Southern Industries, Inc. v. Jeremias

• Decision Date: 29 December 1978
• Citation: 411 N.Y.S.2d 945,66 A.D.2d 178
• Parties: SOUTHERN INDUSTRIES, INC., Respondent-Appellant, v. Ernest JEREMIAS, Appellant-Respondent, et al., Respondents.
• Court: New York Supreme Court — Appellate Division

Page 945

411 N.Y.S.2d 945

66 A.D.2d 178

SOUTHERN INDUSTRIES, INC., Respondent-Appellant, v. Ernest JEREMIAS, Appellant-Respondent, et al., Respondents.

Supreme Court, Appellate Division, Second Department.

Dec. 29, 1978.

Gitomer, Schwimmer & Gitomer, P. C., Forest Hills (Gary B. Berns, Forest Hills, of counsel), for appellant-respondent.

Otterbourg, Steindler, Houston & Rosen, P. C., Garden City (Abraham Kaplan, Garden City, of counsel), for respondent-appellant.

Before HOPKINS, J. P., and DAMIANI, GULOTTA and HAWKINS, JJ.

DAMIANI, Justice.

The principal issue in this case is whether a transfer of substantially all of the assets of an insolvent corporation to a director thereof in return for the satisfaction of an antecedent debt is barred by the fraudulent conveyance provisions of the Debtor and Creditor Law. We hold the transfer invalid.

Ernest Jeremias was an officer, director and major stockholder of a publically held corporation named Mazel Knitting Mills, Inc. Jeremias had loaned the corporation substantially in excess of $200,000 and this debt was reflected in the corporate books. The petitioner, Southern Industries, Inc., was a supplier of yarn to Mazel Knitting Mills on an open account.

There came a time when Mazel Knitting Mills ceased to do business and, in August, 1976, a meeting of shareholders was called to deal with its troubled financial condition. At the meeting it was resolved that the corporation, through its board of directors, should sell all of its machinery, equipment, furniture and inventory and use the proceeds to satisfy creditors to the extent possible. On August 9, 1976, pursuant to this resolution, Jeremias, acting as president of Mazel Knitting Mills, sold all its furniture, fixtures, equipment, inventory and certain of its machinery to himself in consideration of the cancellation of $150,000 of the antecedent debt owed to him by the corporation.

Southern Industries was Mazel Knitting Mills' other major creditor. After the corporation ceased doing business, the account of Southern Industries remained unpaid and, in October, 1976, it commenced an action against Mazel Knitting Mills. On December 2, 1976 judgment was entered in favor of Southern Industries and against Mazel in the sum of $31,062.89. Early in January, 1977 an execution on that judgment was issued to the Sheriff of Kings County and thereafter he entered Mazel's place of business and levied upon the entire contents of the premises. The Sheriff scheduled a sale for February 18, 1977.

On February 2, 1977, prior to the date fixed for the Sheriff's sale, a public auction was held at the instance of Jeremias, who contended that he, and not the corporation, was the owner of the property. The proceeds of the auction were in excess of $60,000.

After serving restraining notices, Southern Industries commenced this special proceeding pursuant to subdivision (b) of CPLR 5225 against Jeremias and the auctioneers to compel them to satisfy its judgment from the proceeds of the auction. Upon consent of all the parties, the proceeding was dismissed as to the auctioneers upon condition that they deposit $35,000 of the proceeds with the Treasurer of Nassau County. After a hearing, Special Term awarded judgment to petitioner directing that its judgment against Mazel Knitting Mills be satisfied from the funds on deposit with the County Treasurer, together with interest, costs and disbursements, but denying petitioner's application for a counsel fee and Sheriff's poundage. Jeremias has appealed from so much of the judgment as is adverse to him and the petitioner has appealed from so much thereof as denies it a counsel fee and the Sheriff's poundage.

