Fraudulent Conveyance Claims Dismissed For Failure to Plead Fraud With Particularity

• Posted on: Apr 23 2018

New York creditors often look to the Debtor and Creditor Law (the “DCL”), as well as the common law, to recover assets that have been (or may be) transferred by debtors to another party. Whether the debtor transfers assets with intent to defraud or without fair consideration, the DCL provides creditors with a number of remedies.

The DCL in Brief

Under Section 276 of the DCL,

[e]very conveyance made … with actual intent … to hinder, delay, or defraud either present or future creditors, is fraudulent.…

In general, a party pleading a cause of action for fraudulent conveyance must allege specific facts, including, among other things, the identity of the specific transactions or conveyances that the plaintiff alleges were fraudulent. Syllman v. Calleo Dev. Corp., 290 A.D.2d 209, 210 (1st Dept. 2002); see CPLR 3016 (b).

The burden of proving actual intent is on the party seeking to set aside the conveyance. Marine Midland Bank v. Murkoff, 120 A.D.2d 122, 126 (2d Dept. 1986); see also ACLI Gov’t Sec., Inc. Rhoades, 653 F. Supp. 1388, 1394 (S.D.N.Y. 1987). “Actual intent” to defraud must be proven by clear and convincing evidence. ACLI Gov’t Sec., 653 F. Supp. at 1394. Since it is rarely susceptible to direct proof, actual intent is typically established through circumstantial evidence surrounding the allegedly fraudulent act. Consequently, courts allow creditors “to rely on badges of fraud to support his case, i.e., circumstances so commonly associated with fraudulent transfers that their presence gives rise to an inference of intent.” Wall St. Assoc. v. Brodsky, 257 A.D.2d 526, 529 (1st Dept. 1999) (internal quotation marks and citations omitted). “Among such circumstances are: 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.” Id. See also United Parcel Service v. Jay Norris Corp., 102 Misc. 2d 231, 233 (Sup. Ct., Nassau Cty. 1979) (inference raised from the relationship of the parties to the transaction and the secrecy of the sale); Gafco, Inc. v. H.D.S. Mercantile Corp., 47 Misc. 2d 661, 664 (Sup. Ct., N.Y. Cty. 1965) (“Inadequacy of consideration, secret or hurried transactions not in the usual mode of doing business, and the use of dummies or fictitious parties are common examples of ‘badges of fraud.’”). A conclusory allegation that the plaintiff has been defrauded is not sufficient. Syllman, 290 A.D.2d at 210.

Under Section 273 of the DCL:

[e]very conveyance made … by a person who is or will be thereby rendered insolvent is fraudulent as to creditors without regard to actual intent if the conveyance is made … without a fair consideration.

To establish a fraudulent conveyance under Section 273, the creditor must establish that: (1) the debtor made a conveyance; (2) the debtor was insolvent prior to the conveyance or rendered insolvent thereby; and (3) the conveyance was made without fair consideration.

“A person is insolvent when the present fair salable value of his assets is less than the amount that will be required to pay his probable liability on his existing debts as they become absolute and matured.” DCL § 271(1). This is a “balance sheet test.” See In re Gordon Car & Truck Rental, Inc., 59 B.R. 956, 961 (Bankr. N.D.N.Y. 1985). A debtor who transfers property without fair consideration is presumed to be insolvent.

Fair consideration is deemed to have been given when: (1) the transferee conveys property in exchange for the transfer, or the transfer discharges an antecedent debt; (2) the property exchanged by the transferee is of “fair equivalent” value to the property transferred by the debtor; and (3) the transferee makes the exchange in “good faith.” See In re Sharp Intern. Corp., 403 F.3d 43, 53–54 (2d Cir. 2005) (citing HBE Leasing v. Frank, 61 F.3d 1054, 1058–59 (2d Cir. 1995)) (“fair consideration” requires not only that the exchange be for equivalent value, but also that the conveyance be made in good faith).

The burden of proving both insolvency and the lack of fair consideration is on the party challenging the conveyance and the determination of insolvency or what constitutes fair consideration is generally one of fact to be determined under the circumstances of the particular case. Matter of Am. Inv. Bank v. Marine Midland Bank, 191 A.D. 2d 690, 692 (2d. Dept. 1993) (citations omitted).

(This Blog previously addressed the pleading standards here.)

Carlyle, LLC v. Quik Park 1633 Garage LLC

In Carlyle, LLC v. Quik Park 1633 Garage LLC, 2018 NY Slip Op. 02436 (1st Dept. Apr. 10, 2018) (here), the Appellate Division, First Department dismissed claims under DCL §§ 273 and 276 because the plaintiff failed to satisfy the burdens discussed above.

Background

Carlyle arose from Plaintiff’s attempt to recover approximately $2.5 million in damages allegedly suffered as a result of a fraudulent scheme to transfer and dispose of assets and monies for the purpose of thwarting Plaintiff’s ability to collect debts owed to it by Defendants, including a judgment in a related action.

Plaintiff, Carlyle LLC, operates The Carlyle Hotel (the “Hotel”) pursuant to a commercial lease, under which it leases most of the building comprising the hotel and a parking garage adjoining the hotel (the “Garage”). Plaintiff subleased the Garage on December 7, 2001 (the “Sublease”) to non-party Beekman Garage LLC (“Beekman Garage”), an entity allegedly controlled by Defendant Rafael Llopiz (“Llopiz”), the principal and controlling member of Defendant Quik Park 1633 Garage LLC (“Quik Park 1633”). Pursuant to a written agreement, and with Plaintiff’s consent, Beekman Garage assigned its interest in the Sublease to non-party Quik Park Beekman LLC (“Quik Park Beekman”), an entity also allegedly controlled by Llopiz.

