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Special Considerations for Fraudulent Transfers

Daniel C. Fleming

THE ROADMAP FOR FRAUDULENT TRANSFERS

The New Jersey Fraudulent Transfer Act sets the roadmap for whether to sue when determining whether your client has been the victim of a fraudulent transfer.  Under N.J.S.A. 25:2-25(a), you have to look at the so-called “badges of fraud” connected to the transfer.  These badges of fraud include whether:

a. the transfer was to an insider;

b. the debtor retained possession or control of the property transferred after the transfer;

c. the transfer was disclosed or concealed;

d. before the transfer was made, the debtor had been sued or threatened with suit;

e. the transfer was of substantially all the debtor’s assets;

f. the debtor absconded;

g. the debtor removed or concealed assets;

h. the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred;

i. the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred;

j. the transfer occurred shortly before or shortly after a substantial debt was incurred; and

k. the debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor

Fraud has, and always will be, a moving target.  If someone wants to defraud you, they will, and they are by no means confined to the foregoing list of “badges” in their methods of operation.  New Jersey’s recognizes that such a flexible approach to fraudulent transfer actions is mandatory.

I.  RELATIVES OR INSIDERS

Dealings between close relatives whereby the property of a debtor is conveyed to a member of his family are at best viewed with suspicion.  Coles v. Osback, 22 N.J. Super. 358, 364 (App. Div. 1952); Haberstroh v. De Marco, 2 N.J. Super. 429, 432 (Ch. Div. 1949) (interpreting Fraudulent Conveyance Act, N.J.S.A. 25:2-3).

In United Jersey Bank v. Vajda, 299 N.J. Super. 161 (App. Div. 1997), the plaintiff obtained a default judgment against the defendant in August, 1994 for $91,000.  299 N.J. Super. at 162.  Then, the defendant transferred assets to his sister, including his stock in a corporation.  Id.  On January 31, 1996, the trial court entered an order setting aside the transfer.  Id.  The defendant appealed.  Id. The defendant contended, inter alia, that the court could not cancel the transfer of his stock to a non-party, and that his sister should have been made a defendant in the action; and, that there was no intent to defraud shown.  Id.  Also, the defendant argued that there was consideration for the transfer based on past indebtedness to his sister.  Id.  The defendant claimed that he owed “some money” to his sister, “maybe $50,000,” but there was no promissory note.  Id. at 163.

The Appellate Division found the issues raised by the defendant to be clearly without merit.  Id.  The Appellate Division affirmed the trial court’s order setting aside the transfer of the corporate stock as modified.  Id. at 166.  The Appellate Division stated that “transfers made to close relatives are especially suspect.”  Id. at 165.

II.  STATUTE OF REPOSE, NOT STATUTE OF LIMITATIONS

In Intili v. DiGiorgio, 300 N.J. Super. 652 (Ch. Div. 1997), the issue was whether the plaintiff’s claims under the UFTA were time barred.  300 N.J. Super. at 654.

On May 14, 1990, the plaintiff filed a complaint in the Law Division against the defendants for money due on a note.  Id. at 655.  On July 16, 1990, final judgment by default was entered in the Law Division Action.  Id.  On November 19, 1991, one of the defendants conveyed his interest in real property in Paterson to a relative for no consideration.  Id.  On January 4, 1993, the Law Division vacated the default judgment.  Id.  On October 25, 1993, the plaintiff obtained final judgment on the merits against the defendants in the Law Division action.  Id.

On May 1, 1996, the plaintiff filed the Chancery Division action seeking to void the real property transfer.  Id.  The defendants moved to dismiss the plaintiff’s complaint as extinguished under N.J.S.A. 25:2-31.  Id.  The plaintiff urged the court to toll and apply equitable considerations to Sec. 31’s time limitations.  Id. at 656.  The plaintiff contended that the UFTA claim was not time barred, because the Legislature did not intend Sec. 31 to be a statute of repose.  Id.  The plaintiff asserted that the Legislature intended Sec. 31 to be a statute of limitations, which may be tolled for equitable reasons.  Id.

The Chancery Division held that the Legislature’s purpose would be frustrated if time limitations were relaxed.  Id. at 661.  Therefore, the defendants’ motion to dismiss the fraudulent transfer complaint as extinguished was granted.  Id.  The court reasoned that the transfer date was the date that the real property deed evidencing the sale was recorded.  Id., note 4.  The UFTA is a statute of repose, which extinguishes the right, not just a statute of limitations, which extinguishes the remedy, subject to equitable tolling.

