The Former DCL Gets Its Day In Court

• Posted on: Dec 27 2022

By: Jeffrey M. Haber

On December 23, 2022, the Appellate Division, Fourth Department issued two decisions involving New York’s former Debtor and Creditor Law (“DCL”): Inner Harbor Phase I L.P. v. Cor Inner Harbor Co. LLC, 2022 N.Y. Slip Op. 07319 (4th Dept. Dec. 23, 2022) (here); and Hospitality Concepts, LLC v. Bernhardt, 2022 N.Y. Slip Op. 07349 (4th Dept. Dec. 23, 2022) (here). We examine both decisions below.

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.

[Ed. Note: This Blog previously examined the NYUVTA, the former DCL and the changes the NYUVTA made to the former DCL (here).] 

Both Inner Harbor and Hospitality Concepts were brought prior to the effective date of the NYUVTA. 

Under the former DCL, transfers, gifts, assignments and other conveyances are considered to be fraudulent under certain circumstances. 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 

Unlike DCL §§ 273 and 275, DCL § 276 concerns actual fraud, as opposed to constructive fraud, and does not require proof of unfair consideration or insolvency. 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.”⁴ 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.⁵ “Depending on the context, badges of fraud will vary in significance, though the presence of multiple indicia will increase the strength of the inference.”⁶ A conveyance made with actual intent to defraud is fraudulent regardless of whether the debtor receives fair consideration.⁷ 

Inner Harbor Phase I L.P. v. Cor Inner Harbor Co. LLC

Inner Harbor arose from a $4,000,000 promissory note.

Plaintiff, a limited partnership, loaned $4,000,000 to COR LLC for the purpose of building a hotel at the Inner Harbor in Syracuse. Plaintiff’s limited partners were 10 foreign investors who sought to obtain green cards pursuant to the EB-5 Immigrant Investor Program.⁸ In furtherance of the project, COR LLC applied for and received site plan approval from the City of Syracuse (“City”), i.e., the owner of the property upon which the hotel was to be built. Shortly thereafter, however, the City transferred title to the land to defendant COR West Kirkpatrick Street Company LLC (“COR Kirkpatrick”), which, according to plaintiff, is owned and controlled by the same parties who own and control COR LLC.

Several months later, plaintiff and COR LLC executed the promissory note. Thereafter, plaintiff transferred $4,000,000 to COR LLC’s attorneys, also a defendant in the action (“Law Firm”), to be held in escrow pending transfer to COR LLC. Pursuant to the escrow agreement, the Law Firm was to disburse the funds to COR LLC. Despite that provision in the escrow agreement, the Law Firm transferred large portions of the funds to COR Kirkpatrick. According to the Court, “[a]t no point did plaintiff object to the transfers”.⁹ Plaintiff maintained that COR LLC received no consideration for the transfers to COR Kirkpatrick and that, as a result, COR LLC was left completely devoid of assets.

Although COR Kirkpatrick had no legal obligation to make payments on the promissory note, it made some payments. All payments ceased when the first addendum came due. When plaintiff sought information from COR LLC, plaintiff was informed that COR LLC was insolvent inasmuch as it had no interest in the hotel and had no tangible assets.

Plaintiff commenced the action against COR LLC, COR Kirkpatrick, the Law Firm and the individual members or owners of COR LLC (“individual defendants”). In the first cause of action, plaintiff alleged that COR LLC breached the promissory note. In the second cause of action, plaintiff asserted a fraud cause of action against all defendants. In the third cause of action, plaintiff alleged that the Law Firm breached the escrow agreement by releasing funds to COR Kirkpatrick rather than to COR LLC. In the fourth and fifth causes of action, which were asserted against all defendants, plaintiff alleged that defendants engaged in fraudulent conveyances in violation of the former DCL (e.g., sections 273, 274 and 276). 

In lieu of an answer, defendants jointly moved to dismiss all causes of action except the first one. 

The motion court granted the motion as to the second cause action (for fraud) and denied the remainder of the motion. As to the fraud claim, the motion court found that the complaint was devoid of any facts to support the claim asserted:

As to the first element — misrepresentation of a material fact — the entirety of plaintiff’s allegation is found in paragraph 49 of the complaint. That paragraph provides: “[d]efendants made representations to [p]laintiff regarding [COR LLP’s] interest in the Hotel Project and the Hotel and the distribution of Proceeds.”

Wholly absent are any facts sufficiently specific as to the substance of any misrepresentation allegedly made, i.e., the words used, when any misrepresentation was allegedly made or the identity of the person who allegedly made the misrepresentation. Under these circumstances, plaintiff fails to comply with the specificity requirements of CPLR 3016(b) and the fraud cause of action must be dismissed.¹⁰

Since the complaint was “[d]evoid of essential facts concerning the alleged misrepresentation(s),” the Court was unable “to address the sufficiency with which plaintiff pled the additional elements of fraud, i.e., scienter, justifiable reliance or injury”. Accordingly, the motion court granted defendants’ motion.