New York has adopted the provisions of the Uniform Fraudulent Conveyance Act as article 10 of the Debtor and Creditor Law. Section 276 of the Debtor and Creditor Law provides that every conveyance made with the Actual intent to hinder, delay or defraud creditors is fraudulent and void. In this connection the actual intent to defraud consists of deception intentionally practiced to frustrate the legal rights of another (see 37 C.J.S. Fraud § 2, subd. b). A prime example of this type of fraud is where a debtor transfers his property to another while retaining the use thereof so as to continue in business free from the claims of creditors. The actual intent to defraud was not proven in this case. Mazel Knitting Mills did not transfer its property to Jeremias in order to put that property out of the reach of creditors while it still continued in business.

Section 273 of the Debtor and Creditor Law covers constructive, as opposed to actual, fraud. Constructive fraud may be defined as a breach of a duty which, irrespective of moral guilt and intent, the law declares fraudulent because of its tendency to deceive, to violate a confidence or to injure public or private interests which the law deems worthy of special protection (37 C.J.S. Fraud § 2, subds. c, e). In substance, section 273 provides that without regard to the actual intent to defraud, every conveyance made by a person who is or will thereby be rendered insolvent is fraudulent as to creditors if made without "fair consideration." It appears that Mazel Knitting Mills was insolvent at the time of the transfer. It owed Jeremias in excess of $200,000 and another $30,000 to the petitioner, but its assets, consisting of furniture, fixtures, equipment, inventory and machinery, brought only $60,000 at a subsequent auction sale. In any event, there is no doubt that the transfer of substantially all of its assets to Jeremias left nothing with which to pay the debt it owed to petitioner. Since at the time of the transfer Mazel Knitting Mills was, or was rendered, insolvent, that transfer must be set aside if it was made without fair consideration.

Section 272 (subd. a) of the Debtor and Creditor Law provides, in relevant part, that "fair consideration" is given for "property, or obligation":

"When in exchange for such property, or obligation, as a fair equivalent therefor, and in good faith, property is conveyed or an antecedent debt is satisfied".

Special Term held that the cancellation of an antecedent debt owed to a major stockholder of a corporation was Not a fair equivalent for the property transferred to his ownership. It has been held that for the purpose of section 272 of the Debtor and Creditor Law, the amount realized at the forced sale of previously transferred property does not necessarily reflect the ordinary market value of such property (De West Realty Corp. v. Internal Revenue Ser., D.C., 418 F.Supp. 1274, 1279). However, it is not contended on this appeal that the cancellation of a valid $150,000 antecedent debt in exchange for property which brought only $60,000, did not constitute a fair equivalent of valuable consideration. The proof in this case establishes that there was an exchange of equivalent value; but in addition thereto, the law requires that the transfer must be made in "good faith".

The wording of section 272 of the Debtor and Creditor Law, which contains the phrase "good faith", is identical to that of section 3 of the Uniform Fraudulent Conveyance Act. Because business throughout this country largely disregards State lines, the purpose of a uniform law on the subject of fraudulent conveyances was to enable lenders to know with certainty that they could rely upon the property of their debtors, though situated in another State (see Commissioners' Prefatory Note, 7A Uniform Laws Annotated, Uniform Fraudulent Conveyances Act, p. 161). Accordingly, in construing a provision of the Uniform Act we should, whenever possible, respect the decisions of the courts of other jurisdictions where it is in force, with a view to ensuring a harmonious national interpretation.

A major case dealing with the interpretation of the phrase "good faith" as used in the act is Sparkman & McLean Co. v. Derber, 4 Wash.App. 341, 481 P.2d 585, where it was held that a person seeking to set aside a conveyance upon the basis of lack of good faith must prove that one or more of the following factors is lacking: (1) an honest belief in the propriety of the activities in question; (2) no intent to take unconscionable advantage of others; and (3) no intent to, or knowledge of the fact that the activities in question will hinder, delay, or defraud others. The term "good faith" does not merely mean the opposite of the phrase "actual intent to defraud". That is to say, an absence of fraudulent intent does not mean that the transaction was necessarily entered into in good faith. The lack of good faith imports a failure to deal honestly, fairly and openly.

Measured by these standards, the instant transfer must be deemed void for lack of good faith because it was consummated with the intent to obtain an unconscionable advantage for one, who is an officer, director and major stockholder of the corporation over the rights of other general creditors. Former New York law expressly...