Carlos J. Cuevas
Carlos J. Cuevas ()

Intentional fraudulent conveyance litigation is an important component of bankruptcy and commercial litigation. New York has enacted an intentional fraudulent conveyance statute, N.Y. Debtor and Creditor Law §276. Section 276 states:

Every conveyance made and every obligation incurred with actual intent, as distinguished from intent presumed in law, to hinder, delay, or defraud either present or future creditors, is fraudulent as to both present and future creditors.

N.Y. Debt. Cred. Law §276.

To state a claim under §276, a creditor must prove a conveyance and actual intent to hinder, delay or defraud present or future creditors. Federal National Mortgage Association v. Olympia Mortgage, 2013 WL 417352 at *11 (E.D.N.Y. 2013). Significantly, where actual intent to defraud creditors is proven, the conveyance will be set aside regardless of the adequacy of consideration given. Sharp International v. State Street Bank and Trust Company (In re Sharp International), 403 F.3d 43, 56 (2d Cir. 2005).

The creditor must prove actual intent on the part of the transferor. Gowan v. The Patriot Group (In re Dreier), 452 B.R. 391, 433 (Bankr. S.D.N.Y. 2011). Actual intent must be established by clear and convincing evidence. U.S. v. McCombs, 30 F.3d 310, 328 (2d Cir. 1994).

New York courts have long observed that direct proof of actual fraudulent intent can rarely be obtained. Stewart v. Lyman, 62 A.D. 182, 70 N.Y.S. 936, 940 (1st Dept. 1901). To prove fraudulent intent, courts often employ the “badges of fraud.” Nonas v. Romantini, 271 A.D.2d 292, 292-93 (1st Dept. 2000). One court has made the following observations concerning the “badges of fraud.”

The determination of actual fraud depends upon an analysis of “badges of fraud” associated with the transaction, which are “circumstances so commonly associated with fraudulent transfers that their presence gives rise to an inference of intent,” to hinder, delay, or defraud a present or future creditor. See Fed. Nat’l Mortg. Ass’n v. Olympia Mortg. Corp., No 04-CV-4971, 2013 WL 417352, at *11 (E.D.N.Y. Jan. 29, 2013) (internal quotation and citation omitted). Badges of fraud include (1) “a close relationship between the parties to the transaction,” (2) a “hasty transfer” not made in the usual course of business, and (3) “inadequacy of consideration.” See id. Courts may also consider “the general chronology of the events and transactions under inquiry” as a badge of fraud. Ostashko, 2002 WL 32068357, at *18 (citation omitted).

Lesser v. U.S. Bank N.A., 2013 WL 3788877 at *8 (E.D.N.Y. 2013).

‘Messer v. Chu’

A recent case that applied the badges of fraud to avoid two intentional fraudulent conveyances is Messer v. Chu (In re Gao), 2016 WL 5724771 (Bankr. E.D.N.Y. 2016). There, Judge Nancy Hershey Lord wrote a thoughtful opinion concerning the application of the badges of fraud to establish fraudulent intent. Trustee Messer commenced an adversary proceeding to avoid two transfers by the debtor to the defendant, debtor’s significant other, at a time when the defendant was a defendant in a state court action in Texas.

In December 2010, the debtor was named as a defendant in a civil action in Texas. On or about May 31, 2012, the debtor sold his membership interest in a limited liability company for $870,000 (Transfer I). A $180,000 check concerning Transfer I was made payable to the defendant instead of the debtor. The debtor effectuated his second transfer on or about Sept. 11, 2012 when the debtor transferred his interest in the residence in which he and the defendant resided to the defendant (Transfer II) (collectively the Transfers). There was no consideration for Transfer II. The debtor remained living in the residence with the defendant and their children.

Trustee Messer moved for summary judgment under the cause of action for an intentional fraudulent conveyance. The court was satisfied that the debtor had effectuated two transfers of his property.

