Claiming Fraud: Requirements for Sufficient Complaints

By: Tara Guarino

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff Member

            In order to be deemed sufficient, a complaint alleging fraudulent transfers must meet specific pleading requirements.[i] In In re 45 John Lofts, LLC, a bankruptcy court in New York denied Defendants’ motion to dismiss debtor 45 John Loft LLC’s (the “Debtor”) fraudulent transfer complaint finding that the complaint was sufficiently pled.[ii]  Before Debtor’s bankruptcy filing, a member of the Debtor executed an unauthorized Agreement of Purchase and Sale (“PSA”) for the sale of an 84 unit condominium for $64.5 million dollars.[iii] The 84 unit condominium was the Debtor’s sole asset and the member subsequently misappropriated the $14.3 million dollar down payment.[iv] After investors learned of the unauthorized PSA, the member attempted to hide the theft of the down payment.[v]  In February 2015, Debtor filed a petition for relief under title 11 of the United States Code (the “Bankruptcy Code”).[vi]  Thereafter, the Debtor filed a complaint against the Defendants that sought the avoidance of numerous transfers of funds and cited a multitude of actions against the Defendants, including both intentional and constructive fraudulent transfers.[vii] Defendants sought the dismissal of the complaint and cited “numerous attacks on the sufficiency of the pleading.”[viii] However, the bankruptcy court found the arguments to be without merit, and deemed the complaint sufficiently pled; thus, the bankruptcy court denied the motion to dismiss.[ix]   

            Intentional (“actual”) and constructive fraud are the two types of fraudulent transfers that may be avoided and the pleading standards set forth for each fraudulent transfer are different.[x]  Intentional fraudulent transfer claims must meet a stringent particularity standard, whereas constructive fraudulent transfer claims must simply satisfy the requirements of Federal Rule of Civil Procedure 8(a)(2), the “fair notice” standard.[xi]  Section 548(a)(1)(A) of the Bankruptcy Code defines intentional fraudulent transfer as “transfers made with intent to hinder, delay, or defraud any creditor.”[xii] Because proof of intent is often difficult to achieve, “badges of fraud,” or circumstances that deduce intent, can also be used to state a claim of intentional fraud, including: (1) close relationships between parties involved in the transfer; (2) transfers that prove to be unusual in the standard course of business dealing; (3) inadequate consideration; and (4) retention of the property by transferor after conveyance.[xiii]

            Constructive fraud is when “a trustee can prove the presence of several conspicuous elements, rather than proving actual fraud itself.”[xiv] Section 548(a)(1)(B) of the Bankruptcy Code explains that constructive fraud can be proven where a debtor received less than a reasonable equivalent in exchange for transfer or obligation, was left insolvent after such transfer, was engaged in a business transaction where the debtor’s property was an unreasonably small capital, where the debtor intended to incur debts that would be beyond his or her ability to pay, or when a transfer was made for an insider’s benefit.[xv]

             In the instant case, Debtor properly plead the intent to defraud by alleging extensive misconduct by Defendants.[xvi] The complaint also alleged that Debtor received nothing of value in return after the Adjusted Down Payment was transferred to Defendants and that Debtor was left insolvent, complying with sections 548(a)(1)(B)(i) and (ii) of the Bankruptcy Code and meeting the requirements of “constructive fraud.”[xvii] The New York bankruptcy court determined that the debtor’s complaint was sufficiently pled, and subsequently denied the Defendant’s motion to dismiss.[xviii]

            The particularity standard for intentional fraud, as well as the “fair notice” standard for constructive fraud were met. The stringent intentional fraud standard requires the demonstration of an intent to deceive, permissible through the use of the “badges of fraud.”[xix] Constructive fraud can be established by “prov[ing] the presence of several conspicuous elements.”[xx] Both New York law and the Bankruptcy Code allow recovery of all transfers made with actual fraudulent intent, as well as constructive fraudulent intent; in the instant case, the court adhered to those standards. [xxi]