Pergament v. Torac Realty, LLC (In re Diamond Fin. Co.)

• Docket Number: Case No. 20-71877-reg,Adv. Proc. No. 21-08101-reg
• Decision Date: 22 February 2024
• Citation: Pergament v. Torac Realty, LLC (In re Diamond Fin. Co.), 658 B.R. 748 (Bankr. E.D. N.Y. 2024)
• Parties: IN RE: DIAMOND FINANCE CO., INC., Debtor. Marc Pergament, Chapter 7 Trustee of the Estate of Diamond Finance Co., Inc., Plaintiff, v. Torac Realty, LLC, Defendant.
• Court: U.S. Bankruptcy Court — Eastern District of New York

658 B.R. 748

IN RE: DIAMOND FINANCE CO., INC., Debtor.

Marc Pergament, Chapter 7 Trustee of the Estate of Diamond Finance Co., Inc., Plaintiff, v. Torac Realty, LLC, Defendant.

Case No. 20-71877-reg

Adv. Proc. No. 21-08101-reg

United States Bankruptcy Court, E.D. New York

Signed February 22, 2024

Neil H. Ackerman, Kirschenbaum & Kirschenbaum, P.C., Garden City, NY, Mark E. Cohen, Mark E. Cohen, Esq., Robert L. Pryor, Pryor & Mandelup, L.L.P., Westbury, NY, Steven G. Legum, Mineola, NY, for Defendant.

Michael S. Fox, Theodore J. Hawkins, Jonathan T. Koevary, Olshan Frome Wolosky LLP, New York, NY, for Plaintiff.

Marc A. Pergament, Marc A. Pergament, Trustee, Garden City, NY, Plaintiff, Pro Se.

DECISION AFTER TRIAL

Robert E. Grossman, United States Bankruptcy Judge

This matter is before the Court pursuant to an adversary proceeding brought by Marc Pergament, the chapter 7trustee(the "Plaintiff" or the "Trustee") to recover from Torac Realty, LLC("Torac" or the "Defendant"), inter alia, a series of transfers by the Debtor and two affiliates of the Debtor as intentional and constructive fraudulent conveyances under the New York Debtor and Creditor Law("NY DCL") and § 548 of the Bankruptcy Code.While the adversary proceeding is against an entity that received transfers from the Debtor and its affiliates, the type of operation the Debtor was engaged in, including the intent of the Debtor when making the transfers to the Defendant, is an important piece of this adversary proceeding for several reasons.

The Debtor and the affiliated companies, which were owned and controlled by Mr. Robert Diamond, were presented to the public as an automobile financing company for car purchasers with less than stellar credit.The Debtor could charge high interest rates for these car loans due to the purchasers' lackluster credit ratings, and the costs of its operations would be borne by the difference between these high interest rates and the interest rate the Debtor incurred to borrow funds for its operations.The problem with the Debtor's business model was that the Debtor did not collect sufficient funds from the car purchasers to cover its operations, let alone make a profit.After losing credit lines with institutional lenders, the Debtor turned to friends and family to fund the Debtor's operations by promising a steady rate of return of 10% interest, paid at regular monthly intervals.The Debtor's principal boasted to the investors that his business was very successful and was growing every year.The Debtor's principal was also using the Debtor as the central entity which operated its affiliates to further its investment strategy.While the complete reason the Debtor's principal transferred funds in and out of the related entities remains unanswered, it did serve the purpose of creating an illusion of profitability for the investors.What these investors did not know was that the Debtor's business was losing money every year in ever increasing numbers, and the number of investor dollars had to increase each year just to make the monthly interest payments to the investors.This is commonly known as a Ponzi scheme.In addition to using the investor funds to run the Ponzi scheme, a significant amount of funds was transferred from the Debtor to Auto City International, Inc., which ran a used car dealership.While it appears that these funds disappeared from Auto City International, Inc. and most likely cycled back to the Debtor's principal and his family members, this adversary proceeding does not concern the ultimate whereabouts of these funds.

The Trustee seeks to take advantage of the Ponzi label to establish elements of fraudulent intent by the Debtor and the general insolvency of the Debtor for the purposes of proving that the transfers to Torac were intentional and constructive fraudulent conveyances, as alleged in the complaint.While the Debtor did have some actual business, the purpose of the business quickly became a front to lure unsuspecting investors to invest with the Debtor.Without the patina of a legitimate business, the Ponzi operation would fail.The Debtor's principal knew this and used the business for these purposes, but unlike Bernard Madoff and others engaged in similar activity, he did not admit to operating a Ponzi scheme.Rather, he claimed he was attempting to save the business.After a three-day trial, the Trustee has not only established that this was a Ponzi scheme, but he has successfully established each cause of action set forth in the complaint.