Judge Lord focused on the issue of fraudulent intent, and she employed the badges of fraud as the key component of her legal analysis. The court made the following observation concerning the employment of the badges of fraud to establish fraudulent intent on the part of the transferor:

“The existence of a badge of fraud is merely circumstantial evidence and does not constitute conclusive proof of actual intent. However, the existence of several badges of fraud can constitute the requisite clear and convincing evidence of actual intent [to defraud].” In re Actrade Fin. Techs., Ltd., 337 B.R. 791, 809 (Bankr. S.D.N.Y. 2005) (citing 4 Collier on Bankruptcy, ¶ 548.03(2) (15th ed. 1983)); see also In re Singh, 434 B.R. 298, 311-12 (Bankr. E.D.N.Y. 2010) (quoting Actrade, 337 B.R. at 809).

Id. at 10.

Judge Lord employed the following badges of fraud in her analysis of the fraudulent intent issue:

(1) the lack or inadequacy of consideration;

(2) the family, friendship or close associate relationship between the parties;

(3) the retention of possession, benefit or use of the property in question;

(4) the financial condition of the party sought to be charged both before and after the transaction in question;

(5) the existence or cumulative effect of a pattern or series of transactions or course of conduct after the incurring of debt, onset of financial difficulties, or pendency or threat of suits by creditors; and

(6) the general chronology of the events and transactions under inquiry.

Id.

The court found that virtually all of the badges of fraud were present. As to the first badge of fraud, there was no consideration for the Transfers. As to the second badge of fraud, the debtor and defendant lived to together, for at least 12 years, in a house they owned jointly; the debtor and defendant had a joint bank account; and the debtor and defendant have two children together. As to the third badge of fraud—retention of possession, benefit or use of property in question—the court thought that the evidence was inconclusive as to Transfer I. The evidence did not establish whether the debtor retained possession, benefit or use of the $180,000. However, the evidence was compelling as to Transfer II, and the court stated:

The opposite is true with respect to this transfer. The Debtor used the address of the House as his street address when filing his Chapter 7 petition on May 28, 2014, over a year and a half after the Real Estate Transfer, and it is admitted that he lived in the House through that date.

Id.

As to the fourth badge of fraud, the court thought that this factor also reflected fraudulent intent. The debtor’s Schedules A and B failed to reflect the joint interest in the residence and the membership interest in the limited liability company. The court found that the debtor, through the Transfers, had attempted to make himself judgment proof. Judge Lord wrote:

Without the 5% Interest and the Debtor’s interest in the House, the Debtor had only nominal assets left to satisfy the $1,917,766.76 judgment entered against him in the Texas State Court Action. Thus, the Debtor appears to have endeavored to render himself “judgment proof” by divesting himself of any assets on which a judgment creditor could collect.

Id.

As to the remaining badges of fraud—the course of events disclosed in the record—the debtor became a defendant in a multi-million dollar lawsuit, and subsequently transferred virtually all of his wealth to his children’s mother, for no consideration. Under these circumstances, Judge Lord found that Trustee Messer had satisfied his burden of proof by clear and convincing evidence that the Transfers were made with actual intent to defraud the debtor’s creditors.

Analysis

Judge Lord reached the correct conclusion. The evidence concerning fraudulent intent was compelling. The Transfers rendered the debtor judgment proof at a time in which he was a party to a lawsuit in which he could be held liable for a multi-million dollar judgment. The debtor transferred property to his significant other for no consideration. The debtor transferred his interest in his residence, and he remained living at the residence with his significant other and his children. This was a textbook case of an intentional fraudulent conveyance. Therefore, Trustee Messer was appropriately granted summary judgment.

The badges of fraud are an indispensable instrument in proving fraudulent intent in an intentional fraudulent conveyance action. A transferor and transferee will not testify that they conspired to defraud a debtor’s creditors. Circumstantial evidence can establish fraudulent intent in an intentional fraudulent conveyance action.