Factoring, Commercial Financing Services and Claims That Range from Replevin to Fraud

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Posted on: Jul 26 2023

In Merchant Factors Corp. v. Crush Apparel & Accessories Inc., 2023 N.Y. Slip Op. 50755(U) (Sup. Ct., N.Y. County July 21, 2023) (here), plaintiff, Merchant Factors Corp., a factoring and commercial financing services provider, brought suit against defendant Crush Apparel & Accessories Inc. (“Crush Apparel”), among others,¹ to recover for an allegedly fraudulent scheme to steal and divert millions of dollars in goods, services, and real property that defendants pledged as collateral, and against which plaintiff made cash advances.

Plaintiff asserted 20 causes of action in its amended complaint, including: (1) replevin; (2) conversion; (3) injunction; (4) accounting; (5) fraudulent misrepresentation; (6) aiding and abetting fraud; and (7) actual and constructive fraudulent conveyances. Defendants moved to dismiss the complaint, pursuant to CPLR § 3211(a)(7), for failure to state a cause of action. As discussed below, the motions were granted in part and denied in part.

Below, we examine the motion court’s decision with regard to the replevin and conversion, fraudulent misrepresentation, and fraudulent conveyance causes of action.

Background

In August 2017, Merchant and Crush Apparel, an importer and distributor of clothing, entered into a factoring agreement, pursuant to which Crush Apparel sold and assigned all of its accounts receivable to Merchant in return for substantial cash advances. Pursuant to the factoring agreement, Crush Apparel gave Merchant a security interest in all of its assets (the “Collateral”). In addition, Crush Apparel expressly represented and warranted that each account receivable generated and assigned to Merchant: (1) “covered a bona fide sales and delivery of merchandise”; (2) “relate[d] to merchandise or services which have been accepted by [Crush Apparel’s] customers … without dispute”; (3) was “payable in accordance with the terms of [the] related invoice”; and (4) was “absolutely enforceable against [Crush Apparel’s] customers free and clear of any lien, encumbrance or dispute.”

Merchant was also permitted under the factoring agreement to (and did) re-factor accounts receivable assigned by Crush Apparel with The CIT Group/Commercial Services, Inc. (“CIT”). As a result, customer payments on such accounts were required to be remitted directly to CIT. Merchant alleged that from December 2017 through September 2019, more than 2,000 checks totaling over $14.2 million were remitted to CIT drawn on a Crush Apparel bank account, purporting to reflect payments that Crush Apparel received directly from its customers.

As an inducement to enter into the factoring agreement, Crush Apparel executed a written inventory supplement to the factoring agreement. Under the inventory agreement, Crush Apparel gave Merchant “a continuing security interest” in its inventory and “all contract rights with respect thereto.” Merchant perfected its security interest by filing a Uniform Commercial Code financing statement with the appropriate authorities.

Merchant maintained that the remitted funds did not reflect legitimate, bona fide sales. In that regard, Merchant alleged that Crush Apparel fabricated nearly all of the sales to induce Merchant to advance funds to Crush Apparel. Merchant alleged that it advanced funds to Crush Apparel believing that the invoices were bona fide and collectible accounts receivable under the terms of the factoring agreement.

Merchant further alleged that the Kraiem defendants transferred certain property relevant to the factoring agreement for less than fair consideration and in an effort to defraud their creditors, including Merchant. In this regard, the property in Brooklyn, N.Y. (the “Brooklyn Property”) was transferred for $1,500,000 and the property in New Jersey (the “New Jersey Property”) was transferred for $0.00.

The Motion Court’s Decision

Replevin and Conversion

Defendants sought dismissal of Merchant’s fifth and sixth causes of action for replevin and conversion, arguing that dismissal was appropriate because: (1) plaintiff failed to allege that the Kraiem defendants exercised unauthorized dominion over Merchant’s funds transferred from Crush Apparel’s bank accounts; (2) Merchant could not identify any specific, identifiable funds because those funds were comingled; and (3) Merchant did not demand the return of any specific funds.

Merchant countered, arguing that it had a first priority security interest in the Collateral and that defendants were wrongfully retaining possession of the Collateral.

