A party seeking to enforce a judgment against an asset of a judgment debtor that is held by a third party may petition for a turnover order through a special proceeding provided for by CPLR Article 52.  Justice Saliann Scarpulla’s recent decision in The Wimbledon Fund, SPC (Class TT) v. Weston Capital Partners Master Fund II, LTD (Wimbledon)[1] illustrates several of the potential issues that may arise during such a proceeding.

I. Background

Wimbledon concerns a petition by The Wimbledon Fund, SPC (“Class TT”) for an order pursuant to CPLR  5225 and 5227 directing Weston Capital Partners Master Fund II, Ltd. (“Weston”) and Wimbledon Financing Master Fund, Ltd. (“WFMF”) (together, “Respondents”) to turn over to the Sheriff of the City of New York property and money equal to approximately $3.5 million in partial satisfaction of a New York court judgment that Class TT had obtained against Schwartz IP Services Group Inc., otherwise known as “SIP.”[2]

Class TT alleged that it was the victim of a wide-ranging fraudulent scheme that caused its investor to lose more than $17 million.  At the time of the alleged fraud, Class TT was managed by Albert Hallac (“Hallac”), Jeffrey Hallac (“Jeffrey”), and Keith Wellner, through Weston Capital Asset Management, LLC and its related affiliate Weston Capital Management LLC.  Class TT alleged in its petition that Hallac and Wellner had arranged for Class TT to transfer $17.7 million to SIP for the ostensible purpose of investing in certain notes.  However, once SIP received the $17.7 million, instead of investing in the notes, Hallac, Wellner, and SIP’s President David Bergstein immediately transferred all of the money to several third parties, including Partners II, another investment fund managed by Hallac.  After discovering the scheme, the SEC and the U.S. Attorney for the Southern District of New York brought fraud charges against and ultimately convicted Hallac, Wellner, and Bergstein.[3]

In August 2015, Class TT brought a lawsuit in the U.S. District Court for the Central District of California (the “California action”) to recover more than $17 million of the investors’ funds from several defendants, including SIP and Bergstein.  The parties ultimately reached a settlement and signed an agreement containing a general release.[4]

Class TT thereafter filed a petition in the Commercial Division seeking: 1) to have SIP’s transfers of money to Partners II set aside as fraudulent conveyances, and 2) an order directing Weston to turn over approximately $3.5 million in partial satisfaction of a New York court judgment against SIP.  Weston moved to dismiss.[5]

II. Discussion

A. Choice of Law

In deciding the motion, Justice Scarpulla began by addressing and soundly rejecting Weston’s argument that Class TT’s claims should be dismissed because Cayman law applies to the tort of fraudulent conveyance and because both Class TT and Partners II are domiciled in the Cayman Islands.  The Commercial Division explained that Weston’s argument failed for two reasons.  First, Weston conceded that New York and Cayman law are the same as relevant to this action, which meant that the case did not turn on the potential applicability of Cayman law.  Second, fraudulent conveyance laws are “conduct-regulating” which means that the law of the jurisdiction where the tort occurred generally applies.  Here, the tort occurred in New York because the fraudulent conveyances were deposited in Partners II’s New York bank account; Weston conducted business on Partners II’s behalf in New York; Hallac confirmed in his plea allocution that many of the fraudulent actions described “occurred while conducting business in New York City”; and the judgment that is the basis for this turnover proceeding was issued by a New York court.[6]

Weston also argued that the court should apply Texas’ statute of limitations on fraudulent conveyance claims applies because SIP, a Texas corporation, is the real party in interest and the action accrued outside New York.  The Commercial Division rejected this argument for lack of any support in case law.[7]

B. The Release

The Commercial Division next rejected Weston’s release-based arguments.  Weston contended that because the settlement agreement in the California action contained a general release of claims against SIP, Class TT was precluded from bringing its petition against Weston.  The Commercial Division rejected this argument because Partners II was not a party to the California action and the settlement agreement explicitly preserved Class TT’s claims against Partners II.[8]

The Commercial Division also rejected Weston’s argument that Class TT had released its claims because by receiving the money transfers, Partners II had allegedly become SIP’s assignee and therefore subject to the settlement agreement.  The Commercial Division concluded that “Partners II did not become an assignee of the corporate entity of SIP by virtue of its receipt of a money transfer,” and noted the complete lack of case law support for this argument.  The general release in the settlement agreement in the California action therefore did not bar Class TT’s claims.[9]

