In a pair of recent decisions, Justices Shirley W. Kornreich and Lawrence K. Marks of the Commercial Division ruled that creditors could proceed on their fraudulent conveyance claims seeking reversal of asset transfers made by debtors under New York’s Debtor and Creditor Law (“DCL”). The decisions highlight two basic theories of fraudulent conveyance claims permitted by the DCL: intentional fraud claims, which require a showing that the debtor made the transfer with the intent defrauding its creditor, and constructive fraud claims, which do not require a showing of fraudulent intent.
In CDR Creances S.A.S. v. First Hotels & Resorts Investments, Inc., No. 650084/2009, Justice Marks dealt with allegations of intentional fraudulent conveyance and whether there was sufficient evidence of intent to survive summary judgment. The plaintiff, CDR Creances S.A.S. (“CDR”), had obtained judgments against two companies (Summerson International Establishment and Blue Ocean Finance, Ltd) controlled by Maurice, Leon, and Sonia Cohen. The judgments were for the damages CDR had suffered from the Cohens’ conspiracy to defraud CDR of the proceeds from a commercial loan and sale of a hotel. CDR then brought this action to force the sale of First Hotels & Resorts Investments, Inc.’s (“First Hotels”) sole asset, a condominium, for satisfaction of the judgments. As alleged in CDR’s complaints, First Hotels is a Canadian company controlled by the Cohens that was used to launder the proceeds of the Cohens’ fraud.
At issue on summary judgment were transfers made to First Hotels by judgment debtor Blue Ocean (through a third entity, Whitebury Shipping Ltd.) for the purchase of the condo in 2004. CDR alleged that these transfers were fraudulent under DCL section 276 because they were made by the Cohens with the intent “to hinder, delay, or defraud” their creditors. First Hotels contended that there was only one transfer at issue in the complaint and that it was merely a loan that First Hotels repaid, meaning (or so First Hotels argued) that there was no fraud and no transfer for the court to set aside.
In denying the summary judgment motion, Justice Marks rejected First Hotels’ characterization of CDR’s claims. To set aside an asset transfer, DCL section 276 requires that the transfer be made with the “actual intent” to “hinder, delay, or defraud either present or future creditors,” a standard that dates back to the original English fraudulent conveyance statue of 1571. Plaintiffs may overcome the difficulty of proving actual intent by relying on what the courts have for centuries called “badges of fraud”: situations so commonly associated with fraud that they allow a reasonable inference of fraud.
CDR argued that intent to defraud was all it needed to show to sustain a claim under DCL section 276, not lack of consideration as with constructive fraud, and that discovery had shown other transfers between First Hotels and the other shell companies besides the one repaid loan. The court noted that a previous judge hearing the case had already held that CDR’s allegations that the Cohens formed a web of shell companies to divert and hide funds owed to CDR sufficiently alleged badges of fraud. The court agreed with First Hotels that CDR had provided no controlling case law in which the contested property was returned and a fraudulent conveyance claim was nevertheless sustained, but ruled that First Hotels failed to show why this would be dispositive on the issue of actual intent under DCL section 276, which does not require that the transferred assets be made permanently unavailable or that the transfer was made without fair consideration.
The court also noted that if all funds had indeed been returned by First Hotels then there would likely be no remedy available to CDR since the DCL only returns the parties to the situation they were in before the fraudulent transfers. However, the court agreed with CDR that the other transfers could not be ignored and that First Hotels had not shown that all the funds had been repaid, resulting in questions of fact that prevent summary judgment.
The Constructive Fraud Theory
The second case, Stillwater Liquidating LLC v. Partner Reinsurance Company, Ltd., No. 652451/2015, involves allegations of constructive fraud relating to a creditor’s effective seizure of all of the assets of the debtor—worth far more than the debt owed to that creditor—to the detriment of the other creditors. In Stillwater, a hedge fund made hundreds of millions of dollars’ of loans to law firms that were secured by the firms’ accounts receivable. In 2009, after the hedge fund and a related fund with an interest in the loans began to fail, both funds transferred their assets (the portfolio of loans primarily made to law firms, the “Law Firm Loans”) to a separate entity, Stillwater Funding LLC (“Stillwater Funding”). Stillwater Funding then borrowed $31.5 million from Partner Reinsurance Company, Ltd. (“PartnerRe”), which loan was secured by the Law Firm Loans.
Stillwater Funding ultimately defaulted on the loan by PartnerRe. In 2011, Stillwater Funding entered into a Consent Foreclosure and Sale Agreement (“CFSA”) with PartnerRe pursuant to which PartnerRe received all of the collateral (the Law Firm Loans) in exchange for satisfaction of the debt and a right to a contingent payment under certain circumstances. At the time that the CFSA was executed, Stillwater Funding owed approximately $39 million to PartnerRe and the Law Firm Loans were allegedly worth approximately $286 million.
In 2011 and 2012, the hedge funds became the subjects of multiple class actions as well as bankruptcy proceedings. The current plaintiff, Stillwater Liquidating LLC, was created as part of a court-approved global settlement agreement entered into by the hedge funds and the plaintiffs and creditors to collect more than $575 million allegedly owed to creditors. Plaintiff sued PartnerRe and others in order to reverse the transfer of the Law Firm Loans. Plaintiff alleged, among other things, that the CFSA represented a constructive fraudulent conveyance pursuant to DCL sections 274 and 275 because the exchange of approximately $286 million worth of collateral to satisfy a debt of $39 million was not fair consideration. The defendants moved to dismiss on the ground, among others, that there was no fraudulent conveyance on the alleged facts.
Justice Kornreich denied the motion to dismiss as to the fraudulent conveyance claims and concluded that the plaintiffs had adequately alleged that the CFSA constituted constructive fraud. Pursuant to DCL sections 274 and 275, a transaction can be set aside if it was made without fair consideration or was made in bad faith; evidence of intent to defraud is not required.
PartnerRe argued that since the CFSA was a foreclosure, the transfer was not a “voluntary act” and therefore could not be a “conveyance” within the meaning of the DCL. The court rejected this argument because it found that the CFSA, despite the wording in the agreement, was not a true foreclosure in the first place.[i] The court concluded that the CFSA did not meet the UCC’s requirement for a foreclosure, specifically because the vast disparity between the amount of the loan and the alleged value of the collateral did not satisfy the UCC’s requirement of good faith. The court noted that in a proper foreclosure, excess value of the collateral could have been retained by the debtor and be available for the satisfaction of other debts. As alleged, the extreme difference in value between the Law Firm Loans and the amount of debt they secured meant that the CFSA lacked fair consideration and so was not made in good faith.
The court noted that the fact that PartnerRe was a legitimate creditor of Stillwater Funding did not change the analysis. A debtor can generally favor one creditor over another (with exceptions) but cannot engage in constructively fraudulent or sham transactions. The court held that plaintiff’s allegations regarding the debt owed to PartnerRe and the value of the collateral it received through the CFSA was sufficient to state a claim for constructive fraudulent conveyance.
Stillwater and CDR demonstrate two different ways that creditors can use the DCL to recover from debtors. Whether the debtor’s transfer of assets is done with intent to defraud creditors or without fair consideration, the DCL provides creditors with a remedy. In these two recent cases, the Commercial Division has provided specific examples of how creditors can successfully bring their claims. The First Department may have an opportunity to weigh in on the topic as notices of appeal have been filed in both cases.