SONTCHI, J.
Before the Court is Plaintiff's motion for partial summary judgment. Plaintiff has brought this action against two former officers and directors of Debtor, seeking to recover payments made by Debtor to Defendants in the weeks prior to Debtor's bankruptcy from the proceeds of a settlement between Debtor and a third party.
As the party requesting summary judgment Plaintiff must "put the ball in play, averring an absence of evidence to support the nonmoving party's case." The burden then shifts to the defendants to identify "some factual disagreement sufficient to deflect brevis disposition." More specifically, the "disagreement must relate to some genuine issue of material fact." In order to demonstrate the existence of a genuine issue of material the defendants must supply sufficient evidence (not mere allegations) for the Court to find for them and to deny the motion for partial summary judgment.
In order to determine whether Plaintiff is entitled to summary judgment in this case the Court must determine whether there is a genuine issue of material fact as to one or more of the following:
1. Were the funds at issue transferred to John J. Masiz ("Masiz") and Joseph F. Frattaroli ("Frattaroli" and, collectively with Masiz, "Defendants") not fraudulent conveyances because the funds were "earmarked" for them and, thus, were never property of the estate?
2. Were the transfers to Defendants by Vaso Pharmaceuticals, Inc. ("Debtor" or "Vaso") — which was allegedly controlled by Masiz and Frattaroli — made with the actual intent to hinder, delay and defraud creditors? More specifically, were Defendants in a position to dominate or control Debtor's disposition of property such that the intent to hinder, delay, or defraud creditors may be imputed to Debtor rendering the transfers fraudulent?
a. Did Defendants possess the requisite intent to hinder, delay, or defraud Debtor's creditors?
b. Were Defendants in a position to dominate or control Debtor?
c. Was the domination and control of Debtor by Defendants related to Debtor's transfer of property to Defendants?
3. Did Debtor make the transfers without receiving reasonably equivalent value while Debtor was insolvent?
a. Under the totality of the circumstances did Debtor receive reasonably equivalent value?
4. Were the transfers constructively fraudulent?
a. Were Defendants insiders?
b. Were the transfers on account of an antecedent debt?
c. Was Debtor insolvent at the time of the transfers?
d. Did Defendants know Debtor was insolvent at the time of the transfers?
5. Are the transfers avoidable under section 550 of the Code?
a. Were the transfers were made for the benefit of Defendants?
b. Did Defendants receive the transfers in satisfaction of a present or antecedent debt, in good faith, and without knowledge that the transfers may be avoided?
6. Assuming the transfers are avoidable for one or more of the reasons set forth above, is Plaintiff entitled to pre-judgment interest on the transfers from the date they were made?
As set forth below, there is a genuine issue of material fact in connection with some but not all of the issues identified above and the motion for partial summary judgment will be granted in part and denied in part.
On March 11, 2010 (the "Petition Date"), Vaso filed a voluntary petition for relief under Chapter 11 of Title 11 of the United States Code. Soon thereafter, Debtor filed an adversary action against Iroquois Master Fund, Ltd. ("Iroquois"),
In October 2010, Vaso filed its Second Amended Chapter 11 Plan of Reorganization,
Thereafter, Trustee commenced this present action (via the "Complaint") against Masiz and Frattaroli seeking avoidance of preferential transfers, avoidance of fraudulent transfers (under multiple federal and state theories), disallowance of claims, and unjust enrichment.
Vaso's business was commercializing over-the-counter pharmaceutical products developed by BioChemics, Inc. ("Biochemics") and manufactured by an independent third party.
In 2003, Vaso engaged Robinson & Cole LLP ("Robinson & Cole") to represent it in connection with an initial public offering ("IPO") of its stock. The IPO was completed on December 15, 2003. Thereafter, Vaso and Masiz were involved in 16 securities class action lawsuits and an SEC lawsuit related to the IPO. At the time, Vaso believed it had an action against Robinson & Cole related to (alleged) negligent legal advice made in connection with the IPO. Vaso alleged that Robinson & Cole harmed Vaso as a result of the lawsuits filed by the SEC and private investors based on alleged misstatements attributable to Robinson & Cole.
Vaso settled its lawsuits with its stockholders and the SEC. As part of the SEC settlement, Masiz agreed to refrain from serving as an officer or director of a public company, including Vaso, for five years. Nonetheless, Masiz remained at Vaso as a "corporate strategist" at the same salary he had been receiving as an officer of Vaso. Although Masiz could no longer sign documents and bind Vaso, Masiz remained active and handled the business dealings with Iroquois.
In August 2005, Iroquois and the Noteholders loaned Vaso $2.5 million, secured by a blanket lien in Vaso's property. At the time of the loan, Vaso's biggest asset was its claim against Robinson & Cole arising from the IPO. Iroquois was aware of the claim and discussed it with counsel to Vaso prior to loaning money to the company.
In April 2006, due to Vaso's financial position, Masiz agreed to continue working at Vaso without pay. In May 2008, Frattaroli also agreed to forego his compensation as President, CFO and acting CEO. In their opposing papers the Defendants assert that, although they were foregoing compensation, they were not accruing unpaid wages.
In November 2006, Vaso brought a legal malpractice action against Robinson & Cole in the Superior Court of the Commonwealth of Massachusetts (the "Robinson & Cole Litigation"). Vaso was represented by Kelley Drye & Warren LLP ("Kelley Drye") in that litigation. At the time of the filing of the Robinson & Cole Litigation, Vaso anticipated an award of between $30 and $60 million.
