In re Sharp Intern. Corp.

• Decision Date: 05 December 2003
• Docket Number: Adversary No. 01-1439 (CEC).,Bankruptcy No. 99-21317-608.,Bankruptcy No. 99-23347-608.,No. 02-CV-5306 (DGT).,02-CV-5306 (DGT).
• Citation: 302 B.R. 760
• Parties: In re SHARP INTERNATIONAL CORP., and Sharp Sales Corp., Debtors. Sharp International Corp., Plaintiff, v. State Street Bank and Trust Company, Defendant.
• Court: U.S. District Court — Eastern District of New York

302 B.R. 760

In re SHARP INTERNATIONAL CORP., and Sharp Sales Corp., Debtors Sharp International Corp., Plaintiff, v. State Street Bank and Trust Company, Defendant.

Bankruptcy No. 99-21317-608.

Bankruptcy No. 99-23347-608.

Adversary No. 01-1439 (CEC).

No. 02-CV-5306 (DGT).

United States District Court, E.D. New York.

December 5, 2003.

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Kramer Levin Naftalis Frankel LLP, New York City, for Debtors.

James C. McCarroll, Kramer, Levin, Naftalis & Frankel, LLP, New York City, for Trustee.

Bingham McCutchen, New York City, Jonathan B. Alter, Bingham, McCutchen LLP, Hartford, CT, for Creditor Committee.

Scott D. Corrigan, Peter Neil Wang, Freidman, Wang & Bleiberg, PC, New York City, for Plaintiff/Appellant.

Michael R. Young, Willkie, Farr & Gallagher, LLP, New York City, for Defendant.

Kelley Drye, Neil Matthew Merkl, Kelley, Drye & Warren, LLP, New York City, for Appellee.

Memorandum and Order

TRAGER, District Judge.

Plaintiff-Appellant Sharp International Corp. ("Sharp") appeals an order of the Bankruptcy Court for the Eastern District of New York (Craig, J.), dismissing in its entirety an adversary complaint filed by Sharp against its former secured lender, State Street Bank and Trust Company ("State Street"). The complaint asserts a claim against State Street under New York common law for aiding and abetting Sharp's three officers in breaching their fiduciary duties to the company. Sharp further claims that a $12 million payment Sharp made to State Street in April 1999 in satisfaction of a valid antecedent debt is avoidable as a constructive and/or intentional fraudulent conveyance pursuant to New York Debtor & Creditor Law (the "D.C.L.") §§ 273-276. Lastly, Sharp asserts that any claim State Street may subsequently raise by virtue of its return of the $12 million payment — if such relief were to be ordered — should be equitably subordinated to the claims of Sharp's other unsecured creditors.

Background

(1)

Sharp is a closely-held New York corporation, which, at all times relevant to this case, was engaged primarily in the business of importing, assembling and distributing wrist watches, clocks, pens and mechanical pencils. See Compl. ¶¶ 5, 9. This adversary proceeding arises out of a massive fraud against Sharp and its creditors perpetuated by Sharp's former officers, Herbert, Lawrence, and Bernard Spitz (the "Spitzes").

In 1993, the Spitzes purchased 100 percent of Sharp's common stock. From then until October 1999, the Spitzes served as Sharp's sole officers, with responsibility over Sharp's day-to-day affairs.¹ See id. ¶ 10. In January 1995, the Spitzes sold a 13 percent ownership interest in Sharp to an outside investor, Bohoradzaner, Inc. Pursuant to agreements executed in connection with this sale, Bohoradzaner, Inc. had "the right to a seat on Sharp's Board of Directors, the right to inspect Sharp's books and records, the right to veto certain corporate transactions, and a variety of other corporate governance rights." Id. ¶ 11. Jaime Bohoradzaner, the principal of Bohoradzaner, Inc., served as a member of Sharp's Board of Directors from January 1995 until October 1999. See id. Sharp alleges that "[n]either Bohoradzaner, Inc. nor Mr. Bohoradzaner played any role in, or had any knowledge of, the fraud and embezzlement committed by the Spitzes." Id.

The Spitzes' fraud had two basic components. First, beginning some time prior to 1997 and continuing until October 1999, the Spitzes fraudulently inflated Sharp's reported sales and revenues and used these falsified financial statements "to raise increasingly large sums of money from a succession of banks and other lenders."² Id. ¶ 15. At the same time, the Spitzes looted Sharp of the funds they caused it to fraudulently raise, as well as other corporate funds. See id. ¶ 16. In 1998 and 1999 alone, the Spitzes stole more than $44 million from Sharp, diverting the funds to a variety of companies, most of which were owned by or otherwise affiliated with the Spitzes, and which provided no consideration to Sharp in exchange for the transfers. See id.