As to the DCL claims (the fourth and fifth causes of action), the motion court denied the motion, holding that, although “the complaint [was] sparse on facts”, plaintiff adequately alleged that “it is a creditor of COR LLC, defendants (excluding [the Law Firm]) had a close relationship with common control, the transfers of funds from COR LLC to COR Kirkpatrick were made ‘to an insider’ with absent or inadequate consideration rendering COR LLC insolvent, the existence of a debt antecedent to the transfer, and the transfers were made with actual intent to hinder and delay creditors”. The motion court further found that “[a]s an alternative to actual knowledge, Inner Harbor [adequately] allege[d] that defendants had constructive knowledge of intent to hinder and delay.” 

The motion also held that the foregoing allegations sufficed to support plaintiff’s veil piercing allegations against the individual defendants. 

Defendants appealed.¹¹

Defendants argued that the motion court should have dismissed the fourth and fifth causes of action pursuant to CPLR § 3211 (a) (1)¹² because plaintiff ratified the transfer of assets from COR LLC to COR Kirkpatrick.¹³ The Court “reject[ed] that contention”.¹⁴ The Court “conclude[d] that the documentary evidence [did] not establish ratification as a matter of law”.¹⁵ The Court explained that “[a]lthough the documentary evidence may establish all of the facts alleged by defendants, including the fact that plaintiff’s loan was unsecured and that plaintiff knew that COR LLC intended to transfer the funds to COR Kirkpatrick, there [was] no evidence that plaintiff knew that COR LLC would not receive any consideration for the transfers, thus rendering COR LLC insolvent and rendering plaintiff unable to receive any of the benefits of its bargain”.¹⁶ “Indeed,” said the Court, “there [was] no evidence that plaintiff could have possibly anticipated that COR LLC would intentionally render itself insolvent in that manner, as the complaint alleges”.¹⁷

The Court also rejected the individual defendants’ argument that plaintiff failed to state a claim for veil piercing. The Court found that “plaintiff raised sufficient allegations that the individual defendants ‘exercised complete domination and control over the corporation and abused the privilege of doing business in the corporate form to perpetrate a wrong or injustice’”.¹⁸ The Court explained that “plaintiff sufficiently alleged that ‘corporate funds were purposefully diverted to make [COR LLC] judgment-proof,’ and [that] such allegations were “sufficient to satisfy the pleading requirement of wrongdoing which is necessary to pierce the corporate veil on an alter-ego theory”.¹⁹ 

The Court further rejected defendants’ contention that the motion court should have granted the individual defendants’ motion as to the fourth and fifth causes of action on the ground that the complaint failed to allege that the loan proceeds were transferred to the individual defendants or that the individual defendants used the proceeds for personal or improper purposes. Analyzing the argument under the former DCL, the Court concluded that “the factual allegations in the complaint [were] sufficient to state causes of action against the individual defendants for a violation of those former sections of the Debtor and Creditor Law”.²⁰

Hospitality Concepts, LLC v. Bernhardt

Hospitality Concepts was an action involving the payment for services that plaintiff provided to defendant Bedford Falls Enterprises, LLC (“BFE”), the owner of The Gould Hotel (“hotel”) in Seneca Falls, New York. In August 2018, BFE sold the hotel; however, neither BFE nor defendant Jay Bernhardt, BFE’s sole member, paid the amount owed to plaintiff. Subsequently, BFE transferred certain of its monetary assets to defendant JGB Properties, LLC (“JGB Properties”). Bernhardt was also the sole member of JGB Properties. Following its transfer of assets, BFE had insufficient funds with which to pay the amount owed to plaintiff. 

In a prior action, plaintiff obtained a judgment against BFE for the unpaid amount and interest, but BFE had dissolved by that time. 

Plaintiff commenced the action seeking, inter alia, to hold Bernhardt personally liable and to set aside the conveyances to defendants as fraudulent pursuant to former DCL §§ 273 and 276. 

Thereafter, plaintiff moved for summary judgment on, inter alia, the second cause of action against defendant Bernhardt, BFE, JGB Enterprises and JGB Properties under those former sections, and on the first cause of action against Bernhardt. The motion court granted plaintiff’s motion with respect to its first and second causes of action. 

The motion court found that plaintiff had met its burden of proof under DCL § 273 by showing that the transfers at issue rendered BFE insolvent and that there was no evidence that the transfers were made for fair consideration. Moreover, the motion court found that even if there was fair consideration, the conveyances lacked good faith because Bernhardt and BFE were aware of its debt to plaintiff and plaintiff’s attempts to resolve the dispute before the sale of the hotel. Further, said the motion court, BFE’s subsequent sale of the hotel and the conveyances to JGB Properties soon thereafter demonstrated a failure to deal honestly, fairly and openly.

