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In a recent Third Circuit opinion, Crystallex Int’l Corp. v. Petróleos de Venez., the court held that the transfer of assets by a foreign subsidiary of a debtor was not a fraudulent transfer under the Delaware Uniform Transfer Act (DUFTA). Nos. 16-4012 & 17-1439, 2018 U.S. App. LEXIS 95 (3d Cir. Jan. 3, 2018). As justification for its ruling, the majority opinion cited DUFTA’s requirement that the transfer be conducted “by a debtor” and well-settled Delaware state law defining subsidiaries as separate legal entities from parent corporations. While the opinion is arguably reasonable in light of a strict reading of Delaware law, a dissent by Circuit Judge Julio M. Fuentes indicates that a more equitable decision would prevent the fraud that will inevitably result from the majority’s holding.

The facts of Crystallex involve the diversion of assets by a parent-debtor through a series of subsidiaries, resulting in the funds being placed in foreign territory, beyond creditor reach. Creditor Crystallex International Corp., a Canadian gold producer, owned the rights to Las Cristinas gold reserve in the Bolivarian Republic of Venezuela. Crystallex invested over $640 million over nearly a decade for mine development. But Venezuela refused to issue the permits required to extract and sell the gold, despite Crystallex’s numerous applications. Venezuela claimed Crystallex stalled progress on the mine, terminated the mining agreement and assumed ownership of Las Cristinas in a 2011 gold mine nationalization effort. Venezuela transferred Crystallex’s interest to the state-owned Petróleos de Venezuela, S.A. (PDVSA), which then sold 40 percent to the Venezuelan Central Bank for $9.5 billion. This seizure resulted in Crystallex’s bankruptcy and its initiation of a World Bank arbitration against Venezuela. During the arbitration, Venezuela constantly advised that it would not pay any award. The arbitrators held that Venezuela breached a bilateral investment treaty with Canada and awarded Crystallex $1.202 billion. The District Court for the District of Columbia confirmed the award under the Federal Arbitration Act.

Venezuela is the sole shareholder of its alleged alter ego, Venezuela-based national oil company PDVSA. PDVSA owns PDV Holding (PDVH), which itself owns CITGO Holding.  CITGO Holding owns CITGO Petroleum Corporation. PDVH, CITGO Holding and CITGO Petroleum are Delaware corporations.

Crystallex sued PDVH in the District of Delaware, alleging PDVH violated DUFTA through debt offerings and asset transfers among PDVSA, PDVH, CITGO Holding and CITGO Petroleum. To prevent the seizure of Venezuela’s assets, Venezuela needed its Delaware corporation subsidiaries to remove all assets from the U.S. Venezuela’s directions made their way down the chain of subsidiaries to have CITGO Holding issue $2.8 billion in debt and transfer the proceeds to parent PDVH as a shareholder “dividend.” PDVH then declared an identical dividend to PDVSA. This series of transactions diverted Venezuela’s U.S. assets back to the home country, resulting in the dividends being outside the reach of United States creditors.

PDVH argued that Crystallex failed to state a claim under DUFTA because the purportedly fraudulent transfer was not made “by a debtor.”  The district court denied PDVH’s motion to dismiss the complaint under F.R.C.P. 12(b)(6). The district court held that a non-debtor transferor could be liable for its dividend transfer since DUFTA includes indirect forms of transfer. The district court, citing DUFTA’s broad equitable principles, also held that Merriam-Webster’s definition of “by” would include transfer “on behalf of” or as an “instrumentality” of the debtor.

The Third Circuit accepted PDVH’s petition for review, ultimately holding that DUFTA does not extend to transfers by non-debtors and reversing the district court order. As a diversity case, the Third Circuit was bound under Erie Doctrine to apply Delaware Chancery Court and state law principles. The majority posited that PDVH is not a debtor, and the only potentially liable debtors, Venezuela and PDVSA, did not transfer any property, but merely received $2.8 billion. The court argued that DUFTA contemplates transfers by the debtor, but not to the debtor.  Citing the only relevant precedent on the matter, two Delaware Chancery Court cases, the court concluded that the Delaware Supreme Court would not extend fraudulent transfer liability to non-debtor transferors. The court also noted that the Delaware Chancery Court similarly rejected fraudulent transfer claims against non-debtor transferors under the federal Bankruptcy Code, which is nearly identical to DUFTA.

