Sparkman & McLean Co. v. Derber

Citations: 481 P.2d 585; 4 Wash. App. 341; 1971 Wash. App. LEXIS 1345Docket: 213-40668-2

Court: Court of Appeals of Washington; February 25, 1971; Washington; State Appellate Court

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Sparkman and McLean Company initiated foreclosure proceedings on a mortgage for the Port Townsend Plaza property in Jefferson County, Washington, with Harold Derber listed as the trustee for Universal Mercury Limited. This property had additional claims from A.M. Schwitalla and Ernest Jonson, the receiver for Balanced Investments Corporation (BIC), who alleged that a June 12, 1967, transfer of the property from BIC to Derber was fraudulent. The transfer involved BIC conveying the plaza to a fictitious entity, Universal Mercury Limited, effectively controlled by Derber. The receiver sought to confirm BIC's title against Schwitalla, who held a $7,500 mortgage tied to a promissory note. The court ruled in favor of the receiver, quieting title against Schwitalla, declaring the mortgage and note void due to lack of valid consideration. The appeal did not involve other parties or questions of priority, as a stipulation was in place for potential judicial changes. The background reveals that Schwitalla, a Florida attorney specializing in corporate insolvency, was engaged by BIC's president Harrison O. Ash to assist with a merger with Texas International Sulphur Company (TIS) amidst BIC's precarious financial situation. Despite starting chapter 11 proceedings for TIS when BIC was solvent, BIC's financial condition deteriorated, particularly after trading its Kent Valley asset for the less profitable Port Townsend shopping center, which was under significant rental collection pressure from the first mortgagee.

Debenture bondholders of BIC were demanding cash instead of preferred stock as the bonds matured, prompting ongoing consultations involving Schwitalla regarding BIC's financial difficulties. On June 7, 1967, Ray S. Adiel was elected president of BIC, and two days later, Schwitalla submitted a new statement for services, seeking confirmation of his employment from the new management. He requested mortgage and promissory note forms to secure his fees, citing the need for confirmation. The mortgage pertained to a portion of the Port Townsend Plaza and was executed and recorded on June 12, 1967. At the time, BIC was insolvent, and its assets later came under a respondent receiver's control.

There was no evidence that Schwitalla was formally hired as general counsel; his role was limited to the chapter 11 proceedings for TIS and future financing efforts. He engaged in discussions with corporate officers regarding BIC's finances and drafted legal documents for a fraudulent transaction with the non-existent Universal Mercury Limited, a finding unchallenged on appeal. The trial court ruled that Schwitalla's mortgage was a fraudulent conveyance under the Uniform Fraudulent Conveyance Act, concluding it was void due to BIC's insolvency and lack of valid consideration.

The court highlighted that under RCW 19.40.040, any conveyance made by an insolvent party without fair consideration is fraudulent to creditors, irrespective of intent. Fair consideration is defined in RCW 19.40.030, and a transfer can also be deemed fraudulent if made with actual intent to defraud creditors, per RCW 19.40.070. It is noted that both the transferor (BIC) and transferee (Schwitalla) must have knowledge of the intent to defraud for the transaction to be classified as fraudulent, with mere suspicion not sufficing for such knowledge.

The trial court's findings regarding the appellant's mortgage lack clarity on whether it was fraudulent under RCW 19.40.040 (fair consideration) or RCW 19.40.070 (intent to defraud), or both. Finding of fact 13 indicates that A.M. Schwitalla was aware that the work related to Texas Sulphur International did not benefit BIC and was for personal gain, which could support a conclusion of fraud due to lack of fair consideration and actual intent to defraud. The appeal involves factual determinations about the burden and quantum of proof necessary to invalidate the conveyance under the Uniform Fraudulent Conveyance Act. Previous cases have not clearly distinguished between the good faith requirement in fair consideration and the actual intent to defraud, often focusing solely on whether the services provided were reasonably valued against what was received. In Manello v. Bornstine, the Supreme Court noted that as long as there is fair consideration, showing actual intent to defraud is necessary to classify a transfer as fraudulent. The distinction between good faith and fraud is significant, as proving actual fraudulent intent imposes a heavy burden on the claimant. The court emphasized that mere suspicion regarding good faith is insufficient; evidence must be compelling to establish that a conveyance is genuinely fraudulent, supported by a presumption of honesty in transactions.

In Columbia Int'l Corp. v. Perry, there is ambiguity regarding whether the burden and quantum of proof apply to RCW 19.40.040 (good faith) or RCW 19.40.070 (actual fraud). The court's prior finding of 'fair' consideration suggests that the rules pertain to actual fraud under RCW 19.40.070. Workman v. Bryce outlines that the burden of proof for fraud lies with the party wishing to set aside a conveyance, but shifts to the defendant to demonstrate good faith if the consideration is grossly inadequate. Transactions between relatives require heightened scrutiny, necessitating satisfactory proof of good faith and adequate consideration.

Tacoma Ass'n of Credit Men v. Lester defines good faith as comprising three elements: honest belief in propriety, no intent to exploit others unconscionably, and no intent or knowledge of actions that would defraud others. Absence of any of these elements establishes lack of good faith. The burden of proof lies with individuals controlling multiple businesses to prove the good faith of their transactions.

Key principles derived from the analysis include: 1) The initial burden lies with the party seeking to set aside the conveyance under both RCW 19.40.040 and RCW 19.40.070. 2) For proving actual intent to defraud, a heavy burden exists requiring 'clear and satisfactory proof.' 3) To prove lack of good faith under RCW 19.40.040, substantial evidence must show one of the good faith elements is lacking. 4) Under certain conditions, the burden may shift to a favored creditor to prove the good faith of transactions with an insolvent party, especially in transactions involving close relatives or related businesses.

The burden of proving good faith lies with the creditor favored by a preference in transactions involving an attorney and client, where such dealings are presumed fraudulent unless the attorney can demonstrate good faith. This principle aligns with established case law regarding fiduciary relationships. The pivotal question is whether the appellant proved he received the note and mortgage in good faith. The evidence indicates he did not, as he was aware of the precarious financial situation of BIC and had previously engaged in drafting documents related to fraudulent transactions. His choice to use Florida counsel for drafting documents concerning Washington property raised concerns, as local counsel should have been consulted to adhere to Washington law. Schwitalla's prior knowledge of BIC's financial chaos and his involvement in questionable transactions undermine his claim of good faith. Consequently, the court affirmed the decision to set aside the mortgage but deemed it erroneous to also invalidate the note for lack of consideration.

Appellant initially acted in good faith while providing services to BIC, anticipating a potential merger with TIS, a public company with 2,500 to 3,000 shareholders. This merger could have enhanced BIC's financing capabilities, crucial for the corporation in March 1967 when appellant was retained. After commencing services, appellant could not abandon the legal proceedings and ultimately completed the work. As a result, he is entitled to file a claim with the receiver as a general creditor of BIC for the reasonable value of the services performed. The judgment affirms the voiding of appellant's mortgage but reverses the invalidation of his claim for service value. Notably, the mortgage was executed by BIC's president and secretary in June 1967 and recorded shortly thereafter, and the trial court did not classify appellant's promissory note as a fraudulent obligation under RCW 19.40.040.