The following is a case update written by Corey R. Weber, a member of the ad hoc group of the California Lawyers Association’s (CLA) Business Law Section, analyzing a recent decision of interest:
The bankruptcy court determined after trial that the bankruptcy trustee had met his burden on claims to avoid and recover actual intent and constructively fraudulent transfers under both the Bankruptcy Code and Connecticut fraudulent/voidable transfer statutes against a member and owner of the debtor. Coan v. Chen (in re LXEng LLC), 2019 WL 4146478 (Bankr. D. Ct. 2019). To view the full opinion, click here.
Facts: The chapter 7 bankruptcy trustee filed an adversary proceeding to avoid and recover fraudulent transfers from the debtor to one of its members and owners. The debtor was a limited liability company that was in the business of sale of engineering services related to solar panel technology. The trustee’s claims were filed under the Bankruptcy Code (11 U.S.C. § 544, 548 and 550) and the Connecticut Uniform Voidable Transactions Act (Conn. Gen. Stat. § 52-552a, et seq.). After a ten day trial, the bankruptcy court found in favor of the trustee on the claims to avoid and recover fraudulent transfers based on both actual intent and constructive fraud.
The debtor, LXEng, LLC, had two owners, Dr. Jie Xiao and Michael Little. Upon Little’s death, Dr. Xiao became the 90% owner and member, and his wife, Xin Chen, became the 10% owner and member. They had two children together. Chen filed for divorce in June 2013, shortly before the bankruptcy filing, and the divorce judgment and property settlement agreement were entered in July 2013. Chen and Xiao did not disclose to the judge in the divorce proceeding pending litigation against the debtor (including a multi-million dollar suit by Dow Corning Corporation and Hemlock Semiconductor Corporation against the debtor and Xiao for misappropriation, use of trade secrets and other claims, in which a motion for default judgment was pending).
The debtor and Xiao transferred substantial funds and assets to Chen, together with Xiao’s interest in an account holding funds from distributions from the debtor. Chen then moved those funds into other bank accounts to protect the funds after she had been sued for fraud, among other things. Chen sent $1.43 million to China “to assure it was outside of the reach of creditors and this Court’s jurisdiction.”
The amounts were transferred by the debtor to Chen as cash advancements, shareholder distributions, dividend distributions or pension contributions. However, Chen did not attend meetings of the debtor’s members, did not participate in calls or meetings with customers, and her duties on behalf of the debtor were limited to administrative functions such as handling the mail, paying bills, reviewing resumes, and networking. Chen did not have a written employment or consulting agreement with the debtor. Later, when the debtor received substantial mail and legal notices, Chen failed to open the mail.
The court did not find Chen’s testimony defending against the claims credible, stating that “[t]he Court instead reasonably infers that the Debtor undertook all of these transfers for one purpose: to shield assets from the Debtor’s mounting creditors and protect Ms. Chen from any claimants who might also pursue her.” The court further found that:
From their rigid and unresponsive demeanor, the pattern of ostensibly rehearsed and conclusory answers to probing questions, the palpable discomfort upon cross-examination, the general vagueness and evasiveness in their responses upon detailed cross-examination, their often confusing and contradictory replies, and after affording due weight to their unabashed, unapologetic, and continuous course of conduct to shelter assets and avoid creditors, this Court finds that Ms. Chen and Dr. Xiao lacked fundamental credibility and good faith as witnesses.
Reasoning: The court determined that the trustee prevailed on both actual intent and constructive fraudulent transfer claims. Initially, the court commented on the lack of credibility of Xiao and Chen, concluding that:
This case presents the Court with the age-old adage: if it looks like a duck, swims like a duck, and quacks like a duck, then it is probably a duck. This case makes it hard to ignore the repeated quacks in the room, leaving the Court to conclude there is a duck in its midst. Consistent with that adage, this Court finds that the fraudulent conduct evaluated herein was manifest and palpable.
As to the actual intent fraudulent transfer claims sought to be avoided pursuant to 11 U.S.C. § 548(a)(1)(A) and the Connecticut statutes, the court considered badges of fraud reflecting the debtor’s intent to hinder, delay or defraud creditors. The court noted that direct evidence of fraudulent intent is rare and fraudulent intent may be inferred by the circumstances surrounding the transfer. Citing to In re Colonial Realty Co., 226 B.R. 513, 522 (Bankr. D. Conn. 1998) and Acequia v. Clinton (In re Acequia, Inc.), 34 F.3d 800, 906 (9th Cir. 1994) the court stated that “[o]ne badge of fraud can “spur mere suspicion; the confluence of several can constitute conclusive evidence of actual intent to defraud.” Following Christian Bros. High Sch. Endowment v. Bayou No Leverage Fund, LLC (In re Bayou Grp., LLC), 439 B.R. 294, 204 (S.D.N.Y. 2010), the court reiterated that the actual intent to hinder, delay or defraud is the debtor’s intent and not the intent of the transferee. The court found that “[h]ere, the Debtor and its sole two insider members initiated a material and sustained cascade of fraudulent, evasive, and deceptive activities in the two years preceding the Petition Date.”
