FRAUDULENT CONVEYANCES Nassau Academy of Law CLE Live ...

302 B.R. 760 Page 9302 B.R. 760(Cite as: 302 B.R. 760)[4][5] There is no requirement that the alleged aiderand abetter have an intent to harm. However, to satisfythe knowledge prong, the defendant must haveactual knowledge of the primary violator's underlyingbreach of fiduciary duty. See Kaufman, 760N.Y.S.2d at 169, 307 A.D.2d at 125. "Constructiveknowledge of the breach of fiduciary duty by anotheris legally insufficient to impose aiding and abettingliability." Id.[6] Furthermore, to the extent the underlyingbreaches of fiduciary duty are based on fraudulentconduct, the complaint must meet the heightenedpleading requirement of Rule 9(b) of the FederalRules of Civil Procedure, which mandates that allallegations of fraud be pled with particularity. However,Rule 9(b)'s particularity requirement does notapply to "conditions of the mind"--including knowledge--whichmay be averred generally.In this case, the first and third elements of the aidingand abetting claim-- an underlying breach of a fiduciaryduty and resulting damages--are adequately pledin Sharp's complaint. As officers of Sharp, theSpitzes owed fiduciary duties to the corporation,which they breached by causing Sharp to raise millionsof dollars through fraudulently inflated financialstatements, and by converting the fraudulently acquiredproceeds as well as other corporate funds totalingin excess of $44 million. Further, Sharp wasclearly damaged by the Spitzes' large-scale looting ofthe company--indeed, the Bankruptcy Court has entereda judgment against the Spitzes (and several oftheir companies) jointly and severally in the amountof $44,378,650.30.The focus of the Bankruptcy Court's opinion--and ofthe parties' arguments in this appeal--concerns StateStreet's "knowing participation" in the Spitzes' conduct.The Bankruptcy Court began its analysis of thiselement of the aiding and abetting claim by endeavoringto "identify precisely the breach of fiduciaryduty for which Sharp seeks to hold State Street liable."Bankr.Dec. at 513. In this connection, theBankruptcy Court concluded that it was necessary todivide the Spitzes' fraud "into two conceptually distinctcategories: (1) causing Sharp to raise millions ofdollars through fraudulent representations; and (2)unlawfully diverting more than $44 million in Sharpfunds to companies that provided no consideration toSharp." Id. The court further contended that"[a]lthough these two types of wrongful conduct mayhave been combined by the Spitzes to form an overallfraudulent scheme, the wrongs are logically separableand give rise to two distinct causes of action and todifferent types of damages." Id. Moreover, the BankruptcyCourt noted, Sharp's claim against StateStreet--as evidenced by the damages sought in thecomplaint--was based on the Spitzes' looting ofSharp, rather than the accounting fraud that facilitatedthe looting. See id.; Compl. 58, "wherefore"clause "a" (seeking damages in excess of $19 millionfor the aiding and abetting claim, representing thesums misappropriated by the Spitzes *771 after StateStreet allegedly discovered the scheme).The Bankruptcy Court's analysis of Sharp's aidingand abetting claim is, in large part, driven by thisanalytical framework. See id. at 515 ("[The] facts[alleged in Sharp's complaint] at most support aninference that State Street had actual knowledge thatthe Spitzes were fraudulently inflating Sharp's receivables,"not that they were misappropriating corporateassets); id. at 517 ("[E]ven if accepted as adequateto plead that State Street assisted the Spitzes indefrauding the Noteholders, [Sharp's allegations] do [] not support a claim that State Street induced, participatedin, or substantially assisted the Spitzes indiverting monies from Sharp.").Sharp challenges the bankruptcy court's "bifurcation"of the Spitzes' fraud, arguing that "the Complaint... sets forth a unified integrated fraud in whichthe Spitzes raised money on behalf of Sharp throughfalse pretenses, and then stole that money for theirown purposes." Sharp Mem. in Supp. of Appeal("Sharp Mem.") at 17. At least at the pleading stage,plaintiff is correct that the rigid separation of thecomponents of the Spitzes' scheme for purposes ofevaluating the adequacy of the allegations of StateStreet's "knowing participation" is artificial and unwarranted.The fraudulent financial reporting throughwhich the Spitzes induced creditors to loan money toSharp and the Spitzes' embezzlement of those andother corporate funds were two steps in a singlescheme. See id. ("[T]he fraud in the falsification ofSharp's sales and revenues in order to raise moneywas inextricably linked to the theft of monies fromSharp."). Indeed, as discussed infra, in a case such asthis involving a closely-held corporation, the firststep would have been all but pointless without thesecond. Thus, on a motion to dismiss, State Street's© 2009 Thomson Reuters. No Claim to Orig. US Gov. Works.