Just In Time For Finals: Court Poses, Then Answers, Law School Exam Question On Fraudulent Conveyances

Money
In Motorworld, Inc. v. Benkendorf, the Appellate Division decided to "put the issue raised in [the] appeal as if it were a law school exam," and then answer the exam question. Here is how it described the case:

A owns all the outstanding stock of DEF and GHI; her husband, B, operates all these and other entities wholly-owned by A. XYZ has done work for some of A and B's entities over the course of many years.

One of XYZ's principals asked B for a loan. B agreed, and A transferred $499,000 to DEF, a moribund entity. DEF then transferred $500,000 to XYZ, which executed a promissory note in DEF's favor; this note became DEF's only asset and its only debt is its unspoken obligation to repay A.

XYZ continued to perform work for GHI, and the note's due date was repeatedly extended; meanwhile, GHI's indebtedness to XYZ rose to approximately $1,000,000. Consequently, DEF executed a release of the note in exchange for XYZ's forgiveness of GHI's debt.

Was DEF's release of the note a fraudulent conveyance?

Believe it or not, this description was actually less complicated than the facts of the case.

 

In Motorworld, plaintiff was one of approximately 19 entities owned by Carole Salkind and operated by her husband, Morton Salkind. Morton was a real estate developer for many years. After an illness, he decided that he did not want to own any of the various companies through which he did his business. He decided instead that his wife would own them but he would "remain in control" of the business.

Motorworld was one of these companies. However, it was described by the Appellate Division as a "moribund" entity. Its only asset was a loan that it gave to William and Gudrun Benkendorf. The Benkendorfs were longtime business associates of Morton. The Benkendorfs' landscaping company, Benks, had done a significant amount of work on Morton's projects over the years. (The trial court estimated that Benks performed approximately $10 million work of work for Morton's companies.) This loan was at the center of the dispute in Motorworld.

In 2004, Benks was having some financial difficulties, and was looking for a loan from the Salkinds. At the same time, Benks was owed approximately $1 million by the Salkinds for work it had performed for some of their other companies, but not Motorworld. Nonetheless, the Salkinds agreed to provide the loan through Motorworld, and did so by having Carole first transfer $499,000 from a personal account to Motorworld's account. Motorworld then loaned $500,000 to the Benkendorfs in exchange for a promissory note. The due date on the note was extended several times by the parties.

In 2008, Motorworld executed a release, relieving the Benkendorfs of their obligations under the note in exchange for "site work services" that had been provided by Benks to other Salkind entities, not Motorworld. The parties disagreed over the origins of the release — the Benkendorfs claimed that they expressed to Morton that there should be a setoff on the amounts owed under the loan based on the money Benks was owed, while Morton said he repeatedly told the Benkendorfs there would be no setoff — but that was not relevant to the issues in the case.

A few years later, Carole filed for bankruptcy. The trustee sued the Benkendorfs and Benks, claiming that the release was a fraudulent conveyance. The trial judge agreed, holding that there was no actual fraud, but that the transfer was the product of constructive fraud because Motorworld did not receive any benefit in exchange for the release. Entities other than Motorworld benefitted by having their debt to Benks released, but Motorworld received no benefit. Accordingly, the trial court deemed the conveyance to have been fraudulent.

The Appellate Division reversed. It began by recognizing that, absent fraud, Motorworld was free to release the Benkendorfs from their debt regardless of whether there was an exchange of consideration. Under New Jersey law, "a person entitled to enforce an instrument, with or without consideration, may discharge the obligation of a party to pay the instrument." It further observed that the trial court had concluded that there was no actual fraud, therefore the only question was whether the release constituted constructive fraud.

The Appellate Division concluded that it did not. It agreed with the trial court that Motorworld did not receive equivalent value in exchange for releasing the note. But, the Appellate Division held that this conclusion, while correct, "ignore[d] one critical fact — "the debtor [Motorworld] may have received no value for the transfer, but its only creditor, the party for whose benefit the court is empowered to set aside the conveyance [Carole], received a reasonably equivalent value" (emphasis in original). In other words, "instead of being constructively defrauded by [Motorworld's] release . . . [Carole] actually benefited." She benefited from the fact that two of her solely-owned entities were absolved of a greater debt than the one forgiven by Motorworld.

Because the fraudulent conveyance statutes are designed to prevent fraud, it would be inappropriate to employ them when there has been no fraud, and the Appellate Division held that, in Motorworld, "no creditor was defrauded either actually, constructively, or theoretically."

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