Lloyds TSB Bank plc v. CNB International, Inc. Litigation Trust

Filing 34

DECISION AND ORDER affirming Lloyd's TSB Bank plc's liability on alternate grounds, vacating the Bankruptcy Court's award of damages and remanding the case to Bankruptcy Court for determinations consistent with the Decision and Order. Clerk of Court to take all steps necessary to close the case. Signed by Hon. Richard J. Arcara on 9/20/2010. (JMB)

Lloyds TSB Bank plc v. CNB International, Inc. Litigation Trust

Doc. 34

UNITED STATES DISTRICT COURT W E S T E R N DISTRICT OF NEW YORK In re: C N B INTERNATIONAL, INC. Debtor, C a s e No. 99-11240 B

CNB INTERNATIONAL, INC. LITIGATION TRUST, Plaintiff-AppelleeCross Appellant, vs. LLOYDS TSB BANK plc, Defendant-AppellantCross-Appellee. DECISION AND ORDER 08-CV-774A Adversary Proceeding Case No. 01-1193B

IN T R O D U C T IO N T h is appeal concerns the liability of Lloyds TSB Bank plc ("Lloyds") for fu n d s it received as the result of a constructively fraudulent conveyance in 1996. United States Bankruptcy Judge Carl L. Bucki determined that Lloyds was liable to the CNB International, Inc., Litigation Trust (the "Trust") in the amount of $ 1 0 ,6 3 9 ,0 0 0 , plus interest computed at a federal rate totaling $2,372,526.14. CNB Int'l, Inc. v. Kelleher (In re CNB Int'l, Inc.), 393 B.R. 306 (Bankr. W .D .N .Y . 2 0 0 8 ). For the reasons set forth below, Lloyds' liability is affirmed on alternate

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grounds, and the case is remanded to Bankruptcy Court for a calculation of d a m a g e s and other determinations consistent with this opinion.

B AC K G R O U N D 1 T h e debtor in this case, CNB International, Inc. ("CNB"), was formed for the p u rp o s e of acquiring the assets of three entities: Clearing-Niagara, Inc. ("C le a rin g -N ia g a ra "), E.W . Bliss Company ("Bliss"), and Enprotech. CNB was fo rm e d by Timothy Kelleher, who served as the Chairman and Chief Executive O ffic e r of Verson plc ("Verson"). Verson was the ultimate corporate parent of C le a rin g - N ia g a r a . S in c e 1985, Verson maintained a credit relationship with Lloyds. Sometime around mid-1994, Lloyds and Verson realized that Verson's o u ts ta n d in g loans from Lloyds were significantly undersecured. To remedy the p ro b le m , Verson proposed to sell its North American assets through an initial p u b lic offering. To obtain bridge financing necessary to implement the offering, V e rs o n caused Clearing-Niagara to pledge all of its assets to Lloyds. In e xc h a n g e , Lloyds agreed to provide a $10 million bridge loan to Verson. Clearing-Niagara received none of the proceeds of that loan even though it p le d g e all of its assets as collateral. As security for the Loan, Lloyds obtained a

1

The Bankruptcy Court's opinion contains a detailed and thorough recitation of the facts. Only those relevant to this appeal are repeated here.

2

priority security interest in all of Clearing-Niagara's assets, second only to a s e c u rity interest held by Marine Midland Bank. The initial public offering never materialized. Instead, Mr. Kelleher (V e rs o n 's CEO) proposed to form a new corporation ­ CNB ­ for the purpose of a c q u irin g the assets Clearing-Niagara, Bliss and Enprotech. In order to purchase th e assets of those three entities, CNB secured a term loan in the amount of $38 m illio n from AT & T Commercial Finance Corp. ("AT&T"); a revolving credit facility in the amount of $25 million from Marine Midland Bank, N.A. ("Marine Midland"); a n d a further loan of $7,313,500 from an entity in which Kelleher and his wife w e re among the partners. As security for its revolving credit facility, Marine M id la n d received a first priority lien in all inventories, accounts and related c o n tra c ts of CNB. AT&T received a first priority lien on all other tangible and in ta n g ib le assets of CNB, and a second priority lien in the assets pledged to M a rin e Midland. C N B 's purchase of the assets closed on October 18, 1996 (the entirety of th e purchase and sale of the assets of all three entities will be referred to herein a s the "Formation Transaction"). As part of the Formation Transaction, in e xc h a n g e for the assets of Clearing-Niagara, CNB paid the sum of $43,805,838 a n d assumed various liabilities. Pursuant to written instructions approved ahead o f time by all parties to the Formation Transaction, this $43,805,838 was tra n s fe rre d from CNB's account into an account maintained by Clearing-Niagara. 3

All of these funds were immediately disbursed to other parties (again, pursuant to th e previously-approved written instructions), among them Lloyds and Marine M id la n d . Marine Midland received, inter alia, $14,471,480 in satisfaction of a p rio r loan to Clearing-Niagara, and discharged its first priority security interests in th e assets of Clearing-Niagara which were being acquired by CNB. Lloyds re c e ive d a total of $25,985,569, of which $1.6 million was security for a standby le tte r of credit issued by Lloyds relating to Clearing-Niagara's obligations re g a rd in g its employee stock ownership plan, and the remaining $24,385,569 w a s transferred into an account owned by Verson, where it was credited against V e rs o n 's overdraft credit facility and reduced Verson's debt to Lloyds by that a m o u n t. In exchange, Lloyds released its second priority security interest in the a s s e ts of Clearing-Niagara being purchased by CNB. A fte r the closing of the Formation Transaction, CNB did not achieve p ro je c tio n s and on March 10, 1999, it filed a Chapter 11 petition under the B a n k ru p tc y Code. An official committee of unsecured creditors was subsequently a p p o in te d . W h ile operating as a debtor-in-possession, CNB joined with the c o m m itte e to file this adversary proceeding. On April 26, 2001, the Bankruptcy C o u rt confirmed a plan of reorganization, which required the formation of the T ru s t to prosecute this and various other adversary proceedings for the benefit of c r e d ito r s .