“Conversion is an unauthorized assumption and exercise of the right of ownership over goods belonging to another to the exclusion of the owner’s rights. Money, if specifically identifiable, may be the subject of a conversion action.”² “Two key elements of conversion are (1) plaintiff’s possessory right or interest in the property and (2) defendant’s dominion over the property or interference with it, in derogation of plaintiff’s rights.”³

“To state a cause of action for replevin, a plaintiff must establish a superior possessory right to property in a defendant’s possession.”⁴ The objective of replevin is the recovery of property.⁵ Where a defendant has acquired property legally, the plaintiff must allege demand for return of the property and refusal by the defendant for both conversion and replevin.⁶

The motion court denied the motion as to the replevin and conversion claims.⁷ The motion court held that Merchant’s security interest sufficed to show entitlement to immediate possession of the Collateral in the event of a default of the factoring agreement.⁸ The motion court found that Crush Apparel and the Kraiem defendants were wrongfully retaining possession of the Collateral, including, but not limited to, Crush Apparel’s inventory.⁹ Finally, the motion court held that plaintiff adequately alleged a demand for the collateral, especially in light of the fact that it sought a temporary restraining order and preliminary injunction.¹⁰

Fraudulent Misrepresentation

Defendants sought dismissal of Merchant’s tenth cause of action for fraudulent misrepresentation, arguing that dismissal was appropriate because the claim duplicated Merchant’s breach of contract claims. In opposition, Merchant maintained that the fraud claim was pleaded in the alternative and that, even if not permitted to do so, it properly alleged a duty independent of the contract.¹¹

[Eds. Note: we have written extensively on the duplication of claims doctrine. Readers can find a discussion of the doctrine and its application here, here, here, here, and here.]

The motion court denied the motion dismiss the fraudulent misrepresentation claim.¹² The motion court held that Merchant’s fraud claim was not duplicative of its breach of contract claims. The motion court found that Merchant did more than “merely allege that defendants entered into [the factoring] agreement with an intention not to perform thereunder, but rather, allege[d] that, after that agreement was entered into, defendants misrepresented or concealed existing facts.”¹³ In that regard, said the motion court, plaintiff alleged that defendants “misrepresented or concealed that: (1) the accounts receivable assigned to Merchant were bona fide collectible receivables constituting legitimate sales and deliveries of goods to customers; (2) checks issued to CIT constituted legitimate customer payments; and (3) Crush Apparel was generating more than $7 million in sales.”¹⁴

The motion court also held that plaintiff adequately alleged “that that it relied on invoices submitted by Crush Apparel, and advanced funds to Crush Apparel” in reliance thereon.¹⁵

Fraudulent Conveyance

Defendants also sought dismissal of Merchant’s fourteenth through sixteenth causes of action for violations of the Debtor and Creditor Law (“DCL”).¹⁶ With respect to the fourteenth cause of action, alleging a fraudulent transfer of the New Jersey Property, defendants argued that: (1) 108 Crosby was not a proper defendant because it was not a debtor or potential debtor to Merchant; (2) Merchant failed to allege that defendants did not receive adequate consideration for the transfer of the property; (3) the transfer took place before Merchant sent any demand letters; and (4) the buyers of the property were necessary parties to the cause of action.

As for the fifteenth cause of action, alleging a fraudulent transfer of the Brooklyn Property, defendants argued that Merchant failed to allege intent to defraud.

DCL (former) § 276 provides that “[e]very conveyance made and every obligation incurred with actual intent, as distinguished from intent presumed in law, to hinder, delay or defraud either present or future creditors, is fraudulent as to both present and future creditors.” To state a cause of action under DCL (former) § 276, the plaintiff must comply with CPLR § 3016, and allege that the conveyance was made with “intent to hinder, delay or defraud present or future creditors.”¹⁷

“Due to the difficulty of proving actual intent to hinder, delay, or defraud creditors, the pleader is allowed to rely on ‘badges of fraud’ to support his [or her] case, i.e., circumstances so commonly associated with fraudulent transfers that their presence gives rise to an inference of intent.”¹⁸ These include “a close relationship between the parties to the alleged fraudulent transaction, a questionable transfer not in the usual course of business, inadequacy of the consideration, the transferor’s knowledge of the creditor’s claim and the inability to pay it, and retention of control of the property by the transferor after the conveyance.”¹⁹

The motion court held that 108 Crosby was a potential debtor to Merchant in that it executed a corporate guaranty, in which it: “guarantee[d] the due and full performance by the Principal, in all respects of the Factoring Agreement.”²⁰

The motion court also held that Merchant sufficiently alleged badges of fraud sufficient to support the DCL (former) § 276 claims.²¹ The motion court found that Merchant alleged that Joan and 108 Crosby transferred the New Jersey Property for $1,500,000, at a time when their alleged fraudulent scheme was about to be exposed. That fact sufficed to satisfy the intent element of the claim, said the motion court, rendering the absence of adequate consideration of no moment.²² The motion court also found that Merchant sufficiently alleged that Erica and Joan transferred the Brooklyn Property to 201 Oakhurst, an entity controlled by the Kraiem defendants, for no consideration. Given plaintiff’s allegations that Erica and Joan were aware of Merchant’s claim and Crush Apparel’s inability to pay it, the motion court held that Merchant satisfied the pleading requirements of the claim.²³

