Fraudulent Conveyances Under The Former DCL

• Posted on: Feb 2 2022

By: Jeffrey M. Haber

On April 4, 2020, the New York Uniform Voidable Transactions Act (“NYUVTA”) became effective, replacing Article 10, Sections 270-281 of the Debtor and Creditor Law (“DCL”), the State’s almost century-old fraudulent conveyance law. 

This Blog previously examined the NYUVTA, the DCL and the changes the NYUVTA made to the DCL (here). 

Since the NYUVTA applies to cases filed on or after April 4, 2020, there remain many cases under the former DCL that are being litigated in the courts of New York. Today, we examine Flowers v. 73rd Townhouse, LLC, 2022 N.Y. Slip Op. 00627 (1st Dept. Feb. 1, 2022) (here).

A Primer on the Former DCL

The DCL governs fraudulent conveyances.  For example, DCL § 273 (conveyances by insolvent) provides that conveyances that render a debtor insolvent that are made without fair consideration, are fraudulent as to creditors regardless of intent;  DCL § 273-a (conveyances by defendants) provides that a conveyance made without fair consideration by a defendant in an action for money damages is fraudulent as to the plaintiff in that action, regardless of intent, if the defendant fails to satisfy a resulting judgment in the action; DCL § 274 (conveyance to defendants in a business or transaction) provides that conveyances made without fair consideration in a business or transaction for which the capital remaining after the conveyance is unreasonably small, are fraudulent as to creditors regardless of intent; DCL § 275 (conveyance by defendants to the detriment of current and future creditors) provides that conveyances and obligations incurred without fair consideration when the debtor intends or believes that he/she will incur debts beyond his/her ability to pay as they mature, are fraudulent as to both present and future creditors; and, DCL § 276 (conveyance made with intent) provides that conveyances made with actual intent to “hinder, delay, or defraud either present or future creditors, [are] fraudulent as to both present and future creditors.”

To set aside a conveyance or obligation incurred under DCL §§ 273, 273-a, 274 and 275, the plaintiff must establish that the conveyance or obligation incurred was made without “fair consideration”. Under DCL § 272, “[f]air consideration … is not only a matter of whether the amount given for the transferred property was a ‘fair equivalent’ or not ‘disproportionately small’ … but whether the transaction [was] made in good faith.”¹ “Good faith is required of both the transferor and the transferee, and it is lacking when there is a failure to deal honestly, fairly, and openly.”² 

A claim under DCL § 275 requires, in addition to the conveyance and unfair consideration elements discussed, an element of intent or belief that insolvency will result.³ 

DCL § 276, unlike Sections 273 and 275, concerns actual fraud, as opposed to constructive fraud, and does not require proof of unfair consideration or insolvency.⁴ Because it is difficult to prove actual intent, the plaintiff may rely on “badges of fraud” to raise an inference of fraud, i.e., circumstances so commonly associated with fraudulent transfers “that their presence gives rise to an inference of intent.”⁵ 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.⁶ “Depending on the context, badges of fraud will vary in significance, though the presence of multiple indicia will increase the strength of the inference.”⁷ A conveyance made with actual intent to defraud is fraudulent regardless of whether the debtor receives fair consideration.⁸ 

Flowers v. 73rd Townhouse, LLC

[Ed. Note: the facts discussed below come from the decision of the motion court (here).]

Flowers involved, inter alia, alleged fraudulent conveyances that defendant 73rd Townhouse, LLC (“73rd Townhouse”), a single purpose entity created to hold title to a townhouse located on East 73rd Street in Manhattan (the “premises”), made to evade collection of a $500,000 consent judgment entered in favor of plaintiff in a prior action (the “prior action”).

Pursuant to a real estate contract dated January 17, 2004, plaintiff and his then-wife agreed to purchase the premises from 73rd Townhouse. The contract provided for (i) a purchase price of $17 million and (ii) the seller to perform renovations on the premises subject to “the plaintiff’s right to make ‘reasonable adjustments and modifications’ (i.e., change orders)”.⁹ The contract required plaintiff to close under certain circumstances even if renovations were not completed, but the contract also required 73rd Townhouse to “deposit into an escrow account 120% of the cost of completing the remaining work.”¹⁰ The contract further required 73rd Townhouse to deposit $500,000.00 into an escrow account at closing to be held until delivery of a valid certificate of occupancy with 73rd Townhouse remaining liable for “other penalties for excessive delay.”¹¹ 

73rd Townhouse failed to complete the renovations in accordance with the change orders in time for the closing. After a dispute arose between the parties as to whether plaintiff was obligated to close, 73rd Townhouse attempted to terminate the contract. As such, the prior action ensued. Thereafter, plaintiff moved for summary judgment on the complaint.

