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Setting Aside Fraudulent Transfers Part I: What to Look for When Going After Officers or Successor Company
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Setting Aside Fraudulent Transfers Part I: What to Look for When Going After Officers or Successor Company

February 9, 2015 Banking & Financial Services Industry Legal Blog

Reading Time: 13 minutes

You have a claim against a corporation and/or its officers, but you find out that the corporation is dissolved and there is a successor corporation in its place that appears to be essentially the same corporation. Now what? In Bernard v. Kee Mfg. Co., Inc., Florida’s Supreme Court adopted the traditional corporate law rule and its exceptions by holding that the liabilities of the selling predecessor will not be imposed on the buying successor company “unless (1) the successor expressly or impliedly assumes obligations of the predecessor, (2) the transaction is a de facto merger, (3) the successor is a mere continuation of the predecessor, or (4) the transaction is a fraudulent effort to avoid liabilities of the predecessor.” 409 So. 2d 1047, 1049 (Fla. 1982).  Based on the foregoing, a claimant must prove one of these exceptions to the general rule to implicate the liability of the successor corporation on behalf of the predecessor company. In this bLAWg post, we will focus on the successor’s liability pursuant to the fraudulent effort to avoid liabilities. Note, this particular issue may be closely linked to improper dissolution or failure to properly wind down, but that is a topic for another discussion interrelated to a creditor seeking recovery from officers, shareholders, and corporations.

Returning to the initial question, lets say you have a claim against ABC Corp., which now appears to be operating as ABC Corp. I. To an outsider, it looks like ABC Corp. I is identical to ABC Corp. in the fact that it utilizes the same business focus and type of work, uses the same website, building, telephone number, fax numbers, etc… If you were to bring a claim against ABC Corp. and ABC Corp. claimed insolvency, this should raise a red flag and alert you to look at (1) whether the debtor has recently transferred any valuable assets or incurred a large debt, (2) the identity of the transferee, and (3) the consideration for that transfer or debt. If it appears that ABC Corp. I is the same debtor as ABC Corp., there may be a fraudulent transfer, which keeps ABC Corp. I on the hook for ABC Corp.’s debts.

Florida follows the Uniform Fraudulent Transfer Act (UFTA), which states that any transfer made with “actual intent to hinder, delay or defraud” any current or future creditor is considered a fraudulent transfer.  Fla. Stat. § 726.105. Because actual intent to defraud is hard to prove, Florida courts, guided by the UFTA, will look to indicia of fraudulent intent referred to as “badges of fraud.”  Fla. Stat. § 726.105(2). The badges of fraud that a court may consider include whether:

(a)   The transfer was to an insider,

(b)   The debtor retained possession of the property transferred after the transfer,

(c)   The transfer was disclosed or concealed,

(d)   Before the transfer was made, the debtor had been sued or threatened with suit,

(e)   The transfer was the debtor’s entire estate,

(f)   The debtor absconded,

(g)   The debtor removed or concealed assets,

(h)   The value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred,

(i)   The debtor was insolvent,

(j)   The transfer occurred shortly before or shortly after a substantial debt was incurred, and

(k)   The debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.

§ 726.105(2). This list is not exhaustive and courts look to the totality of the circumstances surrounding the transfer and “while a single badge of fraud may create only a suspicious circumstance, several of them together may afford a basis to infer fraud.” Mejia v. Ruiz, 985 So. 2d 1109, 1113 (Fla. 3d DCA 2008). Other factors include the same officers and shareholders, the same attorney and registered agent, the same business focus, substantially the same customers and employees, and the same telephone numbers. Lab. Corp. of Am. v. Prof’l Recovery Network, 813 So. 2d 266, 269 (Fla. 5th DCA 2002).

In applying the badges of fraud to determine whether a transfer was fraudulent, the court in Cuervo v. Airport Services, Inc., 984 F. Supp. 2d 1333 (S.D. Fla. 2013), found successor liability on behalf of the successor company pursuant to the fraudulent transfer. In Cuervo, the plaintiffs sued for problems during employment with ASI’s cleaning service. During the initial stages of litigation, ASI moved for bankruptcy and essentially became insolvent. The plaintiffs amended the complaint to add Proficient as a defendant because Proficient took over the ASI’s operations prior to ASI filing bankruptcy. In analyzing the claim for successor liability and applying Florida law, the court looked at the totality of the circumstances and listed the following facts as the indication of a fraudulent transfer: (1) Proficient operated and serviced ASI’s clients; (2) Proficient used ASI’s equipment; (3) there was no personnel or management change between the two corporations; and (4) ASI’s timing of the bankruptcy coupled with the transfer of assets.

