Grochocinski v. Schlossberg, et. al. (In re Eckert)
The chapter 7 trustee filed this adversary proceeding in order to avoid the transfer of two different real properties: the “Union Court” property and the “Turnbridge” property. The details of the transactions are described herein.
Union Court
The debtor entered into a sales contract for this new home on Union Court in Bartlett, Ill., on Aug. 4, 2002. Over the next year the debtor made cash payments of $120,000 toward the purchase price of the house, which was $804,674.50. By the time the house was finished, the debtor could not obtain a mortgage to finance the remainder he owed.
The debtor subsequently entered into an agreement with David Schlossberg and Gary Laliberte whereby the partnership of Schlossberg and Laliberte would purchase Union Court using the $120,000 already invested by the debtor as a down payment. The debtor would then pay rent and maintain an option to repurchase the property from Schlossberg and Laliberte at a later date for an agreed upon amount. The debtor’s $120,000 contribution would allegedly also be preserved as equity in the house for the debtor upon his repurchase. This transaction occurred in June 2003.
The debtor signed his right to repurchase the property over to his wife, Christine—though he admitted at trial that this was forged. Later, in October 2005, the debtor orchestrated a further sale of the property after continuously missing payments to Schlossberg and Laliberte. This sale occurred from Schlossberg and Laliberte to a Marcelo Carlos for $920,000. The sale to Carlos turned a net profit of approximately $200,000. When this money was disbursed at the closing, $76,000 was paid to Schlossberg and Laliberte, then transferred by check to Christine Eckert, who then signed the check over to Carlos, the buyer! Another $52,357.54 was paid to Schlossberg and Laliberte. These transfers were being challenged in the trustee’s adversary proceeding.
Turnbridge
In November 2004, the debtor attempted to sell another home—the Turnbridge property. It was appraised at a value of $420,000 in December 2004. Subsequently, the debtor sold this property to Schlossberg for $325,000. Less than a year after the sale to Schlossberg, he sold the property at a profit of $130,000. The debtor admitted to selling the property for below market value and had an agreement with Schlossberg to take 40 percent of the profits from Schlossberg’s future sale of the home. This profit was never disclosed by the debtor in his bankruptcy case and never paid by Schlossberg.
The Bankruptcy Code – Section 548
11 U.S.C. §548 of the U.S. Bankruptcy Code addresses fraudulent transfers.[1] Judge Squires, in In re Eckert, recognized that 11 U.S.C. §548(a)(1)(A) is considered “actual fraud” and §548(a)(1)(B) is considered “constructive fraud.” While illustrated in the text of the Bankruptcy Code, the true difference between actual and constructive fraud is that actual fraud requires a showing that the transferor actually intended to commit fraud, as opposed to constructive fraud, where no actual fraudulent intent by the transferor is required. Grochocinski v. Schlossberg, et al., 388 B.R. 813, 830 (Bankr. N.D. Ill. 2008). To show both actual and constructive fraud, the burden falls upon the trustee or party that is asserting the fraud. Id.
Asserting, and then winning, a claim under §548(a)(1)(A) is extremely difficult because there is rarely direct evidence of the intent underlying a transfer of property. This typically means that trustees rely on §548(a)(1)(B) to show that a transfer was fraudulent.
In Eckert, the trustee was blessed with exceptionally good evidence in the form of e-mails in which the debtor asserted, “this contract for deed is a great way to protect my assests [sic] since I trust you and you hold title I am asset free almost…i.e., ‘why sue Jeff, he aint [sic] got nothin! [sic].” The debtor also wrote several months later confirming one of the transfers was “the deal with asset protection in mind….”
Unfortunately for the trustee in In re Eckert, the Union Court transfer took place 27 months prior to the bankruptcy petition being filed, which effectively bars that transaction from being considered a fraudulent transfer because the statute only contemplates transfers that have taken place within two years prior to the filing of bankruptcy. The Turnbridge property transaction occurred nine months prior to the bankruptcy filing and therefore was subject to avoidance.
While there was direct evidence that the debtor sold the Turnbridge property to Schlossberg at a reduced rate and that the debtor would share in profits when Schlossberg later sold the property at a higher value—intending to defraud creditors—the Court determined that this evidence was not enough, in and of itself, to show actual fraud. Grochocinski v. Schlossberg, et al., 388 B.R. at 832. The Court required that the “badges of fraud” be analyzed in determining whether actual fraud occurred. Id. at 830-831.
