FRAUDULENT CONVEYANCES Nassau Academy of Law CLE Live ...

302 B.R. 760 Page 11302 B.R. 760(Cite as: 302 B.R. 760)vorable to the plaintiff."). The test, therefore, is notwhether the facts alleged compel an inference favorableto Sharp, but rather whether they permit such aninference.Viewed in this light, Sharp's allegations are sufficientto plead State Street's actual knowledge of boththe false sales invoicing and probable looting by theSpitzes. State Street contends that the "limited information"revealed by the D & B Reports, concerning asubset of Sharp's customers, would not have led StateStreet to conclude that "the Spitzes were engaged infraudulent conduct on a major scale," as the complaintalleges, Compl. 48-- especially in light ofSharp's allegation that State Street confirmed thatseveral of Sharp's largest reported customers were infact purchasing Sharp products. *773 See State StreetMem. at 11; Compl. 38. However, State Street didnot review the D & B Reports in a vacuum. Indeed,the bank had for months been troubled by Sharp'sfailure to comply with the reporting requirements,and its persistent refusals to provide State Street withaccess to its books or to permit physical inventorycounts. The gravity of State Street's concerns is amplydemonstrated by the serious investigative effortsit allegedly initiated, notwithstanding the fact that onpaper "Sharp appeared to be oversecured and was notin monetary default." Compl. 35. In this context,the eventual discovery by State Street that Sharp wasreporting sales to a supposed customer who had, infact, gone out of business years earlier, or to otherswho by all appearances were not even in the watchbusiness, provides a sufficient factual predicate tosupport Sharp's allegation--at the pleading stage--thatState Street confirmed its suspicions, effectivelycrossing the line from constructive to actual knowledgeof the Spitzes' fraud.Despite State Street's discovery of evidence indicatingthat Sharp was not reporting its sales honestly,the Bankruptcy Court, relying on its bifurcation ofthe fraud, concluded that Sharp had not adequatelypled State Street's actual knowledge of the "wrong forwhich Sharp seeks recovery against State Street,"viz., the Spitzes' conversion of Sharp's funds.Bankr.Dec. at 515. As the Bankruptcy Court wouldhave it, the facts pleaded concerning the D & B Reports"at most support an inference that State Streethad actual knowledge that the Spitzes were fraudulentlyinflating Sharp's receivables," but "[t]he factthat a company is inflating its receivables does notnecessarily mean that the company's principals arelooting it." Bankr.Dec. at 515. In the particular circumstancesof this case, however, it is difficult toimagine another possible reason for the Spitzes toreport fictitious sales. [FN4] Sharp was not a publicly-heldcorporation, which could stand to benefit--at the expense of future shareholders--from inflatingthe apparent value of the company and thus drivingup stock prices. In this respect, Cenco, Inc. v. Seidman& Seidman, 686 F.2d 449 (7th Cir.1982)--citedby the Bankruptcy Court as an example of a corporatefraud involving fraudulent overstatement of inventory,but no subsequent looting--is inapposite. Asthe Bankruptcy Court explained, the Cenco case involveda publicly-traded corporation whose managers"inflated the company's apparent net worth and thusthe market value of its stock[,]" using the "inflatedstock to buy up other companies on the cheap." Id. at451. No such motive could plausibly account for thereporting of fraudulent sales by Sharp's management.Indeed, inasmuch as there was no public market forSharp's stock the nexus between the overvaluation ofthe company and looting by management is inescapable.[FN5]FN4. When asked at oral argument to provideanother plausible reason that mighthave motivated the Spitzes to report fraudulentsales, counsel for State Street respondedthat State Street might have supposed thatthe Spitzes "want[ed] to make the companylook good until they sell it to a third party."Tr. of Aug. 13, 2003 Oral Arg. at 12. Such ahypothesis would have been highly speculativeat best, however, since State Streetwould have had to assume that a prospectivebuyer would do very little due diligence and,therefore, not discover that the sales volumewas not as reported.FN5. For these reasons, State Street's relianceon In re Investors Funding Corp. ofN.Y. Sec. Litig., 523 F.Supp. 533(S.D.N.Y.1980) (quoted in State StreetMem. at 17) is similarly unpersuasive. Inthat case, a Chapter X trustee sued a bankruptcorporation's former auditors who hadcertified financial statements that "materiallyoverstated the income and assets of the[corporation] while materially understatingits losses and liabilities." Id. at 536-37. The© 2009 Thomson Reuters. No Claim to Orig. US Gov. Works.