Prior to filing the action against Robinson & Cole, in January, 2006, Vaso and Kelley Drye entered into a fee agreement (the "Kelley Drye Fee Agreement") with regard to the Robinson & Cole Litigation whereby Kelley Drye was to receive (a) 100% of its fees charged at normal billing rates; and (b) a 25% interest in the remaining balance of the recovery in the event the Robinson & Cole Litigation resulted in a settlement or the entry of a judgment or verdict.
Thereafter, the Notes matured on May 1, 2007, at which time Vaso defaulted on the Iroquois Loan by failing to repay the principal balance. To date, the Iroquois Note is in default (although Iroquois received a portion of the principal from the settlement of Iroquois Action).
Since 2007, Vaso has had little or no operations and no manufacturing capacity. As of December 31, 2007, Vaso had total current assets of $121,004 and total current liabilities of $7,116,676. As of September 30, 2008, Vaso had total current assets of $100,556 and total current liabilities of $8,681,943. In March 2009, Vaso voluntarily ceased being a reporting company under the Securities Exchange Act.
Prior to 2009, Vaso believed it would be awarded between $30 and $60 million in the Robinson & Cole Litigation. However, in January 2009, the Massachusetts court granted Robinson & Cole's motion for summary judgment on the issue of damages sharply reducing Vaso's potential recovery. Vaso had asserted that damages should be measured by the drop in share price of a company's stock.
While the parties were engaged in mediation, the Massachusetts court made additional rulings that further reduced Vaso's potential recovery. More specifically, the $12 million of potential damages referenced above included $7.5 million based upon Vaso's return of funds to its lender at that time, Millennium Partners.
As noted above, at the beginning of 2006, Vaso stopped paying Masiz his $175,000 yearly salary due under his employment contract and Frattaroli's salary was deferred beginning in May, 2008 (the "Accrued Wages"). Frattaroli has testified that "[d]uring the pendency of the [Robinson & Cole] Litigation, Vaso's independent Board of Directors approved an arrangement between the Debtor and myself [Frattaroli] and Masiz whereby we would receive payment in consideration of their uncompensated services rendered to Vaso, if, and only if, Vaso was successful in the [Robinson & Cole] Litigation."
On December 19, 2009, Vaso and Robinson & Cole entered into an agreement resolving the Robinson & Cole Litigation in exchange for a $2.5 million payment from Robinson & Cole to Vaso (the "Robinson & Cole Settlement Agreement"). Neither Kelly Drye nor Defendants were parties to the Robinson & Cole Settlement Agreement.
Recall that Vaso and Kelly Drye had previously entered into the Kelly Drye Fee Agreement under which Kelly Drye was to receive (a) 100% of it fees and (b) 25% of any remaining recovery after the payment of its fees. Under the Kelly Drye Fee Agreement, Kelly Drye would have received $1,833,000 out of the $2.5 million in proceeds of the Robinson & Cole Settlement Agreement — leaving $667,000 for Vaso. A few days after Vaso and Robinson & Cole executed the Settlement Agreement, Vaso and Kelly Drye entered into a Settlement Agreement By and Between Vaso Active Pharmaceuticals, Inc. and Kelly Drye & Warren, LLP (the "Kelly Drye Settlement Agreement").
Under the Kelly Drye Settlement Agreement, "[o]f the $1,883,000 of the Vaso Settlement Amount that Kelley Drye is entitled to retain pursuant to the Fee Agreement, Kelley Drye shall (1) accept $595,000 payment, in full satisfaction of the fees and other charges owing to it by [Vaso and] . . . (3) direct Robinson Cole to make payment of the remainder of the Vaso Settlement Amount, in the amount of $1,905,000, directly to the Company, "acknowledging that [Vaso] intends to pay $904,000, as part of the conditions of [the Kelly Drye Settlement Agreement] to [Masiz and Frattaroli] in respect of the [Accrued Wages]."
Under the Kelly Drye Settlement Agreement, the proceeds of the Robinson & Cole Settlement Agreement were to flow through Debtor into the hands of Defendants. Importantly: (a) only Robinson & Cole and Debtor are parties to the Robinson & Cole Settlement Agreement; and (b) only Debtor and Kelly Drye are parties to the Kelly Drye Settlement Agreement. In addition, the Kelly Drye Settlement Agreement was not executed by Vaso. The sole signatory is Kelly Drye.
Vaso received its $1,905,000 in settlement proceeds from Robinson & Cole on December 29, 2009 (the date of the Kelly Drye Settlement Agreement). Vaso immediately paid $598,000 to Masiz and $306,000 to Frattaroli on account of the Accrued Wages, which amounts included interest at 10% APR. Vaso subsequently (but prior to the Petition Date) paid $178,363 to Masiz and $16,827 to Frattaroli for "regular payment of wages" that accrued after the December 29
Meanwhile, at the time this money was going in and out of Vaso's coffers, Frattaroli understood that Vaso did not have the ability to pay its creditors in full:
To review, of the $2.5 million paid by the Robinson & Cole in the settlement of the Robinson & Cole Litigation, $598,000 went to Masiz, $306,000 to Frattoli and $595,000 to Kelly Drye — totaling $1.5 million and leaving $1.0 million for the Debtor's estate. After the subsequent payments of $178,363 and $16,927 were made to Masiz and Frattaroli, respectively, Vaso was left with $804,810 of the $2.5 million settlement proceeds.