The badges of fraud used by the court to show 548(a)(1)(A) include:
1. Absconding with the proceeds of the transfer immediately after their receipt;
2. Absence of consideration with the transferor and transferee know that outstanding creditors will not be paid;
3. A huge disparity in value between the property transferred and the consideration received;
4. The fact that the transferee is or was an officer, agent or creditor of an officer of the corporate transferor;
5. Insolvency of the debtor; and
6. The existence of a special relationship between the debtor and the transferee.
In this matter, the debtor did not abscond with the proceeds after the transfer. While Schlossberg was not an officer or agent of the transferor, there was a special relationship between the debtor and transferee—specifically, they had been friends and business associates for many years. There was inadequate consideration paid for the property, the debtor was insolvent, and both parties knew that creditors would not get paid. These facts were sufficient to show that four of the six badges of fraud were present. Grochocinski v. Schlossberg, et al., 388 B.R. at 834.
The court found that there was more than enough evidence, between satisfying the badges of fraud and the testimony and documentary evidence, of intent to show actual fraud.
As described above, actual fraud is shown through direct evidence and the badges of fraud. However, under §548(a)(1)(B), courts look specifically to the statute, analyzing the circumstances of the transaction against the statutory language of the Code. In this instance, Judge Squires noted that the debtor made a transfer of his interest in the Turnbridge property. The transfer was made within the limits set by the Code—within two years prior to the bankruptcy filing—nine months prior in this instance. When the transfer took place, the debtor was insolvent because the debtor had already incurred debts that he couldn’t pay as they matured. Further, the court found that Schlossberg was an “insider” of the debtor. None of these facts was in the debtor’s favor.
Judge Squires scrutinized the definition of “insider” and included Schlossberg in that category because the Turnbridge sale was not conducted at arm’s length and was, in fact, a scheme devised to shield his assets whereby Schlossberg would share his profits and was a willing participant. Additionally, the court still had to evaluate whether the debtor received consideration of a reasonably equivalent value for the property. Judge Squires evaluated this based on a two-part test: (1) Did the debtor receive value; and (2) was it reasonably equivalent to what the debtor gave up? According to Judge Squires, there are many methods used to evaluate the reasonably equivalent value, such as:
1. Whether the value of what is transferred is equal to the value of what was received;
2. The fair market value of what was transferred and received;
3. Whether the transaction took place at arm’s length; and
4. The good faith of the transferee.
Judge Squires, in addition to using the factors above, looked to the definition of fair market value as the price that a seller is willing to accept and a buyer is willing to pay on the open market and in an arm’s length transaction. The sheer fact that an appraisal for the property showed its value to be $95,000 higher than for what the debtor sold the property, and then Schlossberg resold the Turnbridge property for a profit of $130,000, was self-evident to the court that this was not an example of a transfer for reasonably equivalent value.
The trustee showed the requirements in the statute were met, including the fact that reasonably equivalent value had not been given for the transfer of the debtor’s interest in the Turnbridge property, demonstrated to the dourt that the debtor committed constructive fraud.
State Law
The court analyzed the fraudulent transfers made by the debtor in this case, both actual and constructive, under §548 of the Bankruptcy Code. As noted above, one of the attempts to prove a fraudulent transfer—the Union Court property—failed due to the timeframe set forth in the Code. However, 11 U.S.C. §544(b)(1) was the saving grace in this case, and in potentially many other instances. This provision allows a trustee to take advantage of state law avoidance actions with respect to fraudulent conveyances until four years after the transfer was made.[1] Id. at 838.
In this matter, the Illinois Uniform Fraudulent Transfer Act (IUFTA) is applicable. 740 ILCS 160/1, et seq. 740 ILCS 160/5 addresses claims that arose before or after the alleged fraudulent transfer, and 740 ILCS 160/6 speaks to claims that arose before the alleged fraudulent transfer was made.
For claims arising under Illinois law, trustees are particularly fortunate since the provisions of the IUFTA parallel §548 of the Code. Thus, as a court determines facts for the fraudulent transfer claims under the Code, these findings will be just as applicable to claims made under the IUFTA.
