9th Cir. Rejects Debtor’s Attempt to Avoid SBA Judgment by Disclaiming Inheritance

The U.S. Court of Appeals for the Ninth Circuit recently affirmed the district court’s judgment in favor of the U.S. Small Business Administration in a Federal Debt Collection Procedures Act (FDCPA) lawsuit the SBA filed against a loan guarantor to satisfy a default judgment assigned to it after the guarantor disclaimed an inheritance to avoid paying the judgment.

The Federal Debt Collection Procedures Act, 28 U.S.C. §3001 et seq., which governs the collection of money owed to the U.S. government, should not be confused with the federal Fair Debt Collection Practices Act, which is found at 15 U.S.C. §1692 et seq. and governs how debt collectors may collect debts from consumers.

A copy of the opinion in Small Bus. Admin. v. Bensal is available at: Link to Opinion.

The SBA, a federal government agency, guaranteed 75 percent of a $175,000 small business loan between a private bank and a company, and the company’s owner personally guaranteed the loan. The company defaulted on the loan, and the private bank sued the company and guarantor, obtaining a default judgment against them. When neither the company nor the guarantor satisfied the default judgment, the bank assigned the default judgment to the SBA to honor its guaranty of the loan, which totaled more than $300,000.

The guarantor later inherited a share of his deceased father’s trust, which was valued at more than $150,000.  Instead of accepting the inheritance, he signed a disclaimer under California law that allowed him to renounce his share of the trust and legally pass it to his two children, thereby attempting to prevent his creditors from accessing his share of the trust.  The SBA filed a lawsuit under the FDCPA seeking to void the disclaimer under the FDCPA’s prohibition of fraudulent transfers of property.

The guarantor countered that California law permitted the disclaimer because it states that a disclaimer is not a voidable transfer, and that the default judgment obtained against the guarantor was not a “debt” as defined by the FDCPA.  The trial court disagreed, holding that the FDCPA pre-empted California law and that the default judgment was a debt within the meaning of the FDCPA. The guarantor appealed.

In affirming, the Ninth Circuit explained that the FDCPA’s fraudulent transfer provision, 28 U.S.C. §3304(a), permits the federal government to void a fraudulent transfer by a debtor who owes a debt to the United States where the existence of the debt pre-dated the transfer, there was a transfer of assets, there was a lack of equivalent value in exchange for the transfer, and there was debtor insolvency at the time of the transfer. The parties’ arguments focused on whether the guarantor’s disclaimer qualified as a transfer of property and whether the default judgment constituted a debt within the meaning of the FDCPA.

The guarantor argued that he had acted lawfully under the California Probate Code, which states that a disclaimer is not a voidable transfer. The Ninth Circuit held, however, that California law directly conflicted with the FDCPA, which defines “transfer” so as to include the guarantor’s disclaimer because it involves “every mode…of disposing of or parting with an asset or an interest in an asset…” 28 U.S.C. §3301(6).  Thus, the Court held, the disclaimer was a transfer of property that could be voided under the FDCPA and the federal statute pre-empted state law, which the Ninth Circuit found was supported by U.S. Supreme Court precedent.

The guarantor’s argument that the default judgment did not qualify as a debt under the FDCPA also failed.  The FDCPA defines “debt” as an amount owed to the U.S. government because of a direct loan or a loan insured or guaranteed by the United States, includes a long list of various types of debts and financial obligations, and contains the catch-all phrase “other source of indebtedness.”  28 U.S.C. §3002(3).  The Ninth Circuit found that the default judgment fit into the catch-all phrase and that limiting language attached to the catch-all phrase (“owing under the terms of a contract originally entered into by only persons other than the United States”) did not prevent the default judgment from qualifying as “debt” under the statute.

In reaching its ruling, the Ninth Circuit examined the statutory language and purpose of the FDCPA, the House report and legislative discussion on the statute, and case law interpreting limiting language in statutes. It reasoned that looking beyond the label given to the debt and analyzing the source of the debt, especially the contract that had created the debt, led to the conclusion that the SBA was a party to the contract that created the debt and had the statutory authority to pursue its collection.

The Court rejected the guarantor’s arguments that the default judgment had not been entered in favor of the United States, but merely assigned to the SBA, that the financial obligation was merely a guaranty and not a loan, and that the SBA improperly sought to enforce the entire default judgment instead of only the portion related to the SBA loan. The Ninth Circuit found each of the arguments to be without merit or legal authority.

Accordingly, the Ninth Circuit affirmed the trial court’s holding that the SBA was allowed to reach the guarantor’s trust share because the FDCPA pre-empted California’s disclaimer law and the default judgment was a debt within the statute.

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Amy Jonker is a commercial litigator whose practice focuses on defending consumer financial services companies in class actions, individual matters, and regulatory investigations, representing employers in investigations and litigation, and successfully resolving commercial disputes. She has extensive experience delivering positive outcomes in complex commercial litigation in state and federal courts across the country, including for many financial institutions and law firms for claims filed under the Fair Debt Collection Practices Act (FDCPA), the Fair Credit Reporting Act (FCRA), the Fair and Accurate Credit Transactions Act (FACTA), the Telephone Consumer Protection Act (TPCA), UDAAP and state consumer protection laws, under the Family and Medical Leave Act (FMLA), Title VII, the Americans with Disabilities Act (ADA), whistleblower claims, and in complex insurance disputes. Her experience covers all phases of litigation at both federal and state levels, including obtaining dismissals of complaints, obtaining summary judgment on claims and defenses, handling all phases of discovery in both individual and class actions, negotiating individual and class action settlements, preparing for and participating in trials and arbitrations, conducting oral arguments, and federal and state court appellate work.