The summary judgment standard is well known. Rule 56(c) of the Federal Rules of Civil Procedure, made applicable to adversary proceedings by Rule 7056 of the Federal Rules of Bankruptcy Procedure, directs that summary judgment "should be rendered if the pleadings, the discovery and disclosure materials on file, and any affidavits show that there is no genuine issue as to any material fact and that the movant is entitled to judgment as a matter of law."
When requesting summary judgment, the moving party must "put the ball in play, averring an absence of evidence to support the nonmoving party's case."
In order to demonstrate the existence of a genuine issue of material fact in a jury trial, the nonmovant must supply sufficient evidence (not mere allegations) for a reasonable jury to find for the nonmovant.
The requirement that the movant supply sufficient evidence carries a significant corollary: the burden of proof is switched to the non-movant who "must present definite, competent evidence to rebut the motion."
Defendants have asserted a "global defense" to Plaintiff's attempt to recover the funds transferred to Defendants out of the Robinson & Cole settlement proceeds. They argue that, even though the settlement proceeds were transferred to Debtor and immediately paid to Defendants, the payments they received from Debtor were not fraudulent conveyances because the funds were "earmarked" for them and never became Debtor's property.
"The earmarking doctrine is entirely a court-made interpretation of the statutory requirement that a voidable preference must involve a transfer of an interest of the debtor in property. Under this doctrine, [when] funds are provided by [a] new creditor to or for the benefit of the debtor for the purpose of paying the obligation owed to [an existing] creditor, the funds are said to be `earmarked' and the payment is held not to be a voidable preference."
Counter-intuitively, "the earmarking doctrine is not an affirmative defense under [Fed.R.Civ.P.] 8, but rather a challenge to the trustee's claim that particular funds are part of the bankruptcy estate . . . Where, as here, the trustee establishes that the transfer of the disputed funds was from one of the debtor's accounts over which the debtor ordinarily exercised total control . . . the trustee makes a preliminary showing of an avoidable transfer `of an interest of the debtor' under [section] 547(b). The burden then shifts to the defendant in the preference action to show that the funds were earmarked."
It is undisputed that the proceeds of the Robinson & Cole Settlement Agreement at issue were paid by Robinson & Cole to Debtor into one of Debtor's accounts over which Debtor ordinarily exercised total control. It is further undisputed that those funds were immediately transferred from Debtor's account to Defendants. Thus, the burden has shifted to Defendants and, in order for the earmarking doctrine to apply in this case, they must establish "(1) the existence of an agreement between [Robinson & Cole] and [Debtor] that the [proceeds of the Robinson & Cole Settlement Agreement] will be used to pay [the Accrued Wages of Defendants], (2) performance of that agreement according to its terms, and (3) the transaction viewed as a whole ... does not result in any diminution of [Debtor's] estate."
Defendants argue that the Kelley Drye Settlement Agreement is the operative agreement through which the earmarking doctrine applies in this case. More specifically, they argue that the Kelley Drye Settlement Agreement provides that the transfers were to be paid to Defendants out of the proceeds of the Robinson & Cole Settlement Agreement and "but for" the Kelley Drye Settlement Agreement, Kelley Drye would not have taken a reduced fee and the money (including the amounts paid to Defendants) would have been retained by Kelley Drye in satisfaction of Debtor's legal bill. Defendants' summary and interpretation of the Kelly Drye Settlement Agreement must be considered accurate for purposes of this motion. But, that is neither here nor there.
Defendant's argument fails as the Kelly Drye Settlement Agreement is not the operative agreement. Indeed, no agreement exists that meets the test for applying the earmarking doctrine. The very first element of the earmarking doctrine's three part test is: "the existence of an agreement between the new lender and the debtor that the new funds will be used to pay a specified antecedent debt." Applied to the facts in this case, it requires: "the existence of an agreement between [Robinson & Cole] and [Debtor] that the [proceeds of the Robinson & Cole Settlement Agreement] will be used to pay [the Accrued Wages of Defendants]."
Robinson & Cole is not a party to the Kelly Drye Settlement Agreement. Thus, that agreement cannot be the basis for applying the earmarking doctrine. The only agreement between Robinson & Cole and Debtor is the Robinson & Cole Settlement Agreement resolving the Robinson & Cole Litigation. But, that agreement is silent regarding the disposition of the proceeds of the settlement. Indeed, it does not even mention the Kelly Drye Settlement Agreement.
The terms of the Robinson & Cole Settlement Agreement, the Kelly Drye Fee Agreement, and the Kelly Drye Settlement Agreement are clear and unambiguous. Thus, Defendants cannot establish a genuine issue of material fact sufficient to rebut Plaintiff's prima facie case. As such, as a matter of law, the earmarking doctrine is inapplicable in this case and Defendant's argument to the contrary is rejected by the Court.
In Count II and Count V of the Complaint, Plaintiff seeks to recover Debtor's payments to Masiz and Frattaroli as having been made with the intent to hinder, delay and defraud its creditors. More specifically, in Count II, Plaintiff seeks recovery of the payments under the federal fraudulent conveyance law set forth in section 548(a)(1)(A) of the Code. In Count II, Trustee relies on section 544(b)(1) of the Code to seek recovery of the transfers as fraudulent conveyances under state law, i.e., section 1304(a)(i) of Title 6 of the Delaware Code.
"Section 548(a)(1) of the Code grants a trustee [or DIP] the power to avoid any transfer by a debtor of an interest in property [or any obligation incurred by the debtor] made within two years before the filing of a bankruptcy petition if the transfer was actually or constructively fraudulent. Under section 548(a)(1)(A), transfers or obligations incurred by a debtor may be avoided if made with actual intent to hinder, delay or defraud a past or future creditor."