Notwithstanding, the motion court dismissed the fourteenth cause of action because plaintiff failed to include the buyers of the Brooklyn Property as necessary parties.²⁴ The motion court explained that Merchant could not recover a money judgment against Joan and 108 Crosby for the value of the property that was fraudulently conveyed.²⁵ The motion court explained that “[n]either Joan nor 108 Crosby were transferees, and the amended complaint only [made] conclusory allegations that Joan and 108 Crosby benefitted from the fraudulent transfers.”²⁶

Regarding the sixteenth cause of action, asserting a fraudulent conveyance claim with respect to the Crush Apparel money transfers, the motion court denied the motion. The motion court rejected the argument that the claim was duplicative of the replevin and conversion claims because it sought damages and the delivery of the Collateral pursuant to the factoring agreement and inventory agreement.²⁷

The motion court held that the sixteenth cause of action also stated a cause of action under DCL (former) § 276, given the allegations that “(1) Victor, Erica, Raphael and/or Joan were authorized signatories on the entities’ bank accounts…; (2) approximately $1.9 million of Merchant’s monies were transferred and/or paid to Victor, Raphael, Erica, Joan, 201 Oakhurst or to pay down the mortgages on the Deal Property and Brooklyn Property…; and (3) defendants sought to hide the transfers by moving money through various accounts….”²⁸ The foregoing facts, said the motion court, sufficed as “badges of fraud” and, therefore, gave “rise to an inference of intent to defraud Merchant.”²⁹

With respect to the seventeenth through twentieth causes of action, under DCL (former) §§ 274 and 275, the motion court granted the motion.

To state a cause of action for constructive fraudulent conveyance, the plaintiff must allege lack of “fair consideration” and that one of the following three conditions is satisfied: “(i) the transferor is insolvent or will be rendered insolvent by the transfer in question, DCL [former] § 273; (ii) the transferor is engaged in or is about to engage in a business transaction for which its remaining property constitutes unreasonably small capital, DCL [former] § 274; or (iii) the transferor believes that it will incur debt beyond its ability to pay, DCL [former] § 275.”³⁰

Fair consideration requires that “the exchange not only be for equivalent value, but also that the conveyance be made in good faith.”³¹ Fair consideration exists “when in exchange for such property or obligation, as a fair equivalent therefor, and in good faith, property is conveyed or an antecedent debt is satisfied” or “[w]hen such property, or obligation is received in good faith to secure a present advance or antecedent debt in an amount not disproportionately small as compared with the value of the property, or obligation obtained.”³²

The motion court found that Merchant only made conclusory allegations that Crush Apparel was insolvent or was rendered insolvent by the transfers, “Crush Apparel was engaged in a business or a transaction or was about to engage in a business or a transaction, for which any property remaining in its hands after the transfer constituted an unreasonably small capital,” and that “[t]he Crush Apparel Transfers were made for less than fair consideration and with the intent or belief that Crush Apparel would incur debts beyond its ability to pay as said debts matured.”³³

Takeaway

There are a number of takeaways from the motion court’s decision.

First, there is a distinction to be made between unidentified funds, such as cash, and collateral (comprised of inventory, for example) for which there is a security interest, for purposes of replevin and conversion. As discussed, defendants focused solely on the funds advanced by Merchant (i.e., the cash advances) rather than on the alleged unlawful retention of the Collateral upon which Merchant’s claims for replevin and conversion were premised.

Moreover, a demand for the return of the property being unlawfully held and the refusal to comply with said demand can come in many different forms. As noted by the motion court, “refusal of a demand need not use the specific word ‘refuse’ so long as it clearly conveys an intent to interfere with the demander’s possession or use of his property.”³⁴ The allegations in the amended complaint and the proceedings for the TRO and preliminary injunction detailed Merchant’s demands made prior to filing the initial complaint to recover the Collateral – allegations that defendants did not contest.

Second, Merchant Factors shows that a plaintiff can avoid dismissal of a fraud claim on duplication grounds when the alleged misstatement or omission is made after the contract is formed. As explained by the motion court, the misrepresentation does not concern performance of the contract, or a future intent to perform, but rather relates to existing facts after the contract was formed. In that situation, a duty independent of, or collateral to, the contract is established. We wrote about this distinction here. In Merchant Factors those misrepresentations concerned the legitimacy of the accounts receivable, customer payments, and Crush Apparel’s revenue.

