Newsletter of Law offices of Solomon J Jaskiel

1. The L aw Offices of Solomon J. Jaskiel, esq.
Litigation on Point December 2011
A Powerful Weapon
PREFERENTIAL TRANSFERS
AS FRAUDULENT CONVEYANCES
The Problem
Creditors suspect that the debtor has paid other creditors
close to him– instead of paying the creditor. Such payment
are called preferential transfers. Preferential transfers
are typically recoverable only in bankruptcy. Under a
relatively unknown line of cases, a creditor may be able
to recover payments made to an insider.
The law of fraudulent conveyances is a powerful tool for
collecting debts from unscrupulous debtors. In the classic case, the
debtor has put his or her assets out of a creditor’s reach by giving
them to someone else. The law allows a creditor to retrieve those
assets. The hallmark of a fraudulent conveyance is the transfer of the
asset without adequate consideration in return.
If a debtor prefers one creditor over another, the transfer
would not seem to be fraudulent. “[A]n insolvent debtor has the
right to sell and transfer the whole or any portion of
his property to one or more of his creditors in pay-
ment of or to secure his debts, when that is his hon-
q
Preferential
est purpose, although the effect of the sale or trans-
transfers
fer is to place his property beyond the reach of his
are not only
other creditors and render their debts uncollectible”
recoverable
Micalden Invs. S.A. v Guerrand-Hermes, 30 A.D.3d
in bankruptcy
341, 342-3, 819 N.Y.S.2d 228 (1st Dep’t 2006).
cases.
Since he is paying a debt, the debtor received fair
consideration. The consideration is the satisfaction q
of the loan.
Only if the debtor subsequently files for or is forced into
bankruptcy, can the trustee recover the payment for the benefit of
all creditors, using the federal law of preferential transfers. Debtors
are often forced into bankruptcy for the sole purpose of recovering
preferential transfers.
Under the relatively unknown line of cases, a creditor can,
One in a series of articles using the state fraudulent conveyance law, recover preferential trans-
designed to highlight fers made to certain persons, even if the debtor is not in bankruptcy.
useful litigation tactics
3025 Quentin Road, Brooklyn, NY 11234 tel: 347.462.2295 fax: 212.202.4009 email: soljas@gmail.com

2. Unlike bankruptcy, the creditor can recover the trans- gives that person an unconscionable advantage over the
fers for his own benefit, and does not need to share it other creditors. Either the individual is violating his or
with all creditors. her duty to act as a trustee of the assets of the corpora-
tion for the benefit of creditors or he or she is using the
The seminal case in New York is Southern
access to inside information and his or her control of
Industries, Inc. v. Jeremias, 66 A.D.2d 1978 (2d Dep’t
the corporation to benefit himself over other creditors.
1978). Jeremias was an officer, director and major
Either way, a payment to an insider is not made in good
stockholder of Mazel Knitting Mills, Inc. (the “cor-
faith and can be recovered by the creditor. Also see
poration”). Over the years, Jeremias had legitimately
Farm Stores, Inc. v School Feeding Corp., 102 A.D.2d
loaned the corporation over $200,000. At the same
249 (2d Dep’t 1984), aff’d, 64 N.Y.2d 1065 (1985).
time, Southern Industries, a trade creditor of the corpo-
American Panel Tec v Hyrise, Inc., 31 AD3d 586, 588
ration, was owed over $30,000.
(2d Dep’t 2006)(citing cases).
Soon after, the corporation ceased doing
The filing of a judgment of confession consti-
business, the board of directors decided to transfer its
tutes a transfer of a debtor’s property. The judgment
remaining assets, worth approximately $60,000, to
creditor obtains a lien on the
Jeremias in partial payment of the debt owed to him.
debtor’s property. Under the
Southern Industries, around that time, obtained a judg- q
doctrine of Southern Industries,
ment against the corporation. It then began an action Payment made
even if the judgment creditor is
seeking to recover the payment made to Jeremias, argu-
legitimately owed the money, to insiders
ing that the transfer was a fraudulent conveyance.
the confession of judgment may are not made
Article 10 of the New York Debtor and Credi- be avoided if the judgment credi- in good faith.
tor Law (“DC&L”) defines to two types of fraudulent tor is an insider of the judgment
conveyances: (a) those made with an actual intent to debtor. Posner v. Posner 1976 q
hinder, delay or defraud creditors (DC&L § 276) and (b) Irrevocable Family Trust, 12
those that are constructively fraudulent (DC&L §§ 273 A.D. 3d 177, 784 N.Y.S.2d 509 (1st Dept. 2004) (Court
et seq.). The Court held that the transfer, by the corpora- avoided confession of judgment given to trust con-
tion to Jeremias, was constructively fraudulent. trolled by debtor).
A transfer will be deemed constructively It remains to be seen how far courts will go in
fraudulent if it is made at a time when a debtor is unable extending Southern Industries’ doctrine.
to pay his or her debts or is insolvent and is not made in
In most small corporate businesses, the prin-
exchange for “fair consideration.” One of the elements
cipal shareholders have contributed their own funds to
of “fair consideration” is that the transfer must be made
either start up the business or to help it grow or survive.
“in good faith.” DC&L § 272(a).
If the funds are deemed capital contributions, creditors
The Court defined “good faith” broadly: the must be paid before the funds may be returned to the
transfer must be made (a) with a true belief in the pro- shareholders. If the funds were contributed as a loan,
priety of the transfer, (b) without the intent to take im- the shareholder may think that he can “pay himself
moral advantage of others, and (c) without the intent back” before other creditors. The doctrine of Southern
to hinder, delay or defraud others. Essentially, “good Industries mandates that creditors recover these funds
faith” means that the parties to the transfer must be from the principal.
dealing honestly, fairly and openly.
The first step in applying this doctrine is to ob-
The Court maintained that a transfer by a tain information. Creditors should act quickly after ob-
corporation to a person who is an officer, director and taining a judgment to subpoena bank records, the most
major shareholder (otherwise known as an “insider”) expedient way of ascertaining the movement of assets. n
S ol o m on J . J a sk i el , e s q .
Commercial and Estate Litigation n Creditors’ Rights