about personal liability because the property was being leased to third parties for recreational hunting purposes. All three loans were extended to mature in 2009.

Clifton failed to make payments, to provide a business plan or to secure additional collateral. First Citizens initiated foreclosure proceedings in February of 2009 and eventually secured a deficiency judgment of $745,000 against him.

During the foreclosure proceedings, Clifton and his daughters entered into an assignment agreement resulting in a transfer by Clifton in PDC to Streamline, an LLC that was nonexistent on the date of the transfer but whose members, upon creation, were Clifton’s daughters and ex-wife.

In 2010, First Citizens initiated supplemental proceedings, but by this time, Clifton had no remaining assets. First Citizens began this case under the Statute of Elizabeth (S.C. Code §27-23-10), alleging causes of action for fraudulent conveyance, civil conspiracy and partition.

court money 2The Circuit Court found sufficient “badges of fraud” to infer Clifton possessed fraudulent intent when he transferred his 50% interest in the property to PDC.

This is the first valuable reminder from this case:  The conveyance to Streamline was held void ab initio because Streamline did not exist at the time of the conveyance. (Dirt lawyers, make sure your entities are properly created before you assist your clients in making conveyances to them!)

A second valuable reminder involves requirements concerning transfers of interests in member-managed LLCs like PDC. When Clifton attempted to transfer his interest in PDC to a separate LLC, he failed to obtain Whiteman’s consent. Section 33-44-404 (c)(7) of the South Carolina code states that, in a member-managed LLC, the admission of a new member requires the consent of all members. The lack of consent in this case would have invalided the transfer to streamline even if the transfer to PDC had been held valid. (Dirt lawyers, make sure you follow statutory procedures when dealing with transfers of interests in entities.)

The case then sets out a simple South Carolina primer on the Statute of Elizabeth. The statute provides:

Every gift, grant, alienation, bargain, transfer and conveyance of lands…for any intent or purpose to delay, hinder, or defraud creditors and others of their just and lawful actions, suits, debts, accounts, damages, penalties, and forfeitures must be deemed and taken…to be clearly and utterly void.

Citing earlier cases, the Court of Appeals stated that this statute can be used to set aside conveyances whether or not consideration is paid.

Where there is valuable consideration, the following element must be established:

  1. The transfer was made with the actual intent to defraud creditors;
  2. The grantor was indebted at the time of the transfer;
  3. The grantor’s intent is imputable to the grantee.

Where there is no valuable consideration, no actual intent to hinder or delay creditors is required. Instead, the transfer will be set aside if:

  1. The grantor was indebted to the plaintiff at the time of the transfer;
  2. The conveyance was voluntary; and
  3. The grantor failed to retain sufficient property to pay the indebtedness to the plaintiff at the time when the plaintiff seeks to collect the debt.

In this case, the Circuit Court found and both parties agreed that valuable consideration was paid. For that reason, First Citizens was required to prove that Clifton transferred the property with the intent to delay, hinder or defraud First Citizens.

Citing earlier cases again, the Court of Appeals stated that when a party denies fraudulent intent, as Clifton did, the creditor must prove “badges of fraud”. One badge of fraud may not create a presumption of fraud, but several badges of fraud does create the presumption.

Nine badges of fraud have been identified by our courts:

  1. The insolvency or indebtedness of the transferor;
  2. Lack of consideration for the conveyance;
  3. Relationship between the transferor and the transferee;
  4. The pendency or threat of litigation;
  5. Secrecy or concealment;
  6. Departure from the usual method of business;
  7. The transfer of the debtor’s entire estate;
  8. The reservation of benefit to the transferor; and
  9. The retention by the debtor of possession of the property.

The Court held that six of the nine badges of fraud were present in this case, resulting in a presumption of fraud. The Court next considered whether Clifton successfully rebutted the presumption. The Court concluded that Clifton wanted to protect the property from creditors, despite offering the legitimate reason for the transfer, that Whiteman was concerned about personal liability on hunting property.

Finally, the Court held that the invalidity of the conveyance of Clifton’s undivided 50% interest in the property does not invalidate Whiteman’s conveyance despite the fact that only one deed was used.