Liability may also arise where all the stock of the predecessor is purchased and the predecessor’s assets are stripped by the acquiring corporation. In Kelly v. American Precision Industries, Inc., an action for personal injuries was brought against the successor corporation on theory that it had assumed liability of its predecessor in delivering allegedly defective garbage truck. Kelly v. American Precision Indus., 438 So. 2d 29 (Fla. 5th DCA 1983). The Court ruled that a successor corporation was responsible for liability of a predecessor corporation in delivering the allegedly defective garbage truck where the successor purchased all of predecessor’s stock and stripped it of all its assets, with the benefit going solely to successor which was tantamount to a de facto merger. Id. Although this case was not one that pertained to fraudulent transfers per se, it should be noted that employing successor theories of liability associated with de facto mergers can be a basis for pursuing otherwise hopeless claims. The court in Kelly reversed the trial court holding, finding that appellee could be held liable for the injury caused by the truck because the predecessor corporation was a mere instrumentality of appellee, as evidenced by the fact that appellee stripped the predecessor of all its assets and derived the benefit from the asset sale without properly avoiding the liabilities associated with the transfer of the company. Id.

The fraudulent nature of the transaction may be found to exist in the transfer of assets of a corporation without consideration or for grossly inadequate consideration to a successor corporation to the prejudice of creditors for the benefit of the same individuals who constitute the beneficial owners of each of the corporations involved. Cleveland Trust Co. v. Foster, 93 So. 2d 112 (Fla. 1957). The Court considered the fraudulent transfer theory of successor liability in Lab. Corp. of Am. v. Prof’l Recovery Network, 813 So. 2d 266, 269 (Fla. 5th DCA 2002). In Lab Corp, Professional Recovery Network, Inc. (PRN) was being pursued for debts incurred to Lab Corp by Drug Programs Management, Inc. (DPM). In its suit, Lab Corp asserted, among other things, that PRN was formed for the purpose of defrauding DPM’s creditors. The Court in considering the fraudulent transfer claim stated that at least several “badges of fraud” can be found in the record, including the transfer of DPM’s customers, receivables, accounting system and database to PRN without consideration, and the transfer of DPM’s vehicles to McKown at far less than fair market value. Id.

The court reasoned a continuation of business resulting in liability of the successor corporation for its predecessor’s debts occurs when the successor corporation is merely a continuation or reincarnation of the predecessor corporation under a different name. Id. The “purchasing corporation must not merely be a ‘new hat’ for the seller, with the same or similar entity or ownership.” Id. While having common attributes does not automatically impose liability on a successor corporation, merely repainting the sign on the door and using new letterhead certainly gives the appearance that the new corporation is simply a continuation of the predecessor corporation. Id. To determine if a fraudulent transfer or de facto merger has occurred in this context, the finder of fact may look at any factors reasonably indicative of commonality or of distinctiveness. “The bottom-line question is whether each entity has run its own race, or whether there has been a relay-style passing of the baton from one to the other.” Id., citing Oman Int’l Fin. Ltd. v. Hoiyong Gems Corp., 616 F. Supp. 351, 361 (D.C.R.I. 1985 ). See 300 Pine Island Assoc. v. Steven L. Cohen & Assoc., 547 So. 2d 255, 256 (Fla. 4th DCA 1989 ). The significant question is whether there has been a change in form, but not in substance. When mere changes in form occur, as held by the court in Lab Corp., courts will find that de facto mergers are tantamount to fraudulent transfers importing the existing liabilities onto the successor corporations.

Illustrative of a case where disparity in purchase price was sufficient to support a fraudulent transfer claim is Graef v. Hegedus, 698 So. 2d 655 (Fla. 2nd DCA 1997) where the court held that given the disparity in the value of the transferred assets and the consideration paid for the purchase of assets by the successor company that genuine issues of material fact remain unresolved as to whether this transaction constitutes a fraudulent transfer under section 726.105, Florida Statutes, of the Uniform Fraudulent Transfer Act. However, mere knowledge that the seller is indebted to another or even knowledge of the existence of a valid and pending cause of action against the seller may be insufficient to show the purchaser’s participation in a fraudulent conveyance as set forth in Orlando Light Bulb Service, Inc. v. Laser Lighting & Electrical Supply, Inc., 523 So. 2d 740 (Fla. 5th DCA 1988).