C. Standing

Weston also claimed that Class TT lacked standing to bring its petition because David Bergstein was the “true beneficiary” of the petition and he would have lacked standing to bring this action had he sought to do so on his own.  The Commercial Division rejected this argument because Bergstein was not a party to the action and in any event this argument was legally unsupported.[10]

D. Champerty

Weston further argued that Bergstein was in fact an “undisclosed petitioner” because he contributed settlement proceeds to be used to finance actions such as this one, which in turn meant the action must be dismissed based on champerty grounds.  The Commercial Division rejected this argument, explaining: “If Bergstein was assigned the claim and commenced this action in his own name, then dismissal for champerty would have been appropriate. Here, however, the petitioner is Class TT which has the right to pursue this action on its own behalf.”[11]  The Commercial Division thus refused to dismiss Class TT’s claims based on the champerty doctrine “[i]n light of the narrowness of the champerty statute and the fact that Class TT is asserting claims on its own behalf, rather than as an assignee.”[12]

E. Unclean Hands

Weston also argued that Class TT was “an association-in-fact consisting of TT and Bergstein,” and maintained that Bergstein could not bring this petition due to unclean hands.  The Commercial Division found this argument unpersuasive both because Bergstein was not actually a petitioner and in any event “unclean hands does not furnish a ground for dismissal” of a fraudulent conveyance suit.[13]

F. Sufficiency of Fraudulent Conveyance Cause of Action
1. Constructive Fraudulent Conveyance

Under New York law,

Any conveyance that renders a conveyor insolvent is fraudulent as to creditors without regard to actual intent, if the conveyance was made without fair consideration.  Where a transfer was made without fair consideration, a presumption of insolvency and fraudulent transfer arises, and the burden shifts to the transferee to rebut that presumption.  Notably, even where there is fair consideration, a transfer may still be constructively fraudulent if good faith is absent for both the transferor and transferee.”[14]

Class TT alleged that Partners II had received more than $3 million of its money without providing any consideration to Class TT or SIP, and that SIP was insolvent at the time when it made those transfers. These allegations shifted the burden to Weston, which in turn argued that Hallac’s actions could not be attributed to Partners II because he was only acting out of self-interest and that Bergstein had received $9 million from Partners II and had paid back only $3 million, which showed that Partners II did not benefit from the scheme.  The Commercial Division summarily rejected these arguments, stating that “[e]ven if Partners II paid fair consideration to SIP, the transfers would still be constructively fraudulent because Weston cannot show that both SIP (transferor) and Partners II (transferee) acted in good faith,” especially in light of Hallac’s, Wellner’s, and Bergstein’s criminal convictions.[15]

2. Intentional Fraudulent Conveyance

“To state a claim for intentional fraudulent conveyance, the plaintiff must plead facts, with sufficient particularity, that show that the challenged conveyance lacked fair consideration and was made with the actual intent to hinder, delay or defraud creditors.”[16]  Because it is difficult to prove actual intent, parties pleading an intentional fraudulent conveyance claim may support their claim by relying on “badges of fraud” such as “a close relationship between the parties to the alleged fraudulent transaction; a questionable transfer not in the usual course of business; inadequacy of the consideration; the transferor's knowledge of the creditor's claim and the inability to pay it; and retention of control of the property by the transferor after the conveyance.”[17]

Here the petition alleged numerous such badges of fraud: “Partners II did not pay consideration to SIP; at the time of the transfer, SIP (through Bergstein, Hallac and Wellner) knew that Partners II did not owe any consideration to SIP or Class TT; and SIP's payment to Partners II was part of a large-scale fraudulent scheme,” plus “[t]hese allegations are supported by testimony from Hallac and Wellner,” who along with Bergstein were “sentenced in criminal cases based on this fraudulent scheme.”[18]  The Commercial Division accordingly deemed the conveyances from SIP to Partners II to constitute “a textbook example of an intentional fraudulent conveyance . . . establish[ing] Class TT's entitlement to a judgment setting the conveyances aside.”[19]

Having rejected all of Weston’s arguments, the Commercial Division denied the motion to dismiss and directed Weston to turn over approximately $3.5 million plus post-judgment interest.[20]

Conclusion

Wimbledon provides for an interesting illustration of several issues that may arise during a CPLR Article 52 proceeding for a turnover order.