A significant factor in the majority’s holding was that Delaware corporate law considers parent and subsidiary corporations to be separate legal entities. The court was therefore reluctant to disrespect PDVH’s discrete corporate status from Venezuela and PDVSA. The majority refused to acknowledge the dictionary definition of “by” since case law sufficiently held that “by a debtor” requires the debtor itself to conduct the transfer. The court also held that DUFTA’s “broad equitable powers” were not available where Delaware courts already “closed the door to non-debtor transferor liability under the state statute.” While the court acknowledged that “transfers” can be indirect, the specific claim of fraudulent transfer under DUFTA still requires transfer “by a debtor.” Ultimately, the palpable badges of fraud indicating Venezuela’s intent to defraud Crystallex only attach to one of three necessary elements of a DUFTA claim: “actual intent.” Without transfer “by a debtor,” intent alone is insufficient for a DUFTA claim.

The majority also refused to adopt any theory of aiding and abetting or conspiracy against Venezuela and PDVSA for their well-orchestrated scheme. The court noted that case law precluded such a holding and explicitly held that aiding and abetting or conspiracy are not actionable under DUFTA.

While the majority underscored its adherence to the Erie Doctrine and Delaware Chancery Court case law, an emphatic dissent by Judge Fuentes appealed to the inherent equity of DUFTA. Judge Fuentes argued that PDVH’s issuance of the $2.8 billion dividend to Petróleos was a “transfer” of debtor property “by a debtor” since the action occurred at Venezuela’s direction. Furthermore, he claimed that PDVH was a proper defendant because it “clearly facilitated the fraudulent transfer.” Judge Fuentes avowed that the majority read the term “indirect” out of DUFTA, where it should have classified the dividend as an indirect—but nonetheless fraudulent—transfer by the debtor. He added that “by a debtor” was undefined and the dictionary definition of “by” as including “on behalf of” should have been taken into account.

As explained by Judge Fuentes, the majority’s holding allows a foreign sovereign to “fraudulently repatriate assets, so long as the party making the transfer is a non-debtor.” He further postulated that DUFTA grants broad equitable powers to courts to perform remedies in regards to fraudulent transfers.

Judge Fuentes read the relevant Delaware Chancery Court cases differently than the majority and asserted that these cases did not hold that non-debtor transferors were “immune from liability under [DUFTA].” One of the relevant cases cited, he argued, only addressed an aiding and abetting claim. He did not consider this case to be an aiding and abetting or conspiracy claim but rather an assertion that PDVH “directly participated in the fraudulent scheme.” Regarding the other case cited by the majority, Judge Fuentes claimed that it solely held for the premise that only a creditor of the debtor has standing to bring a fraudulent transfer claim. The case did not address the issue of whether non-debtor transferors are liable under DUFTA.

The dissent eventually concluded that, regardless of the interpretation of “by a debtor” in DUFTA’s text, there did not exist a more worthy case for the statute’s broad equitable authority. Judge Fuentes determined that a combination of the unlawful usurpation of the mine by Venezuela, the sale of its interest to Petróleos, Venezuela’s purposeful delays in issuing permits, and the fraudulent scheme to acquire $2.8 billion from PDVH during the course of the arbitration against Venezuela, all made this a prime example of fraudulent transfer warranting the equitable powers of the court granted by DUFTA.

Whether one agrees with the strict reading of DUFTA and relevant Delaware Chancery Court case law of the majority or the more equitable and broader interpretation of the dissenting Judge Fuentes, the precedent this case sets is clear: corporations now have a textbook formula for avoiding creditors governed by DUFTA by diverting assets through the debtor’s foreign subsidiaries. While the majority’s hands may have been bound by the Erie Doctrine, it is undeniable that its holding will help perpetuate further fraud against United States-based creditors. The procedure for any corporation looking to avoid the reach of creditors is simple: divert the assets to a foreign subsidiary, or series of subsidiaries, in exchange for a shareholder dividend to the parent corporation. Parents and subsidiaries will be treated as separate entities under Delaware law, and the assets will not be attachable due to Foreign Sovereign Immunities Act restrictions against prejudgment attachment of sovereign property.

 

Komyati is a principal with Bressler, Amery & Ross in Florham Park. His practice includes bankruptcy and creditors’ rights, securities, arbitration and commercial litigation. Levine is an associate in the firm’s Corporate and Securities practice groups.