In Orlando Light Bulb Service, the appellee distributor brought an action against selling corporation and appellant buying corporations for a debt owed by selling corporation to appellee. The trial court held appellants liable, finding that their purchase of assets from selling corporation was a de facto merger and a mere continuation of the business. However, the appellate court held that there was no de facto merger or mere continuation of the business because the transaction did not involve substantially all of selling corporation’s assets, appellants paid fair market value, there was no commonality of shareholders, appellants had been engaged in the same business for 10 years, and selling corporation continued to function for a time after the sale. Thus the transfer was not a fraudulent transfer. Orlando Light Bulb Service, Inc. v. Laser Lighting & Electrical Supply, Inc., 523 So. 2d 740 (Fla. Dist. Ct. App. 5th Dist. 1988)

As a further juxtaposition of what is not a fraudulent transfer as to impose successor liability, in Reina v. Gingerale Corp., 472 So. 2d 530 (Fla. 3d DCA 1985), the court stated that the only assertion that came close to asserting fraud sufficient to delineate a fraudulent transfer was the allegation that at the time of the sale and transfer of the Coconut Restaurant Corporation’s assets to Gingerale, Gingerale knew of a cause of action against Coconut Restaurant Corporation. However, this alone was not enough to establish a fraudulent transfer because the assertion of knowledge was not supported by any facts and no other facts were present that would lead the court to believe that the transfer was fraudulent. This case shows that while some transfers may appear fraudulent, the analysis is in the facts.

Returning to ongoing hypothetical, lets say that ABC Corp. I is utilizing the exact same website, remains in the same physical location, maintains the same officers, and received a sub-market value transfer of the entirety of the assets of ABC Corp. immediately prior to ABC Corp.’s dissolution. In this instance, a court would likely find that ABC Corp. I is liable for the predecessor corporation as there was a fraudulent transfer. Or, with another set of facts, if ABC Corp. changes ownership from one family member to another family member under the disguise of ABC Corp. I because of the insolvency of the initial family member, this badge of fraud coupled with the fact that nothing else changed (same office, website, employees, etc.), would likely make it a fraudulent transfer.

On the other hand, let’s say that ABC Corp I. was in the same physical location and performs work similar to ABC Corp., but has different officers, different employees, different client roster and uses a different website and phone number. Additionally, ABC Corp. I only purchased a small percentage on ABC Corp.’s assets and the purchase was at the market value of the shares. In that instance, it is unlikely that ABC Corp. I would be liable under a theory of fraudulent transfer.

So what happens if the court did find that a fraudulent transfer from ABC Corp. to ABC Corp. I occurred? With the evidence of a fraudulent transfer, the creditor has the following recovery options against the debtors: (1) Have the transfer or obligation avoided or annulled “to the extent necessary to satisfy the creditor’s claim.” Fla. Stat. §726.108(l)(a); (2) Obtain an “attachment or other provisional remedy against the asset transferred or other property of the transferee,” Florida Statutes § 726.108 (I)(b), as a debtor’s conduct of engaging in fraudulent transfers is one of the enumerated grounds for the issuance of a writ of attachment. Fla. Stat. §76.04; (3) Have a receiver appointed “to take charge of the asset transferred or of other property of the transferee.” Fla. Stat. §726.108(l)(c) 2; and (4) Obtain the entry of a money judgment equal to the lesser of the value of the transferred asset or the amount of the creditor’s claim. Fla. Stat. §726.109(2)-(3). Based on the foregoing, Florida law provides substantial support for creditors seeking recovery from debtors who engaged in a fraudulent transfer.

In sum, for successor companies there are very real dangers associated with the purchase and transfer of assets shrouded with latent and patent liabilities, including being exposed to punitive damages based upon the predecessor’s conduct. Careful drafting of documents in the sale transaction is critical to avoid assuming such liabilities and careful analysis of the badges of fraud is critical to the pursuing creditor. The closer the identity between the predecessor and successor in the assets, management, personnel, stockholders, location, trade name, equipment, and clients, the more likely that successor liability will be found under a fraudulent transfer theory or other theories of law. Even if there is sufficient dissimilarities to avoid liability under a de facto merger or continuation theory of liability claim by a creditor, the pursuing creditors should look to set aside transactions where grossly inadequate consideration is paid by a successor corporation to the prejudice of creditors under circumstances which benefits the same individuals who constitute the beneficial owners of each of the corporations involved. While this bLAWg post focused on the successor corporation component of potentially fraudulent transactions, our next post will focus on the individual liability upon stakeholders which creditors may impose for improper wind down and transfer.

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