New Uniform Asset-Freezing Orders Act Has Rocky Start In Colorado

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Please see update 30 September 2013 at http://onforb.es/1eVASDB

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In 1999, the U.S. Supreme Court decided the landmark case of Grupo Mexicano de Dessarolo v. Alliance Bond Fund, Inc., 527 U.S. 308 (1999), which essentially held that federal courts did not have any general powers to freeze the assets of a debtor before the debtor either absconded with the assets or dissipated them.

The basis for the Court's decision was that, because there is effectively no "federal common law", in the absence of some specific statutory authorization (such as given by Congress to actions brought by the SEC or FTC) the federal courts could not, pre-judgment, freeze a debtor's assets.

While Grupo Mexicano by its own language applied strictly and only to actions brought in federal court, it also caused some self-reflection and second-guessing at the state court level too. While states do have rich common law backgrounds that allow courts to do a lot of things for which there is no specific statutory authorization, some state judges started questioning whether they had the power to enter freeze orders against a debtor's assets.

From this, further questions then started to arise: Could the courts of state A freeze a debtor's assets in state B? Did the courts of state B have to recognize a freeze order entered by the courts of state A? And what about the sometimes-innocent third parties who were holding the debtor's assets in state C -- did they have to follow the freeze orders of the state A courts?

Issues like these are typically dealt with by so-called "Uniform Acts", which are drafted by a group called the "Uniform Law Commission" and which have heavy input by the American Bar Association and other interested parties. For example, and by way of disclosure, I am an Advisor by the American Bar Association on the new revisions to the Uniform Fraudulent Transfer Act. The most well-known such act is of course the Uniform Commercial Code which governs the greatest bulk of the business activity in this country.

Based on court cases and concerns expressed by those who deal with a particular issue, the Uniform Law Commission drafted as proposed Uniform Act, and then proposes it to the various state legislatures for enactment. States are not required to adopt a Uniform Act, and probably few Uniform Acts are adopted by particular states without the state making its own slight changes to conform to its peculiar needs.

Thus it was that the Uniform Law Commission set up a Committee to draft what would be called the "Uniform Asset-Freezing Orders Act" (UAFOA).

Pre-judgment asset freezing orders have their genesis in the Commonwealth courts. In 1975, the English courts affirmed the issuance of a pre-judgment asset-freezing order in the case of Mareva Compania Naviera SA v International Bulkcarriers SA, 2 Lloyd's Rep 509 (1975). Such orders then became known as "Mareva Injunctions", and their popularity has grown with their great effectiveness in freezing the assets of investment fraudsters and the like, to protect their assets to fund their victims' recoveries.

Thus it was that the new UAFOA Committee was able to borrow heavily from the English law that had developed around Mareva injunctions.

The UAFOA excludes two types of cases: First, cases involving consumer debt, since it would seem pretty extreme that somebody who just had unsecured credit card debt would have their assets frozen. Second, the UAFOA doesn't apply to family law actions such as for alimony or child-support since there are already very extensive uniform laws which cover those areas.

Sections 4 and 5 of the UAFOA authorizes the issuance of asset freeze orders on an expedited basis, either with or without notice, respectively. The creditor has to show "there is a substantial likelihood that the party seeking the order will prevail on the merits of the action". Section 7 gives the court the authority to require the creditor to give a bond to protect the debtor or third-parties as necessary. Sections 8 and 9 require courts to recognize both domestic and foreign asset freeze orders issued by other courts.

It is section 6 of the UAFOA that has caused the new Act to stumble out of the gate as it seeks enactment, at least in Colorado as I shall soon relate.

Section 6 deals with the effect of freezing orders when received by nonparties, which means those persons believed to be holding the debtor's assets that are being frozen. For example, if defendant Sammy Scammer has a freeze order issued against his assets, and a copy of the order is served on Sammy's bank, then the bank would be the "nonparty". Adequate safeguards to protect these nonparties, including finally subsection 6(e) which states:

"A nonparty served with an asset-freezing order may move to dissolve or modify the order. The court shall hear and decide the motion on an expedited basis."

The problem is: Which court? Does this section mean the court where the asset freeze order was originally issued, which might be on the other side of the continent (or world), or does it mean the local court where the nonparty is located? It is here that section 1, the definitional section, wholly fails us by not defining "court" or otherwise giving us any guidance as to how this situation would be handled.

So, to go back to our example, let's say that a freeze order is issued against Sammy Scammer in New York City, but his assets are in a bank in Colorado Springs. If "court" means the New York Court, then the bank has to go hire expensive New York counsel if the bank believes that it has some good defense to the asset freeze order. A litigator would then extrapolate this problem to point out that if the bank has to go to New York to fight the asset freeze order, then the bank might be submitting itself to personal jurisdiction in New York for the big fight that comes with all of Sammy's creditors.

These concerns are not merely theoretical. Businesses around the country are already miffed at being dragged to litigate many bankruptcy controversies in Delaware, simply because the debtor entity was formed there. That situation has gotten so bad that Congress is currently being aggressively lobbied to change the laws on how venue is determined so that the bankruptcy of a business is resolved by where its true headquarters is located, and not where it spent $100 or so to buy a piece of paper known as the Articles of Incorporation.

The UAFOA was been introduced in North Dakota and Colorado. No word on the former, but when some members of the Colorado business planning bar got wind of the UAFOA, they began to voice their concerns, and for now the UAFOA has been tabled until these are more fully considered. Similarly, word is that other sections of the American Bar Association are starting to look at the Act to see if it raises concerns within their member constituencies, i.e., the ABA's Trusts & Estates section may start looking at the UAFOA to see if has the potential to impact certain types of trust structures.

The fix seems pretty simple: Simply define "court" as including a nonparty's local court so that they can bring their challenges to the freeze order locally instead of in Timbuktu. Some creditors, however, would rather have their litigation consolidated in one court and might not want to be running around the country fighting asset freezing challenges, and so they might oppose this change. Stay tuned.

But let's not let the perfect be the enemy of the good. In this internet age of financial transactions that can occur within a second, asset freeze orders are critically needed by many creditors and fraud victims to protect what they can by a wrongdoing debtor or fraud artist. As a whole, the UAFOA is good legislation and -- with some inevitable tweeks -- should be adopted.

As a litigator, I can vouch that the state court system for obtaining pre-judgment injunctions and attachment orders is a mess. There is little uniformity between states, few if any procedural rules (and those that do exist are hopelessly outdated), and on the whole the process is almost never worth it for all but the most aggrieved creditor. The UAFOA will be a big help (with tweeks).

For that matter, Congress should conform federal law to the UAFOA as well, and finally get rid of the Grupo Mexicano hole that allows a foreign company to enter into contracts with U.S. companies, and then vamoose back home with their assets if the deal starts looking iffy. But first we need to make sure that the UAFOA works as it should at the state level (with tweeks).

The most immediate problem of the UAFOA is that it seems to have taken everybody by surprise, which is something that has the potential to happen with any new Uniform Act that covers a small niche area of practice as does this one. At least one Colorado practioner complained to me that the UAFOA has "flown under the radar" and was seeking "stealth enactment" by the Colorado legislature. Probably now the word will get out, and the Act will get a healthy examination before consideration by the various state legislatures.

Again, let's not let the perfect be the enemy of the good in relation to the UAFOA (with tweeks).

Current information on the Uniform Asset-Freezing Orders Act, along with the text of the Act and legislative status, can be found on the website of the Uniform Laws Commission at http://www.uniformlaws.org/Act.aspx?title=Asset-Freezing%20Orders%20Act

This article at http://onforb.es/ZWNkJu and http://goo.gl/DXvMy