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N.Y. Supreme Court Rules on Alleged Fraudulent Conveyance and the Attempt to Evade Creditors

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  • Posted on: Feb 24 2020

In very general terms, fraudulent conveyance statutes are designed to protect creditors from situations where a debtor transfers its assets or property to a creditor’s detriment.  Sometimes such transfers are made with actual intent to defraud.  Other times, transfers may be deemed to be constructively fraudulent regardless of the actual intent of the debtor/transferor.

In Sarfati v. Palazzolo, 2020 N.Y. Slip Op. 30432(U) (Sup. Ct., N.Y. County Feb. 7, 2020) (here), Justice Nancy M. Bannon of the Supreme Court, New York County, granted in part and denied in part a motion for summary judgment to set aside the transfer of real property and interests in various companies by defendant, Frank Palazzolo (“Frank”), to his wife, defendant Mary Palazzolo (“Mary”), to the detriment of plaintiff, Mark Sarfati (“Sarfati”), and future creditors.

To put Sarfati in context, we examine the current law in New York – i.e., the Debtor and Creditor Law (the “DCL”) – and New York’s recently enacted version of the Uniform Voidable Transactions Act (“NYUVTA”), which will replace the DCL on April 4, 2020.

A Primer on Fraudulent Conveyance Claims Under Existing Law and the NYUVTA

At present, 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.” Sardis v. Frankel, 113 A.D.3d 135, 141-142 (1st Dept. 2014).  “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.” 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)).

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. Wall Street Assocs. v. Brodsky, 257 AD 2d 526, 529 (1st Dept. 1999) (citation omitted).

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. Id. Because it is difficult to prove actual intent, the plaintiff may rely on “badges of fraud” to raise and inference of fraud, i.e., circumstances so commonly associated with fraudulent transfers “that their presence gives rise to an inference of intent.” Id. (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. “Depending on the context, badges of fraud will vary in significance, though the presence of multiple indicia will increase the strength of the inference.” 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). A conveyance made with actual intent to defraud is fraudulent regardless of whether the debtor receives fair consideration. MFS/Sun Life Trust, 910 F. Supp. at 934 (citation omitted).

Effective April 4, 2020, the foregoing rules will change.

[Ed. Note: In a prior post, we noted that the NYUVTA was being considered by the New York Legislature (here).]

Under New York’s version of the UVTA, which Governor Cuomo signed into law on December 6, 2019, the State has 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.

The changes to the current law are many. Because the changes are too numerous to address in this post, we examine only some of the more substantive changes below.

Section 278: Extinguishment of Claim for Relief

The NYUVTA materially changes the statute of limitations for a creditor to bring an action. Under current law, a creditor has six years to commence a constructive fraudulent conveyance action. Under the NYUVTA, a creditor has only four years to bring a claim to avoid a constructive transfer. Similarly, the period within which to bring a claim following the discovery of actual fraud is reduced to one year from two years. These changes bring New York more in line with the majority of other states and closer to the look-back periods in the Bankruptcy Code.

In addition, the statute of limitations under the NYUVTA appears to be one of repose. Under existing law, the statute of limitations for claims under the DCL is governed by the CPLR and subject to waiver (for example, with regard to affirmative defenses) and tolling. By contrast, under Section 278 of the NYUVTA, the claim for relief “is extinguished” unless the creditor brings the action within the applicable time period.

Section 274(b): Insider Avoidance Claim

Another material change to the law is the creation of an insider avoidance claim similar to an insider preference on an antecedent debt voidable under the Bankruptcy Code. Under Section 274(b) of the NYUVTA, “[a] transfer made by a debtor is voidable as to a creditor whose claim arose before the transfer was made if the transfer was made to an insider for an antecedent debt, the debtor was insolvent at that time, and the insider had reasonable cause to believe that the debtor was insolvent.” A claim under this section must be brought within one year of the transfer. Notably, the NYUVTA does not shift the burden of proving insolvency – the creditor must prove insolvency, as well as each element required for an insider avoidance claim, by a preponderance of the evidence. By contrast, in the bankruptcy context, the debtor’s insolvency is presumed.

Section 272(b): Reasonably Equivalent Value Instead of Fair Consideration

The NYUVTA replaces “fair consideration” and the “good faith” element of a constructive fraudulent conveyance claim under the DCL with “reasonably equivalent value.” See also NYUVTA § 273(a)(2) and § 274.

