Bankruptcy Litigation Committee

ABI Committee News

Practice Tip: Using Summary Judgment to Establish a Fraudulent Conveyance

A widely held assumption in bankruptcy cases and other litigation is that fraudulent intent cannot be established on a summary judgment motion but may only be found after a full trial on the merits. Judges in fraudulent conveyance cases are not accustomed to deciding intent, solvency or constructive fraudulent conveyances on summary judgment evidence and may simply assume that if a case is not settled, it will be tried. However, some recent – and some not-so-recent – cases demonstrate that, given the right underlying facts, you should give some serious thought to bringing a summary judgment motion in a fraudulent conveyance case.

There are two ways that a trustee or debtor-in-possession (DIP) can recover a fraudulent transfer pursuant to §548 of the Bankruptcy Code or corresponding state law. The trustee or DIP can try to establish actual fraud by proving that the debtor made a transfer or incurred an obligation with the “actual intent to hinder, delay, or defraud” creditors. Alternatively, the trustee or DIP can try to establish constructive fraud by proving that the debtor received less than a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent on the date of the transfer. This article will discuss how a trustee or DIP may be able to use the summary judgment vehicle to establish actual intent or a constructive fraudulent conveyance on summary judgment.

Proving Actual Intent

At first glance, establishing actual intent appears to be a fact-intensive exercise because the only way to prove intent, absent an admission, is through circumstantial evidence. However, the practitioner should keep in mind that in certain types of cases or where the facts so overwhelmingly indicate fraudulent intent on the part of the transferor, the “actual intent” element can be established as a matter of law.

For example, in a recent opinion in the case of Gredd v. Bear, Stearns Securities Corp. (In re Manhattan Investment Fund Ltd.), 2007 WL 60843 (Bankr. S.D.N.Y. Jan. 9, 2007), U.S. Bankruptcy Judge Burton R. Lifland held that “Actual intent to hinder, delay or defraud may be established as a matter of law in cases in which the debtor runs a Ponzi scheme or a similar illegitimate enterprise...” Id. at *5. In the Gredd case, the chapter 11 trustee moved for summary judgment under Rule 7056 of the Federal Rules of Bankruptcy Procedure to avoid $141.4 million in margin payments as an actual fraudulent conveyance pursuant to 11 U.S.C. §548(a)(1)(A), which requires intent as an element of proof.
The defendant argued that the motion had to be denied because intent to defraud could not be proven by summary judgment. The court cited an earlier decision in the case that, “This adversary proceeding is an outgrowth of a massive Ponzi scheme...” and referred to the same decision later in its opinion to explain that, “…[w]hen a debtor operating a Ponzi scheme makes a payment with the knowledge that future creditors will not be paid, that payment is presumed to have been made with actual intent to hinder, delay or defraud other creditors – regardless of whether payments were made to early investors, or whether the debtor was engaged in a strictly classic Ponzi scheme.” Id. at *1, *5 (citing Gredd v. Bear Stearns Securities Corp. (In re Manhattan Investment Fund Ltd.), 310 B.R. 500, 502, 509 (Bankr. S.D.N.Y. 2002)) (emphasis added). The court granted summary judgment for the trustee after finding sufficient evidence of actual fraudulent intent in connection with the transfers. Id. at *14.

Although the Gredd decision was predicated on §548 of the Bankruptcy Code, a similar result has been reached under the Uniform Fraudulent Conveyance Act. In The Cadle Company v. Newhouse, 74 Fed. Appx. 1152 (2d. Cir. 2003), the Second Circuit upheld summary judgment under §276 of New York’s version of the Uniform Fraudulent Conveyance Act which provides that “Every conveyance made and every obligation incurred with actual intent . . . to hinder, delay, or defraud either present or future creditors, is fraudulent as to both present and future creditors.” N.Y. Debt. & Cred. §276 (McKinney 2001)

The court first explained that “…[a]lthough ‘actual intent’ to defraud is rarely sufficiently proven to warrant summary judgment, in this case no genuine issue of fact exists as to whether the conveyance was made with ‘actual intent’ to ‘hinder, delay, or defraud’ creditors within the meaning of §276.” The Cadle Co., 74 Fed. Appx. at 153. The court explained that §276 identifies five circumstantial indicators of ‘actual intent’ to defraud, termed ‘badges of fraud,’ all of which existed in the case. The court found that “[f]irst, no consideration was offered by the defendant for the transfer of funds, and the funds came from his mother, a close relative who was indisputably insolvent.” Id. The court continued, explaining that this was a highly unusual case “…involving a one-day trip from New York to Chicago and a wire transfer to a newly created bank account in the defendant’s name. Finally, Mrs. Newhouse retained control over the funds after conveying them to her son by means of a power of attorney to withdraw funds from the bank account.” Id.

In granting summary judgment, the court concluded “…[g]iven these strong indicators of fraudulent intent, the district court correctly concluded that a reasonable jury could only find that this conveyance was made with ‘actual intent’ to ‘hinder, delay or defraud’ creditors for the purposes of §276.” Id.

Proving Receipt of Less Reasonably Equivalent Value and Insolvency

Summary judgment has also been granted where a trustee has sought to establish a fraudulent conveyance by establishing a constructive fraud theory that the debtor received less than a reasonably equivalent value in exchange for the transfer and was insolvent at the time of the transfer.

In the case of Hirsch v. Gersten (In re Centennial Textiles, Inc.), 220 B.R. 165 (Bankr. S.D.N.Y. 1998), Judge Lifland granted summary judgment to a chapter 7 bankruptcy trustee after finding that there were no genuine issues of material fact regarding fair consideration or insolvency under New York’s version of the Uniform Fraudulent Conveyance Act.

In Hirsch v. Gersten, the chapter 7 trustee sought to avoid certain life insurance policies and certain post-conveyance insurance premium payments on those policies paid by the debtor. Id. at 168. The trustee moved for summary judgment, arguing that, at the time of the transfers, the company was insolvent and that the debtor received no consideration for these transfers. Id. The defendant argued that he received the insurance policies as partial compensation to him for his personal pledges, contributions and assumption of liabilities that benefited the debtor and its creditors. Id.at 169. The defendant also argued that the court could not determine insolvency by summary judgment. Id.

First, Judge Lifland found that, “…under New York law, transfers from an insolvent corporation to an officer, director or major shareholder of that corporation are per se violative of the good faith requirement of [N.Y. Debt. & Cred. Law § 272 (McKinney 1990)] and the fact that the transfer may have been made for a fair equivalent is irrelevant.” Id. at 172 (emphasis added). Judge Lifland next found, based upon the affidavit of an accountant, that the debtor was insolvent at the time of the transfers. The court granted summary judgment to the trustee based on (i) a finding of insolvency and (ii) a statutory presumption in law that fair consideration was not given in exchange for the transfer because it was to an officer while the company was insolvent. Id.at 177.

Conclusion

Summary judgment is a powerful tool that a practitioner should not assume to be unavailable in fraudulent conveyance litigation. In many cases bringing summary judgment will help the estate reach a settlement and in other cases it may eliminate the need for a costly trial. In formulating the claims that an estate may have against a transferee, counsel should be cognizant of state statutes and common law that may create presumptions upon which a summary judgment motion may be based. In preparing Rule 2004 discovery and taking post-complaint discovery, counsel should try to obtain factual admissions, which can be used to prove constructive fraud in a summary judgment motion. Finally, counsel should not shy away from trying to prove intent or insolvency through a summary judgment motion. In the right circumstances, judges are receptive to the establishment of the existence of fraudulent conveyances through summary judgment.