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HBE LEASING CORP. v. FRANK

November 2, 1993

HBE LEASING CORPORATION, SIGNAL CAPITAL CORPORATION, REYNA LEASING CORPORATION, REYNA FINANCIAL CORPORATION, and JOHN HANCOCK LEASING CORPORATION, Plaintiffs,
v.
HIRAM H. FRANK, HIRAM J. FRANK, HENRY J. SANDLAS III, HENRY J. SANDLAS IV, BRUCE HUGGINS, KELBY KUNEY, GARY BOWERS, H.H.F. FARMS, INC., H.H. FRANK ENTERPRISES, INC., SPRINGBROOK GRAIN COMPANY, INC., GOLDEN EGGS FARMS, INC., ROBERT AMES and H.H. FRANK ENTERPRISES, INC. PENSION PLAN, Defendants. HBE LEASING CORPORATION, SIGNAL CAPITAL CORP., JOHN HANCOCK LEASING CORPORATION, Petitioners, v. CLEMENCE FRANK, H.H. FRANK ENTERPRISES, INC., HIRAM J. FRANK, HIRAM H. FRANK, GERALD LEFCOURT, JAY GOLDBERG, MICHAEL BERGER, JUDD BURSTEIN, GOLDSTEIN & STOLOFF, RICHARD WARE LEVITT and CLIFF GORDON, Respondents.


GOETTEL


The opinion of the court was delivered by: GERARD G. GOETTEL

GOETTEL, D.J.:

 In proceedings supplementary to judgment, the plaintiffs/petitioners *fn1" move by order to show cause to declare fraudulent and void certain mortgages given by judgment debtor H.H. Frank Enterprises, Inc. to Clemence Frank and to declare fraudulent and to recover payments made to seven attorneys by H.H. Frank Enterprises, Inc. in the earlier action. With respect to these motions, with a single exception, *fn2" the facts are either not in dispute or are, for purposes of the motion, conceded.

 The facts giving rise to the present application may be summarized as follows. The plaintiffs in the earlier action are leasing companies. Over a period of years, they paid certain of the defendants many millions of dollars for equipment, purportedly leased to egg farms which ultimately bankrupted. When the plaintiffs attempted to recover their new and expensive leased equipment, they found nothing but old worn-out chicken farming equipment. They thereafter sued the defendants, all of whom were family members or associates of Hiram H. Frank, the founder and, through most of the years in question, the leader of the Frank family businesses. By the time this suit had been commenced in 1988, the Franks were out of the egg farming business. Their family controlled corporation, H.H. Frank Enterprises, Inc., looked after their assets which included substantial real property in Sullivan County.

 In March 1988, the plaintiffs sued the various defendants under the Racketeer Influenced and Corrupt organization Act ("RICO"), 18 U.S.C. § 1962(c) and (d) and for common law fraud. In November 1992, following a three month jury trial, the jury entered a verdict against nine of the defendants including the first five named defendants and H.H. Frank Enterprises, Inc. (hereinafter referred to simply as "Enterprises"), for almost $ 20 million dollars with substantial interest, and punitive damages of almost $ 5 million dollars. The verdicts are on appeal, but no supersedeas bond has been posted. Virtually nothing has been collected on the judgments. The plaintiffs/judgment creditors proceed here pursuant to New York's C.P.L.R. § 5225(b) and Fed. R. Civ. P. 69(a).

 Respondent Hiram J. Frank is the son of Hiram H. Frank. During the time this case was in litigation, he purported to be the most affluent member of the Frank family. *fn3" During the period of litigation, he purportedly loaned $ 1.7 million dollars to Enterprises. Enterprises, in turn, paid for the personal needs of the members of the Frank family including medical and accounting expenses (as well as other more frivolous things) and, most pertinent to this application, the legal fees of the Franks and all of the other defendants in the action. Each individual defendant had a separate attorney (who, in some instances, also represented a corporation owned by that individual), and more than three-quarters of a million dollars in the fees of other parties was paid by Enterprises. In addition, another three-quarters of a million dollars was paid by the H.H. Frank Enterprises Pension Plan. However, the Pension Plan is not a judgment creditor in this case, and no relief is directly sought from it at this time. There is, also, a separate action pending before Judge Brieant entitled HBE Leasing Corporation, et al. v. Hiram J. Frank, et al., 93 Civ. 1597, which attacks other interfamily transfers purportedly made by Hiram J. Frank in fraud of creditors. (These involve more than $ 2 million dollars.)

