United States District Court, E.D. New York
[Copyrighted Material Omitted]
For Appellant: Christine Tara Quigley, Law Office of Christine T. Quigley, PC, Hicksville, NY.
For Appellee: David A. Blansky, LaMonica Herbst & Maniscalco LLP, Wantagh, NY.
MEMORANDUM AND ORDER
JOSEPH F. BIANCO, United States District Judge.
This bankruptcy appeal arises out of the involuntary bankruptcy proceedings of debtors Janitorial Close-Out City Corp. (" Janitorial" ), Eager Beaver Realty, LLC (" Eager Beaver" ), All Clean Supplies, LLC (" All Clean LLC" ), Sax and Sounds Productions, LLC (" Sax and Sounds" ), Ultimate Sax & Sounds Entertainment Corp. (" Ultimate Sax" ), All-Clean Janitorial Supply, LLC (" All-Clean Janitorial" ), and All Clean Supplies Corp. (" All Clean Corp." ) (collectively, " debtors" ) in the United States Bankruptcy Court for the Eastern District of New York (the " Bankruptcy Court" ). On April 28, 2011, R. Kenneth Barnard (the " Trustee" or " Appellee" ), as trustee of debtors, commenced an adversary proceeding against Linda Schneider (" Schneider" or " Appellant" ) to recover certain funds transferred by debtors to Schneider. The Trustee alleged that Schneider's daughter, Laurie Schneider (" Laurie" ), had operated debtors as a Ponzi scheme and had transferred the funds at issue to Schneider in furtherance of that Ponzi scheme. Following a one-day trial, the Bankruptcy Court concluded that the Trustee was entitled to avoid a total of $185,612.00 in transfers from debtors to Schneider pursuant to the fraudulent conveyance laws of the Bankruptcy Code and the New York Debtor and Creditor Law (" DCL" ). Specifically, the Bankruptcy Court held that (1) the transfers at issue were actually fraudulent because they were made on or after January 1, 2007, while Laurie was operating debtors as a Ponzi scheme, (2) in the alternative, these transfers were constructively fraudulent, and (3) Schneider was not entitled to the transferee's affirmative defense of good faith.
On appeal, Schneider contends that the following factual findings and legal conclusions of the Bankruptcy Court constitute reversible error: (1) the Ponzi scheme presumption, according to which transfers made by a Ponzi entity are presumed to have been made with actual fraudulent intent under the Bankruptcy Code and DCL, applied to the transfers at issue here because (a) Laurie began operating a Ponzi scheme on January 1, 2007; and (b) the transfers were made in furtherance of that Ponzi scheme; (2) DCL § 276, New York's actual fraudulent conveyance statute, does not require proof of a transferee's fraudulent intent; and (3) the transfers at issue were constructively fraudulent, and Schneider was not entitled to the affirmative defense of good faith, because she had not provided fair consideration for the transfers at issue. For the following reasons, this Court determines that none of Schneider's arguments have merit, and affirms the judgment of the Bankruptcy Court. First, based on the evidence in the record--in particular, evidence concerning debtors' finances--the Court cannot conclude that the Bankruptcy Court committed clear error in finding that Laurie began operating a Ponzi scheme on January 1, 2007. Moreover, because the transfers at issue enabled Laurie to extract value from the Ponzi entities and maintain the Ponzi scheme, debtors made the transfers at issue in furtherance of a Ponzi scheme.
Accordingly, the Bankruptcy Court properly applied the Ponzi scheme presumption to all transfers made by debtors to Schneider on or after January 1, 2007. Second, employing normal principles of statutory construction, the Court concludes that DCL § 276 does not require proof of the transferee's fraudulent intent. Thus, the Bankruptcy Court properly held the transfers at issue were avoidable under DCL § 276. Third, the Court affirms the Bankruptcy Court's finding that Schneider failed to provide fair consideration to debtors in exchange for the transfers at issue. Specifically, although debtors apparently transferred $158,612.00 to Schneider in exchange for Schneider's provision of housing to Laurie and her husband, debtors themselves did not receive any benefit from the exchange. Moreover, the Bankruptcy Court did not commit clear error in finding that Schneider provided nothing to debtors in exchange for the other $27,000.00 transferred to her. On this basis, all transfers at issue were constructively fraudulent, and Schneider could not establish the affirmative defense of good faith.
The following facts are drawn from the Bankruptcy Court's findings of fact in its June 24, 2013 order (" Bankr. Ct. Op." ), as well as other facts that were admitted in evidence at the trial and are in the appellate record.
Debtors' businesses fall generally into three categories. First, Ultimate Sax provided music and entertainment services for corporate and private clients. (Bankr. Ct. Op. at 3.) Laurie formed Ultimate Sax as a New York corporation in 2002. ( Id.) Sometime in 2005, Sax and Sounds began operating as a successor entity to Ultimate Sax. ( Id.) Second, All Clean Corp., All-Clean Janitorial, and Janitorial all purported to sell janitorial supplies at the wholesale level. ( Id. at 3-4.) In addition to the wholesale of janitorial supplies, Janitorial's stated purpose was to purchase industrial equipment and machinery from China for resale in the United States. ( Id. at 4.) Laurie formed these three companies between 2002 and 2006. ( Id. at 3-4.) In addition, in August 2008, Laurie told an investor that All Clean LLC was a New York limited liability company; however, it is unclear whether All Clean LLC ever existed as a separate entity from Laurie's other janitorial supply companies. ( Id. at 4.) Third, Eager Beaver, which Laurie formed in or around May 2006, had the stated purpose of purchasing and selling foreclosed residential properties. ( Id. at 3-4.)
