“Badges of Fraud” Make a Prima Facie Case of Fraudulent Conveyance

prima facie case
In McCarthy v. Giron, the Judge Gerald Bruce Lee of the U.S. District Court for the Eastern District of Virginia considered what is necessary to establish a prima facie case of fraudulent conveyance. The Court recognized several facts and circumstances commonly referred to as “badges of fraud” which, if established, create a prima facie case of fraudulent conveyance which must then be rebutted by defendants. In McCarthy v. Giron, 1:13-cv-01559, 2014 WL 2696660 (E.D.Va. June 6, 2014), a bankruptcy trustee brought an adversarial proceeding against Carlos I. Giron and Carlos A. Giron to hold them personally liable for the debts of their company, C & C General Buildings, Inc. (“C & C”), and for fraudulent conveyance. Judge Lee adopted the bankruptcy court’s recommendation regarding a claim of fraudulent conveyance because the Trustee made a prima facie case of fraudulent conveyance based on the presence of certain badges of fraud which were not rebutted by the defendants. The “badges of fraud” formula is an evidentiary rule that gives rise to an inference that a transaction is a fraudulent attempt to evade a creditor.  Once this inference arises, the burden of proof switches from the plaintiff to the defendant to prove the legitimacy and good-faith of the transaction. Judge Lee first looked to the evidence for badges of fraud.  “Under Virginia law, certain facts and circumstances have become badges of fraud, or presumptions of fraud that establish a prima facie case of fraudulent conveyance.” Id. (citing Fox Rest Assoc, L.P. v. Little, 717 S.E.2d 126, 131 (Va.2011).)  The Bankruptcy Court detected a number of badges of fraud related to the transaction:
  1. Threat of litigation by its creditors at the time of transfer
  2. The transfer left the debtor insolvent
  3. Gross inadequacy of consideration for the conveyance
  4. Close relationship (i.e., family members) between the parties
Judge Lee, however, emphasized that “the close relationship of the parties, while not a determining factor of fraud in itself, strengthens the presumption of impropriety arising from the other circumstances discussed.” Id. If badges of fraud are found and a prima facie case of fraudulent conveyance is established, the burden of proof shifts to the defendant to prove the propriety of the alleged fraudulent transaction. Id. (citation omitted). In the instant case, Judge Lee found that the trustee made a prima facie case of fraudulent conveyance which Defendants failed to rebut “because they did not offer any evidence to explain the legitimacy of the transfers, and chose not to testify.” Id. Accordingly, the Court adopted the Bankruptcy Court’s recommendation that the fraudulent conveyance made by Defendants on behalf of C&C was voidable. A debtor who seeks to evade judgments is an old problem, as old as the western legal system itself.  In fact, the “badges of fraud” formula was first set forth in 1601 in Twyne’s Case.[1]  But in recent years, the Virginia General Assembly has breathed new life (and teeth) into the Commonwealth’s fraudulent conveyance statutes with the amendment of Virginia Code § 55-82.1 in 2012.  This amendment granted a court wide discretion to award sanctions and attorney’s fees against any party who assisted or participated in a fraudulent conveyance.  This is a major development in the law impacting creditors’ rights.  Counsel who represent creditors and other financial institutions should keep in mind this remedy.
[1] Twyne’s Case, 3 Coke Rep. 80b, 76 Eng. Rep. 809 (Star Chamber 1601)

EDVA Tightens Reins on Punitive Damages

edva tightens
In an opinion released on July 14th, Judge James C. Cacheris used a motion to dismiss to carve back a plaintiff’s personal injury claim for punitive damages under Virginia state law.  In granting the motion to dismiss, the judge held that punitive damages are only available for “willful and wanton conduct,” not for negligent conduct.  The opinion takes a narrow view of what qualifies as “willful” conduct, and this approach could affect not only the personal injury bar, but also other civil litigators who seek punitive damages in business cases. The case, Gillespie v. Ashford Hospitality Prime, No. 1:15-cv-350, 2015 WL 4361262 (E.D. Va. July 14, 2015), arose from hard facts:  While visiting the Marriott Crystal Gateway Hotel in Arlington, Virginia, the plaintiff and her infant granddaughter were severely injured when a lighting fixture fell from a ballroom ceiling.  The plaintiff sued both the hotel owner and the construction general contractor who installed the light fixture.  In the plaintiff’s personal injury lawsuit for negligence, she sought both compensatory and punitive damages.  The defendants then moved to dismiss the amended complaint. Judge Cacheris denied the motion as to the negligence claim for compensatory damages, but he granted the motion as to the punitive damages.  Quoting prior case law, Judge Cacheris said that “[u]nder Virginia law, to properly plead a claim for punitive damages, a plaintiff must allege sufficient facts to plausibly demonstrate such willful and wanton conduct.  Mere conclusory legal statements, without facts to support them will not suffice.” The judge went on conclude that the alleged negligent installation of the light fixture was not “willful” conduct that would justify punitive damages because the hotel owner did not intend to commit negligence:  “[The hotel owner’s] willful and conscious maintenance of an unreasonably safe hotel defies logic.  Similarly, [the general contractor’s] willful and malicious installation of an unreasonably safe light fixture would be just as bad for its business, such that it is too an illogical proposition.  In short, Plaintiff’s request for punitive damages is vaguely pleaded as a mere conclusion . . . .”.  Judge Cacheris then quoted from previous Fourth Circuit case law, stating that “[e]xemplary damages are allowable only where there is misconduct or malice, or such recklessness or negligence or as evinces a conscious disregard of the rights of others.” This opinion is notable because Judge Cacheris focuses on the question of intent, specifically whether the defendant consciously intended to harm the plaintiff, as opposed to whether the defendant intended a more general act (such as installing a light fixture).  This appears to be a tightening of the availability of punitive damages, not only in personal injury cases, but in commercial business torts.  The opinion is also noteworthy because Judge Cacheris was willing to take this action at the motion to dismiss stage, making conclusions that could be characterized as factual determinations in a future appeal. Regardless of any appeal, business litigators who seek punitive damages should be aware of this opinion and structure their complaints to adequately plead a conscious intent that satisfies the tightened standard.