Third, establishing a fraudulent conveyance under DCL (former) § 276 is, in many respects, no different than establishing fraud. Among other elements, the plaintiff must allege (and prove) intent to defraud. Intent can be shown through circumstantial evidence, or in the DCL context, through badges of fraud. In Merchant Factors, the motion court found that plaintiff sufficiently alleged badges of fraud and/or facts raising an inference of an intent to deceive.

Footnotes

The other named defendants are: 108 Crosby LLC (“108 Crosby”), Erica Kraiem (“Erica”), Victor Kraiem (“Victor”), 201 Oakhurst Inc. (“201 Oakhurst”), I.L.C.K. Inc. (“ILCK”), Jiangsu Taiwan Enterprise Inc. (“Jiangsu”), and Kids Apparel Club, Inc. (“Kids Apparel”).
Peters Griffin Woodward, Inc. v. WCSC, Inc., 88 A.D.2d 883, 883 (1st Dept. 1982) (citation omitted).
Colavito v. New York Organ Donor Network, Inc., 8 N.Y.3d 43, 50 (2006) (citations omitted).
Reif v. Nagy, 175 A.D.3d 107, 120 (1st Dept 2019), lv. dismissed, 35 N.Y.3d 986 (2020).
Genger v. Genger, 2016 N.Y. Slip Op. 30602(U), *7 (Sup. Ct., N.Y. County 2016), aff’d, 147 A.D.3d 443 (1st Dept. 2017).
Chen v. New Trend Apparel, Inc., 8 F. Supp. 3d 406, 456 (S.D.N.Y. 2014).
Slip Op. at *4.
Id.
Id.
Id. Notably, defendants did not contest that Merchant sufficiently alleged a refusal of its demand. Id. (citing, Swain v. Brown, 135 A.D.3d 629, 631 (1st Dept. 2016).
Slip Op. at *6.
Id.
Id. (citing, Comtronics, Inc. v. Pico Prods., Inc., 256 A.D.2d 1202, 1203 (4th Dept. 1998), lv. denied, 1999 N.Y. App. Div. LEXIS 3112 (4th Dept. 1999) (fraud claim not duplicative of breach of contract claim where plaintiff alleged fraud after formation of contract); Minnie Rose LLC v. Yu, 169 F. Supp. 3d 504, 520 (S.D.N.Y. 2016) (“Misrepresentations of present facts made post-contract formation are collateral or extraneous to the contract and are actionable in fraud.”)).
Id. at *6-*7.
Id. at *7.
The former DCL was replaced on April 4, 2020, by the New York Uniform Voidable Transactions Act (“NYUVTA”). Under New York’s version of the UVTA, which Governor Cuomo signed into law on December 6, 2019, the State joined the vast majority of jurisdictions to have adopted the UVTA in whole or in part. Thus, as to transfers made and obligations incurred after the effective date (i.e., April 4, 2020), New York law will be more aligned with the fraudulent transfer laws of most states in the country, as well as with the federal Bankruptcy Code. We previously examined the NYUVTA, the former DCL and the changes the NYUVTA made to the former DCL (here).
RTN Networks, LLC v. Telco Grp., Inc., 126 A.D.3d 477, 478 (1st Dept. 2015).
Wall St. Assoc. v. Brodsky, 257 A.D.2d 526, 529 (1st Dept. 1999) (internal quotation marks and citation omitted).
Id.
Slip Op. at *8.
Id. (citations omitted).
Id. (citing, In re Sharp Intl. Corp., 403 F.3d 43, 56 (2d Cir. 2005) (quoting, United States v. McCombs, 30 F.3d 310, 328 (2d Cir .1994)).
Id.
Id.
Id. (citing, Federal Deposit Ins. Corp. v. Porco, 75 N.Y.2d 840, 842 (1990)).
Id. (citations omitted).
Id. at *8-*9.
Id. at *9.
Id. (citing, Pen Pak Corp. v. LaSalle Natl. Bank of Chicago, 240 A.D.2d 384, 386 (2d Dept. 1997)).
Sharp Intl., 403 F.3d at 53.
Ede v. Ede, 193 A.D.2d 940, 941-942 (3d Dept. 1993).
DCL (former) § 272.
Id.
Swain, 135 A.D.3d at 631.

Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.

This article is for informational purposes and is not intended to be and should not be taken as legal advice.