* First Citizens Bank and Trust Company, Inc. v. Park at Durbin Creek, LLC, South Carolina Court of Appeals Case 5469 (February 15, 2017)

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Just in Time for Halloween, SC Supreme Court Declines Frightening Request to Compel Random Lawyer Trust Account Audits

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The South Carolina Supreme Court amended the rules that govern lawyer discipline on October 25.* The big news here is not the very minor amendments that were adopted but rather the major requested amendments the Court declined to adopt.

The Commission on Lawyer Conduct and the Commission on Judicial Conduct proposed a rule amendment that would have imposed mandatory random audits of lawyer trust accounts. Without comment, the Court declined to adopt this rule change after “careful consideration”.

The Court also declined without comment an amendment that would have required a new position, a presiding disciplinary judge to act as a hearing officer to preside over disciplinary and incapacity hearings.

I have no idea why the Court made these decisions, but my guess is that the motivation revolved around the additional funds that these proposals would have required.

*Appellate Case No. 2015-0002336

Could Efforts to Modernize Mortgage Practice Lead to Changes in SC Law?

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Reuters reports on a “patchwork of state laws” that hinder efforts.

In an article dated September 9, Reuters reports that the practice of notarizing documents, which dates back “at least to Ancient Rome” is becoming “passé” in the era of FaceTime, Skype and live-streamed social media. South Carolina real estate lawyers might want to take deep breaths and read the article, which is linked here

South Carolina practitioners are banking on State v. Buyers Service, our seminal case from 1987 holding that closings are the practice of law, to keep us in the closing business. Buyers Service is still good law in South Carolina and has been cited favorably many times and as late as this year.

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There have been some hints, however, in our long line of “UPL” cases that some of our current Supreme Court Justices may not be as committed to our strong rule as some of the prior Justices have been. (I hope that comment was vague enough to keep me out of trouble if I encounter any of the current or former Justices at a cocktail party. Please notice citations are purposefully missing.)

The South Carolina Supreme Court has repeated in almost every case on point that the purpose of requiring lawyers to be involved in closings is to protect consumers. The Reuters article suggests that the effort to modernize mortgages would also protect consumers. One borrower in the story, a civilian paramedic at a military base in Kuwait, was forced to fly 6,500 miles to buy a house in Virginia. Webcam notaries would cut expenses for lenders, notaries and borrowers, the article suggests.

Are the two efforts to protect consumers diametrically opposed? No doubt, South Carolina lawyers could be on one end of the webcams. I encourage all of us to read the news and to pay attention to how closings happen in other parts of the country and to continually think of ways to modernize our practices.  Keeping up with technology can only contribute toward keeping a real estate practitioner in the closing game.

Don’t Amend Your Master Deed As A Litigation Strategy

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The South Carolina Court of Appeals was not impressed!

The owners of The Gates at Williams-Brice (a great place to tailgate!) were surprised in 2012 when a maintenance company refused to bid on an exterior caulking/sealant job because of perceived construction defects.  Almost immediately, the owners’ association and an individual owner filed a complaint alleging negligence, gross negligence, breach of warranty and strict liability claims. The defendants were numerous developer and contractor entities.

The plaintiffs demanded a jury trial and sought to establish a class action for the condominium owners. The developer filed a motion for a nonjury trial and to strike the class action allegations. The Circuit Court ruled for the plaintiffs, and the defendants appealed. The Court of Appeals, in an Opinion dated August 31*, reversed.

The case contains several practice pointers for dirt lawyers, especially those who draft master deeds and amendments to master deeds and those who represent owners’ associations.

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The Master Deed establishing The Gates at Williams-Brice contained provisions requiring arbitration, waiving the right to a jury trial, waiving the right to a class action, and eliminating the right to secondary, incidental or consequential damages.

The original complaint was filed in December of 2012. An answer, opposing the certification of a class, was filed in May of 2013. Later that month, the complaint was amended to add defendants. And on May 23, the homeowners amended the Master Deed to remove the provisions that thwarted their litigation efforts.

