Kartzman v. Latoc, Inc. (In re Mall At the Galaxy, Inc.)

In re: THE MALL AT THE GALAXY, INC., Debtor.

STEVEN P. KARTZMAN, as Chapter 7 Trustee, Plaintiff, v. LATOC, INC., Defendant.

Case No.: 10-12435 VFP

Adv. Pro. No.: 12-1769 VFP

UNITED STATES BANKRUPTCY COURT DISTRICT OF NEW JERSEY

April 4, 2019

Chapter 7

TRIAL OPINION

APPEARANCES

MELLINGER, SANDERS & KARTZMAN, LLC

101 Gibraltar Drive, Ste. 2F

Morris Plains, NJ 07950

Joseph R. Zapata, Jr., Esq.

Attorneys for Steven P. Kartzman, Chapter 7 Trustee/Plaintiff

PETER A. OUDA, ESQ.

19 North Bridge Street

Somerville, NJ 08876

Attorney for Defendant, Latoc, Inc.

VINCENT F. PAPALIA, Bankruptcy Judge

I. INTRODUCTION

This matter is before the Court following a three-day trial on August 2, 2017, August 4, 2017 and again on February 28, 2018, after certain in limine motions were made that required briefing by the parties and a delay of the trial.¹ In this adversary proceeding, the Chapter 7 Trustee (the "Trustee") of the Debtor, The Mall at the Galaxy, Inc. (the "Debtor"), seeks to avoid as constructively fraudulent transfers: (i) a promissory note (the "Note" or "Latoc Note") in the amount of $2 million from the Debtor to defendant Latoc, Inc. ("Latoc") or ("Defendant"); and (ii) payments in the amount of $592,875 by the Debtor to Latoc on account of the Note (the "Prepetition Transfers").

For the reasons set forth below, the Court finds that the Debtor's Prepetition Transfers to the Defendant were constructively fraudulent because the Debtor did not receive reasonably equivalent value for the transfers and the Debtor was insolvent at the time of each of the transfers under at least two of the three recognized tests for insolvency. Therefore, pursuant to 11 U.S.C. §§ 544, 548 and 550, the avoided Prepetition Transfers may be recovered by the Chapter 7 Trustee for the benefit of the estate.

II. JURISDICTIONAL STATEMENT

The Court has jurisdiction over this matter under 28 U.S.C. § 1334(b) and the Standing Orders of Reference entered by the United States District Court on July 10, 1984 and amended on September 18, 2012. This is a core proceeding under 28 U.S.C. § 157(b)(2)(A), (B), (F) and (O).Venue is proper in this Court under 28 U.S.C. § 1408. The Court issues the following findings of fact and conclusions of law pursuant to FED. R. BANKR. P. 7052. To the extent that any of the findings of fact might constitute conclusions of law, they are adopted as such. Conversely, to the extent that any conclusions of law constitute findings of fact, they are adopted as such.

III. STATEMENT OF FACTS

A. Overview of Debtor's Business

At the time of its bankruptcy filing, the Debtor was owner of approximately 105,000 square feet of commercial and retail space, 76,321 of which was leasable (the "Property"), contiguous to three large residential condominium towers (1,075 units) in Guttenberg, New Jersey. The Debtor was at the time owned by Martin Sergi (90%) and Dennis Squitieri (10%).² From 1986, Sergi was the President, Treasurer and a board member of the Debtor.³ In addition to these substantial roles, Mr. Sergi oversaw much of the Debtor's day-to-day operations and finances.⁴

The Debtor had two alleged subsidiaries, PermaLife Internet, LLC (with a purported 20% equity interest) ("PermaLife Internet") and Piedmont Rubber Recycling, LLC (with a purported 100% equity interest) ("PRR").⁵ Sergi also owned a substantial interest in a related PermaLife entity called PermaLife Products, Inc., which was the parent company of seven other related entities (including PermaLife Internet).⁶

No competent proofs were provided of the Debtor's alleged interest in PermaLife Internet or PRR, including evidence of ownership, such as shares or membership interests, or the precise amounts owned, when the interests were acquired and for what consideration. Thus, in a priordecision on a partial summary judgment motion by the Trustee, the Court determined that Latoc had not provided sufficient evidence to support its ownership claims as to PermaLife Internet or PRR.⁷

In 2008, the Debtor determined to convert its space to 32 separate condominium units and sought to sell them to existing tenants and third parties.⁸ After the conversion, the Debtor was able to sell only 19 of the 32 new units, 18 of which went to existing tenants.⁹ The gross proceeds from these sales were approximately $6 million between May 2008 and August 2009.¹⁰ The Debtor was not able to sell any of the remaining 13 units before it filed for bankruptcy in January 2010.¹¹

