In re Actrade Financial Technologies Ltd.

• Decision Date: 23 June 2005
• Docket Number: Bankruptcy No. 02-16212(ALG).,Adversary No. 04-03601(ALG).,Bankruptcy No. 02-16213(ALG).
• Citation: 337 B.R. 791
• Parties: In re ACTRADE FINANCIAL TECHNOLOGIES LTD., et al. Debtor. Kenneth P. Silverman as Chapter 7 Trustee of Allou Distributors, Inc., et al. Plaintiff, v. Actrade Capital, Inc. and the Actrade Liquidation Trust Defendants.
• Court: U.S. Bankruptcy Court — Southern District of New York

337 B.R. 791

In re ACTRADE FINANCIAL TECHNOLOGIES LTD., et al. Debtor Kenneth P. Silverman as Chapter 7 Trustee of Allou Distributors, Inc., et al. Plaintiff, v. Actrade Capital, Inc. and the Actrade Liquidation Trust Defendants.

Bankruptcy No. 02-16212(ALG).

Bankruptcy No. 02-16213(ALG).

Adversary No. 04-03601(ALG).

United States Bankruptcy Court, S.D. New York.

June 23, 2005.

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Silverman Perlstein & Acampora LLP, By Edward M. Flint, Esq., Ronald J. Friedman, Esq., Jericho, NY, for Kenneth P. Silverman, Esq., Chapter 7 Trustee of Creditor Allou Distributors, Inc.

Bronstein, Gewirtz & Grossman, LLC, By Neil D. Grossman, Esq., Edward N Gewirtz, Esq., Peretz Bronstein, Esq., Noson A. Kopel, Esq., Laura S. Mello, Esq., Schlam Stone & Dolan, LLP, By Bennette D. Kramer, Esq., Jeffrey M. Eilander, Esq., New York City, for Actrade Capital, Inc., and The Actrade Liquidation Trust.

MEMORANDUM OF OPINION

ALLAN L. GROPPER, Bankruptcy Judge.

INTRODUCTION

Actrade Financial Technologies Ltd. and Actrade Capital, Inc., (together, "Actrade" or the "Debtor") filed for relief under Chapter 11 of the Bankruptcy Code on December 12, 2002 and confirmed a Joint Plan of Liquidation (the "Plan") on January 7, 2004. Under the Plan, they propose to pay all creditors in full and to make a substantial distribution to equity holders, with one significant caveat. The Liquidating Trustee (the "Trustee") of Allou Distributors, Inc. ("Allou"), a company in Chapter 7 liquidation in the Eastern District of New York, has filed a $ 48 million claim in the Actrade case in which he asserts that Actrade was the recipient of fraudulent conveyances under the Bankruptcy Code and under applicable State law, the New York Debtor & Creditor Law ("DCL"). The Allou claim is one of the last substantial unresolved claims in the Actrade case.

Actrade objected to the Allou Trustee's claim, and with the parties' agreement the Allou claim was procedurally formulated as an adversary complaint filed in the Actrade case by the Allou Trustee. Actrade has now moved to dismiss the Trustee's amended complaint (the "Complaint") on the grounds that the Trustee has failed to state a claim upon which relief can be granted under Fed. R. Civ. P. 12(b)(6) and has failed to plead fraud with the specificity required by Fed. R. Civ. P. 9(b). For the reasons set forth below, Actrade's motion to dismiss is granted in part and denied in part.

FACTS

THE FACTS AS ALLEGED IN THE COMPLAINT

The following facts alleged in the Complaint, presented in the light most favorable to the plaintiff, are assumed to be true for purposes of this motion.

I. The Allou Fraud

Prior to its bankruptcy, Allou purported to be a nationwide distributor of health and beauty aids, pharmaceuticals, fragrances and cosmetics. (Compl. at ¶ 8.) To finance its operations, Allou entered into an asset-based credit facility with Congress Financial Corp. ("Congress") with a credit line of up to $ 200 million (the "Loan Agreement"). (Compl. at ¶ 20.) The credit available to Allou under the Loan Agreement was calculated on a daily basis as, roughly, 85% of Allou's eligible accounts receivable plus 60% of Allou's eligible inventory, and Allou was required to regularly certify its inventory and accounts receivable by providing collateral reports to its lender. Id. As of March 2003, Allou had outstanding advances totaling approximately $ 195 million under the Loan Agreement. Id.