Section 544(b)(1), in turn, empowers a trustee to avoid "any transfer of the debtor in property or any obligation incurred by debtor that is voidable under applicable law by a creditor holding an unsecured claim . . ." The "applicable law" in this case is section 1304(a)(i) of Title 6 of the Delaware Code, which provides that "(a) A transfer made or obligation incurred by a debtor is fraudulent as to a creditor . . . if the debtor made the transfer and incurred the obligation: (1) With actual intent to hinder, delay or defraud any creditor or the debtor."
How does a legal fiction such as a corporation have an intent to do anything? Of course, corporations act through people and, ultimately, their officers and directors. As such, in certain circumstances, which Plaintiff alleges arise here, a transferee's intent to hinder, delay, or defraud creditors may be imputed to a debtor so as to render a transfer fraudulent.
"To avoid a transaction under section 548(a)(1)(A) [and/or section 544(b)(i) — incorporating 6 Del. C. §1304(a)(i)], a plaintiff must show that the transaction was made `with actual intent to hinder, delay or defraud' creditors. Because direct evidence of fraudulent intent is often unavailable, courts often rely on circumstantial evidence to infer [actual] fraudulent intent."
Searching for such circumstantial evidence, courts look to badges of fraud that include, "but are not limited to: (i) the relationship between the debtor and the transferee; (ii) consideration for the conveyance; (iii) insolvency or indebtedness of the debtors; (iv) how much of the debtor's estate was transferred; (v) reservation of benefits, control or dominion by the debtor over the property transferred; and (vi) secrecy or concealment of the transaction. The presence or absence of any single badge of fraud is not conclusive. The proper inquiry is whether the badges of fraud are present, not whether some factors are absent. Although the presence of a single factor . . . may cast suspicion on the transferor's intent, the confluence of several in one transaction generally provides conclusive evidence of an actual intent to defraud. Additionally, a court may consider other factors relevant to the transaction."
Plaintiff asserts that numerous badges of fraud are present in this case and they are discussed below. Although identified in reference to 6 Del. C. §1304(b), they are applicable to both Count II and Count V of the Complaint.
One badge of fraud is that the transfer in question was made to an insider.
Pursuant to section 101(31) of the Bankruptcy Code, if a debtor is a corporation (as Vaso is), the term "insider" includes: (i) director of the debtor; (ii) officer of the debtor; (iii) person in control of the debtor; (iv) partnership in which the debtor is a general partner; (v) general partner of the debtor; or (vi) relative of a general partner, director, officer, or person in control of the debtor.
There are a number of facts in the record that would support a finding that Masiz was a person in control and/or a non-statutory insider at the time of the transfers.
• Masiz was the former CEO of Vaso.
• BioChemics controlled 77 percent of the voting interest in Vaso and Masiz was the majority shareholder of BioChemics.
• After the settlement of the lawsuit with the SEC, Vaso hired Masiz as a "strategic advisor" at the same pay he was receiving as CEO.
• In April 2009, Masiz (and Frattaroli) submitted to the Vaso Board of Directors a "proposal regarding payment of bonus compensation" to themselves if there was a settlement of the Robinson & Cole Litigation.
• Masiz attended the Robinson & Cole mediation and participated in Vaso's decision to accept the $2.5 million settlement of the Robinson & Cole Litigation.
On the other hand there is evidence in the record supporting a finding that Masiz was not an insider at the time.
• Vaso had an independent board of directors.
• The board of directors approved all transactions, "which could possibly be seen as significant."
• Masiz "oversaw Vaso's day-to-day operations. However, [Masiz] had no authority to bind Vaso without approval from the acting CEO or the Board of Directors, nor did [Masiz] have the authority to sign any documents on behalf of Vaso."
As stated above, it is undisputed that Frattaroli is an insider. There is conflicting evidence, however, as to whether Masiz had "sufficient authority over the debtor so as to unqualifiably dictate corporate policy and the disposition of corporate assets."
It would be a badge of fraud in this case if the transfers to Masiz and Frattaroli were concealed from Vaso's creditors, which Trustee says occurred until approximately one month after the transfers were made.
Iroquois arguably had a first priority security interest in the entirety of the $2.5 million in proceeds from the Robinson & Cole settlement and almost certainly had one in the $1.905 million Debtor received after the payment of Kelly Drye's fees. Nonetheless, Masiz and Frattaroli were paid without regard to Iroquois Noteholders' secured claim
Defendants respond that Frattaroli contacted Iroquois regarding the proposed settlement of the Robinson & Cole Litigation but asserts that "Vaso was not obligated to do so because Iroquois did not have a security interest in the [Robinson & Cole] Litigation or its proceeds, Vaso proposed paying Iroquois approximately $700,000 of the [settlement proceeds] to partially pay down the Iroquois Loan."
There is ample testimony that the claims against Robinson & Cole were part of the Iroquois asset base. Abbe judged the "success" of Vaso in terms of whether the Noteholders would be re-paid, which could happen from the proceeds of the litigation.
Kulick continued that he told Frattaroli that the Noteholders had a senior secured interest in any Robinson & Cole settlement:
The record overwhelming supports a finding that Frattaroli and Masiz concealed the nature and existence of transfers from Debtor's creditors at the time the transfers were made. There is no genuine issue of material fact to the contrary and the court finds that "Delaware Badge of Fraud 3" is applicable here.