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The plaintiffs initiated the present adversary proceeding against several d e fe n d a n ts to recover alleged fraudulent conveyances arising out of the F o rm a tio n Transaction. The plaintiffs subsequently resolved all of the claims e xc e p t for those against Lloyds. A s for the claims against Lloyds, the Bankruptcy Court held a lengthy trial in vo lvin g a plethora of complex legal and factual issues. Ultimately, the B a n k ru p tc y Court found that the Formation Transaction constituted a c o n s tru c tiv e ly fraudulent conveyance pursuant to New York Debtor and Creditor L a w s ("NYDCL") §§ 273 and 2742 because (i) CNB conveyed approximately $11 m illio n more to various parties than it received in exchange during the Formation T ra n s a c tio n ; (ii) CNB was rendered insolvent by reason of the Formation T ra n s a c tio n ; and (iii) CNB was left with unreasonably small capital for the b u s in e s s in which it was about to engage following the Formation Transaction. See In re CNB Int'l, 393 BR at 325-27. T h e Bankruptcy Court also concluded that Lloyds did not constitute an in itia l transferee of the funds it received as a result of the Formation Transaction fo r purposes of Bankruptcy Code § 550(a)(1), but neither did it qualify for the g o o d faith defense of Bankruptcy Code § 550(b) because Lloyds lacked good fa ith and had knowledge of the constructively fraudulent transfer. The B a n k ru p tc y Court assessed Lloyds' liability at $11,264,000, but offset that amount
2

New York's version of the Uniform Fraudulent Conveyance Act ("UFCA") is codified at N.Y. Debt. & Cred. Law §§ 270-281 (McKinney 2010).

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by $625,000 for amounts the Trust had previously received from the settling d e fe n d a n ts . The Bankruptcy Court then imposed prejudgment interest at 2.975 p e rc e n t, representing an average of the weekly one-year constant maturity T re a s u ry yields for the 392 weeks during which the case was litigated. Thus, the B a n k ru p tc y Court's imposition of liability against Lloyds totaled $10,639,000 plus $ 2 ,3 7 2 ,5 2 6 .1 4 in interest, or $13,011,526.14. B o th parties challenge the Bankruptcy Court's determination of liability and th e amount of damages assessed. The Trust challenges the rate of prejudgment in te re s t applied by the Bankruptcy Court.

D IS C U S S IO N A . Jurisdiction "T h e district courts of the United States shall have jurisdiction to hear a p p e a ls . . . from final judgments, orders and decrees . . . of bankruptcy judges e n te re d in cases and proceedings referred to the bankruptcy judges under s e c tio n 157 of this title." 28 U.S.C. § 158(a)(1). Section 157 of that title provides th a t bankruptcy judges may enter orders and judgments regarding core p ro c e e d in g s under the Bankruptcy Code. See 28 U.S.C. § 157(b)(1). Core p ro c e e d in g s include "proceedings to determine, avoid, or recover fraudulent c o n ve ya n c e s ." See 28 U.S.C. § 157(b)(2)(F). A final judgment is one where the c o u rt has made "a decision upon a cognizable claim for relief" that constitutes "an 6

ultimate disposition of [a claim]." See Curtiss-W rig h t Corp. v. General Elec. Co., 4 4 6 U.S. 1, 7 (1980). Jurisdiction lies over this appeal from the Bankruptcy C o u rt's order finding Lloyds liable for a specific amount on account of a fraudulent c o n ve ya n c e .

B . Standard of Review F in d in g s of fact are reviewed for clear error, while conclusions of law are re vie w e d de novo. See, e.g., COR Route 5 Co., LLC v. Penn Traffic Co. (In re P e n n Traffic Co.), 524 F.3d 373, 378 (2d Cir. 2008). A grant of prejudgment in te re s t and the rate used if such interest is granted are matters confided to the b a n k ru p tc y court's broad discretion, and will not be overturned on appeal absent a n abuse of that discretion. Endico Potatoes, Inc. v. CIT Group/Factoring, Inc., 6 7 F.3d 1063, 1071-72 (2d Cir. 1995).

C . Initial Transferee Under the Bankruptcy Code N e ith e r party challenges the Bankruptcy Court's conclusion that the F o rm a tio n Transaction constituted a constructively fraudulent conveyance under N Y D C L §§ 273 and 274. See CNB Int'l, 393 B.R. at 326-27. W h e re a c o n ve ya n c e is fraudulent as to creditors under state law, Bankruptcy Code § 5 4 4 (b )(1 ) provides that a trustee in bankruptcy may step into the shoes of such

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creditors and avoid the fraudulent conveyance himself. See 11 U.S.C. § 5 4 4 (b )(1 ). Bankruptcy Code § 550 states that:

(a ) Except as otherwise provided in this section, to the extent that a tra n s fe r is avoided under section 544 . . . of this title, the trustee may re c o v e r, for the benefit of the estate, the property transferred, or, if th e court so orders, the value of such property, from-- (1 ) the initial transferee of such transfer or the entity for whose b e n e fit such transfer was made; or (2 ) any immediate or mediate transferee of such initial tr a n s fe r e e . (b ) The trustee may not recover under section (a)(2) of this section fro m -- (1 ) a transferee that takes for value, including satisfaction or s e c u rin g of a present or antecedent debt, in good faith, and w ith o u t knowledge of the voidability of the transfer avoided . . .