The Circuit Court found that the provisions at issue were no longer within the Master Deed and that the defendants were precluded from enforcing unconscionable arbitration and alternative dispute resolutions that contained oppressive, one-sided terms.

On appeal, the defendants argued that the Master Deed could not be amended retroactively to remove the provisions at issue. Neither party contested that the homeowners’ actions were taken in anticipation of litigation. The Court of Appeals held that the homeowners knowingly, voluntarily and intelligently waived their rights to a jury trial and to a class action when they signed their deeds.

Citing a North Carolina case**, the Court of Appeals said that to remove the agreed-upon waivers retroactively would effectively substitute a new obligation for the original bargain of the parties. The Court pointed to the cites in the North Carolina case that indicate several jurisdictions apply a reasonableness standard when reviewing amendments to covenants and holding a provision authorizing an owners’ association to amend covenants does not permit amendments of unlimited scope; rather, every amendment must be reasonable in light of the contracting parties’ original intent.

The Court of Appeals discounted several cases involving amendments in condominium projects by the Circuit Court as not controlling. One such case found the developer’s amendment to increase maintenance assessments was enforceable against new purchasers. Another case approved an amendment regarding leasing restrictions. A third case found that an owners’ association properly amended covenants to prohibit the developer from advertising on the property. The final case held that an amendment authorizing the association to suspend utilities for unpaid judgments was properly applied against a unit owner because any alleged retroactivity was proper based on the contractual relationship between the association and the unit owner.

Other cases cited by the Circuit Court were dismissed as neither dealing with amendments to condominium declarations nor to master deeds.

The Court stated that it was unaware of any authority in South Carolina that would permit contracting parties to unilaterally alter agreed upon provisions once litigation has started.

The developer also argued that the amendments were ineffective because they failed to obtain the required permission of lenders and other “bound parties” such as the developer. The Court declined to address that issue because of its other conclusions.

What will the Supreme Court say if it gets the opportunity to rule on this issue?

 

*The Gates at Williams-Brice Condominium Association v. DDC Construction, Inc., S.C. Court of Appeals Opinion 5438 (August 31, 2016)

**Armstrong v. Ledges Homeowners Ass’n, Inc., 633 S.E.2d 78 (N.C. 2006)

Another South Carolina Arbitration Case

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Following these cases is like watching a tennis match!

This is the third blog on this topic this summer! The June 7 blog surrounded a South Carolina Court of Appeals case* that held an arbitration clause in a roofing supplier’s warranty provision was not unconscionable. The lower court had ruled that the supplier’s sale of shingles was based on a contract of adhesion and that the injured property owners lacked any meaningful choice in negotiating the warranty and arbitration terms, which were actually contained in the packaging for the shingles.

The Court of Appeals indicated that the underlying sale was a typical modern transaction for goods in which the buyer never has direct contact with the manufacturer to negotiate terms. The Court found it significant that the packaging for the shingles contained a notation:  “Important: Read Carefully Before Opening” providing that if the purchaser is not satisfied with the terms of the warranty, then all unopened boxes should be returned. The Court pointed to the standard warranty in the marketplace that gives buyers the choice of keeping the goods or rejecting them by returning them for a refund, and blessed the arbitration provision.

SCORE:  15- Love in favor of arbitration

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Let’s Talk Dirt on July 14 addressed a South Carolina Supreme Court case that appeared to take the opposite approach. ** A national residential construction company’s contract contained a number of “oppressive and one-sided provisions”, including an attempted waiver of the implied warranty of habitability and a prohibition on awarding money damages of any kind. The Supreme Court held that the home purchasers lacked a meaningful ability to negotiate their contract, the only remedy through which appeared to be repair or replacement.

SCORE:  15-all.

Note that Justices Kittredge and Pleicones dissented, stating that the contract involves interstate commerce and, as a result, is subject to the Federal Arbitration Act (FAA), “a fact conspicuously absent in the majority opinion”. The dissent stated that federal law requires that unless the claim of unconscionability goes to the arbitration clause itself, the issue of enforceability must be resolved by the arbitrator, not by the courts. The majority construed the Warranties and Dispute Resolution provisions of the contract as comprising the arbitration agreement and thus circumvented controlling federal law, according to the dissent.