The court granted plaintiff’s motion, awarding specific performance albeit without the price abatement plaintiff sought. 73rd Townhouse was directed to turn over title to the property upon payment by plaintiff of the remaining contract price, but also directed that plaintiff deposit $575,000.00 into escrow for possible payment of change orders completed by 73rd Townhouse. Plaintiff appealed the portion of the order declining to order an abatement of the purchase price as a result of the 73rd Townhouse’s failure to complete the renovations. The First Department later modified the court’s order, and remanded the case for a “hearing on the issue of the amount of price abatement to which the [plaintiff was] entitled for the cost of completing the renovation work contemplated by the contract.”¹² 

Pursuant to the court’s order, the closing took place on November 29, 2006. A $575,000.00 escrow was established as a construction reserve in accordance with the order. An additional $400,000.00 escrow was established pursuant to the terms of the contract. 

In February 2007, the court directed the payment of approximately $475,000.00 from these escrowed amounts to 73rd Townhouse. Plaintiff appealed the court’s order. 

On February 24, 2009, the parties settled the prior action by stipulation made in open court by agreeing to a $500,000.00 judgment to be entered against 73rd Townhouse.

With the judgment unsatisfied, plaintiff filed suit on July 10, 2010. According to plaintiff, the settlement on the record was nothing more than a “ruse”. Plaintiff contended that defendants conducted their business dealings involving the premises without regard to corporate formalities, or appropriate documentation, or accounting controls, creating layers of “single-purpose LLCs”, by which they fraudulently stripped assets for the purpose evading creditors such as plaintiff.

Plaintiff contended that the payments made and/or directed by 73rd Townhouse and received by various defendants at the closing and subsequent to the closing, including the monies released from the escrow pursuant to the court’s February 2017 order were fraudulent conveyances under the DCL. Plaintiff maintained that the transfers made by 73rd Townhouse rendered it insolvent and unable to pay the judgment, and that defendants knew of the potential liability to plaintiff at the time of the payments. 

As such, plaintiff claimed that there were fraudulent conveyances under DCL §§ 273, 273-a, 274, 275, 276, 276-a, and 278. Plaintiff moved for summary judgment on each of the causes of action asserted. Defendants opposed. The motion court granted the motion.

The motion court found that plaintiff established through various submissions and an expert report that 73rd Townhouse was insolvent at the time of closing. The motion court noted that the expert report, in particular, detailed how 73rd Townhouse was left with unreasonably small capital at the time of the November 2006 closing, and further transferred $5.8 million to the various owners of 73rd Townhouse or other owner-related entities, while the company was insolvent.

Specifically, these submissions establish entitlement to relief under DCL § 273 to the extent (i) that 73rd Townhouse conveyed over $5.8 million to its owners or owner-related entities, (ii) that it was insolvent at the time of the transfers, or at least was rendered insolvent by the transfers, and (iii) that the transfers were not made for fair consideration inasmuch as the transfers were “preferential transfers to directors, officers, or shareholders of [an] insolvent corporation[] in derogation of the rights of general creditors.” … To the extent that the plaintiff’s submissions further show that 73rd Townhouse was about to engage in a business or transaction, i.e., repaying its debts, and the remaining property following the transfers to the owners or owner-related entities was insufficient to fully repay those debts, the plaintiff has also established entitlement to relief under DCL § 274.¹³

However, said the motion court, plaintiff did not demonstrate, as a matter of law, “that 73rd Townhouse, after making the $5.8 million in transfers following closing, ‘intends or believes that [it] will incur debts beyond his ability to pay as they mature.’” Thus, held the motion court, “summary judgment on the plaintiff’s claim pursuant to DCL § 275 (fourth cause of action) is denied.”

The motion court further found that plaintiff’s submissions established an entitlement to summary judgment pursuant to DCL § 273-a. Specifically, the motion court held that “plaintiff’s submissions demonstrate (i) that the transfers were made without fair consideration, for the reasons previously discussed herein, (ii) that transfers took place after November 2004, when the prior action took place, and (iii) that a final judgment against 73rd Townhouse was rendered, and that it remains unsatisfied.”

