Sale of corporation's assets to shareholder in exchange for debt forgiveness violated California Uniform Fraudulent Transfer Act

Law Reporter, Dec 1998

Mussetter v. Lyke, 10 F. Supp. 2d 944 (N.D. Ill. 1998). A U.S. district court held a corporation's transfer of assets worth approximately $1.7 million to its principal shareholder and another corporation owned by him in return for forgiveness of a $750,000 debt violated the California Uniform Fraudulent Transfer Act (UFTA), GAL. CIV. CODE sec. 3439.04.

Here, a lessor obtained a judgment against a corporate lessee for unpaid rent. Approximately 60 days after the judgment was entered, the corporate lessee transferred its assets to its principal shareholder and another corporation owned by him. The lessor sued the principal shareholder and his corporation, alleging the lessee's assets were fraudulently transferred to prevent satisfaction of the judgment in violation of the UFTA.

The court noted under the UFTA, a plaintiff can prevail by showing ( 1 ) actual fraud-a defendant's intent to hinder, delay, or defraud the plaintiff or (2) constructive fraud-a transfer that did not involve the exchange of reasonably equivalent value. The court observed that these methods are separate and distinct-a plaintiff may prevail by showing fraudulent intent without showing inadequacy of consideration, or by showing inadequacy of consideration without fraudulent intent.

Here, the court found that there were several indicia of actual fraud: (1 ) the transfer was to an insider-the principal shareholder and his corporation, (2) the corporate lessee retained possession and control of its assets for weeks after the purported transfer took place, (3) the lessee and principal shareholder concealed the transfer by failing to disclose it to the SEC and other shareholders, (4) judgment was entered against the lessee shortly before the transfer, (5) substantially all of the lessee's assets were involved in the transfer, (6) the lessee left the state shortly after the transfer, (7) the lessee was insolvent at the time of the transfer, and (8) the lessee incurred substantial debt before and after the transfer.

The court also found defendants' forgiveness of $750000 prior indebtedness was not a reasonably equivalent exchange for assets worth about $1.7 million.

Additionally, the court found the principal shareholder, who had also been chairman of the lessee corporation, had breached his fiduciary duties to the corporation's creditors.

Accordingly, the court entered judgment in favor of plaintiff, including punitive damages for the breach of fiduciary duties. Plaintiff's Counsel:

*Frank P. Tighe III, Oak Brook, Ill.