1 1 U.S.C. § 550. The Bankruptcy Court concluded that Lloyds did not constitute an initial tra n s fe re e for purposes of Bankruptcy Code § 550(a)(1). CNB Int'l, 393 B.R. at 3 2 8 . Instead, it found that Clearing-Niagara was the initial transferee, that Lloyds w a s a subsequent transferee under Bankruptcy Code § 550(a)(2), and that L lo yd s was ultimately not entitled to the defense of Bankruptcy Code § 550(b)(1). Id. at 329-31. The Trust disputes the Bankruptcy Court's determination and a s s e rts that Lloyds, not Clearing-Niagara, was the initial transferee of funds from C N B in the Formation Transaction for purposes of Bankruptcy Code § 550(a)(1). T h e Bankruptcy Code does not define "initial transferee," and the legislative h is to ry is silent on the issue as well. See, e.g., Bonded Financial Services, Inc. v. 8

European American Bank, 838 F.2d 890, 893 (7th Cir. 1988). It is accepted that th e first entity in physical possession of funds is not necessarily a "transferee": "Transferee" is not a self-defining term; it must mean something d iffe re n t from "possessor" or "holder" or "agent." To treat "tra n s fe re e " as "anyone who touches the money" and then to escape th e absurd results that follow is to introduce useless steps; we slice th e s e off with Occam's Razor and leave a more functional rule.

Id. at 894. T h e Second Circuit test for determining whether an entity constitutes an in itia l transferee is the "mere conduit" test, which was adopted in Christy v. A le xa n d e r & Alexander of N.Y., Inc. (In re Finley, Kumble, W a g n e r, Heine, U n d e rb e rg , Manley, Myerson & Casey), 130 F.3d 52 (2d Cir. 1997). Finley, K u m b le held that "a commercial entity that, in the ordinary course of its business, a c ts as a mere conduit for funds and performs that role consistent with its c o n tra c tu a l undertaking in respect of the challenged transaction, is not an initial tra n s fe re e within the meaning of § 550(a)(1)." Id. at 57-59. F in le y , Kumble did not provide a general definition for a mere conduit, but did explicitly adopt the logic of the Seventh Circuit as articulated in Bonded and its progeny. Id. at 58. Bonded is the seminal case on the issue of initial tra n s fe re e s , and the Fourth, Fifth, Sixth, Ninth, Tenth and Eleventh Circuits have a ls o adopted some version of the Bonded standard, referred to as the "dominion" a n d /o r "control" test. See, e.g., Andreini & Co. v. Pony Express Delivery Serv.,

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Inc. (In re Pony Express Delivery Serv., Inc.), 440 F.3d 1296, 1300 (11th Cir. 2 0 0 6 ); Taunt v. Hurtado (In re Hurtado), 342 F.3d 528, 533 (6th Cir. 2003); Bailey v. Big Sky Motors, Ltd. (In re Ogden), 314 F.3d 1190, 1202 (10th Cir. 2002); B o w e rs v. Atlanta Motor Speedway, Inc. (In re Southeast Hotel Prop. Ltd. P'ship), 9 9 F.3d 151, 156 (4th Cir. 1996); Sec. First Nat'l Bank v. Brunson (Matter of C o u te e ), 984 F.2d 138, 141 (5th Cir. 1993); Danning v. Miller (In re Bullion R e s e rve of N. Am.), 922 F.2d 544, 549 (9th Cir. 1991). The simplest statement of th e dominion and control test from Bonded provides that: "the minimum re q u ire m e n t of status as a `transferee' is dominion over the money or other asset, th e right to put the money to one's own purposes." See 838 F.2d at 893.3 N o n e of the circuit-level decisions features a transaction completely a n a lo g o u s to that which was before the Bankruptcy Court, but all are consistent in a p p lyin g the concept of legal dominion or control over the funds at issue as d is p o s itive . See, e.g., Incomnet, 463 F.3d at 1075 (non-profit corporation was the in itia l transferee and not a mere conduit of statutorily-mandated contributions fro m telecommunications providers where the corporation had some discretion o ve r the distribution of such funds; "[t]hese legal restrictions merely limit how [the
3

In Bear, Stearns Sec. Corp. v. Gredd (In re Manhattan Inv. Fund Ltd.), 397 B.R. 1 (S.D. N.Y. 2007), the Southern District suggested that the Second Circuit's mere conduit test frames Bonded's "dominion and control" test in the negative. Rather than stating that a party is an initial transferee if it exercises "dominion and control" over the funds, the Second Circuit's version of the test states that a party is not an initial transferee if it was a "mere conduit" of the funds. Id. at 14-15. This distinction, though helpful conceptually, does not affect the substance of the underlying analysis.

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initial transferee] will exercise its dominion over the funds; they do not preclude [th e initial transferee] from having dominion at all."); Andreini, 440 F.3d at 1302 (in s u ra n c e broker was not an initial transferee of funds from client to insurance p ro vid e r despite the broker having paid the provider before the client's check to th e broker cleared; "[a]t no time were the transferred funds under the unrestricted le g a l control of [the broker] . . . . [F]unds could only be used for the client's p u rp o s e s . . . ."); Hurtado, 342 F.3d at 534-35 (transferor's mother was the initial tra n s fe re e of funds that she distributed at the transferor's subsequent directions; "[th e mother] was not under any legal obligation to follow the [transferor's] d ire c tio n s ."); Ogden, 314 F.3d at 1203-04 (escrow company was not an initial tra n s fe re e where transferor had fraudulently taken funds out of escrow before re p la c in g them after the escrow company discovered the fraud; "the fact that [the e s c ro w company] caused [the transferor] to transfer the disputed funds and re c e ive d some benefit [i.e., it was no longer subject to breach of fiduciary duty c la im s by the initial transferee] from this transfer is insufficient to establish that [th e escrow company] had dominion and control over those funds."); Bowers, 99 F .3 d at 156-57 (corporate management company and its president were not initial tra n s fe re e s where they caused funds from two entities the company managed to b e transferred to satisfy a debt on behalf of another corporation owned by the c o m p a n y's president; "[a]t the time the transfers were effected, [the management c o m p a n y and its president] were acting in their representative capacity as 11