Since the property owners raised no challenges to the arbitration clause itself, the dissent would have required that the other challenges be resolved through arbitration.

In a case dated August 17***, the majority decision is written by Chief Justice Pleicones with Justice Kittredge concurring. (Do you see a pattern here?) This case involved a residential subdivision that had been built on property previously used as an industrial site. The developer had demolished and removed all visible evidence of the industrial site and removed underground pipes, valves and tanks.

The plaintiffs bought a “spec” home in the subdivision and later discovered on their property PVC pipes and a metal lined concrete box containing “black sludge”, which tested positive as a hazardous substance. The present lawsuit was brought, alleging the developer failed to disclose the property defects. The developer moved to compel arbitration.

Paragraph 21 of the purchase agreement stated that the purchaser had received and read a copy of the warranty and consented to its terms. The purchasers had been provided with a “Homeowner Handbook” containing the warranty.

The circuit court, which was affirmed by the Court of Appeals, found the arbitration clause was enforceable for two reasons:

  1. it was located within the warranty booklet, making its scope limited to claims under the warranty. The Supreme Court held that the plain and unambiguous language of the arbitration clause provides that all claims, including ones based in warranty, are subject to arbitration.
  2. The alleged outrageous tortious conduct of the developer in failing to disclose concealed contamination made the outrageous torts exception to arbitration enforcement applicable. The Supreme Court overruled all South Carolina cases that applied to outrageous torts exception, making that exception no longer viable in South Carolina.

The Supreme Court discussed the heavy presumption in favor of arbitration by the FAA and in the federal courts and the push to place arbitration agreements on equal footing with other contracts and enforce them in accordance with their terms.

SCORE30-15 in favor of arbitration

You won’t be surprised to learn that there was a dissent, this time by Acting Justice Toal, and a concurrence, by Justices Hearn and Beatty.

And remember that the CFPB recently announced a proposed rule that would ban financial companies from using mandatory pre-dispute arbitration clauses to deny consumers the right to join class action lawsuits.

SCORE:  30-all

All of these authorities affect matters involving dirt law. So the tennis match involving arbitration clauses in our area is still being played, and we will continue to watch!

*One Belle Hall Property Owners Association v. Trammell Crow Residential Company, S.C. Ct. App. Opinion 5407 (June 1, 2016)
** Smith v. D.R. Horton, Inc., S.C. Supreme Court Opinion 27643 (July 6, 2016)
*** Parsons v. John Wieland Homes, S.C. Supreme Court Opinion 27655 (August 17, 2016

Don’t Share Fees with Non-Lawyers!

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New Ethics Advisory Opinion warns against web-based referral service

South Carolina Ethics Advisory Opinion 16-06 fields questions about an attorney directory website fixed-fee legal referral service. The service works like this:

  • Attorney signs up for the service by agreeing to offer certain flat fee services.
  • The fee for the service is set by the internet advertising directory website (service).
  • The service makes the referral to the attorney, who then contacts the client to arrange a meeting and begin the representation.
  • The service handles payment processing from the client and holds the funds until the legal work is completed.
  • Upon completion of the work, the service transfers the full amount of the fee to attorney’s account.
  • Upon completion of the work, the service charges the attorney a “per service marketing fee” which seems to be based upon the legal work provided and is only incurred when the lawyer provides the legal work. For example, the legal fee for an uncontested divorce may be $995, and the marketing fee is $200, while the legal fee to start a single member LLC is $595, and the marketing fee is $125.

Rule 5.4 of the Rules of Professional Conduct prohibits a lawyer from sharing legal fees with a non-lawyer. There are some exceptions set out in the rule, but those exceptions generally fall into two categories, payments to a deceased lawyer’s estate and payments to non-lawyer employees in a profit sharing compensation or retirement plan. The exceptions, of course, don’t apply to this attorney directory situation.

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The Ethics Advisory Committee stated that the situation described above where the service collects the legal fee and transmits it to the attorney and in a separate transaction, the service receives a fee for its efforts, is an indirect method to share attorney’s fees. Attempting to disguise the fee-sharing arrangement in two transactions doesn’t cure the problem.  Calling the fee received by the service a “per service marketing fee” also doesn’t cure the problem.