B. The Financial and Other Issues Facing the Debtor, Including GTCA Obligations

In 2008, the Galaxy Towers Condominium Association ("GTCA") was the homeowner's association for the entire complex, both residential and commercial. As the condominium's association, the GTCA imposed common charges on the Debtor of approximately $35,000 a month or $420,000 annually.¹² In 2005, Sergi wrote a letter to the Board of the GTCA, describing in detail the many serious issues that confronted the Debtor and outlining potential resolutions.¹³ The letter included financial statements covering the 2003-05 period to support Mr. Sergi's statements about the declining financial and physical condition of the Debtor and its property and how the Debtor's rental income was insufficient to cover expenses.¹⁴

One critical financial issue the Debtor faced at the time was the loss of its theater, its largest tenant, in 2005.¹⁵ Another was the lack of revenue, capital or other funding necessary to pay forbadly needed repairs and capital improvements.¹⁶ Mr. Sergi also accurately forecast that without additional funding and relief from the GTCA, the Debtor could not continue to survive. Recognizing these formidable issues, Mr. Sergi suggested that one of the options the Debtor should consider was to grant a deed-in-lieu of foreclosure to its then-current lender.¹⁷ Thus, there is no doubt that in 2005, and likely well before then, Mr. Sergi knew that the Debtor's financial situation was in a critical state.¹⁸

As the Debtor faced these challenges, it failed to pay the GTCA for common charges and was often behind in other obligations. In 2007, the GTCA sued the Debtor for failure to pay the outstanding dues and obtained a judgment against the Debtor in the amount of $631,089.22.¹⁹ In 2008, the Debtor entered into a settlement agreement and paid the GTCA $706,599.35, representing unpaid dues as well as other charges.²⁰ As part of that settlement agreement, the GTCA allowed the Debtor to convert its space to 32 condominium units.²¹ Approximately $4.4 million of loan proceeds from Valley National Bank were used to pay the GTCA settlement amount and an existing first mortgage on the Property of approximately $3.6 million (with related closing costs).²² The balance of the Valley loan proceeds was to finance construction related to the conversion of the units.²³

C. The Latoc Note

1. The Intertwined Relationships Giving Rise to the Latoc Loan

A description of the circumstances giving rise to the loan from the Debtor to Latoc (the"Latoc Loan") requires a review of the relationships between and among Mr. Sergi, Latoc, the Attars (as defined below) and various "PermaLife" entities. Mr. Sergi was involved in various business transactions with Dibo Attar ("D. Attar") and Raffaele (Raffi) Attar ("R. Attar") and together (the "Attars"), relating to PermaLife Products, Inc. ("PLPI") and affiliated entities (the "PermaLife Entities").²⁴ D. Attar and R. Attar are father and son.²⁵ R. Attar was the President of the Defendant, Latoc, Inc., and the Attars and Mr. Sergi directly or indirectly owned interests in various PermaLife Entities.²⁶ The numerous and intertwined interrelationships between and among the Debtor, Latoc, the PermaLife Entities and the Attars are also described in R. Attar's Declaration submitted in the bankruptcy cases of the Debtor and various PermaLife Entities in an effort to explain those relationships, including the Attars' involvement with Better Half Bloodstock, Inc. ("BHB").²⁷

In 2007, PLPI needed funding and sought financial help from the Attars, who held direct and indirect equity interests in the various PermaLife Entities.²⁸ A loan from BHB to PermaLife was proposed. However, because of R. Attar's roles as equity holder and director of PermaLife and as a principal of BHB, the proposed lender, PermaLife's board refused to authorize the borrowing from BHB.²⁹ To work around this conflict, Mr. Sergi and the Attars turned to the Debtor and Latoc to effectuate the loans to the PermaLife Entities through the Debtor. Accordingly, Latoc and the Debtor entered into the $2 million Latoc Loan transaction by which the loan proceeds were initially provided to the Debtor, but then were immediately transferred to various PermaLife Entities.³⁰ The Court finds that the Latoc Loan was made based upon -- and would not have beenmade without -- the intertwined business relationships between and among Mr. Sergi, the Attars, the Debtor, Latoc and the PermaLife Entities. Put simply, the Latoc Loan transaction made no sense from the Debtor's point of view, as it provided no benefit to the Debtor -- even though it was taking on a $2 million obligation.

2. The Terms of the Latoc Note

To evidence the Latoc Loan, on November 15, 2007, a Subordinated Promissory Note in the amount of $2 million (the "Latoc Note" or the "Note") was executed on behalf of the Debtor.³¹ The Latoc Note provided that the principal amount was due twelve months after the date of issue with a possible one-year extension. Interest accrued at a rate of 10% per annum, with additional interest to be paid to Latoc based on 20% of proceeds of sale of any unit sold by the Debtor so long as the Latoc Note was outstanding.³² Interest was payable monthly, in arrears, on the last day of each month.³³ Additionally, according to a separate October 27, 2008 Letter Agreement between the Debtor and the Defendant, the Debtor could not, without express written consent of Latoc, further encumber or mortgage the Mall Property and was required...