manager . . . . Therefore, neither . . . had the authority to exercise legal dominion a n d control over the funds."); Coutee, 984 F.2d at 141 (law firm was a mere c o n d u it where it received settlement funds on behalf of clients, a portion of which fu n d s were transferred to a bank to repay a loan, making the bank the initial tra n s fe re e ; "the law firm had no legal right to put the funds to its own use, and th u s lacked the requisite dominion required to be the initial transferee."); First N a t'l Bank of Barnesville v. Rafoth (In re Baker & Getty Fin. Serv.), 974 F.2d 712, 7 2 2 (6th Cir. 1992) (transferor gave check to his agent to apply to the transferor's lo a n indebtedness at a bank, but the bank told the agent to deposit the check into th e agent's account until it cleared, at which point the funds were immediately g ive n over to the bank as the initial transferee; "[t]he fact that the money was te m p o ra rily lodged in [the agent's] account does not alter the facts . . . . [I]n law th e money was not [the agent's] and he was simply acting at the direction of [the tra n s fe ro r]."); Bullion Reserve, 922 F.2d at 549 (funds were transferred to an in d ivid u a l, who used them to purchase shares of stock in his and his partner's n a m e , which shares were immediately pledged back to the transferor of the funds p u rs u a n t to a contract; partner was not a transferee because he "had no d o m in io n over the money, nor could he put the money to his own purposes." (q u o ta tio n s omitted)); Nordberg v. Societe Generale (In re Chase & Sanborn C o rp .), 848 F.2d 1196, 1200-01 (11th Cir. 1988) (bank was a mere conduit where it received funds from the transferor to cover a paper overdraft in an account 12

owned by the initial transferee; "there was no real debtor-creditor relationship . . . th e bank merely deposited the funds into [the initial transferee's] account, and [th e initial transferee] used that money to pay the check [that caused the o ve rd ra ft.] W h e n viewed in that manner, [the bank] functioned as a conduit . . . ."); Bonded, 838 F.2d at 893 (bank was not an initial transferee of a check made p a ya b le to its order but accompanied by a note instructing the bank to "deposit th is check into" a specified account; the bank "held the check only for the purpose o f fulfilling an instruction to make the funds available to someone else."). These c a s e s make clear that Clearing-Niagara is an initial transferee only if it exercised le g a l dominion and control over the funds from CNB. See, e.g., Bonded, 838 F .2 d at 893. If not, it was a mere conduit and Lloyds would constitute the initial tra n s fe re e . See, e.g., Finley, Kumble, 130 F.3d at 57-59. This Court agrees with the Trust and finds that Lloyds, not ClearingN ia g a ra , was the initial transferee of the finds. Clearing-Niagara was a mere c o n d u it because it never exercised any dominion and control over the $ 2 5 ,9 8 5 ,5 6 9 transferred to Lloyds. See, e.g., Baker & Getty, 974 F.2d at 722; B u llio n Reserve, 922 F.2d at 549. Clearing-Niagara's receipt of those funds in th e first instance was conditioned upon their immediate transfer to Lloyds. (Def.'s E xs . 116 and 117 at Lloyds' App. 5936-45; 5946-49). Lloyds, not ClearingN ia g a ra , was the initial transferee of those funds under Bankruptcy Code § 5 5 0 (a )(1 ). 13

Lloyds cites Lowry v. Sec. Pacific Bus. Credit, Inc. (In re Columbia Data P ro d ., Inc.), 892 F.2d 26 (4th Cir. 1989) in support of its claim that it was not an in itia l transferee. In that case, the Court stated: "[the initial transferee] used the fu n d s for its own purpose - to reduce its debt to [the subsequent transferee]. The fa c t that [the initial transferee] could not have used the funds for other purposes d o e s not affect this critical factor." Id. at 29. The initial transferee in Lowry had, p rio r to the challenged transfer, granted the subsequent transferee a security in te re s t in its accounts receivable, and the subsequent transferee was entitled to a ll funds which the initial transferee deposited into the subject account. Id. at 27. This, according to Lloyds, is similar to what it asserts was Clearing-Niagara's p a ym e n t to Lloyds on account of Lloyds' security interest in Clearing-Niagara's a s s e ts . H o w e v e r, the crucial distinction between the Lowry transaction and the F o rm a tio n Transaction is that the initial transfer from CNB was contractually c o n d itio n e d upon, inter alia, Clearing-Niagara's immediate transfer of the funds to L lo yd s for the release of Lloyds' security interest in Clearing-Niagara's assets w h ic h CNB was acquiring; Clearing-Niagara never had any discretion to do a n yth in g else with the $25,985,569. (Def.'s Exs. 116 and 117 at Lloyds' App. 5 9 3 6 -4 5 ; 5946-49). Put differently, the transferor in Lowry did not care what the in itia l transferee did with the funds once they left the transferor's possession, see 8 9 2 F.2d at 29; at that point the funds were at the discretion of the initial 14

transferee, which discretion the transferee had already exercised by contracting w ith the subsequent transferee. See id.; see also Incomnet, 463 F.2d at 1075. In c o n tra s t, CNB, as the transferor, would not have transferred its funds in the first in s ta n c e if Clearing-Niagara had not been bound to transfer them immediately to L lo yd s in exchange for, inter alia, the release of Lloyds' second priority security in te re s t in Clearing-Niagara's assets. (Def.'s Exs. 116 and 117 at Lloyds' App. 5 9 3 6 -4 5 ; 5946-49).4 F o r these reasons, for purposes of Bankruptcy Code § 550, ClearingN ia g a ra constituted a mere conduit and Lloyds was the initial transferee of $ 2 5 ,9 8 5 ,5 6 9 from CNB during the Formation Transaction.