Torac, which is the recipient of the transfers the Trustee seeks to recover, relies largely on its claim of innocence to the entire fraud.If the evidence supported a finding that Torac was either a regular good faith lender or an innocent investor which was duped along with all the other investors, Torac may have successfully sought to retain some portion of the transfers under the constructive fraudulent conveyance claims.However, the record reflects that Torac was not an innocent investor.Torac, which provided loans to the Debtor and its affiliates, played a different role than the other investors and was treated differently with respect to how it invested in the business and how it was repaid.Torac was aware of too many irregularities and red flags to retain the funds the Trustee seeks to recover.Torac's principal, who had an ownership interest in one of the transferring entities and was a close friend of the Debtor's principal, asked no questions regarding the Debtor's operations.Torac was also aware that the Debtor's lines of credit with institutional lenders had been cancelled and still claims it asked no questions.Torac and its principal were also the only investors which were repaid in full plus interest, while every other investor lost the bulk of their principal investment.For these reasons, Torac cannot assert a defense of good faith either as a lender or as a recipient of the funds.

PROCEDURAL HISTORY

On April 14, 2020("Petition Date"), an involuntary bankruptcy petition ("Petition") was filed under chapter 7 of the United States Bankruptcy Code against the Debtor.ECF No. 1.¹On May 20, 2020, an order for relief under chapter 7 was entered.Thereafter, the Trustee was duly appointed and qualified as the chapter 7trustee.ECF. No. 23.²The Trustee commenced this adversary proceeding on May 20, 2021 by the filing of a complaint ("Complaint").ECF No. 1.³The Complaint alleges various causes of action under 11 U.S.C. §§ 544,548,550and551, as well as §§ 273,274,275and276 of the New York Debtor and Creditor Law(the "NY DCL").ECF No. 1.On June 9, 2021, an answer ("Answer") was filed in which the Defendant substantially denied the Plaintiff's allegations and asserted various affirmative defenses.ECF. No. 5.No dispositive motions were filed.A three-day trial was held on October 24, 25, and 26 of 2022.The Plaintiff and the Defendant submitted post-trial briefs on December 16, 2022.ECF Nos. 81, 82.Thereafter, the adversary proceeding was marked submitted.

FACTS

Unless otherwise noted, the facts are drawn from the Stipulated Facts annexed to the Joint Pretrial Memo, ECF No. 72, Ex. I ("Stipulated Facts").Diamond Finance Co., Inc.(the "Debtor"), was organized as an auto financing company licensed to conduct business in New York.The Debtor was incorporated in 1988 and was wholly owned by Robert Diamond, who served as its president from 1988 until May of 2020.

The Debtor and other Relevant Parties

1.The Debtor

The Debtor's purported business was to provide automobile financing targeting consumers who were generally unable to secure market-rate financing.The Debtor would purchase the installment sale contracts from dealers in these transactions.Pl.'s Ex. 88at 13-14.The automobile purchaser would then make the required payments directly to the Debtor.Id.The business model required that the spread between the contract rate collected from the consumers on their car loans and the Debtor's cost of operations resulted in a net profit to the Debtor.The two critical aspects which made this business model unsustainable were that the Debtor's overhead expenses were significant, and the collectability of the loans was poor.The Debtor operated through its affiliate entities, Diamond FFP, Inc. and Diamond Finance Co. of New Jersey.Diamond Floor Plan Inc. and Auto City International, Inc. were related to the Debtor, but were described as engaged in floor plan financing and used car sales, respectively.Trial Transcript Day 1 ("Tr."), ECF No. 79, at 139.Each of these entities, including the Debtor, was controlled by Robert Diamond.⁴Trial Transcript Day 2 ("Tr. #2"), ECF No. 80, at 127-128.

2.Diamond FFP, Inc.("FFP")

FFP was incorporated in 2014 and at its inception, was owned equally by Mr. Diamond and Thomas Weitzmann.⁵There is some dispute over when Mr. Weitzmann had fully relinquished his ownership in FFP.However, the record reflects that by 2016, Mr. Weitzmann no longer had an equity interest in FFP based on FFP's 2016 income tax return.⁶FFP had little to no function other than raising capital by issuing notes to individuals solicited by Mr. Diamond.Tr.at 98;Tr. #2at 73.It had no payroll or office space.Tr.at 98.FFP was also an affiliate of the Debtor that was listed on its combined financial statements.Tr.at 144.

3.Diamond Finance Co. of New Jersey ("DFC-NJ")

DFC-NJ was incorporated in 1992 and was licensed by the State of New Jersey Banking Department.DFC-NJ was wholly owned by Mr. Diamond and was included on the Debtor's consolidated financial statements.Like the Debtor, DFC-NJ was also ostensibly in the auto financing business.Tr.at 98.DFC-NJ had no independent employees or office space.

4.Diamond Floor Plan Inc.("Floor Plan")

Floor Plan was incorporated in 2016 for the purpose of providing financing to auto dealers to purchase automobiles for eventual sale.This is generally termed inventory financing....