Banker Beware – Change in Ohio Law Could Result in Unintended Non-Recourse Loans

Kegler Brown Creditors' Rights + Bankruptcy Alert

Lenders and other creditors face new challenges as a result of the Ohio Legacy Trust Act, which became effective in March 2013. Under the Legacy Trust Act, borrowers are now permitted to put their assets in an irrevocable creditor-proof trust while retaining most of the benefit and control of those assets. Lenders and other creditors will not be permitted to reach assets transferred to a Legacy Trust unless:

  • The creditor has an express, voluntary, perfected security interest in the assets, or
  • The creditor can prove by clear and convincing evidence that the borrower was insolvent at the time of the transfer, and that the borrower intended to defraud that specific creditor when the borrower put the assets in trust.

Under Ohio law prior to the enactment of the Legacy Trust Act, a borrower could put its assets into trust while retaining the right to use the assets, but creditors could pierce the trust to the extent that that borrower retained rights in the assets. Under the new law, a borrower can put its assets into trust, retain the right to use the assets, retain the right to control the assets, retain the right to give the assets to someone else, and still fully shield the assets from the borrower’s creditors. Sophisticated borrowers with Legacy Trust protection could have a very well-heeled lifestyle while being essentially uncollectable by creditors, both voluntary and involuntary creditors.

The law also creates very high hurdles for creditors seeking to set aside a borrower’s asset transfer to a Legacy Trust. To set aside a transfer to a Legacy Trust, a creditor is required to prove by clear and convincing evidence that the borrower made the transfer with intent to defraud that specific creditor. It is not enough to prove that the borrower became insolvent as a result of the transfer – instead, the lender is tasked with proving that the borrower specifically intended to defraud the lender by transferring the assets. In another pro-borrower twist, the law requires courts to award attorneys’ fees to the borrower if the lender does not succeed in its lawsuit. The law imposes a short statute of limitations of only eighteen months after the transfer is completed to challenge the transfer. The law also increases Ohio’s homestead exemption to $125,000 per person.

The full impact of the Legacy Trust Act has yet to ripple through the lending community, but the new law has significantly shifted the playing field in favor of borrowers. Banks must take additional steps to investigate borrowers and guarantors when underwriting a loan. Lenders now owe a much higher duty to investigate the borrower’s assets and to remain informed of the way in which the borrowers hold their assets. This duty to investigate a borrower’s assets continues even after the closing. Lenders should consider taking a security interest in each and every asset that forms the basis of an underwriting decision. Lenders should also require borrowers to state with specificity how assets are owned on all financial statements, as well as require borrowers to disclose the transfer of any assets into a Legacy Trust after the loan closing.