D . Liability under New York Debtor & Creditor Laws T h e conclusion that Lloyds constitutes an initial transferee does not end the a n a lys is , however. Bankruptcy Code § 550(a)(1) provides that a trustee may re c o ve r property from an initial transferee "to the extent that a transfer is avoided
4

This point makes the other authorities cited by Lloyds equally unavailing. See, e.g., W ebster v. E.I. Kane Constr., Inc. (In re NETtel Corp., Inc.), 2004 WL 3130571, *2 (Bankr. D. D.C. 2004) (payment was "compensation to [initial transferee] for work performed by [the initial transferee] (albeit through the use of subcontractors)," such that the initial transferee/contractor was not a mere conduit for payments to subcontractors); Ragsdale v. South Fulton Mach. W orks, Inc. (In re Whitacre Sunbelt, Inc.), 200 B.R. 422, 426 (Bankr. N.D. Ga. 1996) (where insider cashed a check to himself from debtor and then wrote a check to another entity to secure release of his guaranty of a debt owed by that debtor, insider "did use [the funds] for his own benefit-to pay off a debt that he personally guaranteed."); Billings v. Key Bank of Utah (In re Granada, Inc.), 156 B.R. 303, 308 (C.D. Utah 1990) ("The partnerships properly exercised control over the funds through . . . their general partner. [The general partner's] control over the funds was also the partnerships' control over the funds," such that partnerships were not mere conduits).

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under section 544 . . . ." 11 U.S.C. § 550(a)(1). Bankruptcy Code § 544, in turn, s ta te s in relevant part: "the trustee may avoid any transfer of an interest of the d e b to r in property . . . that is voidable under applicable law by a creditor holding a n unsecured claim . . . ." 11 U.S.C. § 544(b)(1). The applicable law in this case is the New York Debtor & Creditor Laws. A s stated, the parties do not challenge the Bankruptcy Court's conclusion th a t the Formation Transaction constituted a constructively fraudulent c o n ve ya n c e under NYDCL §§ 273 and 274. W h e re a fraudulent transaction has o c c u rre d , NYDCL § 278 delineates the extent of a transferee's liability to a c re d ito r harmed by such a transaction: 1. W h e re a conveyance or obligation is fraudulent as to a creditor, such c re d ito r, when his claim has matured, may, as against any person e x c e p t a purchaser for fair consideration without knowledge of the fra u d at the time of the purchase, or one who has derived title im m e d ia te ly or mediately from such a purchaser,

a.

Have the conveyance set aside or obligation annulled to the e x te n t necessary to satisfy his claim, or Disregard the conveyance and attach or levy execution upon th e property conveyed.

b.

2.

A purchaser who without actual fraudulent intent has given less than a fair consideration for the conveyance or obligation, may retain the p ro p e rty or obligation as security for repayment.

N .Y . Debt. & Cred. Law § 278.

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Thus, notwithstanding that a fraudulent conveyance has occurred, a p u rc h a s e r for fair consideration who takes without knowledge of the fraud has a c o m p le te defense to a creditor's attempt to have the conveyance set aside. See N .Y . Debt. & Cred. Law § 278(1). Similarly, a purchaser who does not have a c tu a l fraudulent intent but who gives less than fair consideration may retain the p ro p e rty as security for repayment; in effect, such a purchaser is only liable for th e difference between the value it conferred to the debtor and the amount it re c e ive d in exchange. See N.Y. Debt. & Cred. Law § 278(2).5

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The Bankruptcy Court stated that the "damages" in a fraudulent conveyance action under the New York Debtor & Creditor Laws are measured as the difference between the value of the property conveyed and received by the transferor, and that under Bankruptcy Code § 550(a), "[w]hen a defendant has paid some but less than full consideration, that value [recoverable by the trustee] is set as the amount of the inadequacy." CNB Int'l, 393 B.R. at 332. Notwithstanding that these two statements do not have the same meaning, the Bankruptcy Court concluded that where CNB paid a consideration that was $11,264,000 greater than the value of assets that it acquired through the formation transaction . . . [t]hat inadequacy of consideration will constitute damages that plaintiffs may recover as a fraudulent conveyance from a proper party defendant. Id. However, under NYDCL § 278, "where actual intent to defraud creditors is proven, the conveyance will be set aside regardless of the adequacy of the consideration given." Sharp Int'l Corp. v. State Street Bank & Trust Co. (In re Sharp Int'l Corp.), 403 F.3d 43, 56 (2d Cir. 2005), quoting U.S. v. McCombs, 30 F.3d 310, 328 (2d Cir. 1994). Moreover, a transferee's liability under the plain language of NYDCL § 278 is determined by the inadequacy of the value conveyed by the transferee in exchange for the property it receives in a fraudulent conveyance, rather than the inadequacy received by the transferor. See N.Y. Debt. & Cred. Law § 278. See Brown v. Kimmel, 414 N.Y.S.2d 226 (2nd Dept. 1979) (plaintiff's claim against transferees of intentionally fraudulent conveyance under DCL § 278 is "limited only by the value of the transferred property" without discussing consideration given in return); Langan v. First Trust & Deposit Co., 101 N.Y.S.2d 36 (4th Dept. 1950) (court discusses "damages alleged to have resulted from claimed illegal transfer of bankruptcy assets," not a fraudulent transfer action under NYDCL § 278).