It would be a badge of fraud in this case if, prior to the transfer, Debtor had been sued or was threatened with suit relating to the disposition of the proceeds of any settlement of the Robinson & Cole Litigation. On February 4, 2010, at approximately the same time Iroquois learned of the transfers, it filed suit against Debtor in the Supreme Court of New York, County of New York seeking, among other things, specific performance of the Security Agreement, which would require Vaso to turn over the Robinson & Cole settlement proceeds to Iroquois in full or partial repayment of the Notes. But, the transfers occurred five weeks earlier than commencement of that litigation, i.e., on December 29, 2009. There is no evidence that Iroquois actually threatened suit against Debtor prior to the transfer. Plaintiff has failed to show he is entitled to summary judgment as to "Delaware Badge of Fraud 4."
It would also be a badge of fraud here if substantially all of Debtor's assets were transferred to Defendants. Under the Kelly Drye Fee Agreement, Kelly Drye received $595,000 directly from Robinson & Cole. The remaining $1,905,000 was transferred to Debtor and $904,000 of that amount was immediately transferred by Debtor to Frattaroli and Masiz, leaving approximately $1 million for Debtor. But, Frattaroli and Masiz received an additional $195,000, leaving $805,000 to Debtor. According to Debtor's schedules, its assets totaled $686,000 on the Petition Date.
Defendants argue that the transfers they received were not substantially all of Debtor's assets for two reasons. First, they argue that "[w]hen the Board of Directors agreed to pay the Settlement Transfers, if the Debtor was successful in the [Robinson & Cole] Litigation, neither the Board of Directors nor the Defendants imagined that the Settlement Transfers would constitute a substantial percentage of the debtor's assets."
Defendants' second argument is that that Debtor did not transfer substantially all its assets to Defendants because $904,000 is only 40% of the settlement proceeds. Kelly Drye arguably had a security interest in the settlement proceeds and was going to receive payment of at least some of its fees. So, for purposes of this point, the payment to Kelly Drye can be ignored. In addition, Defendants received a total of $1,098,640 not just $904,000. In that case, Defendants received $1,098,640 of $1,905.00 or 58% of the settlement proceeds, leaving Debtor with only $686,000 on the Petition Date. Even if you include the entirety of the $2.5 million of the Robinson & Cole settlement proceeds Defendants received 44% of those proceeds. Defendants argue that a transfer of anything less than 50% of Debtor's assets is not substantially all of those assets. That cannot be the case. The law is not "majority of," but, the more amorphous "substantially all." One can easily imagine substantially all of a company's asset being less than a majority. Consider a manufacturing company that transfers its largest operating division valued at 48% of the company's assets leaving behind a number of small, disparate, unrelated operations and cash. The company has fundamentally changed and, in that case, it must be that substantially all of its assets have been sold. Consider, also, a bankruptcy case where a debtor-in-possession sells 48% of its assets without receiving court approval under section 363 of the Code. Such a transaction would almost certainly be outside the course of business (if for no other reason than few companies are in the business of disposing of 48% of their assets) and, thus, avoidable as an unauthorized post-petition transfer under section 549 of the Code. No matter how you cut it, the payments to Frattaroli and Masiz in this case were of substantially all of Debtor's assets. Plaintiff is entitled to summary judgment on the existence of "Delaware Badge of Fraud 5."
As discussed above, Debtor concealed assets by not disclosing to Iroquois nor its other creditors the terms and amount of the proceeds from the Robinson & Cole Settlement Agreement; the terms and amounts of payments to Kelly Drye under the Kelly Drye Settlement Agreement; and the basis for and the amount of the payments from Debtor's assets to Frattaroli and Masiz. Plaintiff is entitled to summary judgment on the existence of "Delaware Badge of Fraud 7."
It would be a badge of fraud if Debtor did not receive reasonably equivalent value for the transfers to Defendants. Whether Debtor received reasonably equivalent value for the transfers is discussed in detail below. For the reasons set forth in that discussion, there is a genuine issue of material fact as to the existence of "Delaware Badge of Fraud 8.
Lastly, the Trustee argues that the Debtor was insolvent at the time of the transfers, which Defendants concede.
Trustee seeks to recover Debtor's payments to Defendant as having been made with the actual intent to hinder, delay or defraud its creditors. Debtor's intent is imputed from Defendants' intent. In order to apply the imputation doctrine Plaintiff must satisfy three prongs, the first of which is whether Defendants themselves had the intent to hinder, delay or defraud Debtor's creditors. Defendants' intent is gleaned from examining whether "badges of fraud" are present. The Court has just analyzed seven badges of fraud that may be relevant to this case and determined that Plaintiff is entitled to summary judgment for five of them. These are: (i) the transfer was to an insider;
The Trustee concludes that the entry of summary judgment for the five badges of fraud discussed above conclusively shows that Masiz and Frattaroli had the intent to hinder, delay and defraud Debtor's creditors. Defendants responds that they "continued to work for Vaso without compensation for several years in the hopes of preserving the value of the company in order to fully pay all of Vaso's creditors. . . . This selfless act for the intended benefit of the Debtor and its creditors indicates that the Defendants possessed no actual intent to defraud."
Defendants miss the point. The question is not whether Defendants worked without salary with intent to hinder, defraud or delay Debtor's creditors. That would be a ridiculous finding. The question is whether Defendants paid themselves ahead of Debtor's creditors with intent to hinder, delay or defraud those creditors. The answer to that question is clearly "yes." The five badges of fraud for which Plaintiff has been awarded summary judgment easily carry the day. There is no genuine issue of material fact and Plaintiff is awarded summary judgment as to the first prong of the imputation doctrine. Whether the remaining elements have been established is discussed below.