While the Code contemplated actual fraud and constructive fraud, the IUFTA speaks to “fraud in fact” and “fraud in law.” Fraud in fact parallels actual fraud such that there must be an intent to hinder, delay or defraud creditors. The burden of proof lies with the trustee, whereby he must prove all elements by clear and convincing evidence. Though the Code uses six badges of fraud, the UFTA uses 11:
1. The transfer or obligation was to an insider;
2. The debtor retained possession or control of the property transferred after the transfer;
3. The transfer or obligation was disclosed or concealed;
4. Before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit;
5. The transfer was of substantially all the debtor’s assets;
6. The debtor absconded;
7. The debtor removed or concealed assets;
8. The value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred;
9. The debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred;
10. The transfer occurred shortly before or shortly after a substantial debt was incurred; and
11. The debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.
These badges are set forth within the IUFTA. If the presence of seven of the 11 badges of fraud is shown, there is a presumption imposed upon the party against whom the evidence is presented and the burden falls to the party that effectuated the transfer. Id. at 840. Generally, courts have held that when the badges of fraud are present in sufficient number, they may give rise to an inference or presumption of fraud. Id.
Though the badges are not exactly the same, they are similar. The UFTA also has the insolvency and reasonably equivalent value requirements and insider standards contained in the Code, all of which were identified by Judge Squires in his analysis of fraudulent transfers under §548.
Fraud in law under Illinois law, 740 ILCS 160/5(b), is similar to constructive fraud in that no intent is required. The burden of proof under fraud in law is a preponderance of the evidence, because intent is assumed when the elements of constructive fraud are established.
In order to show that a conveyance is fraudulent in law under the UFTA, 740 ILCS 160/5(b), four elements must be present:
1. The debtor made a voluntary transfer;
2. The debtor made the transfer without receiving a reasonably equivalent value in exchange for the transfer;
3. At the time of the transfer, the debtor had incurred obligations elsewhere; and
4. After the transfer, the debtor failed to retain sufficient property to pay his indebtedness.
Additionally, the UFTA, 740 ILCS 160/6(a), provides another cause of action for fraud in law, the elements of which are as follows:
1. A transfer was made by the debtor;
2. The debtor made the transfer without receiving a reasonably equivalent value in exchange for the transferred property; and
3. The debtor either was insolvent at the time of the transfer or became insolvent because of the transfer.
Neither of the “fraud in law” causes of action requires intent, and the first two elements are the same. However, 160/6(a) does require that the claim of the creditor arise before the fraudulent transfer.
Turnbridge Transaction
Under the state law causes of action, the court in this matter felt that since §§548(a)(1) and 160/5(a)(1) paralleled each other, if the transfer is avoidable under §548(a)(1) because the requirements under §548(a)(1) are met, it is also avoidable under §160/5(a)(1) because those same requirements have been met, and §544 of the Code allows the state law to apply. The same principle applies to §§548(a)(1)(B) and 160/5(a)(2), and thus, the trustee was granted leave to avoid the transfer.
The court also found that the trustee demonstrated all of the elements of §160/6(a) in that the creditors’ claims arose prior to the transfer of the Turnbridge property based on the debtor’s schedules. The court found that the debtor transferred its interest to Schlossberg, and finally, the transfer was made without the debtor receiving a reasonably equivalent value in exchange for the transfer. Previously, the trustee had shown that the debtor was insolvent at the time of the transfer and the debtor did not receive a reasonably equivalent value in exchange for the transfer.
Union Court Transaction
Section 548(a)(1)(A) was not applicable in this matter because the transfer occurred 27 months prior to the bankruptcy rather than within the two years prior to the bankruptcy as required by the Code. However, the trustee filed this action within four years of the transfer, which met the requirements under §160/5(a)(1).
The court found that most of the badges of fraud, illustrated above, were proven. Based on the badges of fraud and the direct evidence, also described above, the court found that the trustee had established that the debtor’s transfer of the Union Court property was fraud in fact, and thus, avoidable.
Similar to the Turnbridge transaction, since the court found fraud in fact in the Union Court transaction, it was able to easily find fraud in law per 740 ILCS 160/5(a)(2). The same analysis as the Turnbridge transaction holds true for the Union Court transaction when applying 740 ILCS 160/6(a).
Conclusion
While other facts exist that further bolstered the trustee’s case in the Eckert matter, the operative and basic facts were clear. Much of Judge Squires’ opinion involves sorting through the facts of the case and how each fact applies to the fraudulent transfers that took place. After reviewing this case, one should gain a basic understanding of how to prove fraudulent conveyance cases based on direct evidence and badges of fraud for actual fraud, as well as applying statutory language to the facts to show constructive fraud.
Additionally, trustees and parties-in-interest should not forget to review the applicable state law as requirements may be different as in this case: the timeframes of filing a claim versus when it occurred prior to the bankruptcy, badges of fraud or even the basic elements of a state fraudulent transfer law.