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The Bankruptcy Court engaged in this analysis, but it did so consistent with its determination that Lloyds was a subsequent transferee under the Bankruptcy C o d e and contemplating Clearing-Niagara as the purchaser. See CNB Int'l, 393 B .R . at 331-33. However, just as Lloyds constituted the initial transferee for p u rp o s e s of Bankruptcy Code § 550, Lloyds is more appropriately viewed as the p u rc h a s e r under NYDCL § 278 when the Formation Transaction is "collapsed." "It is well established that multilateral transactions may under appropriate c irc u m s ta n c e s be `collapsed' and treated as phases of a single transaction for a n a lys is under [the New York Debtor and Creditor Laws]." HBE Leasing Corp. v. F ra n k , 48 F.3d 623, 635 (2d Cir. 1995), citing Orr v. Kinderhill Corp., 991 F.2d 31, 3 5 -3 6 (2d Cir. 1993).

In equity, substance will not give way to form, [and] technical c o n s id e ra tio n s will not prevent substantial justice from being done. . . . Thus, an allegedly fraudulent conveyance must be evaluated in c o n te xt; [w]here a transfer is only a step in a general plan, the plan m u s t be viewed as a whole with all its composite implication.

O rr v. Kinderhill, 991 F.2d at 35 (internal quotations omitted). "In deciding w h e th e r to collapse the transaction and impose liability on particular defendants, th e courts have looked frequently to the knowledge of the defendants of the s tru c tu re of the entire transaction6 and to whether its components were part of a
6

This knowledge requirement is different than knowledge for the purposes of Bankruptcy Code § 550(b)(1). See CNB Int'l, 393 B.R. at 330-31. Knowledge for purposes of collapsing is knowledge of the multiple, integrated layers of the transaction rather than knowledge of any fraud or voidability. See In re Best Products Co., Inc., 168 B.R. 35, 57 (Bankr. S.D. N.Y. 1994).

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single scheme." HBE Leasing, 48 F.3d at 635-36, quoting In re Best Products C o ., Inc., 168 B.R. 35, 56-57 (Bankr. S.D. N.Y. 1994). In this case, it is beyond dispute that Lloyds had notice of the structure of th e entire transaction ­ indeed, all of the various stages were contemplated and a u th o riz e d by each of the participants ahead of time. (Def.'s Exs. 116 and 117 at L lo yd s ' App. 5936-45; 5946-49). Therefore, it is appropriate to collapse the tra n s a c tio n to evaluate Lloyds' liability as the recipient of a fraudulent conveyance fro m CNB. See Orr v. Kinderhill, 991 F.2d at 35. T h e effect of collapsing the Formation Transaction is that CNB transferred $ 2 5 ,9 8 5 ,5 6 9 to Lloyds in exchange for (i) a standby letter of credit in the amount o f $1.6 million to be drawn, if necessary, to meet obligations regarding ClearingN ia g a ra 's employee stock ownership plan, and (ii) the release of Lloyds' second p rio rity security interest in the assets CNB was acquiring from Clearing-Niagara. (Lloyds' Br. in Supp. of Appeal at 33-34). If these exchanges were for fair c o n s id e ra tio n and without knowledge of any fraud, then Lloyds has a complete d e fe n s e to liability for its receipt of the funds. See N.Y. Debt. & Cred. Law § 2 7 8 (1 ). Alternatively, if Lloyds gave something less than fair consideration but la c k e d actual fraudulent intent, it is only liable for the difference between the

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amount it received and the value it conveyed. See N.Y. Debt. & Cred. Law § 2 7 8 (2 ).7 F a ir consideration, as contemplated by NYDCL § 278, is elsewhere defined in the New York Debtor and Creditor Laws: "Fair consideration is given for p ro p e rty . . . [w]hen in exchange for such property . . . , as a fair equivalent th e re fo r [sic], and in good faith, property is conveyed or an antecedent debt is s a tis fie d ." N.Y. Debt. & Cred. Law § 272.

T h e fair consideration test "is profitably analyzed as follows: (1) . . . th e recipient of the debtor's property[ ] must either (a) convey p ro p e rty in exchange or (b) discharge an antecedent debt in e xc h a n g e ; and (2) such exchange must be a `fair equivalent' of the p ro p e rty received; and (3) such exchange must be `in good faith.'"

S h a rp Int'l Corp. v. State Street Bank & Trust Co. (In re Sharp Int'l Corp.), 4 0 3 F.3d 43, 53 (2d Cir. 2005), quoting HBE Leasing Corp. v. Frank, 61 F .3 d 1054, 1058-59 (2d Cir. 1995). H o w e v e r, the Second Circuit has previously stated that "[g]ood faith is an e lu s ive concept in New York's constructive fraud statute. It is hard to locate that c o n c e p t in a statute in which `the issue of intent is irrelevant.'" Sharp Int'l, 403 F .3 d at 54, quoting U.S. v. McCombs, 30 F.3d at 326 n.1. Indeed,
7

Strictly speaking, NYDCL § 278(2) would allow Lloyds to retain the property it received in security for repayment of whatever amount it conveyed. However, since the property that Lloyds received was simply cash, if Lloyds conveyed less than it received, the more effective remedy is to require Lloyds to return that difference.

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W h e re , as here, a transferee has given equivalent value in exchange fo r the debtor's property, the statutory requirement of "good faith" is s a tis fie d if the transferee acted without either actual or constructive k n o w le d g e of any fraudulent scheme. See Atlanta Shipping Corp. v. C h e m ic a l Bank, 818 F.2d 240, 249 (2d Cir. 1987); 1 Garrard Glenn, F ra u d u le n t Conveyances and Preferences § 295, at 512 (1940) (U F C A requirement of "good faith" refers solely to "whether the g ra n te e knew, or should have known, that he was not trading n o rm a lly, but that . . . the purpose of the trade, so far as the debtor w a s concerned, was the defrauding of his creditors").

H B E Leasing Corp. v. Frank, 48 F.3d 623, 636 (2d Cir. 1995). This is consistent with the purposes of fraudulent conveyance law (as d is tin g u is h e d from preference actions):

A s the definition of "fair consideration" in [NY]DCL § 272 makes c le a r, even the preferential repayment of pre-existing debts to some c re d ito rs does not constitute a fraudulent conveyance, whether or n o t it prejudices other creditors, because "[t]he basic object of fra u d u le n t conveyance law is to see that the debtor uses his limited a s s e ts to satisfy some of his creditors; it normally does not try to c h o o s e among them."

