On March 10, 2004, David S. Kittay, Esq., the chapter 7 trustee for the estate of Global Service Group, LLC (“Global” or the “debtor”), commenced this adversary proceeding against, inter alia, Atlantic Bank and members and insiders of Global, including Alan Goldman (“Alan”), Gerald Goldman (“Gerald,” and together with Alan, the “Goldmans”), and Robert Cohen. Alan, Gerald and Cohen are sometimes collectively referred to as the (“Insiders Defendants”). The Complaint alleges two general categories of wrongful conduct: fraudulent transfers and the artificial prolongation of Global’s corporate life, resulting in its “deepening insolvency.”
Atlantic Bank moved to dismiss the five claims asserted against it and the Insider Defendants moved to dismiss many of the claims directed towards them. The Court disposed of most of the latter motion from the bench, and reserved decision on three claims. For the reasons that follow, Atlantic Bank’s motion is granted. The three unresolved claims against the Insider Defendants’ are also dismissed but with leave to replead.
BACKGROUND
The following facts alleged in the Complaint are assumed to be true for purposes of these motions. 1
A. Introduction
Global is a limited liability company organized under the laws of New York, and prior to the conversion of this case to chapter 7, was engaged in the business of marble, metal and wood refinishing. (Complaint, ¶¶ 8, 19.) The senior management and principal members of Global included the Goldmans and either Walter or Lauren Liehtman, who are also defendants. 2 (Complaint, ¶ 20.) Cohen served as the debtor’s Chief Finanсial Officer, (Complaint, ¶21), and he and the Gold-mans were authorized to sign checks on Global’s behalf. (Complaint, ¶¶ 20, 21.)
The Complaint also names four defendant entities as fraudulent transferees. Two are owned and controlled by either or both of the Goldmans. These are A & G Goldman Partnership (“A & G”), (Complaint, ¶¶ 14, 121), and Bargold Storage System LLC (“Bargold”). (Complaint, ¶¶ 15, 161.) The other two are Andrew Bryant Associates (“Bryant”), a corporation, (Complaint, ¶ 16), and 95 Bruckner LLC (“Bruckner”), a limited liability company, (Complaint, ¶ 17), and “an insider of the Debtor as that term is defined under the Bankruptcy Code.” (Complaint, ¶ 235.)
B. The Trustee’s Theories
1. Fraudulent Transfers
As noted, the Complaint alleges two general theories of wrongdoing. First, the Goldmans and Cohen authorized certain alleged fraudulent conveyances without requiring the transferees to pay fair and adequate consideration to the Debtor. (Complaint, ¶ 102.) The Complaint identifies the following fraudulent transfers:
a. Goldmans/A & G Transfers
On May 16, 2000, Global transferred $175,000 (or a total of $350,000.00) to each of the Goldmans within days after it obtained its initial loan from Atlantic Bank. (Complaint, ¶¶ 61, 82.) On December 21 and December 27, 2000, Global transferred $31,800.00 and $48,931.67, respectively, to A & G. (Complaint, ¶ 120.)
b. Bargold Transfers
During the two year period preceding the petition date, Global transferred not less than $65,000.00 to Bargold. (Complaint, ¶ 172.) Several of those transfers, aggregating $45,000.00, were made within one year of the petition date. (Complaint, ¶ 160.) In addition, Global transferred not less than $76,424.43 to Bargold after thе petition date. (Complaint, ¶ 199.)
c. Bryant Transfers
Bryant shares the same address as Andrew Kalish, one of the debtor’s former employees. (Complaint, ¶205.) During the two years preceding the filing of its chapter 11 petition, Global transferred at least $116,602.86 to Bryant. (Complaint, ¶216.) Of that amount, $36,000.00 was transferred within one year of the petition date. (Complaint, ¶ 204.)
d. Bruckner Transfers
Within one year of the petition date, Global transferred not less than $51,045.84 to Bruckner (Complaint, ¶ 234.) Following the commencement of the case, the debtor transferred not less than $22,015.28 to Bruckner. (Complaint, ¶ 241.)
e. Lauren Lichtman Transfers.