 The Claim Against Clemence Frank

 While respondent Clemence Frank was not a defendant in the earlier action, she is the wife of Hiram H. Frank and the mother of Hiram J. Frank. She was also the next door neighbor and friend of defendant Henry J. Sandlas III and his wife. She and her husband have resided for many years on what is for Sullivan County a rather lavish estate. However, title to the estate is in Enterprises. For many years, she was a Director of Enterprises. As such, it is claimed that she accumulated substantial independent wealth. In 1992, shortly before this case went to trial, her son, Hiram J. Frank, needed money to settle a government tax suit involving some properties not defendants in this action. *fn4" Instead of loaning her son money from her independent wealth, Clemence Frank purportedly loaned $ 350,000 to Enterprises which then gave her a $ 250,000 mortgage on the estate which she and her husband occupied. Enterprises then purportedly paid the money to Hiram J. Frank as a partial repayment of the $ 1.7 million dollars which he categorized as loans to Enterprises (which had been used to pay the joint legal fees, as well as other expenses of the Franks and their associates). Hiram J. Frank used this money to settle the government's suit. A couple of months later, Enterprises gave Clemence Frank a mortgage for $ 100,000 on other related properties near the Franks' home. *fn5" When the judgment creditors took steps to have a Receiver appointed for these properties in order to collect on their verdict, Clemence Frank went to State Court and had a Receiver appointed first, purportedly to protect her mortgage interests. This move has blocked the attempts of the judgment creditors to sell the Frank's estate, resulting in the instant application.

  Clemence Frank argues that the $ 350,000 that she gave to Enterprises was her own money and that it is not subject to the lien of judgment creditors. For purposes of this motion, the plaintiffs will assume that she had her own separate assets. She further argues that she did not know where the money would go after it went into Enterprises, whose shareholders were her children. *fn6" The court finds this claim to be incredible, but our disbelief is not critical to the decision of this aspect of the motion. Her son, Hiram J. Frank, who benefited from the transfer, argues initially that the transactions are related to those in the new action brought against him pending before Judge Brieant and that this entire proceeding should be referred to Judge Brieant. *fn7" While we do not doubt that most of the Frank family's finances and transactions have an inter-relation, the ones challenged in this proceeding are not a part of the complaint before Judge Brieant. Consequently, we deny that application.

 A threshhold argument made in opposition to the application directed against Clemence Frank is that a proceeding supplementary to judgment should not be used to cancel a mortgage even if the mortgage was fraudulently obtained. However, the petitioners alternatively seek a money judgment for that amount. The net effect of this approach is the same. If a money judgment is granted for the $ 350,000, it satisfies the mortgages.

 The respondents in this proceeding have not disputed the fact that Enterprises, from the time this case was commenced to the present time, existed solely as a conduit for Frank family personal assets and that many of the payments it made benefited the Frank family personally. Indeed, even before the return of the $ 25 million dollar judgment the potential and thereafter judgment debtors had been busy transferring family assets to members of the family who were not defendants in the suit. For that matter, Clemence Frank was also a Trustee of the Pension Plan, as well as a Director of Enterprises, and must have been aware that those two organizations paid out a million and a half dollars in funds for the defense of other defendants.

 Clemence Frank's counsel concedes that a stockholder's loans to his own company will be treated as a capital contribution under the equities when a company is deemed undercapitalized Pepper v. Litton, 308 U.S. 295, 84 L. Ed. 281, 60 S. Ct. 238 (1939); Taylor v. Standard Gas & Elec. Co., 306 U.S. 307, 83 L. Ed. 669, 59 S. Ct. 543 (1939); Re Multiponics, Inc., 622 F.2d 709 (5th Cir. 1980). (This is known as the "Deep Rock Doctrine.") Although Enterprises had a couple of million dollars in assets during the pertinent period, it was confronted with a claim in litigation which ultimately resulted in a judgment for more than ten times its total assets. Were it not for his personal involvement in both sides of the situation (as the owner of Enterprises and as a personal defendant in the various litigations), Hiram J. Frank would not have loaned almost $ 2 million dollars to Enterprises. Clemence Frank concedes that Hiram J. Frank could not legally have lent money to Enterprises which was then used for his own purposes, but argues that her innocent knowledge of the transactions sterilizes them, giving her valid mortgages with which to protect her homestead.

 Under New York's Debtor and Creditor Law, § 273(a), creditors have two separate approaches to avoid transfers. Under the first, they may void any transfer made without fair consideration regardless of the intent of the parties. Under the second approach, even if there was fair consideration, the party in question must prove that the consideration was taken in good faith. Clemence Frank was both an intimate family member of the judgment debtors, and an insider of the corporate debtor Enterprises. Indeed, she claimed her independent wealth came from her relationship to it. She argues, however, that she severed her connection and directorship with Enterprises in 1990 and, therefore, should no longer be treated as an insider. *fn8"

 We are not impressed with this argument. Her advances to Enterprises must also be treated as capital, and the mortgages obtained as being equitably subordinated to the judgment creditors' claims even had the funds been used for legitimate corporate purchases rather than to bail her son out of a potentially large government obligation. This conclusion is supported by the "Deep Rock Doctrine" described above. In the spring of 1992, as the trial of this action was finally about to commence, Enterprises faced a possible judgment ten times its assets and was, therefore, seriously undercapitalized. No outside source would have conceivably lent it money. The funds advanced, therefore, were capital contributions and not loans. The mortgages received were a charade designed to protect the elder ...


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