III.  FRAUDULENT CONVEYANCE ACT, N.J.S.A. 25:2-1 TO 25:2-6

While the Uniform Fraudulent Conveyance Act, N.J.S.A. 25:2-7 to 25:2-19 (UFCA) was repealed, and replaced by the Uniform Fraudulent Transfer Act, N.J.S.A. 25:2-1 to 25:2-6 (FCA) was not repealed and is still effective.

In Gilchinsky v. Westminster Bank, 311 N.J. Super. 339 (App. Div. 1998), the issue was whether pension funds rolled over into an Individual Retirement Account (IRA) are exempt from levy under the Fraudulent Conveyance Act, N.J.S.A. 25:2-1 et seq. (FCA).

In Gilchinsky, the trial court found that a rollover to an IRA was a fraudulent conveyance.  311 N.J. Super. at 341.  The Appellate Division reversed.  Id.

In one of two cases consolidated by the Appellate Division in Gilchinsky, the plaintiff, the Rogers & Hammerstein Organization (R & H), was the employer of the defendant, Gilchinsky.  Id.  R & H deposited funds into Gilchinsky’s profit sharing plan.  Id.  Gilchinsky embezzled funds from R & H to support her gambling habit.  Id.  at 341-342.

On July 21, 1992, R & H sued Gilchinsky in New York to recover the stolen funds.  Id. at 342.  On January 12, 1993, the New York trial court entered an order restraining Gilchinsky from transferring any property.  Id.  In February 1993, the New York court entered summary judgment against Gilchinsky.  Id.  Meanwhile, Gilchinsky established an IRA at NatWest Bank.  Id.  In June 1994, Gilchinsky asked R & H to roll her pension funds in the profit sharing plan into her NatWest IRA.  Id.

On January 5, 1995, R & H filed a New Jersey Superior Court complaint on a foreign judgment to domesticate and enforce the New York judgment.  Id. at 343.  On January 10, 1995, a writ of attachment was issued.  Id.  On February 2, 1995, judgment was entered against Gilchinsky domesticating the New York judgment and directing turnover of the IRA funds levied upon in the IRA.  Id. at 344.  On April 28, 1995, Gilchinsky filed a complaint an Order to Show Cause seeking summary determination that the IRA was immune from levy.  Id.  On May 18, 1995, the trial court denied Gilchinsky’s application.  Id.

On June 7, 1996, the trial court dismissed Gilchinsky’s complaint based on the entire controversy doctrine, since she did not raise the issue in the earlier action filed by R & H to domesticate the foreign judgment.  Id.  Gilchinsky moved for reconsideration of the dismissal and moved in the R & H suit to vacate the judgment.  Id.  The trial court denied Gilchinsky’s motion for reconsideration but granted her motion to vacate the R & H judgment in order to determine whether the IRA was exempt from levy.  Id.  The trial court decided that the IRA was not exempt from levy.  Id. at 345.

On appeal, Gilchinsky contended that funds deposited in the profit sharing plan were exempt from creditors under ERISA while in the plan, so the funds should remain exempt after the transfer into the IRA.  Id.  Also, Gilchinsky argued that the funds transfer from the profit sharing plan into the IRA was not a fraudulent transfer, as argued by R & H.  Id.  The Appellate Division reversed and remanded for reinstatement of Gilchinsky’s IRA.  Id. at 350.  The Appellate Division found insufficient evidence in the record to find a fraudulent transfer.  Id. at 349.  The Appellate Division reasoned that “[t]he thrust behind a fraudulent transfer is that the  debtor conveys title to assets to a third person for the purpose of placing them beyond the reach of creditors.”  Id.  Here, the creditor, R & H, participated in the transfer by rolling over the profit sharing plan funds into Gilchinsky’s IRA.  Id. at 350.  Thus, the transfer was not designed to evade the creditor, R & H, so it was not fraudulent.

IV.  CORPORATE ASSET TRANSFER UNDER THE UNIFORM FRAUDULENT TRANSFER ACT, N.J.S.A. 25:2-20 ET SEQ.

In AYR Composition, Inc. v. Rosenberg, 261 N.J. Super. 495 (App. Div. 1993), the plaintiff appealed from a judgment in its favor limiting damages to commissions earned by the defendants on accounts transferred to a corporation.  261 N.J. Super. at 498.  The defendants cross-appealed from the judgment.  Id.

On November 22, 1989, the plaintiff had filed a complaint against a company known as R/M Inc. (R/M) for collection of sums due and owing on open invoices.  Id.  On January 24, 1990, the plaintiff obtained judgment against R/M.  Id.