During the two years preceding the petition date, Global transferred at least $27,022.78 to Lauren Lichtman. (Complaint, ¶ 259.) Not less than $14,022.78 of that amount was transferred during the one year period before the petition date. (Complaint ¶ 246.)
2. “Deepening Insolvency”
The trustee’s second theory maintains that Global was allowed to operate while insolvent, and incurred additional debt that it could not repay. The following claims are based on this theory:
a. Atlantic Bank
Since its formation in January 2000, Global was insolvent or in the vicinity of insolvency and undercapitalized. (Complaint, ¶ 31.) Atlantic Bank knew or should have known that the debtor would be unable to repay its loans due to its financial condition, but loaned the debtor money anyway, (Complaint, ¶ 32, 33), apparently based upon its relationship with the Gold-mans and the strength of their personal assets. (Complaint, ¶ 33.) The Goldmans pledged their individual assets to Atlantic Bank in order for Global to obtain the necessary loans for working capital and to continue operating. (Complaint, ¶ 51.)
Other creditors extended credit to Global based on Atlantic Bank’s willingness to
b. The Insider Defendants 3
The Goldmans and Cohen, either individually or acting in concert with each other, allowed Global to do business and incur indebtedness while it was insolvent and undercapitalized. (Complaint, ¶ 101.) The Insider Defendants knew that the debtor would be unable to repay these debts based on its financial condition. (Complaint, ¶ 109.) By prolonging the debtor’s corporate life and incurring more debt, the Insider Defendants deepened Global’s insolvency, and reduced any potential recovery for the creditors of the debtor’s bankruptcy estate. (Complaint, ¶ 105.) The expansion of Global’s debt was the proximate cause of the damage to Global and its creditors. (Complaint, ¶ 106.)
C. The Bankruptcy Filing
The debtor filed its chapter 11 petition on November 7, 2001. (Complaint, ¶ 1.) The case was converted to chapter 7 by order dated March 11, 2003. (Complaint, ¶ 1.) David Kittay, Esq. was appointed interim chapter 7 trustee, and subsequently qualified as permanent trustee. (Complaint, ¶ 1.) The trustee filed his forty-seven count Complaint, commencing this adversary proceeding, on March 10, 2004. Atlantic Bank moved to dismiss the First through Fourth and Seventeenth Causes of Action, all of the claims in which it was named. I reserved decision, and these causes of action are discussed below.
The Insider Defendants, A & G and Bargold, represented by the same law firm, moved to dismiss many of the Causes of Action. 4 Following the oral argument of the motion on July 27, 2004, the Court denied the motion to the extent that it was directed at the fraudulent conveyance claims, dismissed the contribution claim, and the trustee withdrew the equitable subordination claim. The Court reserved decision on the claims that implicated the “deepening insolvency” theory, (the Thirteenth through Fifteenth Causes of Action), and these are discussed below.
DISCUSSION
A. Atlantic Bank’s Motion to Dismiss
1. The First Cause of Action/”Deepening Insolvency”
The First Cause of Action alleges that Atlantic Bank engaged in conduct associated with the phrase “deepening insolvency.” “Deepening insolvency” refers to the “fraudulent prolongation of a corporation’s life beyond insolvenсy,” resulting in damage to the corporation caused by increased debt.
Schacht v. Brown,
Peat, Marwick, Mitchell & Co. (“PMM”) had served as the debtor’s outside auditor. The debtor’s chapter X trustee sued PMM, charging that the Danskers used the false financial statements that PMM had certified to further their scheme. Id. at 537. PMM moved for partial judgment on the pleadings or for partial summary judgment, and argued, inter alia, that the knowledge and wrongful conduct of the insiders should be imputed to the debtor’s insiders to defeat recovery. Id. at 533.
PMM’s argument invoked the “adverse interest” exception to the general rule that the agent’s knowledge will be imputed to his principal. According to the District Court, the “adverse interest” exception applied if the agent acted adversely to the interest of his principal, but did not apply “where the agent is also acting for the principal’s benefit, even though the agent’s primary interest is inimical to that of the principal.” Id. at 541. PMM urged that although the Dansker’s were motivated by personal intеrests, the complaint also alleged that the debtor benefitted from the infusion of funds.