Id . at 634 (quoting Boston Trading Group, Inc. v. Burnazos, 835 F.2d 1504, 1508 (1 s t Cir. 1987)); see also Ultramar Energy Ltd. v. Chase Manhattan Bank, N.A., 1 9 1 A.D.2d 86, 90-91, 599 N.Y.S.2d 816, 819 (1st Dep't 1993). T h u s , for purposes of the New York Debtor and Creditor Laws, where the tra n s fe re e of a fraudulent conveyance takes property in exchange for value, "and to the extent" that transferee exchanges value, that transfer is excepted "from

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avoidance as a fraudulent conveyance under . . . the NYDCL." See Foxmeyer D ru g Co. v. GE Capital Corp. (In re Foxmeyer Corp.), 286 B.R. 546, 580 (Bankr. D . Del. 2002). In other words, to the extent that Lloyds received property from C N B in exchange for value, Lloyds would not have liability as the transferee of a fra u d u le n t conveyance, notwithstanding any arguments as to lack of good faith. See N.Y. Debt. & Cred. Law § 278.8 A s a result of the Formation Transaction, Lloyds received $25,985,569 in cash in exchange for (i) a standby letter of credit in the amount of $1.6 million to be d ra w n , if necessary, to meet Clearing-Niagara's obligations regarding its e m p lo ye e stock ownership plan, and (ii) the release of Lloyds' second priority

8

For purposes of NYDCL § 278(2), it is undisputed that Lloyds lacked actual fraudulent

intent: [T]he language "actual fraudulent intent" under NYDCL § 278(2) has been construed such that it is satisfied if a "transferee participated or acquiesced in the transferor's fraudulent design." 13 Romualdo P. Eclavea, Carmody-Wait 2d New York Practice with Forms §§ 85-29 & 85-30 (2002) (emphasis added). Participation and/or acquiescence in a transferor's fraudulent design, in turn, has been found to exist if, inter alia, a transferee had knowledge of a transferor's fraudulent intent. See id.; In re Deitz' Estate, 196 Misc. 893, 93 N.Y.S.2d 597, 600 (N.Y.Sur.Ct.1949); Berlenbach v. Bischoff, 137 Misc. 719, 244 N.Y.S. 369, 371 (N.Y.Sup.Ct. Spec. Term 1930). Accordingly, the language "without actual fraudulent intent" under NYDCL § 278(2) must mean without participation in or knowledge of a transferor's fraudulent scheme . . . . Foxmeyer Corp., 286 B.R. at 580. Thus, in order for Lloyds to have actual fraudulent intent for purposes of NYDCL § 278(2), the transferor must also have had such intent. See id. But the Bankruptcy Court, prior to this trial, granted a motion for summary judgment as to the Trust's counts that related to intentionally fraudulent conveyances under NYDCL §§ 275 and 276. Therefore, Lloyds cannot have actual fraudulent intent for purposes of NYDCL § 278(2).

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security interest in the assets CNB was acquiring from Clearing-Niagara. (Lloyds' B r. in Supp. of Appeal at 33-34).9 U n fo rtu n a te ly, the value conveyed by Lloyds to CNB when Lloyds released its second priority security interest in Clearing-Niagara's assets is not discernible o n the existing record. The Bankruptcy Court did conclude that the business e n te rp ris e value of CNB following the Formation Transaction was approximately $ 5 9 million, see CNB Int'l, 393 B.R. at 324,1 0 and it also suggested that the Bliss a s s e ts might have been worth $15 million while the Enprotech assets acquired by C N B might have been worth $14 million. Id. at 325. If those numbers were c o rre c t, then the Clearing-Niagara assets were worth approximately $30 million ($ 5 9 million ­ ($15 million + $14 million)). Marine Midland held a first priority
9

As to the former of these exchanges, Lloyds clearly conveyed a fair equivalent for its receipt of $1.6 million in that Lloyds provided a standby letter of credit in that amount Any argument that Lloyds did not exchange with CNB for the $1.6 million would appear to be without merit, since: [W ]hen a debtor transfers its property but the transferee gives the consideration to a third party, the debtor ordinarily will not have received fair consideration in exchange for its property. However, under the well established doctrine of Rubin v. Manufacturers Hanover Trust Co., 661 F.2d 979 (2d Cir. 1981), the fact that the consideration initially goes to third parties may be disregarded to the extent that the debtor indirectly receives a benefit from the entire transaction. HBE Leasing Corp., 61 F.3d at 638. Here, CNB received an indirect benefit from the $1.6 million standby letter of credit in that Clearing-Niagara's obligations otherwise became CNB's obligations as a result of the Formation Transaction ­ if CNB had not paid the $1.6 million to Lloyds during the Formation Transaction, it would still have been liable for that obligation following the Formation Transaction.

10

Lloyds' argues that the Bankruptcy Court erred in its adjustment of the discount rate used to determine the business enterprise value of CNB. The Bankruptcy Court is free, on remand, to consider this contention if it uses the same method to calculate the value of the ClearingNiagara assets if it so chooses.

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security interest in those assets, which it discharged upon receipt of a p p ro xim a te ly $14.5 million during the Formation Transaction. (Lloyds' Br. in S u p p . of Appeal at 33). Based on these estimates, it appears that Lloyds re c e ive d $24,385,569 in exchange for the release of a second priority security in te re s t which was only worth approximately $15.5 million. If this is the case then, p u rs u a n t to NYDCL § 278(2) (and via Bankruptcy Code §§ 544(b) and 550(a)), L lo yd s is liable to CNB for approximately $9 million. However, because the p re c is e value to CNB of the second priority security interest released by Lloyds c a n n o t be based upon the existing record, remand to the Bankruptcy Court for th a t determination is necessary.