The court determined that it was “abundantly clear” that the transfers were made with the actual intent to hinder, delay or defraud creditors, that Xiao and Chen were insiders of the debtor, that the debtor’s history was “rife with suspect transfers” and that Xiao and Chen’s divorce shortly before the bankruptcy filing (20 days before) was especially suspect given “the transfer of nearly all of their significant, liquid assets to Ms. Chen” and given litigation and a pending motion for default judgment in the amount of $15.7 million. Chen and Xiao’s lack of disclosure of the pending lawsuits and motion for default judgment in the divorce action added to the badges of fraud. Not mincing words, the court stated that “[t]he purpose of the avoidance statutes is frustrated where, as here, the Debtor exercised dominion or control over the Transfer funds at issue to greatly diminish and annihilate the value of the Debtor’s estate to frustrate a distribution to creditors…”
As to the constructive fraudulent transfer claims pursuant to 11 U.S.C. § 548(a)(1)(B) and the Connecticut statutes, the court found that “there was no credible proof from either the Debtor or Ms. Chen that the Transfers were for any substantive services to the Debtor. The $1.43 Million Transfer cannot be seriously described as consideration for Ms. Chen’s unproductive administrative services to the Debtor.” The court also found that the debtor was “undeniably insolvent” and that “[t]he unrebutted record supports the conclusion that the Debtor was insolvent both before and after the Transfers.”
The court was not persuaded by Chen’s good faith defense (the decision states that Chen withdrew her other affirmative defenses, but does not state what the other defenses were, concluding that the transfers were made while the debtor “was defending, in vain, against two sizeable lawsuits, shifting roughly 80% of its assets to Ms. Chen and leaving the already dwindling company woefully insolvent, unable to pay its debts or defend itself in litigation.”
The court found that Chen was the initial transferee under 11 U.S.C. § 550(a) and that the Trustee was entitled to recover the value of the transfers in the amount of $1,589,171, plus, interest, fees and costs.
Author’s Comment: This decision does not break new ground in fraudulent transfer case law, but provides a good example of a court finding overwhelming evidence of fraudulent intent based on circumstantial evidence and the badges of fraud. It is not a good sign for the defendant in a fraudulent transfer action when the court starts with a procedural history referring to the debtor’s, Xiao and Chen’s “historied presence in courtrooms” in other jurisdictions and “a sustained pattern of irregular and suspect transfers”. The court made a detailed record of factual findings of the debtor’s badges of fraud and of lack of credible testimony by Xiao and Chen. Based on the factual findings in the record, it would likely be difficult for Chen to successfully prosecute an appeal.
After withdrawing other affirmative defenses, Chen’s sole remaining affirmative defense was good faith. Footnote 19 to the decision correctly notes that good faith alone is insufficient to present an affirmative defense under 11 U.S.C. § 548(c), “which requires that the transfer by the bankruptcy estate be given for value and that the transferee took it in good faith.” Given the lack of value provided by Chen to the debtor (the record reflects that the value was minimal compared to the value of the transfers and was comprised largely of minor administrative services), and given Chen’s likely actual knowledge, and, at the very least, inquiry notice of the debtor’s insolvency and fraudulent actions, it would be difficult for Chen to prove an affirmative defense to the fraudulent transfer claims. See, e.g., In re Cohen, 199 B.R. 709, 718-719 (9th Cir. BAP 1996), In re Lull, 386 B.R. 261, 271 (Bankr. D. Hawaii 2008) and In re DBSI Inc., 593 B.R. 795, 828 (Bankr. D. Idaho 2018).
Although the fraudulent transfer claims related to transfers totaling over $2.5 million, in post-trial briefing, the trustee limited the transfers sought to be avoided and recovered the transfers within the two years prior to the bankruptcy case totaling $1,589,171. It is not clear from the decision why the trustee ultimately did not pursue the fraudulent transfers prior to the two year period, but it may have been based on when the litigation against the debtor was filed.
For discussions of other cases dealing with related issues, see:
- 2019-14 Comm. Fin. News. NL 27
- 2019-5 Comm. Fin. News. NL 10
These materials were written by members of the California Lawyers Association Business Law Section for the Commercial Finance Newsletter, published weekly on Westlaw. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further distributed without the consent of Thomson Reuters.