The term “reasonably equivalent value” is found in the Bankruptcy Code. Under the Bankruptcy Code, reasonably equivalent value means “the debtor has received value that is substantially comparable to the worth of the transferred property.” United States v. Loftis, 607 F.3d 173, 177 (5th Cir. 2010) (quoting BFP v. Resolution Tr. Corp., 511 U.S. 531, 548 (1994) (interpreting the same term in the Bankruptcy Code)); see also 28 U.S.C. § 3303(b) and § 3304(b). “Value is given for a transfer or an obligation if, in exchange for the transfer or obligation, property is transferred or an antecedent debt is secured or satisfied, but value does not include an unperformed promise made otherwise than in the ordinary course of the promisor’s business to furnish support to the debtor or another person.” 28 U.S.C. § 3303(a). Intent is not a consideration under this provision.

Section 273(b): Actual Fraud

Like DCL § 276, NYUVTA § 273(a) provides for setting aside transfers or obligations incurred where the defendant or debtor intends to “hinder, delay, or defraud”. NYUVTA § 273(a)(1). Where “badges of fraud” were often identified by the courts under the DCL, Section 273(b) of the NYUVTA enumerates 11 non-exclusive “badges of fraud” that courts may consider in determining intent. These factors include whether the transfer was made to an insider, whether the transfer was concealed, whether the debtor was subject to suit, and whether the debtor absconded.

Section 276(b): Presumption of Insolvency

Unlike the DCL, the NYUVTA presumes insolvency where the debtor is generally not paying the debtor’s debts as they become due other than as a result of a bona fide dispute. NYUVTA § 271(b). The presumption imposes on the party against which the presumption is directed the burden of proving that the nonexistence of insolvency is more probable than its existence. Id. However, like the DCL, the NYUVTA considers a debtor or defendant to be insolvent where a transfer leaves the debtor or defendant with unreasonably small capital, or where the debtor or defendant intended or had reason to believe he/she was about to incur debts beyond his/her ability to pay as they become due. NYUVTA § 273(a)(2)(i) and (ii).

Section 276-A: Attorney’s Fees

Under existing law, a creditor can obtain attorney’s fees upon a finding of intent to defraud under Section 276-a. By contrast, under the NYUVTA, a creditor may recover reasonable attorney’s fees, without regard to intent to defraud, as an “additional amount required to satisfy the creditors’ claim.” The fees are to be fixed at trial and “without regard … to any agreement … between the creditor …, and his or her attorney with respect to the compensation of such attorney.” NYUVTA § 276-A.

Section 276: Available Remedies

Section 276 of the NYUVTA enumerates a non-exhaustive list of remedies available to a creditor under the statute. Among the remedies available are: avoidance of the transfer, attachment, and subject to the “applicable principles of equity and in accordance with applicable rules of civil procedure,” “injunction against further disposition by the debtor or a transferee, or both, of the asset transferred or of other property”, the “appointment of a receiver to take charge of the asset transferred or of other property of the transferee”, and “any other relief the circumstances may require.”

Section 279: Choice of Law

Whose law governs is often a hotly contested issue. Section 279(b) of the NYUVTA brings clarity to the issue. Under this section, a claim for relief is “governed by the local law of the jurisdiction in which the debtor is located when the transfer is made or the obligation is incurred.” When the debtor is a corporation, Section 279(a) provides that the governing law will be its place of business, if it only has one, or its chief executive office, if there is more than one place of business.

Today’s Post: Sarfati v. Palazzolo

When the NYUVTA becomes effective in April 2020, this Blog will examine the cases decided thereunder. However, we believe our readers will remain interested in our examination of cases decided under the DCL until such time as there are no longer any reported cases issued thereunder. As a result, we will continue to write about cases involving conveyances, transfers and/or obligations incurred under the DCL and examine the new cases arising under the NYUVTA.

This brings us to Sarfati v. Palazzo. As noted, Sarfati involved an action under the DCL to enforce a $1,786,100.17 judgment against Frank. Sarfati obtained the judgment on February 11, 2015.

On July 8, 2016, Sarfati commenced the action against both defendants under DCL §§ 273, 273-a, 274, 275, and 276. He did so following Frank’s deposition on April 7, 2016, in which he testified that in 2009 he signed an “Assignment of Notes, Loans, Collateral, and/or Ownership Interests” (the “Assignment”) to his wife. Pursuant to the Assignment, for “$10 consideration,” Frank conveyed all of his interest in two New York real properties, one in East Quogue, New York and the other in Bedford, New York (together, the “Properties”) and his ownership interest in six companies listed in the Assignment: (i) F&M Funding LLC, (ii) Ridgeview Holdings LLC, (iii) Palazzolo Plaza Corp.; (iv) Millie Holdings LLC; (v) BAB Group I, LLC and (vi) BAB Group II, LLC (together, the “Companies”).  Frank testified that, in executing the Assignment, he “made a conscious effort” to “put everything in wife’s name” so that he would not have to “worry about [his] assets” if a judgment were entered against him. Frank also testified that he annually updates the “schedule of assets” attached to the Assignment. The schedule of assets attached to the Assignment set forth the names of the Properties and the Companies in which Frank had some interest that he subsequently conveyed to Mary; however, the Assignment did not specify the exact percentage of interests Frank conveyed to Mary when any conveyance was made, or the value of the assets conveyed.