E.

R e m a in in g Arguments T h e parties have raised additional arguments relating to the Bankruptcy

C o u rt's imposition of damages in the first instance which it might be helpful to a d d re s s prior to remand. First, there is no merit to Lloyds' suggestion that its lia b ility ought to be reduced based upon the percentage1 1 of the funds it received a s a result of the Formation Transaction. As discussed above, the amount of L lo yd s ' liability is dependent solely on the value it provided to CNB by releasing its second priority security interest in Clearing-Niagara's assets; any other entity's lia b ility (or lack thereof) is completely independent of Lloyds' liability. Similarly,
11

Percentage either of the total amount conveyed by CNB, or of the amount conveyed via the Clearing-Niagara portion of the transaction.

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Lloyds is not entitled to any "offsets" under Bankruptcy Code § 550(d) for a m o u n ts collected by the Trust in settlement with other parties to the Formation T ra n s a c tio n . Under the plain language of that section, "[t]he trustee is entitled to o n ly a single satisfaction under subsection (a) of this section." 11 U.S.C. § 5 5 0 (d ). But the amounts recovered by the Trust in settlement from other parties a re independent of the amount of Lloyds' liability, in that none of those parties w e re immediate or mediate transferees of Lloyds as the initial transferee. See 11 U .S .C . § 550(a)(2). T h u s , the amount of Lloyds' liability will be determined solely by subtracting th e value Lloyds conveyed to CNB in releasing the second priority security in te re s t Lloyds held in Clearing-Niagara's assets from the $24,385,569 that L lo yd s received from CNB during the Formation Transaction. See 11 U.S.C. §§ 5 4 4 (b ), 550(a); N.Y. Debt. & Cred. Law § 278(2). W h ile the parties do not challenge the propriety of awarding prejudgment in te re s t, or the date from which such interest should be calculated, the Trust c o n te n d s that the Bankruptcy Court erred by applying a federal rate of interest, ra th e r than the New York statutory rate of interest. The Second Circuit has stated th a t the rate of prejudgment interest to be applied is reviewed for abuse of d is c re tio n . Endico Potatoes, Inc. v. CIT Group/Factoring, Inc., 67 F.3d at 10717 2 , quoting Commercial Union Assurance Co. v. Milken, 17 F.3d 608, 613-14 (2d C ir. 1994), cert. denied, 513 U.S. 873 (1994). 25

[D]iscretionary awards of prejudgment interest are permissible under fe d e ra l law in certain circumstances . . . . [T]he award should be a fu n c tio n of (i) the need to fully compensate the wronged party for a c tu a l damages suffered, (ii) considerations of fairness and the re la tiv e equities of the award, (iii) the remedial purpose of the statute in vo lv e d , and/or (iv) such other general principles as are deemed re le va n t by the court.

W ic k h a m Contracting Co., Inc. v. Local Union No. 3, Int'l Brotherhood of Elec. W o rk e rs , AFL-CIO, 955 F.2d 831, 833-34 (2d Cir. 1992) (citations omitted). "The c o u rt must, however, explain and articulate its reasons for any decision regarding p re ju d g m e n t interest." Henry v. Champlain Enter., Inc., 445 F.3d 610, 623 (2d C ir. 2006). In this case, the Bankruptcy Court opined that:

T h e right to recover prejudgment interest on a fraudulent c o n v e y a n c e arises from that language in [Bankruptcy Code] § 550(a) w h ic h allows a trustee to recover "the value" of the transferred p ro p e rty . To obtain such value, the plaintiffs need some a c c o m m o d a tio n for the time value of money. Prejudgment interest fu lfills this purpose.

C N B Int'l, 393 B.R. at 335-36. The Bankruptcy Court went on to discuss where it fo u n d the appropriate federal interest rate, and why it chose to average that rate fo r "the 392 weeks during which this matter has been litigated." Id. at 336. It d e te rm in e d that rate to be 2.975 percent, which the bankruptcy court found "fairly re fle c ts the time value of money." Id.

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Notwithstanding that other courts within the Second Circuit, see, e.g., G e ltz e r v. Artists Marketing Corp. (In re Cassandra Group), 338 B.R. 583, 5996 0 0 (Bankr. S.D. N.Y. 2006), have applied the New York statutory rate to fra u d u le n t conveyance recoveries under Bankruptcy Code § 544(b)(1), there is s u p p o rt for the imposition of a federal rate in such circumstances. See Lewis v. H a rlin (In re Harlin), 325 B.R. 184, 192 (Bankr. E.D. Mich. 2005) ("[T]he Trustee is confusing her ability to bring an avoidance action under [Bankruptcy Code] § 5 4 4 (b )(1 ) with the remedies available once a transfer has been avoided. The T ru s te e obtained her judgment in federal court and her right to interest is c o n tro lle d by federal law."). In light of the lack of uniformity in the case law on this issue, and in light of th e rational provided by the Bankruptcy Court in support of the rate it imposed, it c a n n o t be said that the Bankruptcy Court abused its discretion in applying a fe d e ra l rate of prejudgment interest. See U.S. v. McCallum, 584 F.3d 471, 474 (2 d Cir. 2009), quoting U.S. v. Lombardozzi, 491 F.3d 61, 78-79 (2d Cir. 2007).

C O N C L U S IO N F o r the reasons set for above, Lloyds' liability is affirmed on alternate g ro u n d s , the Bankruptcy Court's award of damages is vacated, and the case is re m a n d e d to the Bankruptcy Court for determinations consistent with this opinion.

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SO ORDERED.

s/ Richard J. Arcara
HONORABLE RICHARD J. ARCARA UNITED STATES DISTRICT JUDGE DATED: September 20, 2010

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