In words that begat the theory of “deepening insolvency,” the District Court rejected the notion that acts that prolong a corporation’s existence automatically confer a benefit on the corporation:
[E]ven to the extent one focuses upon the artificial financial picture of IFC [the debtor] created by the Danskers which prolonged IFC’s existence several years beyond its actual insolvency, PMM’s position is not persuasive. A corporation is not a biological entity for which it can be presumed that any act which extends its existence is beneficial to it. The complaint plainly alleges that, as a result of the Dаnskers’ practices, IFC’s financial situation was caused to deteriorate even further after 1971. Accepting the allegations of the complaint as true, it is manifest that the prolonged artificial solvency of IFC benefited only the Danskers and their confederates, not IFC.
Id. (emphasis added).
What began as a justification for recognizing the “adverse interest” exception soon morphed into a theory of recovery. Since
Investors Funding,
several courts have accepted the theory that an insolvent corporation suffers a distinct and compen-sable injury when it continues to operate and incur more debt.
5
Some have treated “deepening insolvency” as an independent cause of action.
Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co.,
Decisions since
Investors Funding
suggest that the New York courts regard “deepening insolvency” as a theory of damages that may result from the commission of a separate tort.
See, e.g., Allard,
The distinction between “deepening insolvency” as a tort or damage theory may be one unnecessary to make. Prolonging an insolvent corporation’s life, without more, will not result in liability under either approach. Instead, one seeking to recover for “deepening insolvency” must show that the defendant prolonged the company’s life in breach of a separate duty, or committed an actionable tort that contributed to the continued operation of a corporation and its increased debt.
E.g., R.F. Lafferty & Co.,
Considered against this backdrop, the First Cause of Action falls short. The Complaint alleges, in substance, that Atlantic Bank should be liable for Global’s “deepening insolvency” because the bank made a loan that it knew or should have known Global could never repay. This may be bad banking, but it isn’t а tort. A third party is not prohibited from extending credit to an insolvent entity; if it was, most companies in financial distress would be forced to liquidate. And while the Complaint alleges that Atlantic Bank made the loan on the strength of its relationship with the Goldmans and their personal assets, this is neither surprising nor improper. Banks prefer to lend to those they know, and have the right to insist on guaranties and pledges of personal assets from the corporate principals. Notably, the Complaint does not allege or imply that Atlantic Bank extended the loans to enable the Goldmans to siphon off the funds or commit some other wrong.
This leads to the second problem with the First Cause of Action, and for that matter, with much of the Complaint. The unspoken premise оf the trustee’s “deepening insolvency” theory is that the managers of an insolvent limited liability company are under an absolute duty to liquidate the company, and anyone who knowingly extends credit to the insolvent company breaches an independent duty in the nature of aiding and abetting the managers’ wrongdoing. The assumption is a faulty one.
Under New York law, the management of a corporation is generally vested in the board of directors, N.Y. Bus. CoRP. L. § 701 (McKinney 2003)(“BCL”), and the board appoints or elects the officers.
6
Id.,
§ 715(a). The officers and directors must perform their duties “in good faith and with that degree of care which an ordinarily prudent person in a like position would use under similar circumstances.”
Id.,
§ 715(h)(duties of officers), § 717(a)(duties of directors). Direсtors and officers owe their fiduciary duties to both the corporation and the shareholders.
See Gully v. National Credit Union Administration Board,
The fiduciaries of an insolvent business might well conclude that the company should continue to operate in order to maximize its “long-term wealth creating capacity,” or more generally, its enterprise value. In fact, chapter 11 is based on the accepted notion that a business is worth more to everyone alive than dead.
See NLRB v. Bildisco & Bildisco,
Thus, in contrast to the laws of some foreign jurisdictions, including the United Kingdom,
8
there is no absolute duty under American law to shut down and liquidate an insolvent corporation. The fiduciaries may, consistent with the business judgment rule, continue to operate the corporation’s business.
