Scott E. Mollen

Fraudulent Conveyances—Court Denies Wife's Motion To Dismiss Claims Against Her Arising From Husband's Alleged Fraudulent Conveyances Intended To Avoid Tax Liabilities—Beneficiary's Liability is Direct and it is Unnecessary To Consider Traditional Prerequisites for Veil—Piercing

The United States (government) commenced an action seeking several forms of relief related to "unpaid tax liabilities." A defendant wife moved to dismiss all claims asserted against her, pursuant Federal Rule of Civil Procedure 12(b)(6). The court denied the motion.

The wife's husband was a diamond merchant and real estate developer. He became sick in 2006 and died in 2008. His son and daughter (children) were the executors of his estate. They are also trustees of a trust. The children, wife and others were also defendants in the action. Prior to his death, the husband knew that he was being audited by the Internal Revenue Service (IRS) and "he owed substantial income taxes. He also knew that his estate would owe substantial estate taxes following his death."

The government alleged that the husband undertook a "series of sham transactions designed to shield his assets from collection by the (IRS)." The government claimed that the defendants sought to render the trust "insolvent by placing assets outside the Estate and Trust—but still within their personal control—for less than adequate consideration." The government further alleged that the wife "nominally operates the…companies under the direction of (son)." The son allegedly instructed the wife "to act as sole member and owner of the…companies with the exception that he would retain control over the assets held by the…companies." The government also contended that the son directed the wife to use her former name in conducting business on behalf of the companies "in order 'to obscure the (son's) relationship to the…companies."

The wife previously testified that although she is the sole owner of five companies, she was only aware of one such company. The government also asserted that the companies "never filed tax returns and…they operated from an address associated with (son's) other businesses …." Additionally, the government alleged that a diamond wholesale business had been conveyed for inadequate consideration and the wife "nominally operates (the diamond business) under the direction of the (son)." The wife lacked any experience "operating a diamond business." Additionally, the diamond business had been "capitalized with funds from the trust or other sources under (son's) control." A similar scheme involved an ownership interest in a retail jewelry business.

The government sought to set aside the estate transfers as fraudulent conveyances under NY Debtor and Creditor Law (DCL) §§273 and/or 276 and sought money damages against the children and the wife. The wife argued that although the schemes may have been fraudulent under DCL §§273 and/or 276 and the other defendants may have liability, the government may not seek money damages against her personally.

The court reviewed the remedies available to a creditor who has been victimized by fraudulent conveyance, see DCL §278. Although DCL does not expressly provide for the recovery of money damages, the courts have recognized "that an implied right of action for damages exists where 'the traditional fraudulent conveyance remedy of rescission is no longer practicable'—where, for example, the transferred assets have been sold or comingled with other assets." The U.S. Court of Appeals for the Second Circuit held that "money damages may be awarded under the DCL against persons who 'participate in the fraudulent transfer of a debtor's property and/or transferees of the assets and beneficiaries of the conveyance.'" A majority of courts have held that this "transferee/beneficiary test in the 'disjunctive'" i.e. "that a defendant may be liable for damages if they are either a 'transferee' or a 'beneficiary' of the conveyance."

The court found that the wife was a "beneficiary" of the schemes. Assets had been transferred to entities of which the wife "is the sole owner." Although the wife did not seem to dispute whether she was a "beneficiary" of the schemes, she argued that she cannot be held liable because the government may not "pierce the veil and disregard the corporate form of the transferee companies."

However, under the DCL, "the liability of a beneficiary of a fraudulent conveyance is direct, not the derivative. Thus, once it has been established that a defendant benefited from a fraudulent conveyance, it is unnecessary to consider whether the traditional prerequisites for veil piercing are satisfied."

"Even if, arguendo, it was necessary to pierce the corporate veil in order to hold the [wife] liable," the court would have found that "the requirements for veil-piercing have been met." The wife was the sole member of the transferee companies, the pleadings had not identified any corporate manager, officer, or other individuals authorized to conduct business on behalf of these entities, other than wife. Thus, it appeared that the wife exercised ultimate control and dominion over these entities.

Furthermore, the pleading was "replete with badges of fraud indicating that the transferee companies were created and used to hide the Estate's and Trust's assets from its creditors, including the IRS." All of the subject companies had been owned by the wife, notwithstanding a lack of "apparent experience managing multi-million-dollar real estate or diamond businesses…." The court also noted the wife's use of her prior name, the common addresses, the funding from the trust or other resources under the son's control, and the failure to file tax returns and the entities formation close to the time of the alleged conduct that was part of the subject schemes.