In the complaint, Sarfati asserted eight causes of action. In the first cause of action, Sarfati sought a money judgment directly against Mary in the amount of $1,786,100.17, plus statutory interest from February 11, 2015. The second cause of action sought a declaration that Frank is “the owner” of the Properties, the Companies, and a condominium located in White Plains, New York (the “Condominium”) “and that those assets [were] subject to execution” to satisfy the judgment. The third, fourth, fifth, sixth, and seventh causes of action all sought to set aside “any transfer to Mary of Frank’s interest” in the Properties, the Companies, and the Condominium under DCL § 273 (third), DCL § 273-a (fourth), DCL § 274 (fifth), DCL § 275 (sixth), and DCL § 276 (seventh). The eighth cause of action sought an award of attorney’s fees under DCL § 276-a in an amount to be determined at a hearing.

Sarfati moved for summary judgment on the complaint. The Court granted in part and denied in part the motion. We examine the Court’s decision as to the third through eighth causes of action.

The Court’s Decision

The held that issues of fact prevented summary judgment on the third, fourth, fifth and sixth causes of action. The Court noted that although Sarfati showed that the conveyances at issue were made without fair consideration and with bad faith – Frank testified that he transferred the assets to his wife for $10.00 in order to evade future creditors – he did not prove the other elements of DCL §§ 273, 273-a, 274 and 275. Slip Op. at **7-9. In that regard, the Court found that Sarfati did not prove that “Frank made any specific conveyance to Mary (i) while insolvent or that the conveyance complained of rendered him insolvent, (ii) while Frank was a party to a litigation with the plaintiff or after the judgment was docketed against him, (iii) while Frank engaged in or was about to engage in a business transaction for which his remaining property would constitute unreasonably small capital or (iv) at a time Frank ‘intended or believed’ he would incur debts beyond his ability to pay as they matured.” Slip Op at *9.

The Court granted Sarfati’s motion for summary judgment on the seventh cause of action to set aside “any conveyance” by Frank to Mary under DCL § 276 but limited the holding to those assets conveyed in the Assignment. Id. at **9, 11. The Court found that Sarfati adduced sufficient evidence to show that Frank conveyed to Mary with actual intent to defraud future creditors ownership interests in the Properties and the Companies listed in the Assignment. The Court noted that Frank admitted under oath “that he conveyed these assets to Mary specifically so that future creditors could not enforce any judgments.” Slip Op. at **9-10. Notably, observed the Court, Mary did “not submit any affidavit in opposition to th[e] motion, and thus fail[ed] to dispute that this was the intent of the assignment.” Id. at *10.  “Frank’s admissions under oath,” concluded the Court, were “sufficient to establish the defendants’ ‘actual intent to defraud’ creditors as to the assets conveyed in the assignment.” Id. (citation omitted).

In granting summary judgment on the seventh cause of action, the Court did so only as to liability. The Court explained that the Assignment and Frank’s deposition testimony only established that Frank owned at least some percentage interest in the Properties and the Companies prior to conveying them to Mary. The assignment did not, however, “specify the value or precise percentage ownership interests Frank conveyed to Mary via the assignment that [was] to be set aside in accordance with DCL § 276.” Id.  “As such,” held the Court, “summary judgment on the seventh cause of action is granted as to liability only, and the plaintiff may establish at trial what specific percentage interests in the assets contained in the assignment were by Frank to Mary and the value thereof.” Id. at **10-11.

As to the eighth cause of action, the Court granted the motion because Sarfati “established actual intent to defraud”. Id. at *11. Under DCL § 276-a, therefore, Sarfati was “entitled to attorneys’ fees” the amount of which was to be “fixed at trial.” Matter of Setters v. AI Props. Devs. (USA) Corp., 139 A.D.3d 492, 494 (1st Dept. 2016).

Takeaway

The facts in Sarfati are notable because they illustrate how a creditor can obtain relief whether under existing law or under the NYUVTA. Given the absence of particularity with regard to the assets and property subject to the Assignment, it appears likely that a court would also deny summary judgment under the NYUVTA. Similarly, given the evidence showing that Frank intended to defraud future creditors by conveying to Mary ownership interest in the Properties and the Companies listed in the Assignment, it appears likely that a court would grant summary judgment under the NYUVTA.

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