Official Comm. of Unsecured Creditors of RSL COM PRIMECALL, Inc. v. Beckoff (In re RSL COM PRIMECALL, Inc.),
Adv. Proc. No. 03-2176,
To overcome the business judgment rule, a complaint must contain specific allegations that the fiduciary acted in bad faith or with fraudulent intent.
See Lippe v. Bairnco Corp.,
The First Cause of Action also fails to allege proximate cause. The Complaint implies that “but for” Atlantic Bank’s loans, the debtor would have liquidated before its insolvency became deeper. In
Investors Funding Corp.,
the trustee made a similar argument that “but for” the false financial statements prepared by the defendant accountants, the debtor would not have been able to sell securities, and the insiders would not have been able to steal the sale proceeds.
Applying traditional tort concepts, the District Court concluded that the trustee had failed to plead proximate causе,
i. e.,
that “ ‘the damage was either a direct result or a reasonably foreseeable result of the misleading statement.’ ”
Id.
at 539 (quoting
Globus v. Law Research Serv., Inc.,
Here, the gravamen of the claims against the Insider Defendants was that they caused Global to pay the Goldmans and their affiliates fraudulent transfers, and the Complaint implies that the Gold-mans used at least some of the Atlantic Bank proceeds in furtherance of their scheme. 9 While it was arguably foreseeable that the Atlantic Bank loans would permit the debtor to continue to operate, the Complaint does not allege facts suggesting that Atlantic Bank could have foreseen that the Goldmans would misappropriate the loan proceeds, or operate the insolvent debtor for an improper purpose.
In short, the First Cause of Action does not state a claim upon which relief can be granted, and it is dismissed.
2. Second Cause of Action/Aiding and Abetting
The trustee’s Second Cause of Action alleges an aiding and abetting claim that mirrors the First Cause of Action. The First Cause of Action alleges that Atlantic Bank’s actions “contributed” to Global’s “deepening insolvency,” “resulted” in increased debt, and “allowed” Global to prolong its existence and incur more debt that could have been avoided. (Complaint, ¶ 35.) The Second Cause of Action alleges that Atlantic Bank’s actions “aided and abetted” Global’s continued operations, “al
Even when viewed independently, the Second Cause of Action is legally insufficient. A claim under New York law for aiding and abetting a tortious act must satisfy three elements: “(1) that the principal/third party violated the law or engaged in tortious conduct; (2) that the defendant knew or should have known that the violation or conduct was occurring; and (3) that defendant’s conduct gave substantial assistance or encоuragement to the principal to engage in the violation or tortious conduct.”
Medeiros v. John Alden Life Ins. Co.,
No. 89 Civ. 1278,
The Second Cause of Action does not identify any underlying tortious conduct. It implies, wrongly, that the mere continuation of Global’s operations violated a legal duty. Without a primary violation, there is no wrongdoing to aid and abet. Accordingly, the Second Cause of Action is dismissed for failure to state a claim. 10
3. Third Cause of Action/Equitable Subordination
The Third Cause of Action alleges that Atlantic Bank’s claims should be equitably subordinated under 11 U.S.C. § 510(c).
11
The remedy of equitable subordination is available where (1) the claimant engaged in inequitable conduct, (2) the misconduct caused injury to the creditors or conferred an unfair advantage on the claimant, and (3) equitable subordination is consistent with bankruptcy law.
In re Mobile Steel Co.,
As stated, the Complaint does not charge Atlantic Bank with any wrongful or
4. Fourth Cause of Action/Marshaling
The Fourth Cause of Action relies on the doctrine of marshaling to force Atlantic Bank to satisfy its lien from the Goldmans’ assets. (Complaint, ¶ 46.) Marshaling is an equitable principle designed to protect the rights of a junior creditor by compelling a senior creditor to attempt to collect its claim first from another source unavailable to the junior creditor.
See Meyer v. United States, 375
U.S. 233, 237,
The Complaint fails, however, to allege that Atlantic Bank had the right to resort to a separate fund owned by the estate. As a rule, the same debtor must own the сommon and separate fund.
In re Tampa Chain Co.,
The trustee failed to plead a basis to pierce the corporate veil of Global, and treat Global and the Goldmans as
alter egos.