Finally, the motion court held that plaintiff’s submissions sufficed to establish that the conveyances were made with an actual intent to defraud plaintiff, such that plaintiff was entitled to relief pursuant to DCL § 276. According to the motion court, the expert reports showed that the owners of 73rd Townhouse withdrew approximately $800,000.00 from the company prior to closing, keeping no reserves for potential construction liabilities or contingencies, in violation of normal industry practice wherein a company keeps a reserve or ‘retainage’ of the cost of completion against unexpected costs to complete a project. Such transfers, said the motion court “were both questionable and not done in the usual course of business.” Further, explained the motion court, the expert reports and plaintiffs other submissions showed that the transfers were made for little to no consideration, while defendants were aware of the pending litigation between themselves and plaintiff, and “were made between members of a closely held LLC or other LLC’s owned by the same members, such that it was evident that defendants deliberately made 73rd Townhouse’s assets unavailable to satisfy the judgment, to which its consent was clearly insincere.”

On appeal, the First Department modified the ruling with regard to, inter alia, DCL § 273-a and otherwise affirmed the motion court’s order.

The Court held that the motion court incorrectly granted judgment on the DCL § 273-a claim. The Court explained that DCL § 273-a did not apply to plaintiff’s claims because plaintiff’s price abatement claim, which had been dismissed before the subject transfers were made, were different than the judgment at issue. “Debtor & Creditor Law § 273-a contemplates that the two judgments it refers to — the docketed judgment and the final judgment — shall be substantially the same” and “Plaintiff’s final judgment for $500,000 bears no material relation to his earlier-docketed judgment for specific performance, which is not even a money judgment.”¹⁴ 

The Court also held that plaintiff “established prima facie entitlement to summary judgment on his claims under Debtor & Creditor Law former §§ 273 and 274 by showing that [73rd Townhouse] transferred sums of money to [defendants] or their family limited partnership, all insiders, during a period in which it was insolvent.”¹⁵ The Court noted that the expert report, “which was based on an exhaustive analysis of the financial records produced by defendants,” showed that 73rd Townhouse “was insolvent, on a balance sheet basis, from November 29, 2006, through July 25, 2007, and that, during that period, it made a total of more than $5.7 million in transfers to [defendants] or their family limited partnership.”¹⁶ 

Finally, the Court held that “[t]he claim for intentional fraudulent conveyance under Debtor & Creditor Law former § 276 [was] supported by ‘badges of fraud’ that include[d] defendants’ close family relationships, the general lack of fair consideration for the transfers, and defendants’ knowledge of plaintiff’s claim and [73rd Townhouse’s] inability to pay it.”¹⁷ The Court found that “defendants appear[ed] to have siphoned out [73rd Townhouse’s] assets and settled the claim only after they had drained out all the cash — when, in [one defendant’s] words, the consent judgment was ‘valueless’ because [73rd Townhouse] no longer had any ‘assets with which to satisfy the judgment.’”¹⁸ 

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.

Footnotes

1. Sardis v. Frankel, 113 A.D.3d 135, 141-142 (1st Dept. 2014).  
2. Matter of CIT Group/Commercial Servs., Inc. v. 160-09 Jamaica Ave. Ltd. Partnership, 25 A.D.3d 301, 303 (1st Dept. 2006) (quoting Berner Trucking v. Brown, 281 A.D.2d 924, 925 (4th Dept. 2001)).
3. Wall Street Assocs. v. Brodsky, 257 AD 2d 526, 529 (1st Dept. 1999) (citation omitted).
4. Id.
5. Id. (internal quotation marks and citations omitted).
6. Id.
7. MFS/Sun Life Trust v. Van Dusen Airport Servs., 910 F. Supp. 913, 935 (S.D.N.Y. 1995); see also Gafco, Inc. v. H.D.S. Mercantile Corp., 47 Misc. 2d 661, 664 (Sup. Ct., N.Y. County 1965) (noting, “[a]lthough ‘badges of fraud’ are not conclusive and are more or less strong or weak according to their nature and the number occurring in the same case, a concurrence of several badges will always make out a strong case”) (internal quotation marks and citations omitted).
8. MFS/Sun Life Trust, 910 F. Supp. at 934 (citation omitted).
9. Flowers v. 73rd Townhouse, LLC, 52 A.D.3d 104, 107 (1st Dept. 2008).
10. Id.
11. Id. at 108.
12. Id.
13. Citation omitted.
14. Slip Op. at *1.
15. Id. (citations omitted).
16. Id.
17. Id. at *2.
18. Id.