"The second element of the Adler test is [whether] the transferee was in a position to dominate or control the transferor."
Trustee asserts that, for several reasons, at the time of the transfers in December 2009, Defendants were in a position to dominate or control Debtor. For example, Frattaroli was acting CEO, President and CFO with complete oversight of payments being made by Vaso. Masiz founded Vaso and BioChemics and was the controlling majority shareholder of BioChemics, which, in turn controlled 77% of the voting interest in Vaso. Masiz testified that he alone decided if BioChemics would make an intercompany advance to Vaso.
Defendants respond that, at all times relevant to the transfers, Debtor had an independent Board of Directors of which neither Frattaroli nor Masiz were members. Moreover, Masiz was not an officer of the Debtor and did not have the power to bind Debtor nor sign documents on its behalf. In short, Defendants assert that, although they had significant roles in the management of the Debtor, their management did not rise to the level of "dominion and control."
Under Elrod, even a high degree of functional control of day-to-day operations is not sufficient to imput intent.
The third prong of the imputation doctrine is whether the transferee's domination and control is sufficiently related to transferor's disposition of the property at issue.
Defendants counter that the payments to Defendants were not related to any influence they had with Debtor because the transfers were approved by Vaso's independent Board of Directors, with the advice of counsel.
As stated earlier, under Count II and V of the Complaint, Trustee seeks to recover Debtor's payments to Defendants as having been made with the actual intent to hinder, delay or defraud its creditors. Trustee asserts that Defendants' intent can be imputed to Debtor. In order for that to occur, Trustee must establish that, at the time of the transfers, (i) Frattaroli and/or Masiz had an actual intent to hinder, delay or defraud Debtor's creditors; (ii) they were in a position to dominate or control Debtor; and (iii) their domination and control was sufficiently related to the transfers.
As discussed above, Plaintiff is entitled to summary judgment on the first prong but not the others. As such, Plaintiff is not entitled to summary judgment that Debtor transferred the proceeds of Robinson & Cole settlement to Defendants with the actual intent to hinder, defraud or delay its creditors. Plaintiff's motion for summary judgment on Count II and Count V of the Complaint is denied.
In Count III, Count IV, and Count VI of the Complaint, Trustee seeks to recover the payments made to Defendants as being constructively fraudulent because they were made by Debtor without receiving reasonably equivalent value while Debtor was insolvent. More specifically, in Count III and IV, Plaintiff seeks recovery under the federal fraudulent conveyance law set forth in Code sections 548(a)(1)(B)(i) and (ii) (I), (II) and (III); and 548(a)(l)(B)(iv), respectively. In Count VI, Plaintiff relies on section 544(b) of the Code to seek recovery of the transfers as fraudulent conveyances under state law, i.e., section 1305(a) of Title 6 of the Delaware Code.
The applicable sections of 548 of the Code and section 1305 of Title 6 of the Delaware Code are substantively identical. In order to establish that a transfer was constructively fraudulent under these statutes, "Plaintiff must show that (a) the debtor made the transfer or incurred the obligation without receiving reasonably equivalent value, and (b) regarding the debtor's financial condition, the debtor was either: (i) insolvent or became insolvent as a result of the transfer; (ii) engaged or was about to engage in a business or transaction for which its remaining assets were unreasonably small in relation to the business or transaction; (iii) intended to incur, or believed or reasonably should have believed that it would incur, debts beyond its ability to pay as they became due; or (iv) made the transfer to or for the benefit of an insider under an employment contract outside the ordinary course of business.
"The term `reasonably equivalent value' is not defined by the Bankruptcy Code. Congress left to the courts the task of setting forth the scope and meaning of this term, and courts have rejected the application of any fixed mathematical formula to determine reasonable equivalence. As the Third Circuit has noted, `a party receives reasonably equivalent value for what it gives up if it gets roughly the value it gave.' [Courts] look to the `totality of the circumstances' of the transfer to determine whether `reasonably equivalent' value was given."
Generally, this Court follows a two-step approach, first looking to whether "based on the circumstances that existed at the time of the transfer [or obligation] it was `legitimate and reasonable' to expect some value accruing to the debtor."
The preliminary question is whether it was legitimate and reasonable to expect Defendants to have provided some value to Debtor as a basis for receiving the transfers? The answer is rather obviously yes, which leads to the question of whether Debtor, in fact, received some benefit from Defendants' service. Trustee argues Debtor did not.
In April 2006, Vaso stopped paying Masiz his $175,000 yearly salary due under his employment contract. In May 2008, Vaso ceased paying Frattaroli. Frattaroli testified that the Board of Directors determined "that $175,000 per year plus a $50,000 [annual] bonus was an appropriate valuation of the services" Masiz and he were providing to Vaso without pay. The $904,000 payment to Defendants in December 2009 consisted of a payment to Masiz of $598,000 and to Frattaroli of $306,000. These amounts were the foregone salary and bonuses discussed above plus interest at 10% APR. Vaso subsequently paid $178,363 to Masiz and $16,827 to Frattaroli. It is unclear from the record how those amounts were calculated and why Masiz received such a large payment in comparison to Frattaroli.
Trustee makes numerous assertions in support of his argument that Debtor did not receive any benefit (let alone $904,000 worth) from Defendants' services.