On July 23, 1990, the plaintiff filed suit under the Uniform Fraudulent Transfer Act, N.J.S.A. 25:2-20 et seq.  (UFTA), against R/M’s principals, to void transfer of corporate assets belonging to R/M by its principals to a company named Cherenson Group, which had merged with R/M.  Id. at 499.  The principals of R/M took all its corporate assets with them when they went to work for the Cherenson Group.  Id.  The trial court granted summary judgment to the plaintiff, but limited damages to the amount of commissions earned by the defendants on the accounts that they took from the plaintiff.  Id.  The plaintiff appealed from the limitation on damages.  Id.

The Appellate Division affirmed in part, reversed in part and remanded to the trial court to determine the fair market value of the corporate account assets transferred by the defendants from R/M to the Cherenson group.  Id. at 508.

V.  CONSTRUCTIVE FRAUD UNDER THE UFTA, SECTION 27

In Boardwalk Regency Corp. v. Burd, 262 N.J. Super. 162 (App. Div. 1993), the defendants appealed from a bench trial judgment setting aside transfer of title to a single family home.  262 N.J. Super. at 163.  The Appellate Division affirmed.  Id. at 164.

In Boardwalk Regency Corp. v. Burd, the defendant suffered gambling losses of $1 million at the plaintiff’s casino on June 15, 1990.  Id.  The plaintiff sued for collection and obtained judgment. Id.

On February 28, 1990, one of the defendants, Mr. Burd, had executed a contract to purchase a single family home under construction.  Id.  On March 19, 1990, the sales contract was amended to name his wife, Mrs. Burd, as the sole purchaser.  Id.  The closing occurred on June 25, 1990.  Id.  Mrs. Burd did not contribute anything to the purchase price.  Id.

The trial court found that the transfer date was the date when the real property deed was recorded, June 27, 1990, rather than the February 28, 1990 or March 19, 1990 sale contract execution and amendment dates, respectively.  Id.  The trial court found the transfer to be constructively fraudulent, since the June 27, 1990 recordation date followed the June 15, 1990 date when the Mr. Burd became indebted to the casino.  Id.  Therefore, the trial court found the transfer to be constructively fraudulent, under N.J.S.A. 25:2-27.  Id.  The Appellate Division affirmed.  Id. at 165.  The Appellate Division found that the trial court applied the correct transfer date to find the transfer constructively fraudulent.  Id.  Since the transfer was made subsequent to Mr. Burd becoming indebted to the Boardwalk Regency Corp., the recordation of the deed into Mrs. Burd was constructively fraudulent.  Id.

VI.  BROKER’S COMMISSION

In Flood v. Caro Corp., 272 N.J. Super. 398 (App. Div. 1994), the plaintiff, a real estate broker, sued for a commission on sale of 25 condominium units by the defendant to Seton Hall University.  272 N.J. Super. at 400.  The plaintiff obtained judgment at a bench trial.  Id.  The defendant appealed.  Id.  The Appellate Division affirmed as to the entry of judgment for plaintiff for money damages.  Id.

At the trial level, the plaintiff had also applied for an order to levy upon assets transferred by the defendant.  Id.  The plaintiff had moved post-judgment to declare an assignment by Caro of a mortgage given by Seton Hall to Caro a fraudulent transfer.  Id. at 402.  The trial court had denied the plaintiff’s application to levy on the transferred assets.  Id.  The Appellate Division reversed in part regarding the levy upon the assets transferred.  Id. at 401.

VII.  TRANSFER TO A GOOD FAITH PURCHASER FOR VALUE

In Nat. Westminster v. Anders Engin., 289 N.J. Super. 602 (App. Div. 1996), one of the defendants, Evans-Knott (E-K), a general partnership, transferred real property to a corporation, codefendant Anders, while Evans was insolvent.  289 N.J. Super. at 604.  The consideration was debt forgiveness.  Id.  Then, Anders conveyed the real property to its principal shareholder, Chajkowsky, a codefendant, for $55,000.  Id.

The plaintiff, a creditor of E-K, obtained summary judgment against Anders and Chajkowsky under the UFTA.  Id.  Anders and Chajkowsky appealed.  Id. at 605.  The defendants contended that a transfer by an insolvent partnership to a third party in order to satisfy a debt of a partner is not a fraudulent transfer.  Id.