Timing is Critical when Asserting Trade Secrets and Business Conspiracy Claims in Virginia Courts

partnerships issues
In a recent case, Judge James C. Cacheris of the Alexandria Division of the U.S. District Court for the Eastern District of Virginia issued an opinion that clarified the preemption provision of the Virginia Uniform Trade Secrets Act.  This opinion is useful guidance to commercial litigators in Virginia. In MicroStrategy Servs. Corp. v. OpenRisk, LLC, No. 1:14-cv-1244, 2015 WL 1221263 (E.D.Va. Mar. 17, 2015), the parties were embroiled in contentious litigation that sprang from a failed vendor agreement.  MicroStrategy provided cloud-based data storage to OpenRisk, which in turn was using the storage to develop a software platform to estimate damages to real property caused by natural disasters.  OpenRisk contracted to pay MicroStrategy for the storage space, and then provided its proprietary software to MicroStrategy to utilize the space.  The relationship between the parties soon soured, however, , OpenRisk was hit with significant employee turnover, some of which involved allegations that MicroStrategy poached OpenRisk employees.  This loss of key employees led OpenRisk to cease business operations. MicroStrategy then sued OpenRisk in the Eastern District for failure to pay contracted monthly fees relating to the data storage.  OpenRisk asserted counterclaims for misappropriation of trade secrets, business conspiracy, and aiding and abetting a breach of fiduciary duty.  MicroStrategy moved to dismiss OpenRisk’s counterclaims under Fed. R. Civ. P. 12(b)(6). As low-hanging fruit, Judge Cacheris first focused the counterclaim for “aiding and abetting a breach of fiduciary duty.”  OpenRisk asserted that MicroStrategy “aided and abetted” a key former employee of OpenRisk to violate his fiduciary duty to the company.  Judge Cacheris made short work of this claim and held that Virginia law does not recognize an independent cause of action for aiding and abetting a tort.  The judge distinguished a Supreme Court of Virginia case, Halifax Corp. v. Wachovia Bank, 604 S.E.2d 403 (Va. 2004) by noting that the Virginia high court merely assumed, for purposes of analysis, the existence of such a claim, and this was a far cry from holding that such a claim, in fact, existed. Judge Cacheris next turned to OpenRisk’s claims for business conspiracy under Va. Code § 18.2-499-500 and dealt with the procedural confusion that arises when such claims are pled alongside trade secret claims.  Under the Virginia Uniform Trade Secrets Act, if information qualifies as a “trade secret,” then the uniform act “displaces conflicting tort, restitutionary, and other law of this Commonwealth providing civil remedies for misappropriate of a trade secret.”  Va. Code § 59.1-341(A). The procedural confusion arises from the question of when in the litigation any other preempted claims must be dismissed.  In litigation, a party asserting a trade secrets claim bears the burden of proving that its stolen information qualifies as a trade secret.  Often in such litigation, the parties spar over whether reasonable efforts were taken to safeguard the secrecy of the information.  If the party asserting the trade secrets claim fails to prove this, then it has failed to prove that it had a trade secret to protect.  At that point, the Uniform Act (and the preemption provision) should not apply to the information.  But if this determination is made after the party’s alternative causes of action were dismissed as preempted under the Uniform Act, the party can be left without a remedy.  Thus, the procedural timing matters greatly in trade secrets litigation. Judge Cacheris held that he could not rule as a matter of law on an early motion to dismiss that the conspiracy claims were preempted by the Uniform Act.  He surveyed the case law on the issue and noted that the Virginia Supreme Court has not yet provided a definite answer on the timing issue.  Thus, Judge Cacheris’s opinion would leave the determination of preemption until later in the litigation, though the opinion notes contrary authority from other states holding the determination should be made at the outset of litigation. Finally, Judge Cacheris examined OpenRisk’s trade secrets claim, which was based upon the company’s proprietary software that was provided to MicroStrategy for use in the data storage.  MicroStrategy attacked the claim on the ground that OpenRisk supposedly did not take sufficient efforts to safeguard the secrecy of the software, and Judge Cacheris agreed with this argument.  The judge focused on OpenRisk’s pleading (or lack thereof), specifically that OpenRisk did not allege that the person at MicroStrategy who was provided the software was under any duty of confidentiality.  In other words, the consultant was never made to sign a Non-Disclosure Agreement that legally prevented him from sharing the software.  Because no duty of confidentiality was alleged in the counterclaim, Judge Cacheris sustained the 12(b)(6) motion on this count. MicroStrategy v. OpenRisk provides commercial litigators useful guidance regarding the procedural complexity of alternative trade secrets and business conspiracy claims – two claims that often arise in business disputes.  The opinion is useful for illustrating the EDVA judges currently view these claims, but it also demonstrates what we do not yet know.  Practioners must wait for further answers from Richmond on the remaining issues.