The Court of Chancery recently allowed, after trial, a claimant to disregard the corporate entity, which the court found was involved in a fraudulent conveyance. The case styled: Fringer v. Kersey Homes, Inc., C.A. No. 9780-VCG (Del. Ch. June 25, 2018), begins with the following three sentences: “The great advantage of the corporate form is that it permits investment and ownership without risk of personal liability for entity debt. This advantage has its limits, obviously. One such limitation is involved here.” (FYI: There is no typo in the Plaintiff’s name in the above case caption.)
For those interested in the topic of “piercing the corporate veil,” friend of the blog, Professor Stephen Bainbridge, has co-authored a book that includes an in-depth scholarly analysis of the topic. The good professor has published a lengthy list of books and articles on corporate law that are often cited by the Delaware courts.
Although the net result is the same, this decision does not undertake a “conventional analysis” that directly addresses piercing the corporate veil, and the facts of this case are not likely to be repeated, but a number of more traditional “piercing the corporate veil” cases have been highlighted on these pages over the last 13 years.
The corporation involved, Kelsey Homes, Inc., was a defendant in a prior lawsuit based on allegations of fraud in connection with an agreement to sell a modular home. At the time of that agreement, Kelsey Homes, Inc. was “moribund.” By the time trial approached in the prior fraud suit, its only asset was the modular home at issue in the litigation. Kersey Homes, Inc. had transferred its only asset in a back-dated bill of sale to a relative of one of the stockholders, and then defaulted on the fraud action.
The court found that the stockholders of the corporate defendant were wrong when they thought that a judgment against the now-insolvent Kersey Homes, Inc. would be beyond the reach of the resulting judgment creditors.
The court held that the “sale” of the only corporate asset to a related party was a “sham” and the transfer was fraudulent under Delaware’s Uniform Fraudulent Transfer Act. The court granted the plaintiff in this case a levy on the property, to receive the sales proceeds in an amount sufficient to satisfy the judgment.
The prior fraud suit against Kersey Homes, Inc. regarding the sale of the modular home, resulted in a judgment being entered by the Superior Court. Although Kersey Homes, Inc. had initially defended the Superior Court action, shortly before trial they informed the court that they would not defend it. The modular home that was the subject of the Superior Court lawsuit, was transferred by Kersey Homes, Inc. to an affiliated party in exchange for discharging a prior debt of Kersey Homes, Inc. This transfer of the only asset of Kersey Homes, Inc. was made about one year into the litigation over the home that was the subject of the transfer and about two months prior to judgment being entered shortly before the trial date.
The instant litigation in the Court of Chancery was commenced about two weeks after the judgment was obtained in the Superior Court. The Chancery complaint sought relief against Kersey Homes, Inc. (which filed a certificate of dissolution several months after the Chancery complaint was filed), as well as the principal stockholder of Kersey Homes, Inc. and the related party that had received the fraudulent transfer. Kersey Homes, Inc. did not defend the Chancery litigation.
The court did not believe the testimony of the principal stockholder in part because the transfers were not documented and the only person available to testify about the transfer was the transferor.
The court determined that a more likely explanation for what happened was that the principals of Kersey Homes, Inc. realized they might be liable for a judgment and decided to take steps to evade any judgment that might be obtained. At the time of the fraudulent transfer, Kersey Homes, Inc. was already out of business and insolvent, without assets to satisfy a judgment. But about a year earlier, the only asset of Kersey Homes, Inc. had been transferred for no consideration. In an effort to defend a potential fraudulent conveyance claim, the principals of Kersey Homes, Inc. attempted to cover their tracks and create a story about a backdated transfer one year earlier. The court found that those transfers were intended to avoid execution on a judgment.
Key Legal Principles:
The court reviewed the elements of a claim under the Delaware Uniform Fraudulent Transfer Act (“DUFTA”) whose purpose the court described as providing a remedy to creditors who were defrauded by debtors who transfer assets or incur obligations with the intent to hinder, delay or defraud any creditor or, without receiving reasonably equivalent value. The court described the elements of a claim as recited in Section 1304(a) of Title 6 of the Delaware Code.
There are eleven factors that the statute lists as non-exclusive factors to consider in determining whether there was actual intent to defraud. It is not necessary that all the factors support a finding of intent. In this case, the court found that seven of the factors supported a finding of actual intent to defraud.
The court also found that Kersey Homes, Inc. violated Section 1305(a) which provides that a transfer is fraudulent as to a creditor whose claim arose before the transfer was made, if the debtor made the transfer without receiving a reasonably equivalent value or the debtor became insolvent as a result of the transfer. See footnote 117.
The opinion also discussed the broad latitude that a court has to craft a remedy subject to applicable principles of equity. Even though the original judgment was against a defunct corporation, the court traced the fraudulently transferred assets of the corporation to its current owner who was a stockholder in that corporation.
In sum, the court allowed the plaintiff to levy execution on the home involved in order to satisfy the judgment obtained in the Superior Court. The court also required the defendants to account for rental receipts on the house, and to the extent the sale of the property is insufficient to satisfy the judgment, the shortfall shall be made up from the rental receipts.
Because of a statute that applied in the Superior Court to grant treble damages for consumer fraud on senior citizens, the court found it inequitable to depart from the American Rule on fees.