Rule 7.2 (c) prohibits a lawyer from giving anything of value for recommending the lawyer’s services, with three exceptions. One of the exceptions allows a lawyer to pay for the “reasonable costs of advertisements”. The Ethics Advisory Committee pointed to Comment 7 to the rule which lists reasonable advertising costs such as newspaper, radio and television advertisements and on-line directory listings.  The Committee stated that the permitted advertising is typically for a fixed cost per add or per run of air time, and that reasonableness of the costs can be assessed by the market rate.

The Opinion says that the internet service purports to charge the lawyer fees based on the type of legal service rather than the cost of advertising. Since it doesn’t cost the service any more to advertise online for a family law matter than for preparing corporate documents, the fees are not rational and do not fall under the exception for “reasonable costs of advertisements”.

Dirt lawyers, be careful when assessing any type of referral arrangement, and, when in doubt, ask questions of the Ethics Advisory Committee.

The SC-NC Boundary Legislation Passed!

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SC law “clarifying” the boundary will be effective at the beginning of the year.

The long awaited and much debated legislation defining the boundary line between The Palmetto State and the Tar Heel State was signed by Governor Nikki Haley on June 10.  The effective date of the law is January 1, 2017.

The purpose of the law is “clarifying the original location of the boundary” with North Carolina along Horry, Dillon, Marlboro, Chesterfield, Lancaster, York, Cherokee and Spartanburg Counties and providing additional information about the plats describing the location along Greenville, Pickens and Oconee counties.  In other words, our legislature doesn’t believe the law establishes a new boundary line.

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As expected, much of the legislation deals with tax issues. The legislative intent is set out specifically, and includes the thought that no business or residence owner should be liable for back taxes to South Carolina nor refunds from South Carolina as a result of a change from one state to the other. And the Department of Revenue is given the authority to compromise taxes in cases that result in taxation in both states.

Several issues are of particular interest to dirt lawyers. For example, no deed recording fees or county filing fees may be charged for deeds recorded as a result of the boundary clarification.

On the effective date of the legislation, Registers of Deeds (and Clerks of Court in those affected counties that do not have ROD offices) will be required to file a Notice of State Boundary Clarification for each affected piece of property. The form is described specifically in the legislation and requires the legal description, tax map number, derivation (if available), the names of the owners of record and the “muniments of title”, a defined term meaning “documents of record setting forth a legal or equitable real property interest or incorporeal hereditament in affected lands of an owner”.

I’m a dirt lawyer of more years than I like to divulge, but I admit I had to investigate the meaning of that word. The learned source, Wikipedia, indicates a muniment of title is the written evidence a landowner can use to defend title, such as a deed, will, judgment or death certificate.

Apparently, lawyers in states with marketable title legislation may be familiar with this term. South Carolinians have neither the benefit of tidy legislation to correct our title problems nor the knowledge and widespread use of this nifty term, until now.  We will all need to use and pronounce the word, muniment, next year. A North Carolina colleague asked me where the RODs and Clerks of Court will obtain the information to supply the  muniments of title. My best guess is that somebody is going to have to do a lot of title work!

(Note to Professor Spitz:  I apologize if you taught me that term in law school. It’s been a long, long time!)

Also of interest to dirt lawyers are provisions relating to foreclosures. A foreclosing attorney will have to file and serve the summons and complaint along with the aforesaid Notice of Boundary Clarification and an attorneys’ certification “that title to the subject real property has been searched in the affected counties and the affected jurisdictions” on all parties having interest in the real property pursuant to the muniments of title.  Whew! The foreclosure can then proceed after thirty days. I’m not sure how all that will be sorted out. I assume South Carolina foreclosure lawyers will be hiring counterparts across the state line to assist in these title examinations.

How will dirt lawyers and title insurance companies deal with sales and mortgages for properties that change states?  I think we are going to take these issues on a case-by-case basis and work together to sort out the various issues that are surely to arise. Be sure to involve your title insurance underwriter in these decisions rather than going out on a limb alone!