The Appellate Division affirmed the trial court’s holding that the transfer to Anders was fraudulent.  Id.  The Appellate Division reversed the trial court’s holding that the transfer from Anders to Chajkowsky was fraudulent, and remanded for a determination whether the shareholder was a good faith transferee for value.  Id.

The Appellate Division reasoned that the transfer from E-K to Anders was fraudulent because “[a] transfer made in satisfaction of the debt of another is not made for reasonably equivalent value.”  Id. at 605-606.  Thus, the transfer from E-K to Anders was constructively fraudulent.  Therefore, the Appellate Division affirmed in part, reversed in part and remanded.  Id. at 610.

VIII.  NOTICE TO PURCHASER/TRANSFEREE OF FRAUD

Notice of fraud may arise from a purchaser’s knowledge of circumstances that should have put him on inquiry.  Palestroni v. Jacobs, 18 N.J. Super. 438, 440 (App. Div. 1952) (interpreting N.J.S.A. 25:2-5).  The burden of proving fraud in a case of this nature rests upon the plaintiff.  Id.  Fraud will not be presumed, and circumstances that merely arouse suspicions will not support an inference of fraud.  Id.  Accord, O’Neill v. Little, 107 N.J. Super. 426, 432 (Ch. Div. 1969) (interpreting N.J.S.A. 25:2-3).

In order to set aside a conveyance to a third party as a fraud against creditors, the transferee must have participated in or have had knowledge of the transferor’s fraudulent purpose.  O’Neill v. Little, supra, at 433.  A transfer is not made in good faith if the transferee has knowledge of fraudulent intent of his grantor or if he is aware of circumstances which should have put him in inquiry and which were equivalent to notice of said fraudulent intent.  Id. at 434.

IX.  LIABILITY FOR THIRD PARTY PROFESSIONALS

The Supreme Court of New Jersey has not yet ruled as to whether third party professionals, such as lawyers and accountants, can be held liable for assisting a debtor with a fraudulent transfer.  However, basic principles of tort law that New Jersey adheres to clearly suggest that third party professionals can in fact be held liable for their clients fraudulent transfers as aiders and abettors.

This is a very common problem for many practitioners.  A client walks in the door and explains that his business is doing poorly because of excessive debt, and so he wants to create a new corporation that will continue to operate the same basic business.  Or, a client walks in and tells the practitioner that he is a defendant in a products liability lawsuit where the plaintiff died or suffered serious injury, and there is no product liability insurance to protect the client.  That client may also want his professional to create a new corporation out of which he can continue to operate the same business.  An individual client may ask a lawyer to help him deed his property to his wife because of a lawsuit he is facing.  In all of these scenarios, the lawyer or accountant assisting these clients could be held liable for aiding and abetting a fraudulent transfer.

New Jersey courts have recognized the Restatement of Torts’ definition of aiding and abetting.  See, e.g., Hurley v. Atlantic City Police Dept., 1999 WL 150301 (3rd Cir. 1999).  According to Section 876(b) of the Restatement of Torts, the tort of aiding and abetting consists of the following:

(1) the party whom the defendant aids must perform a wrongful act that causes an injury;

(2) the defendant must be generally aware of his role as part of an overall illegal or tortuous activity at the time that he provides the assistance; and

(3) the defendant must knowingly and substantially assist the principal violation.

Under the Restatement of Torts, an attorney or accountant can be held liable as an aider and abettor to their client’s fraudulent transfer.  A creditor victim of a fraudulent transfer can satisfy the first element by demonstrating that the debtor client’s transfer was fraudulent and deprived the creditor with a source of recovery.  The creditor victim can easily establish the second element by showing that an attorney or accountant should know better and understand that his client was seeking to use the professional as a tool to further the fraudulent transfer scheme.  Lastly, the creditor victim can establish the third element by demonstrating that the attorney or accountant was aware of the reasons that the client wanted to effect the transfer in issue, and that at least in the client’s eyes, the transfer could not have been consummated without the assistance of the lawyer or accountant.

When prosecuting cases against lawyers for helping their clients with fraudulent transfers, the courts will not allow the attorney to hide behind the attorney-client privilege.  Specifically, the attorney-client privilege set forth in RPC 1.6 does not apply in such circumstances.  RPC 4.1 states:

(a) In representing a client a lawyer shall not knowingly:

(1) make a false statement of material fact or law to a third person; or

(2) fail to disclose a material fact to a third person when disclosure is necessary to avoid assisting a criminal or fraudulent act by a client.

(b) The duties stated in the Rule apply even if compliance requires disclosure of information otherwise protected by PRC 1.6.