Notwithstanding the liberal pleading standards under Fed.R.Civ.P. 8(e), the plaintiff must plead facts sufficient to show a basis to pierce the corporate veil,
See, e.g., Kaplan v. Aspen Knolls Corp.,
Paragraph 51 suggests the factual basis for treating the Goldmans and the debtor as “common debtors.” It states that they are members of the debtor and pledged their individual assets to Atlantic Bank to enable the debtor to obtain the operating loan. It concludes that “[therefore, A. Goldman, G. Goldman and the Debtor constitute the same debtor for purposes of applying the doctrine of marshaling.” These averments appear to be keyed to the minority view that the controlling shareholder and the corporation may be treated as a common shareholder when the former’s assets provide the primary collateral that secures the loan to the latter. They do not, however, state a basis for piercing the corporate veil. Furthermore, the Court is not required to credit the conclusory allegation that the Goldmans and the debtor are the same debtor for purposes of the marshaling doctrine, and accordingly, the claim for marshaling asserted against Atlantic Bank in the Fourth Cause of Action is dismissed for failure to state a claim on which relief can be granted.
5. Seventeenth Cause of Action/Contribution
The Seventeenth Cause of Action asserts a claim for contribution against Atlantic Bank (as well as the Gold-mans, the Lichtmans and Cohen) because the defendants “each contributed to the deepening of the Debtor’s insolvenсy and the expansion of the Debtor’s liabilities when they knew that the Debtor would be unable to pay such liabilities.” (Complaint, ¶ 116.) Contribution may be available among joint tortfeasors who are liable for the same injuries to a third party.
See
N.Y. C.P.L.R. 1401 (McKinney 1997);
In re Agent Orange Prod. Liability Litig.,
The Complaint alleges that the estate is a victim of the defendants’ actions, and not that Global and the other defendants are or may be liable jointly for the same injuries suffered by a third party. 13 Accordingly, the Seventeenth Cause of Action fails to state for contribution against Atlantic Bank. 14
B. Insider Defendants’ Motion to Dismiss
Three claims against the Insider Defendants were not resolved at the hearing on their Motion to Dismiss — the Thirteenth, Fourteen and Fifteenth Causes of Action. The Thirteenth Cause of Action alleges that the defendants breached their
Second, they allowed “the Debtor to do business and incur indebtedness while the Debtor was insolvent and under-capitalized.” (Complaint, ¶ 101.) The Insider Defendants were not, however, under an absolute duty to liquidate Global because it was undercapitalized or insolvent, and the trustee now concedes the point. (See Memorandum of Law in Support of Trustee’s Objection to Motion of [Insider Defendants], A & G Goldman Partnership, and Bargold Storage System LLC to Dismiss the Complaint, dated July 15, 2004, at 20)(ECF Doc. # 24.) His submissions on this motion nonetheless argue that “it appears that the Goldmans continued to operate the Debtor as a means of siphoning the Debtor’s funds for their individual benefit.” (Id.)
If the Complaint included this allegation, these claims might be legally sufficient. The prolongation of Global’s operations would smack of self-dealing, constitute a breach of fiduciary duty, and open up recovery under the theory of “deepening insolvency.”
See In re Latin Inv.,
The Fourteenth Cause of Action repeats the preceding claim. It alleges that the Insider Defendants caused “the Debtor to expand its debt and prolong its corporate life while the Debtor was continuously insolvent, ... deepened the insolvency of the Debtor and incurred additional debts which would have otherwise been avoided.” (Complaint, ¶ 105.) This is no different than the earlier allegation that the Insider Defendants allowed “the Debtor to do business and incur indebtedness while the Debtor was insolvent and undercapital-ized.” (Complaint, ¶ 101.) It is legally insufficient for the same reason.