State Street's relationship with Sharp (and the Spitzes) commenced in November 1996, when State Street approved a $20 million demand line of credit to Sharp — secured by Sharp's assets — to refinance Sharp's then-current debt with LaSalle Bank and to support Sharp's operations. See id. ¶ 17. The terms of State Street's loan to Sharp were formalized in a Credit Agreement and a Security Agreement, both of which were dated December 12, 1996. See id. ¶ 18. The $20 million credit limit notwithstanding, State Street permitted Sharp's indebtedness to rise to approximately $26 million in 1997. See id. ¶ 19. In July 1998, the Spitzes raised $17.5 million through the issuance of subordinated notes to a group of investors (the "Noteholders"). See id. ¶ 15. Sharp subsequently used a portion of the July 1998 proceeds to pay down the debt to State Street. Thus, by the fall of 1998, the State Street debt had been reduced to $15 million. See id. ¶ 19.

Sharp alleges that State Street began to suspect the possibility of the Spitzes' fraud some time during the summer of 1998, when Sharp breached its loan agreement in numerous respects. In particular,

Sharp failed and refused to provide State Street with borrowing base reports, detailed accounts receivable aged trial balances, and other documentation, as required by the Credit and Security Agreements, despite State Street's constant requests for such information; Sharp failed and refused to implement an accounting system that would generate monthly financial statements, despite Sharp's prior agreement to do so; and Sharp refused to utilize the State Street lockbox account, through which, pursuant to the parties' Agreements, Sharp's account receivables were required to flow.

Id. ¶ 31. Moreover, based on the documentation that Sharp did furnish, State Street grew concerned that Sharp was growing at an "alarmingly rapid pace" and was consuming a large amount of cash. Id. ¶ 32.

Sharp contends that State Street's sensitivity to this kind of behavior was "heightened" as a result of a fraud it had discovered at another of its borrowers, PT Imports, with whom State Street developed a lending relationship in 1993. See id. ¶¶ 21, 28. During the summer of 1998, State Street determined that PT Imports had "created fictitious accounts receivable and customers, had created fictitious purchase records, and had falsely identified vendors who did not exist." Id. ¶ 25. State Street concluded this fraud "had directly caused it to lend large amounts of money to PT Imports." Id. Accordingly, in June 1998, State Street commenced an action against PT Imports in New York State court, seeking damages in excess of $19 million. See id. ¶ 26. Like the loan to Sharp, the PT Imports loan was made for the purpose of refinancing a debt to LaSalle Bank. See id. ¶¶ 17, 21. Furthermore, both Sharp and PT Imports had dealings with another Brooklyn-based entity, named Kent International, whose "principals had fraudulently inflated the company's net sales figures by creating false sales with related real customers and fictitious customers." Id. ¶ 27.

In the fall of 1998, despite the fact that the Sharp loan was current, well within line limits, and — based on Sharp's reported financial condition, appeared to be oversecured — State Street took various actions that demonstrated its mounting concerns regarding the Sharp loan. That September, Nancy Loucks ("Loucks"), a Senior Vice President and Credit Risk Officer at State Street, who had also had oversight responsibility for State Street's lending relationship with PT Imports, assigned James Benninger ("Benninger") from State Street's loan workout department to assist with the Sharp credit. See id. ¶ 33. Charles Glerum ("Glerum"), outside counsel specializing in troubled loans, was also put on the case. See id. Loucks has admitted that she "devoted more time to the Sharp credit than to any other credit on which she worked throughout the summer and fall of 1998, even though Sharp was not in monetary default during this time period." Id. ¶ 37. Loucks further alerted a number of high-level State Street officials of her concerns. See id.

On two separate occasions, State Street took the "unusual step" of contacting several of Sharp's largest customers to confirm that they were, in fact, purchasing products from Sharp. See id. ¶ 38. In early October, State Street sent letters to Sharp seeking information from Sharp regarding its largest customers and requesting access to Sharp's facilities to conduct a physical inventory count. See id. ¶ 39. State Street also requested the work papers of Sharp's outside auditor, KPMG Peat Marwick ("KPMG"), in connection with the audit it had done for the fiscal year ending March 31, 1998. See id. ¶ 40.

On October 22, 1998, State Street's outside counsel retained First Security Services Corporation ("First Security"), a firm specializing in investigating financial fraud, to conduct a formal investigation of Sharp. See id. ¶ 41. Sharp alleges on information and belief that the purpose of the investigation was to determine whether fraud was being committed by Sharp and whether State Street had any legal claims against Sharp as a result. See id. On November 3, 1998, First Security produced a 60-page report relaying the results of its investigation, which was reviewed by State Street's outside counsel, Loucks, and other high-level officials at State Street. "Loucks has admitted that this report further heightened her concerns of fraud at Sharp." Id. ¶ 42.

On November 4, 1998, State Street representatives met with the Spitzes at Sharp's facilities. State Street indicated its intent to conduct formal confirmations of Sharp's receivables with the aid of Sharp's auditor, KPMG. Sharp refused to consent to these confirmations and further instructed...