At the motion to dismiss stage, the court believed that these allegations "are enough to support a plausible inference that the transferee company's corporate form was abused to facilitate the schemes." Thus, the court found that if the corporate veil were pierced, the wife would be deemed a "transferee" and, however, it was clear that she could be held liable as a "beneficiary" even if she were not a "transferee".

The wife also argued that it was her husband, "not she, that should be regarded as the true alter-ego of the transferee companies and the true beneficiary of the schemes." The court stated that such argument ignored the fact that the son could only control the transferee companies and funneling assets through the wife. Although the son's involvement may create liability for him, it did not "exculpate" the wife.

Although the wife may have acted as the agent for her husband, "an agent remains liable for his or her own tortious conduct." Although the wife was the "less sophisticated party, she is not a minor or incompetent," and there was "no basis in the complaint to assume that her participation was anything less than voluntary." "A wrong is a wrong, regardless of whether the wrongdoer carries it out on her own initiative or at the request of another."

Additionally, the wife argued that she was not a "participant" in the fraudulent conveyances. The court acknowledged that there appeared to be "split of authority regarding whether a 'passive' beneficiary or transferee who does not otherwise 'participate' in the fraudulent conveyances may be held liable." However, the allegations were sufficient to support an inference that the wife had "participated" in the schemes. In addition to at least one of the schemes, the wife had signed the "operative corporate document that effected a fraudulent conveyance at issue."

The wife previously testified that she was not "aware" of the existence of most of the subject companies. This suggested that she may have been deceived by her son as to the transactions that had been carried out under her name and that perhaps she had not acted with a "sufficiently culpable state of mind to justify the imposition of personal liability." That argument failed "on both the facts and the law." The "lack of knowledge of the fraudulent conveyance is not a defense." DCL §278 "exempts from liability only those who are 'purchasers for fair consideration without knowledge of the fraud at the time of purchase.'"

Although DCL §278, only refers to "the traditional remedies of rescission and/or attachment, there is no reason why the rule should be different where 'rescission is no longer practicable' and money damages is sought." The court reasoned that if the rule were otherwise, "a debtor could easily circumvent the purposes and objectives of the DCL by giving the assets to a friend or relative, keeping them blissfully unaware of the fraud or retaining de facto control over the assets (or their proceeds, if the assets are later sold)." Here, the schemes were allegedly implemented "without fair consideration." The wife had not disputed such fact. Accordingly, the court held that her "purported lack of awareness of the fraud is no defense."

Moreover, the court observed that on the motion to dismiss, although it could be inferred that the wife's participation "was not knowing and informed," "no such conclusion is required." The wife had "personally signed the membership interest and stock transfer agreement at the core" of one scheme and the significance of certain other transactions was, "by contrast,…marginal …." Thus, the court stated that although the wife may not have been aware of certain entities, she may "still have been generally aware of the existence and fraudulent nature of these schemes." Accordingly, the wife's motion to dismiss was denied.

U.S. v. Lax, U.S. District, E.D.N.Y., Case No. 18-CV-4061, decided Oct. 11, 2019, Glasser, J.

Landlord-Tenant—NYC Housing Authority's Actions Failed To Meet Reasonable Inquiry Standard—NYCHA Sanctioned for Filing Multiple Cases for Overlapping Rents—High Volume of Cases and "Decades Old" Software System Not a Good Defense

A court had found that several landlord tenant proceedings were frivolous and pursuant to 22 NYCRR 130-1.1(c), the court had scheduled a hearing to address sanctions.

NYCHA witness testified that NYCHA held periodic training sessions and an additional training session was scheduled to take place within a "few weeks." The training sessions were to "remedy the issue of multiple cases seeking the same rents." The witness stated that the process had been impaired by a heavy case load," but noted that steps were being taken to remedy the problem. Another NYCHA witness explained that landlord-tenant petitions are generated by a rent collections system (RCS) which is "decades old" and which has "many patches." A recent "correction" had been "implemented so that if the RCS detects another petition, a new petition will not be generated unless the old case is cancelled. Cancellations are done manually after consultations with an attorney from the Landlord-Tenant Division." The correction is supposed to "red flag" duplicate petitions and new training for property managers was to be implemented.

The court found that "overlapping rents" were "sought in multiple non-payment proceedings" and the "petitions seeking overlapping rents lack a reasonable inquiry contrary to Rule 130-1.1." The court noted that the duplicate petitions were not a result of "individual mistake or an isolated event." Petitions had been signed by "different managers and verified by different attorneys."

NYCHA witnesses stated that NYCHA was "taking the situation seriously." A different court, in 2017, had found that "NYCHA has taken necessary steps to prevent the filing of multiple overlapping cases." However, the subject court opined that "while there were proposed steps to be taken to prevent the filing of multiple cases, those steps are not being fully implemented or are not effective enough to prevent the continued filing of overlapping cases." Numerous overlapping cases had been filed more than two years after a hearing which had addressed the subject problems.