Defendants respond that Debtor received some benefit in exchange for the transfers as Defendants provided services to the Debtor for several years without receiving any compensation for such services. That there was value received, they argue, is supported by the decision of the independent Board of Directors, with the guidance of outside consultants and counsel, to pay $175,000 per year with an annual bonus of $50,000. Presumably an independent board would not approve such salaries unless it believed the company was receiving value. Defendants further note that the valuation of Debtor's services was on the lower end of a range of salaries paid by other companies in the greater Boston area, implying Vaso was actually under paying Defendants.
It is clear from the record that Debtor received some benefit from the services provided by Masiz and Frattaroli in the years they forwent their salary. Thus, the Court must turn to whether the value of those services was reasonably equivalent to the $904,000 Debtor paid for them.
The Court must determine whether Vaso received "fair market value" for paying Defendants $904,000 from the settlement proceeds (approximately 36%) to run a business that had essentially stopped operating except to pursue litigation. As touched on above, however, Frattaroli testified that he hired an independent consultant who opined that Frattaroli "should expect to make approximately $175,000 at Vaso with an additional bonus of $50,0000 [sic] per year." Frattaroli further testified that "Vaso's independent Board of Directors reviewed the consultant's report and determined that $175,000 per year plus a $50,000 bonus was an appropriate valuation of the services that Masiz and [Frattaroli] rendered to Vaso." No additional, corroborating evidence — such as board minutes or a copy of the consultant's report — is before the Court. But, Plaintiff has not submitted any evidence in support of its position other than to argue it just can't be that the management of a debtor that never turned a profit, assessed $17 million in losses through its history, and had $686,000 in assets and $8 million in liabilities on the Petition Date can be worth anything like what Defendants received. Plaintiff's argument has a certain visceral appeal but it is not evidence. There is a genuine issue of material fact as to whether the services provided by the Defendants was "roughly equivalent"
The second prong of the "reasonably equivalent value" test is whether the payments to Defendants were made at arms' length. The Third Circuit has stated that a "seller's pursuit of alternative transaction partners and selfish negotiations for financial concessions epitomize arm's length bargaining, . . . but where a seller negotiates solely for the benefit of the surviving entity or in total disregard of the price, the transaction cannot be considered at arm's length."
There is conflicting evidence as to whether the negotiations between Debtor and Defendants related to Defendants' salary and the decision to pay the Accrued Wages were conducted at arms' length. For example, Frattaroli is an insider but there is a genuine issue of material fact as to whether Masiz is an insider. Frattaroli testified the Board of Directors set Defendants' compensation after considering a consultant's report but there is no collaborating evidence and the Court cannot judge Frattaroli's credibility on a paper record. In short, there is a genuine issue of material fact as to whether negotiations were conducted at arms' length.
The third prong of the "reasonably equivalent value "test is whether Defendants acted in good faith. "The Bankruptcy Code does not define either `good faith' or `good faith transferee.' Collier has observed that because the question of good faith arises in varied circumstances, the term defies an easy or precise definition. Accordingly, courts generally evaluate good faith defenses on a case-by-case basis. This requires the court examine what the transferee objectively "knew or should have known," such that a transferee does not act in good faith when it has sufficient knowledge to place it on inquiry notice of the voidability of the transfer."
Defendants did not act in good faith in causing Debtor to transfer the settlement proceeds of Robinson & Cole Litigation to themselves. The question is whether, at the time of the transfers, Defendants were on inquiry notice of the voidability of the transfers. Frattaroli testified that at the time of the transfer he knew that Vaso was unable to pay all of its creditors 100 percent.
Pursuant to § 548(a)(1)(B), a plaintiff establish the lack of reasonably equivalent value and one of four alternative additional elements: the debtor (i) was insolvent or became insolvent as a result of the transfer; (ii) was engaged or was about to engage in a business or transaction for which its remaining assets were unreasonably small in relation to the business or transaction; (iii) intended to incur, or believed or reasonably should have believed that it would incur, debts beyond its ability to pay as they became due; or (iv) made the transfer to or for the benefit of an insider under an employment contract outside the ordinary course of business.
Under section 1304(a)(2) (a) or (b), of Title 6 of the Delaware Code, Plaintiff must establish lack of reasonably equivalent value and the one of two alternative elements. These are whether Debtor: (i) intended to incur, or believed or reasonably should have believed that it would incur, debts beyond its ability to pay as they became due; or (ii) made the transfer to or for the benefit of an insider under an employment contract outside the ordinary course of business.
Insolvency satisfies both the federal and state tests in this instance. The term insolvent is defined in the Bankruptcy Code generally to mean a "financial condition such that the sum of such entity's debts is greater than all of such entity's property, at a fair valuation."
As Defendants have conceded insolvency the other, alternative bases for establishing constructive fraud need not be discussed. Nonetheless, in the interests of completeness, the Court will briefly address them. The second alternative element is the unreasonably small capital test, which analyzes whether, at the time of the transfer, the company had insufficient capital, including access to credit, for operations.
The final alternative element is whether the transferee was an insider or incurred such obligation to or for the benefit of an insider under an employment contract and not in the ordinary course of business. Frattaroli was an insider at the time of the transfers but there is a genuine issue of material fact as to whether Masiz was one. In addition, it is clear from the record that the transfers were outside the ordinary course of business. It is not clear, however, whether either or both Defendants had an employment contract with Debtor at the time of the transfers. Thus, Plaintiff is not entitled to summary judgment on this alternative element.