Laurie was a principal and officer of each debtor. ( Id. at 4.) Her husband, Christopher Laybourne (" Laybourne" ), who is a musician, was employed by one or more debtors. ( Id. at 2-3.) Tax records also indicate that Laybourne owned 100% of Sax and Sounds from 2004 to 2006. (R-2, Aff. of Esther DuVal, Jan. 31, 2013 (" DuVal Aff." ) ¶ 9.) Debtors paid salaries to Laurie and Laybourne, which debtors recorded as compensation in their financial records. (Bankr. Ct. Op. at 3.)
2. The Ponzi Scheme
Between 2003 and 2006, Laurie sought investments to finance debtors' purchases of (1) janitorial supplies, (2) industrial equipment and machinery from China, (3) and foreclosure properties in Nassau and
Suffolk Counties in New York. ( Id. at 4.) Beginning in 2006, Laurie entered into written agreements with investors, pursuant to which investors were guaranteed rates of return ranging from 36% to 200%. ( Id. at 4-5.) The first investor agreement was executed on June 6, 2006; that investor was repaid in full, with interest, on December 6, 2006. ( Id. at 5.) The next investor agreement was executed on January 1, 2007. ( Id.) Thereafter, from January 2007 to January 2009, Laurie entered into almost two hundred additional investment agreements on behalf of various debtors. ( Id.) In total, the written investment agreements represented $37.2 million in investments and promised $9.8 million in guaranteed profits (a 26.2% average return on investment). ( Id.)
According to an analysis of debtors' financial records performed by Certified Public Accountant Esther DuVal (" DuVal" )--analysis upon which the Bankruptcy Court relied ( see id. at 6)--debtors disbursed almost all cash received from 2007 to 2009, their " obligations to existing investors exceeded the cash balance at all points in time, on a monthly basis from 2007 through 2009," and " both the deficit and the obligations due grew steadily over time" (DuVal Aff. ¶ ¶ 40-41). In other words, from 2007 to 2009, debtors continued to solicit new investments but " did not maintain sufficient cash to meet the minimum investment principal obligations reflected in the investors agreements," let alone the guaranteed profits. ( Id. ¶ 65.) Consequently, DuVal determined that debtors " had no way of meeting the investor obligations without using money raised from new investors to pay out older investors." ( Id. ¶ 70.) Based on her financial analysis, DuVal opined, and the Bankruptcy Court concluded, that Laurie operated debtors as a Ponzi scheme designed to defraud investors. ( Id. ¶ ¶ 5, 78; Bankr. Ct. Op. at 6.).
3. Debtors' Transfers to Schneider
a. The 2003 Loan and 2004 Transfer
In 2003, Schneider transferred between $50,000 and $60,000 to Laurie, so that Laurie could finance her businesses (the " 2003 Loan" ). (Bankr. Ct. Op. at 6.) When Schneider learned that Laurie was receiving funds from outside investors, she demanded repayment of the 2003 Loan. ( Id. at 6-7.) On April 21, 2004, All Clean Corp. transferred $35,000 to Schneider, apparently as repayment for the 2003 Loan from Schneider to Laurie (the " 2004 Transfer" ). ( Id. at 7.)
b. The Rent Transfers
In 2005, Schneider purchased a single-family home in Oceanside, New York (the " Oceanside Property" ) as an investment property for $705,000. ( Id.) She financed the purchase with her inheritance from her grandfather's estate and two loans: one secured by a mortgage on the Oceanside Property, and the other secured by a junior mortgage on Schneider's primary residence. ( Id.) Schneider testified that she intended for Laurie and Laybourne to live in the Oceanside Property, and that she purchased the Oceanside Property in part because it had room for a sound studio for Laybourne. ( Id.)
Laurie and Laybourne moved into the Oceanside Property in March 2005 and lived there until October 2012. ( Id.) No written lease was ever executed. ( Id.) In fact, neither Laurie nor Laybourne ever paid rent. ( Id.) Instead, between March 2005 and January 2009, debtors Sax and Sounds, All Clean Corp., All Clean Janitorial,
Eager Beaver, and Janitorial made a total of twenty-seven transfers to Schneider totaling $192,091.58 (the " Rent Transfers" ). ( Id.) Schneider testified at trial that the Rent Transfers represented the rent for the Oceanside Property, and she reported the Rent Transfers on her tax returns for the years 2004 to 2009. ( Id.) In addition, the parties agreed at trial that the Rent Transfers represented the approximate fair market rental value of the Oceanside Property. ( Id. at 9.)
According to her trial testimony, Schneider believed that debtors made the Rent Transfers so that Laurie and Laybourne could live in the Oceanside Property, and that debtors intended the Rent Transfers to be part of Laurie's and Laybourne's compensation. ( Id.) However, neither Laurie nor Laybourne reported the Rent Transfers as income on their joint tax returns for the years 2005 to 2007. ( Id. at 8.) Moreover, debtors did not record all Rent Transfers in their financial records, and those that ...