Finаlly, the Fifteenth Cause of Action alleges that the Insider Defendants aided and abetted Global’s “deepening insolvency.” It uses language nearly identical to the Fourteenth Cause of Action. The latter asserts that the Insider Defendants “caused” Global to expand its debt and prolong its life, and “allowed” the debtor to continue to operate and incur more debt which could have been avoided. (Complaint, ¶ 105). The Fifteenth Cause of Action alleges that “as a direct result of’ the Insider Defendants’ actions, Global incurred additional debt that they knew Global would not be able to pay, (Complaint, ¶ 109), and their conduct “allowed” Global to incur more debt which it could have avoided if it had ceased operations. (Complaint, ¶ 110.) There is nо difference between the two claims, and the Fifteenth Cause of Action suffers from the same
The three claims will be dismissed, however, with leave to replead. It appears that the trustee may be able to allege a legally sufficient claim that the Goldmans (and possibly others) prolonged Global’s existence so that they could continue to receive fraudulent transfers. I granted leave to replead other dismissed claims following the oral argument, and the trustee will have another opportunity to assert this claim, consistent, of course, with the dictates of Fed. R. BANKR.P. 9011.
In conclusion, the claims against Atlantic Bank are dismissed. The remaining claims against the Insider Defendants are dismissed with leave to replead within thirty days of the date of the order, which the trustee is directed to settle, reflecting the disposition of both motions.
Notes
. A court may dismiss a complaint under Fed. R.Civ.P. 12(b)(6), made applicable to this adversary proceeding by Fed. R. BankrP. 7012, only if it appears beyond doubt that the plaintiff would not be entitled to any type of relief, even if he proved the factual allegations in his complaint.
Conley v. Gibson,
. Paragraph 20 refers to "Liehtman,” but does not identify which "Liehtman.” Lauren is a "relative” of Walter. (Complaint, ¶ 248.)
. The "deepening insolvency” claims are also made against Walter Lichtman, but he did not move to dismiss.
. The Causes of Action deemed to be encompassed in the motion are those identified in the Notice of Motion. In some instances, the movants mentioned other Causes of Action in their submissions, but these have not been considered.
. Technically, the same theory should apply to a solvent company that works itself into insolvency.
. These general rules can be modified by the certificate of incorporation or a shareholders’ agreement.
. The directors of a New York corporation need not wait until insolvency to consider this community of interests. Under BCL § 717(b), their decision to act may take account of the long-term and short-term interests of the shareholders and the corporation, and the long-term and short-term effect of their actions on (1) the corporation’s prospects for potential growth, development, productivity and profitability, (2) the corporation's current employees, the beneficiaries of any retirement or similar plans, and its customers and creditors, and (3) "the ability of the corporation to provide, as a going concern, goods, services, employment opportunities and employment benefits and otherwise to contribute to the communities in which it does business."
. Under the law of the United Kingdom, directors who continue to operate a business and incur debt when they know that the company is headed for liquidation face liability for wrongful trading.
See In re Ionica, PLC,
. These allegations were not incorporаted in the first four causes of action asserted against Atlantic Bank.
. Given this conclusion, it is unnecessary to consider whether the trustee lacks standing to assert the aiding and abetting claim under the holding of
Shearson Lehman Hutton, Inc. v. Wagoner,
. Section 510(c) states:
Notwithstanding subsections (a) and (b) of this section, after notice and a hearing, the court may — (1) under principles of equitable subordination, subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim or all or part of an allowed interest to all or part of another allowed interest; or (2) order that any lien securing such a subordinated claim be transferred to the estate.
. Section 544(a)(2) of the Bankruptcy Code grants the trustee the rights and powers, as of the commenсement of the case, of "a creditor that extends credit to the debtor at the time of the commencement of the case, and obtains, at such time and with respect to such credit, an execution against the debtor that is returned unsatisfied at such time, whether or not such a creditor exists.” Under N.Y. C.P.L.R. 5202(a) (McKinney 1997), an unsatisfied execution creditor acquires rights in the judgment-debtor’s personal property that are superior to all but senior secured creditors and bona fide purchasers for value.
. At the argument on the Insider Defendants' motion to dismiss, the trustee clarified his contribution theory. If the estate is liable to the creditors, the contribution defendants are also liable for the same injuries, and the estate would therefore be entitled to contribution. The Complaint does not include these allegations.
. The contribution claim was dismissed as against the Insider Defendants following oral argument of their motion for the same reasons.