On May 1, 2009, Plaintiff and Quik Park Beekman entered into a sublease modification and extension (“Sublease Extension”), which extended the term of the Sublease through April 30, 2016. On that same date, with Plaintiff’s consent, Quik Park Beekman assigned its interest under the Sublease to Quik Park Beekman II LLC (“Quik Park Beekman II”), another entity allegedly controlled by Llopiz. Under the Sublease Extension, Quik Park Beekman II was obligated to pay monthly rent to Plaintiff through April 30, 2016.

Plaintiff alleged that it was never paid any rent. At the same time, the entities operating the Garage continued to collect revenues, in excess of $100,000 for each month the rent went unpaid.

On July 24, 2013, Plaintiff terminated the Sublease, as well as any tenancy or occupancy of Quik Park 1633 in the Garage. Despite the termination, the various Quik Park-related entities and/or Defendant Quik Park 1633, continued to occupy the premises without paying any rent or compensation to Plaintiff until January 31, 2014, when they vacated the Garage.

On August 7, 2013, Plaintiff commenced a related action, titled The Carlyle, LLC v. Beekman Garage LLC et al., seeking unpaid rent, late fees on unpaid rent, and attorney’s fees. On October 14, 2015, the court entered a judgment against Beekman Garage, Quik Park Beekman and Quik Park Beekman II (the “Quik Park Entities”) for a little over $1.5 million.

On September 3, 2013, Plaintiff commenced a holdover proceeding in New York Civil Court, titled The Carlyle LLC v. Quick Park Beekman II LLC et al., seeking damages for post-lease-termination use and occupancy of the premises. The court granted summary judgment in Plaintiff’s favor on its possessory claims but did not determine a monetary award.

Motion Court Proceedings

In December 2015, Plaintiff filed suit in New York Supreme Court against Llopiz and Quik Park 1633 for, among other things, fraud, fraudulent conveyance, unjust enrichment and conversion.

Plaintiff alleged that Defendants intentionally transferred all, or substantially all, of the funds out of the various Quik Park Entities and into certain shell entities and persons controlled by Llopiz, including Quik Park 1633. Plaintiff further alleged that those conveyances were made without fair or adequate consideration and rendered the Quik Park Entities insolvent, and thus incapable of paying the debts owed to Plaintiff.

Defendants moved to dismiss the complaint arguing, inter alia, that Plaintiff failed to plead its fraudulent conveyance claims with the specificity required by CPLR 3016 (b). Among other things, Defendants contended that the complaint failed to identify any specific transfers or conveyances that were fraudulent or that were not supported by adequate consideration.

The motion court sustained the fraudulent conveyance claims notwithstanding the fact that Plaintiff failed to identify the transactions alleged to be fraudulent. The court found that Plaintiff had alleged “enough facts to warrant further discovery as to whether, among other things, defendants wrongfully removed assets from any of the underlying judgment debtors.” The court cited to the following facts in support of its decision: “a close relationship between Llopiz and Quik Park 1633 on the one hand, and the various nonparty Quik Park Entities on the other,” payment to Plaintiff by Llopiz and/or Quik Park 1633, occupancy of the premises by Quik Park 1633, and the absence of sufficient assets by various Quik Park Entities to satisfy the judgments.

In sustaining the fraudulent conveyance claims, the court also found dispositive facts drawn from information subpoenas that Plaintiff served on Defendants:

First, the Responses indicate that the various Quik Park Entities had bank accounts into which, and from which, money from the operation of the garage was transferred. According to plaintiff, and not disputed by defendants, the Responses also indicate that the monies in such accounts were periodically transferred to a bank account in Quik Park 1633’s name, controlled by Llopiz.

The Responses further indicate that the Quik Park Entities closed their accounts at some point, and the companies are no longer operational. Further, the Responses state that Llopiz is a member of an unidentified entity which now owns the Quik Park Entities.

Defendants appealed.

[A copy of the motion court’s decision can be found here.]

The First Department’s Decision

The Court unanimously reversed the motion court’s decision to sustain the fraudulent conveyance claims.

With regard to the claim under DCL § 276, the Court found that “plaintiff failed to allege fraudulent intent with the particularity required by CPLR 3016(b).” Citations omitted. The Court noted that “[t]he key allegations” in the complaint “were made ‘[u]pon information and belief,’ without identifying the source of the information.” Citation omitted. Additionally, “the timing of the allegedly fraudulent transfers — beginning two years before the judgment debtors incurred the subject debts — undermine[d] the claim of fraudulent intent.” Citations omitted. Combined, these pleading failures sufficed to require dismissal of the fraudulent conveyance claims under DCL § 276.

With regard to the claim under DCL § 273, the Court found that Plaintiff failed to meet its pleading burden, noting that the allegations concerning the absence of fair consideration, were also made on information and belief. Citation omitted. Accordingly, the Court reversed the denial of the motion with regard to the constructive fraudulent conveyance claims.

Takeaway

The purpose of the DCL is to protect creditors from fraudulent transactions entered into by debtors in attempt to shelter assets from the estate. To secure the protections under the DCL, creditors must comply with applicable pleading standards. The failure to meet these standards will result in the dismissal of the claim. Carlyle illustrates the importance of this point.