Restructuring

Contributed by Yvanna Custodio
In American Federated Title Corp. v. GFI Management Services, Inc., the United States District Court for the Southern District of New York had occasion to discuss the interplay between corporate veil piercing and fraudulent transfer claims under New York law, finding that although certain loan repayments by the debtor companies to their principals and an affiliated entity satisfied the objective standards for constructive fraudulent transfers under New York Debtor and Creditor Law, the circumstances surrounding such payments would not necessarily justify applying the more stringent standards for disregarding the corporate form. 
In American Federated, the plaintiff sued four limited liability companies for breach of contract and unpaid rent, which culminated in a settlement judgment in the plaintiff’s favor.  The defendants, however, failed to pay the judgment.  As a result, the plaintiff sought to hold the owners of the LLCs and an affiliated corporation liable under veil-piercing and fraudulent transfer theories, pointing to the payment of management fees to the affiliated corporation by the debtors and repayments of loans made to the debtors’ insiders while the debtors were insolvent.
In denying the veil-piercing claim, the district court reiterated the high standard for piercing the corporate veil under New York law, emphasizing the oft-quoted statement, “the corporate form is not lightly to be disregarded.”  When determining whether the equitable remedy of veil-piercing is appropriate, “New York courts apply a two-prong standard that requires proof of both external control and wrongdoing.”  Although the district court noted that the allegations of “purposeful asset-stripping” by the defendants during the motion-to-dismiss phase would justify piercing the corporate veil under New York law, during trial, the plaintiff “failed to offer adequate proof that [the d]efendants completely dominated [the debtors and their affiliated company] and compelled them to perform several wrongful acts, all of which were part of a sustained effort to siphon assets.”  Thus, the court declined to pierce the veil because the plaintiff failed to meet its burden.
The district court also distinguished between actually fraudulent transfers and constructively fraudulent transfers.  Unlike actually fraudulent transfers, which are transfers made “to hinder, delay, or defraud either present or future creditors,” constructively fraudulent transfers, on the other hand, are “defined exclusively by the objective conditions of the asset transfer at issue, without regard to the debtor’s intent in making the transfer.”  In order to be constructively fraudulent, a transfer must lack “fair consideration” and involve a debtor “who is or will be thereby rendered insolvent.”  Although the court found no basis to avoid the debtors’ payment of management fees (citing insufficient evidence supporting a lack of fair consideration), the court, however, granted the constructive fraudulent transfer claim with regard to the loan repayments because the elements of insolvency, lack of fair consideration, and payments to an insider were met.  In so ruling, the court highlighted the interplay between constructively fraudulent transfers and corporate veil piercing, explaining that because a constructively fraudulent transfer does not require actual intent to defraud, the evidence supporting such a claim may not be enough to disregard the corporate form, which requires proof of both “external control and wrongdoing.”  According to the court, “Absent persuasive evidence of a culpable motive, . . . a claim that is successful [on constructive fraudulent transfer grounds] may not establish wrongdoing sufficient to justify veil-piercing.”
As American Federated demonstrates, creditors seeking to increase the size of the pie by developing legal theories aimed at avoiding a debtor’s transfers (through actual or constructive fraudulent transfer arguments) or pursuing assets of the debtor’s equity holders (through the remedy of veil-piercing), will be well-served in remembering that satisfying the standards for one legal theory may not be sufficient to support relief on what may appear to be a similar ground.  For our loyal readers interested in learning more about veil piercing under New York law, read one of our past posts, Plain Vanilla Veil Piercing Still Alive and Well in New York.
Yvanna Custodio is an Associate at Weil, Gotshal & Manges LLP in New York.