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First Department Affirms Finding That Transfer of Property to Newly Created Company To Avoid Foreclosure Judgment Fraudulent For Purposes of Former DCL § 276

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  • Posted on: Nov 23 2020

Sometimes, a case involves facts and circumstances that, on their face, lead a court to determine that a fraud was committed. Such was the case in First Franklin Fin. Corp. v. Merchant, 2020 N.Y. Slip Op. 06852 (1st Dept. Nov. 19, 2020) (here). 

In First Franklin, a judgment debtor transferred property subject to a foreclosure sale to a company that he had formed all on the same day. Such facts and circumstances, said the lower court, represented “badges of fraud” under former Debtor & Creditor Law (“DCL”) § 276 that were indicative of an intent to hinder, delay or defraud the debtor’s creditors. The Appellate Division, First Department agreed.

Background

Non-party Nereid 2028, an entity created and partially owned by defendant Arnold Merchant (“Merchant”), moved to set aside a non-judicial sale of real property located in the Bronx, New York (the “Property”). Merchant had borrowed $95,000.00 from First Franklin in 2005. The debt was secured by a mortgage dated September 29, 2005. 

Merchant defaulted on the note, failing to make the payment due on March 1, 2008, and each payment date thereafter. As a result, First Franklin commenced a foreclosure action. The lower court entered an order of reference in March 2010, and a Judgment of Foreclosure and Sale in January 2016.

On June 18, 2018, a referee held an auction of the Property. On the same day, Merchant incorporated Nereid 2028 and transferred a 50% interest in the Property to it for $10.00. Also, on the same day, Nereid 2028 declared bankruptcy. 

The bankruptcy proceeding was dismissed on July 20, 2018, due to certain deficiencies in the filing, which Nereid 2028 failed to correct.

On March 20, 2019, Nereid 2028 filed an order to show cause in the foreclosure action, seeking to set aside the purchase of the Property. The motion court denied the motion. 

The court held that the circumstances surrounding the transfer were fraudulent, finding that the transfer was “obviously undertaken for the sole purpose of impeding the foreclosure sale.”

Here, the attendant circumstances are rife with … “badges of fraud.” These include the close relationship between the parties to the transaction, inadequate consideration for the transaction, and the retention of the benefit of the property by defendant, who maintained a 50% ownership interest.

The motion court concluded that the badges of fraud indicated that the conveyance was made “with intent to defraud” and held that the transfer was “null and void.”

Nereid 2028 appealed.

The First Department affirmed.

In a pithy decision, the Court found that “[t]he [motion] court correctly found” the transfer to be fraudulent and, therefore, null and void: 

The [motion] court correctly found that judgment debtor defendant Arnold Merchant’s purported transfer of the property for $10, on the eve of a foreclosure sale, to a brand new entity that he created and caused to commence a Chapter 11 proceeding just a few hours before the foreclosure sale, bore all the badges of fraud necessary to conclude that the transfer was fraudulent as to plaintiff. 

Slip Op. at *1 (citing 5706 Fifth Ave., LLC v. Louzieh, 108 A.D.3d 589 (2d Dept. 2013)).

Takeaway

An action under former DCL § 276 requires proof that the transferor actually intended to hinder, delay, or defraud his/her creditors, whether they be present or future creditors. Since “[d]irect evidence of [actual] fraudulent intent is often elusive … courts will consider ‘badges of fraud’ which are circumstances that accompany fraudulent transfers so commonly that their presence gives rise to an inference of intent.” Dempster v. Overview Equities, 4 A.D.3d 495, 498 (2d Dept. 2004), lv. denied, 3 N.Y.3d 612 (2004) (internal quotation marks omitted). “Badges of fraud” from which fraudulent intent may be inferred include: (1) a close relationship between the parties to the transaction, (2) secrecy and haste in making the transfer, (3) the inadequacy of consideration, (4) the transferor’s knowledge of the creditor’s claim, or a claim so likely to arise as to be certain, and the transferor’s inability to pay it, and (5) the retention of control of property by the transferor after the conveyance. Dempster, 4 A.D.3d at 498.

Of the five (5) badges of fraud listed, at least four (4) of them were present in First Franklin: (1) haste in making the transfer: it was done “on the eve of a foreclosure sale”; (2) inadequate consideration: the consideration for the transfer was $10.00; (3) the transferor had knowledge of the creditor’s claim: Merchant knew of the judgment and the foreclosure sale; and (4) retention of control of the property by the transferor after the conveyance: Merchant “created” Nereid 2028 (“and caused [it] to commence a Chapter 11 proceeding”) and, thereafter transferred a 50% interest in the Property to it, while retaining the other 50% for himself. It is not surprising that the motion court concluded that “the attendant circumstances [were] rife with … sufficiently alleged ‘badges of fraud’” – a conclusion with which the First Department agreed (the circumstances surrounding the transfer “bore all the badges of fraud necessary to conclude that the transfer was fraudulent as to plaintiff”).

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