New Jersey Supreme Court Rules That Release of Debt of Closely-Held Corporation in Exchange for Release of Debt by Second Closely-Held Corporation Is a Fraudulent Transfer

Michael A. Rowe

In Motorworld, Inc. v. William Benkendorf, et al. (A-64-15), the Supreme Court of New Jersey held that a corporation’s release of a debt constituted a fraudulent transfer under the Uniform Fraudulent Transfer Act (“UFTA”), N.J.S.A. 25:2-20 to -34.

In 1998, Morton Salkind arranged for his wife, Carole Salkind, to become the sole shareholder of 19 closely held corporations, including: (i) plaintiff Motorwold, Inc. (“Motorworld”); (ii) Fox Development, Inc. (“Fox”); and (iii) Giant Association (“Giant”). Defendant William Benkendorf was the owner of defendant Benks Land Services, Inc. (“Benks”). In 2004, Morton retained Benks to provide landscaping services to some of the companies owned by Carole, including Fox and Giant, but not Motorworld. Over time, Fox and Giant accumulated a debt to Benks of more than $1 million. Later in 2004, Motorworld loaned Benkendorf and his wife, defendant Gundrun Benkendorf, $600,000 so that the Benkendorfs could resolve a tax issue. Carole transferred $499,999 from her personal account into Motorworld’s account and the Benkendorfs executed a Note, stating that they would pay the principal amount. The Benkendorfs also agreed not to use the Note to offset any monies owed to them by any company owned by Carole, including Fox and Giant.

Despite several amendments to the Note, the Benkendorfs failed to pay the Note and thus faced substantial interest and late charges. The Benkendorfs requested that the Salkinds treat the amount due on the Note as a set off of the more than $1 million owed to Benks by Fox and Giant. The Salkinds agreed and executed a Release, on Motorworld’s behalf, pursuant to which Motorworld would cancel the Note, and Benks would forego its right to collect from Fox and Giant the more than $1 million owed by Benks to Fox and Giant.

In 2009, Morton and Carole filed for bankruptcy protection. Carole listed Fox, Giant, and Motorworld as assets. The Trustee contended that:  (i) Motorworld conducted no business; and (ii) the Benkendorfs’ $600,000 debt to Motorworld was its only asset. As a result, the Trustee filed a complaint, on behalf of Motorworld, against the Benkendorfs, seeking to collect on the Note. In response to the Benkendorfs’ argument that the Release extinguished their debt to Motorworld, the Trustee sought to void the Release as a fraudulent transfer under the UFTA. N.J.S.A. 25:2-27(a) provides that a transfer made by a debtor is constructively fraudulent as to a creditor whose claim arose before the transfer was made, if the debtor made the transfer without receiving “reasonably equivalent value” in exchange for the transfer and the debtor was insolvent as that time or became insolvent as a result of the transfer. The trial court concluded that the Release constituted a fraudulent transfer under the UFTA, because Motorworld received no “reasonably equivalent value” and became insolvent because of the transfer. The trial court voided the Release and entered judgement in plaintiff Motorworld’s favor.

The Benkendorfs appealed. The Appellate Division reversed, finding the transfer benefitted Carole by relieving her of the more than $1 million owed by Fox and Giant to Benks. The Supreme Court granted the plaintiffs’ petition for certification. The Supreme Court reversed the judgment of the Appellate Division and remanded the matter to the Appellate Division. The Supreme Court found that: (i) the Release effected a “transfer” within the meaning of the UFTA; (ii) by virtue of that transfer, Motorworld lost its sole asset and became insolvent; and (iii) although that transfer may have benefitted Fox and Giant, it failed to provide the “slightest benefit to Motorworld, much less ‘reasonably equivalent value’ for Motorworld’s release of a $600,000 debt.” See pp. 21-23. The Supreme Court noted that “Motorworld was not Carole Salkind’s alter ego and that the record revealed no reason to disregard the corporate form.” Thus, although the Release may have benefited Fox and Giant, it failed to benefit Motorworld. Id.

The Supreme Court reasoned that neither “Motorworld nor Carole Salkind had the slightest obligation to pay Benks’ bills to Fox and Giant for work that Benks performed on those entities’ behalf,” and therefore, “Motorworld received ‘no value’ when the Release extinguished those liabilities to Benks.” Id. at 23-25. Thus, because the UFTA provides that the value must be received by the debtor itself, the Supreme Court concurred with the trial court’s conclusion that the transfer was not made for “reasonably equivalent value” and therefore the Release was a fraudulent transfer. Id. at 27.

The decision demonstrates that third-party vendors must be careful when conducting business with various closely held corporations which are owned by the same individuals and then entering into agreements between these third-party vendors and closely held corporations which ignore the corporate formalities among those corporations.

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