In or about March 2003 it was discovered that Allou had been fraudulently inflating inventory and accounts receivable in its collateral reports in order to artificially inflate its borrowing base. (Compl. at ¶ 21.) While the full extent of the Allou fraud remains unknown, the Trustee alleges that the fraudulent scheme had been ongoing since at least the mid-1990's and that it increased in magnitude and scope over the years. (Compl. at ¶ 22.) The Allou Trustee alleges, among other things that Allou, under the control of the Jacobs family, created tens of millions of dollars worth of bogus invoices reflecting fictitious sales to alleged customers.¹ (Compl. at ¶ 23.) Allou included the receivables from these fictitious sales in its collateral reports, thereby inflating the amount it was permitted to borrow under the Loan Agreement. Allou also artificially inflated the inventory balance in its collateral reports by engaging in sham purchases from certain affiliated or controlled entities, including Impax Trading Corporation ("Impax") and Evergreen, Inc. ("Evergreen"). (Compl. at ¶ 25.) Allou allegedly used these entities not only to falsify its records as to purchases but, when these entities were paid for goods that never existed, Impax and Evergreen would recycle the funds back to Allou, thereby providing validation for the cash balances and the accounts receivable set forth in Allou's collateral reports. (Compl. at ¶¶ 24, 25.) It is alleged that the Jacobs family attempted to cover up its fraudulent activities by setting fire to Allou's Brooklyn warehouse on September 25, 2002, and by the subsequent attempted bribery of a New York City Fire Marshal. (Compl. at ¶ 27.) In connection with the fraud, approximately $ 58 million was allegedly stolen by the Jacobs and Jacobs-related entities. (Compl. at ¶ 24.)

On April 9, 2003, shortly after the Allou fraud was uncovered, three of its creditors filed an involuntary Chapter 11 petition against it pursuant to § 303 of the Code. (Compl. at ¶¶ 9, 28.) Several members of the Jacobs family were also placed in involuntary bankruptcy on June 30, 2003, and an interim trustee was appointed over the Jacobs' estates on August 7, 2003. (Compl. at ¶¶ 28-31.) A trial was held on the appointment of an interim trustee for Allou at which documentary evidence was produced demonstrating the Jacobs' fraudulent activities and their attempts at a cover-up. (Compl. at ¶ 29.) The Bankruptcy Court for the Eastern District of New York found that the Jacobs appeared to have engaged in looting and money laundering, and on September 16, 2003, Allou's Chapter 11 case was converted to Chapter 7 and the Allou Trustee was appointed. (Compl. at ¶¶ 30-31; Order of May 29, 2003, directing appointment of a trustee, Case No. 03-82321, Docket No. 121; Order of Sept. 16, 2003, converting debtors' Chapter 11 cases to Chapter 7 proceedings and authorizing trustee to operate estate assets, Case No. 03-82321, Docket No. 583.)

II. Actrade and its Trade Acceptance Draft Program

Founded in 1987, Actrade provided short-term financing to buyers and sellers of goods through a Trade Acceptance Draft program (the "TAD Program"). (Compl. at ¶ 34.) Instead of buying goods on credit, or issuing a post-dated check, a buyer would obtain from Actrade and issue to the seller a "Trade Acceptance Draft" ("TAD"), an instrument (allegedly similar to a check) equal in value to the full amount of the invoice price for the goods plus Actrade's commission on the transaction. (Compl. at ¶ 36.) The seller would immediately assign or tender the TAD to Actrade, and Actrade would pay the seller the invoice amount (the face amount of the TAD less Actrade's commission). Upon maturity of the TAD, its face amount (including Actrade's commission) would automatically be debited from the buyer's bank account and deposited into Actrade's account. Id. The typical maturity date for a TAD was one month after payment was made to the seller. Id.

To be eligible to participate in the TAD Program, a potential buyer was required to execute a Buyer's Acknowledgment Form ("BAF") issued by Actrade, in which the buyer was required to represent the bona fides of the underlying transaction. (Compl. at ¶ 50.) The BAF was drafted by Actrade and was non-negotiable. Id. Potential sellers in the TAD Program were required to execute a Seller's Letter of Understanding ("SLU"), also drafted by Actrade and non-negotiable. (Compl. at ¶ 52.)

III. The Alleged Wrongdoing at Actrade

The Allou Trustee alleges in the Complaint that while Allou's principals were engaged in a massive fraudulent scheme, there was serious wrongdoing at Actrade as well. The Allou Trustee's allegations of wrongdoing at Actrade are based in large part on allegations made by Actrade shareholders in a 2002 class action suit. As the Allou Trustee describes it, the amended shareholder complaint (the "Shareholder Complaint") includes numerous examples of instances where Actrade facilitated intra-company transactions that (in the view of the Allou Trustee) call into question all of Actrade's TAD transactions. (Compl. at ¶¶ 41, 43.) TADs, it is alleged, were used to disguise risky loans and inter-company money transfers among related entities, and the Shareholder Complaint contains several examples of inter-company money transfers that Actrade assertedly facilitated.² The Shareholder Complaint also contains allegations that Actrade engaged in fraudulent lending practices and that it defrauded its surety companies into providing coverage for certain of its losses and engaged in self-dealing for the purpose of inflating its own results. (Shareholder Compl. at ¶¶ 38, 133-78.) Based on these allegations, the Allou Trustee concludes that "contrary to representations to the investing public, Actrade was actually in the business of making high-risk loans (not purchasing negotiable instruments from sellers) to financially struggling companies." (Compl. at ¶ 42.)

Eventually, as the Allou Trustee also alleges, on August 7, 2002, Actrade issued a public statement announcing the formation of an audit committee to investigate the allegations of irregularities and improprieties in Actrade's business. (Compl. at ¶ 44.) On December 12, 2002, Actrade issued a press release that it would file for bankruptcy protection. (Compl. at ¶ 46.) The press release indicated that allegations against Actrade involved the legitimacy of "the majority of the domestic [TADs] . . . including, among other...