Under Counts III, IV and VI, Trustee seeks to recover the payments made to Defendants as being constructively fraudulent because they were made by Debtor without receiving reasonably equivalent value while Debtor was insolvent. Debtor has established that three of the four alternative elements necessary to establish the second prong of the reasonably equivalent value test are met — insolvency, insufficient capital and intent to incur debt beyond the debtor's ability to pay. As any of the three are sufficient to meet the test, Plaintiff is entitled to summary judgment on this prong.
As to the first prong, Plaintiff must establish that, under the totality of the circumstances, Debtor did not receive reasonably equivalent value. This, in turn, requires Plaintiff to establish (i) Debtor did not receive fair market value in exchange for the transfers, (ii) the transfers were not made at arms' length; and (iii) Defendants did not act in good faith. Although Plaintiff has established Defendants did not act in good faith, there is a genuine issue of material fact as to fair value and arms' length.
Thus, Plaintiff has not met his burden and the motion for entry of summary judgment is denied as to Count II, Count IV and Count VI.
In Count VII, Plaintiff relies on section 544(b) of the Code to seek recovery of the transfers to Defendants as fraudulent conveyances under state law, i.e., section 1305(b) of Title 6 of the Delaware Code. It is Plaintiff's burden to establish the transfers were made for the benefit of an insider for an antecedent debt when the Debtor was insolvent and the transferee knew the Debtor was insolvent.
Frattaroli was an insider of the Debtor at the time of the transfers but there is genuine issue of material fact as to whether Masiz was one.
"Debt" is defined in the Bankruptcy Code as a "liability on a claim."
Defendants argue that there was no antecedent debt because Debtor did not become legally bound to pay the Defendants for their past employment until Debtor received the proceeds of the Robinson & Cole Litigation settlement.
At this time, the Court pauses to discuss Defendants' incongruous position as to whether the transfers were in return for their services for which they were not paid. Although the amount of the transfers was pegged to what their salary (allegedly) should have been (with the additional 10% interest), Defendants have also said (when convenient) that Vaso was not accruing the Defendants' wages and that the transfers were as a result of a successful settlement of the Robinson & Cole Litigation.
Debtor was insolvent at the time of the transfers.
Defendants knew at the time of the transfers that Defendant was insolvent.
Plaintiff has established that the transfers were made on account of an antecedent debt while Debtor was insolvent and Defendants knew Debtor was insolvent. In addition, Plaintiff has established Frattaroli was an insider at the time of the transfers. As to Masiz, however, there is a genuine issue of material fact as to whether he was an insider. Thus, summary judgment shall be entered against Frattaroli as to Count VII. Summary judgment as to the elements other than the insider requirement shall be entered against Masiz but must be denied as to Count VII as a whole.
Section 550 of the Code provides that "to the extent that a transfer is avoided under section 544 . . . [or] 548 . . . of this title, the trustee may recover . . . the property transferred . . . from the initial transferee of such transfer or the entity for whose benefit such transfer was made."
This test is written in the negative. Provided that liability is satisfied under section 548, the transfers are avoidable unless (a) they were not made for the benefit of Defendants; and (b) Defendants did not receive the transfers in satisfaction of a debt, were not acting in bad faith and had no knowledge of the avoidability of the transfers. All of these elements have been discussed above and have been affirmatively established by Trustee.
Defendants concede that they received the transfers.
The transfers were on account of antecedent debt; Defendants were not acting in good faith; and Defendants received the transfers.
To the extent that summary judgment is entered on any of the Counts discussed above, the transfers are avoidable under section 550 of the Code.
The Trustee requests summary judgment on his entitlement to pre-judgment interest. The awarding of pre-judgment interest is within the discretion of the Court.
The Court has determined that the entry of summary judgment on some elements of the asserted Counts and on one of the Counts in its entirety. In addition, the Court has determined that the earmarking doctrine is not applicable here. The overriding theme of this case and this opinion is that Defendants acted with pre-meditated intent to pursue their own remuneration at the expense of Debtor's other creditors. Whether certain Counts may or may not be established at this time or ever cannot hide the underlying facts. Not only is there not a sound reason to deny Trustee pre-judgment interest there is a sound basis to award that interest. Thus, pre-judgment interest shall be awarded in connection with any and all Counts for which liability is established.
This has been a lengthy opinion. The Court has discussed the earmarking doctrine and requests for summary judgment as to six separate Counts asserted against Defendants, the analysis of which required applying multiple legal tests with many sub-parts. The Court has also discussed whether the transfers are avoidable under section 550 of the Code and whether pre-judgment interest should be awarded.
It is important to recall the procedural posture of the case — this is Plaintiff's motion for the entry of summary judgment. In applying that standard the Court has determined that Plaintiff is entitled to summary judgment on certain elements of the applicable legal tests as well as on Count VII against Frattaroli in its entirety. On the other side, the Court has denied summary judgment on certain elements of legal tests and, as a result, has denied entry of summary judgment on most of the Counts brought by Plaintiff.
The Court began this opinion with a series of questions that must be answered to determine whether entry of summary judgment is appropriate. It closes by answering those questions and identifying whether Plaintiff's motion will be granted or denied based on those answers. The ultimate rulings (as opposed to the legal tests and their sub-parts) are identified in bold.
In final summation, the Court will enter summary judgment against Frattaroli under Count VII. The motion for summary judgment on Counts II, III, IV, V and VI is denied. Summary judgment is granted in connection with whether the transfers are avoidable under section 550 of the Code and the award of pre-judgment interest. An order will be issued.
6 Del. C. § 1304(b)(1-11) (hereinafter referred to as the "Delaware Badges of Fraud").