The court also noted that 22 NYCRR 103-1.1(b) states that "by signing a paper, an attorney or party certifies that, to the best of that person's knowledge, information and belief, formed after an inquiry reasonable under the circumstances," that "the presentation of the paper or the contentions therein are not frivolous." In opposing sanctions, courts must consider whether the attorney "adhered to the standards of a reasonable attorney." Thus, [b]y signing the certification on court papers, an attorney certifies that it is not frivolous but rather is based on knowledge, information and belief, formed after an inquiry reasonable under the circumstances."

The court then noted that the "filing of multiple cases for overlapping rents places an undue burden on the courts and the litigants. The courts must create multiple files, enter multiple judgments and maintain multiple records. The litigants are even more burdened because of the risks of a potentially unlawful eviction. Litigants must come to court on multiple days (potentially losing work hours, paying for expert child care, increased commuting costs) and must figure out which is 'active' and can lead to an eviction. The courts and the litigants alike are forced to figure out which judgment is satisfied and which one should be stayed by an Order to Show Cause."

The court found that NYCHA's actions in the subject proceedings did not meet the "reasonable inquiry standard." The court stated that a "reasonable inquiry, such as a search of the tenant file at the management office, or review of the court records, would have disclosed that there are multiple cases being filed." Although NYCHA had to deal with the high volume of cases and "decades old" software, the court held that those factors do not "alleviate the need for reasonable inquiry on the part of the attorneys and its managers." Moreover, a reasonable inquiry "may alleviate petitioner's claim of high volume and allow petitioner to properly pursue one case for one respondent instead of two, three, or four cases with overlapping rents." The filing of multiple cases drains limited public and private resources and increases the potential for illegal evictions. Thus, the subject tenants be awarded rental credits and certain cases be dismissed.

N.Y.C. Hous. Auth. v. Various Tenants, Number II, Civil Court, Bronx Co., Case No. 801366/19, decided Oct. 18, 2019, Sanchez, J.

Landlord-Tenant—Landlord's Effort To Acquire Possession Based on "Personal Use" Need Rejected—Housing Stability and Tenant Protection Act of 2019 (HSTPA) May Be Applied Retroactively—Landlord Failed To Allege "Immediate Compelling Necessity"

A landlord commenced a holdover proceeding in March 2019, seeking possession of Apartment 4R in the subject building (4R) for personal use. The landlord's Notice of Non-Renewal (Notice) stated that the landlord and his wife, who presently occupy unit 2R, seek to create a "larger contiguous space … to better enjoy their life together" utilizing units 1L, 2L, 2R, 3L,3R, and 4R. The landlord explained how he intended to use the various units. The petition alleged that if the other units could not be recovered, the landlord still intended to recover 4R, in order to enlarge his current living space, which was on the second floor.

The tenant moved to dismiss the proceeding on the grounds that the landlord failed to show an "immediate and compelling necessity" to recover 4R for personal or for a family member's use pursuant to §26-511(c)(9)(b) of the NYC Admin. Code, as amended by the Housing Stability and Tenant Protection Act of 2019 (HSTPA)

The landlord acknowledged that the Notice failed to assert an "immediate and compelling necessity," but contended that the HSTPA new requirements should not be applied "ex post facto because the 'immediate and compelling necessity' requirement" did not exist when the Notice was served. The landlord argued that retroactive application of the HSTPA would be "unfair" and a "flagrant breach of his constitutional rights." Alternatively, the landlord sought to meet the new HSTPA standard by way of an attorney's affirmation that expressed the need for 4R for his "mother and brother, both of who suffer from some unspecified mental illness."

The court explained that the HSTPA provided that "the amendment to §26-511(c)(9)(b) 'shall take effect immediately and shall apply to any tenant in possession at or after the time it takes effect.'"

The court found that the landlord failed to show that the new HSTPA requirement should not be applied to the case at bar. The landlord had also failed to "specify which constitutional rights have been violated [or] cite legal authority to support his constitutional argument." Moreover, an appellate court had "recently held that another provision of the HSTPA that materially affected pending claims withstood constitutional scrutiny because the legislature's enactments carry an 'exceedingly strong presumption of constitutionality ….'"

Since the predicate notice could not be amended, and the predicate notice failed to state an "immediate and compelling necessity," the court held that the Notice was "not reasonable under the attendant circumstances…." Accordingly, the court held that the petition failed to state a cause of action and dismissed the proceeding.

Zagorski v. Makarewicz, Civil Court, Kings Co., Case No. 58268/2019, decided Oct. 21, 2019, Wang, J.

Scott E. Mollen is a partner at Herrick, Feinstein