On plaintiff’s claim under former DCL § 276 claim, the motion court found indicia of fraudulent intent (i.e., badges of fraud), including that (1) plaintiff was a creditor of BFE; (2) Bernhardt was involved in and had a close relationship with the parties to the action; (3) consideration for the conveyances was absent or inadequate; (4) Bernhardt knew of BFE’s debt to plaintiff before the alleged conveyances; and (5) the hotel was BFE’s primary asset. Notably, the motion court found that defendants failed to offer any explanation for the 2018 conveyances, or negate with evidence in admissible form the demonstrated “badges of fraud.” 

On plaintiff’s claim against Bernhardt (under the first cause of action), the motion court held that plaintiff successfully pierced the corporate veil. The motion court found that Bernhardt (1) was BFE’s sole member; (2) had sole authority to proceed with the sale of the hotel on behalf of BFE; (3) sold the hotel on behalf of BFE; and (4) knew of BFE’s past due balance owed to plaintiff prior to the sale. These facts, which defendant did not dispute, were “more than nonspecific and conclusory allegations regarding [plaintiff’s] claims of fraud.” The motion court concluded that “[o]n the record before this Court, there [was] sufficient evidence to find Bernhardt exercised domination over [BFE] and JGB Properties and that before making the challenged conveyance to JGB Properties he knowingly sold The Hotel without first either remitting payment to Hospitality or disputing the invoices. As such, Bernhardt abused the privilege of doing business in the corporate form.…” Accordingly, the motion court granted the motion as to the first cause of action.

Defendants appealed.

The Fourth Department agreed with the motion court and dismissed the appeal.

With regard to the DCL § 273 claim, the Court held that “plaintiff met its initial burden on the motion by establishing that BFE’s conveyance to JGB Properties rendered BFE insolvent and was made without fair consideration.…”²¹ Like the motion court, the Court found that “defendants failed to raise an issue of fact in opposition” to the motion.²²

As to former DCL § 276, the Court held that the record supported the motion court’s finding as to the existence of badges of fraud.²³ Therefore, the Court concluded that “plaintiff met its initial burden of establishing fraudulent intent, and that defendants failed to raise an issue of fact in opposition”.²⁴

Finally, as to veil piercing claim, the Court held that “[b]ased upon, among other things, Bernhardt’s concessions in his answer and interrogatories regarding his involvement in BFE and JGB Properties, as well as the evidence of past financial practices between those entities, … the [motion] court properly determined that plaintiff [was] entitled to summary judgment on its cause of action based on Bernhardt’s individual liability.”²⁵

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. P’ship, 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 A.D.2d 526, 529 (1st Dept. 1999) (citation omitted).
4. Id. (internal quotation marks and citations omitted).
5. Id.
6. 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).
7. MFS/Sun Life Trust, 910 F. Supp. at 934 (citation omitted).
8. See 8 USC § 1153(b)(5)(A).
9. Slip Op. at *2.
10. Citations and footnote omitted.
11. Plaintiff did not cross-appeal the dismissal of the fraud claim.
12. “Under CPLR 3211 (a) (1), a dismissal is warranted only if the documentary evidence submitted conclusively establishes a defense to the asserted claims as a matter of law”. Leon v. Martinez, 84 N.Y.2d 83, 88 (1994); see also Goshen v. Mutual Life Ins. Co. of N.Y., 98 N.Y.2d 314, 326 (2002). In other words, the submitted documents must “utterly refute[] the allegations in the complaint and conclusively establish[ ] a defense as a matter of law”. Himmelstein, McConnell, Gribben, Donoghue & Joseph, LLP v. Matthew Bender & Co., Inc., 37 N.Y.3d 169, 175 (2021), rearg. denied, 37 N.Y.3d 1020 (2021) (quoting, Goshen, 98 N.Y.2d at 326 (internal quotation marks omitted)).
13. Slip Op. at *2.
14. Id.
15. Id. (citations omitted). “Ratification is the act of knowingly giving sanction or affirmance to an act that would otherwise be unauthorized and not binding.” Northland E., LLC v. J.R. Militello Realty, Inc., 163 A.D.3d 1401, 1405 (4th Dept. 2018) (internal quotation marks omitted); see also Green Tree Servicing, LLC v. Feller, 159 A.D.3d 1246, 1247-1248 (3d Dept. 2018).
16. Slip Op. at *2-*3 (citations omitted).
17. Id. at *3.
18. Id. (citations omitted).
19. Id. (citations omitted).
20. Id. (citations omitted).
21. Slip Op at *2.
22. Id.
23. Id.
24. Id. (citation omitted).
25. Id. (citation omitted).

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.