FRAUDULENT CONVEYANCES Nassau Academy of Law CLE Live ...

302 B.R. 760 Page 5302 B.R. 760(Cite as: 302 B.R. 760)horadzaner, Inc., served as a member of Sharp'sBoard of Directors from January 1995 until October1999. See id. Sharp alleges that "[n]either Bohoradzaner,Inc. nor Mr. Bohoradzaner played anyrole in, or had any knowledge of, the fraud and embezzlementcommitted by the Spitzes." Id.FN1. Specifically, Bernard Spitz served asSharp's Chief Executive Officer, HerbertSpitz served as President, and LawrenceSpitz was Chief Financial Officer. See id. 10.The Spitzes' fraud had two basic components. First,beginning some time prior to 1997 and continuinguntil October 1999, the Spitzes fraudulently inflatedSharp's reported sales and revenues and used thesefalsified financial statements "to raise increasinglylarge sums of money from a succession of banks andother lenders." [FN2] Id. 15. At the same time, theSpitzes looted Sharp of the funds they caused it tofraudulently raise, as well as other corporate funds.See id. 16. In 1998 and 1999 alone, the Spitzes stolemore than $44 million from Sharp, diverting thefunds to a variety of companies, most of which wereowned by or otherwise affiliated with the Spitzes, andwhich provided no consideration to Sharp in exchangefor the transfers. See id.FN2. So great was the scope of the fraudthat "[t]he great majority of Sharp's reportedaccounts receivable balances during fiscal1997, 1998, and 1999 was comprised of fictitioussales," including reported sales to fictitiouscustomers and fictitious sales to actualcustomers. Id. 13. The Spitzes reportedSharp's net sales to be $52.1 millionin 1997 (when its actual sales for that yearwere approximately $24 million), $80.2 millionin 1998 (when actual sales were approximately$21 million), and $118.1 millionin 1999 (when actual sales were approximately$19 million). See id. 14.State Street's relationship with Sharp (and theSpitzes) commenced in November 1996, when StateStreet approved a $20 million demand line of creditto Sharp--secured by Sharp's assets--to refinanceSharp's then-current debt with LaSalle Bank and tosupport Sharp's operations. See id. 17. The terms ofState Street's loan to Sharp were formalized in aCredit Agreement and a Security Agreement, both ofwhich were dated December 12, 1996. See id. 18.The $20 million credit limit notwithstanding, StateStreet permitted Sharp's indebtedness to rise to approximately$26 million in 1997. See id. 19. In July1998, the Spitzes raised $17.5 million through theissuance of subordinated notes to a group of investors(the "Noteholders"). See id. 15. Sharp subsequentlyused a portion of the July 1998 proceeds to pay downthe debt to State Street. Thus, by the fall of 1998, theState Street debt had been reduced to $15 million.See id. 19.Sharp alleges that State Street began to suspect thepossibility of the Spitzes' fraud some time during thesummer of 1998, when Sharp breached its loanagreement in numerous respects. In particular,Sharp failed and refused to provide State Streetwith borrowing base reports, detailed accounts receivableaged trial balances, and other documentation,as required by the Credit and Security Agreements,despite State Street's constant *766 requestsfor such information; Sharp failed and refused toimplement an accounting system that would generatemonthly financial statements, despite Sharp'sprior agreement to do so; and Sharp refused to utilizethe State Street lockbox account, throughwhich, pursuant to the parties' Agreements, Sharp'saccount receivables were required to flow.Id. 31. Moreover, based on the documentation thatSharp did furnish, State Street grew concerned thatSharp was growing at an "alarmingly rapid pace" andwas consuming a large amount of cash. Id. 32.Sharp contends that State Street's sensitivity to thiskind of behavior was "heightened" as a result of afraud it had discovered at another of its borrowers,PT Imports, with whom State Street developed alending relationship in 1993. See id. 21, 28. Duringthe summer of 1998, State Street determined thatPT Imports had "created fictitious accounts receivableand customers, had created fictitious purchaserecords, and had falsely identified vendors who didnot exist." Id. 25. State Street concluded this fraud"had directly caused it to lend large amounts ofmoney to PT Imports." Id. Accordingly, in June1998, State Street commenced an action against PTImports in New York State court, seeking damages inexcess of $19 million. See id. 26. Like the loan toSharp, the PT Imports loan was made for the purposeof refinancing a debt to LaSalle Bank. See id. 17,© 2009 Thomson Reuters. No Claim to Orig. US Gov. Works.