Home New Opinions Level 8 Apparel Trustee Sues “Insider” Defendants for “Fraudulent Transfers” and Misappropriation of Funds

Level 8 Apparel Trustee Sues “Insider” Defendants for “Fraudulent Transfers” and Misappropriation of Funds


January 27, 2021, Southern District of New York – Angela Tese-Milner, the Chapter 7 Trustee of the estate of Level 8 Apparel LLC (the “Debtor”) brought a complaint against the Debtor’s insiders for the alleged systematic diversion, misappropriation, and looting business and assets of the Debtor.

The complaint contains twenty-four claims for relief to avoid and recover; ” fraudulent transfers,” preferential transfers, and unauthorized post-petition transfers. The complaint also sought to recover damages for “fraud,” conversion, “breach of fiduciary duty,” “misrepresentation,” unjust enrichment, and aiding and abetting the primary misconduct. The “insider” defendants filed a motion to dismiss the complaint under Rule 12(b)(6) of the Federal Rules of Civil Procedure.

The Trustee contended that the “insider” defendants engaged or participated in a systematic and continuous “fraudulent scheme” to divest the Debtor of its assets and shield them from its creditors. The “insiders” allegedly caused the Debtor to enter into a one-sided sales representative agreement. The agreement heavily favored a party named, Capstone and obligated Debtor to perform valuable services for Capstone for an unspecified and uncertain commission. According to the complaint, the agreement allegedly turned the Debtor into a shell company with no identifiable assets besides the workforce and unlimited potential liabilities. The “insiders” continued to augment the “fraudulent scheme” and improperly divert the funds repeatedly from the Debtor to newly formed companies. The Debtor allegedly received no consideration for these transfers.

The “insider” defendants contended that the Court should dismiss the complaint because even assuming, arguendo, that the Trustee prevails against them on her claims for relief, the recovery would benefit only the secured creditors or the holders of the administrative claims in Chapter 7 and Chapter 11 cases. They further argued that prosecution of the adversary proceeding constitutes ‘purposeless litigation’ that benefits only the Trustee and her counsel and not general unsecured creditors.

The Court ruled that nothing in the complaint or the record supports the “insiders” contention that there was no equity in the Debtor’s assets for benefit of the estate’s general unsecured creditors. The Court noted that the Trustee seeks to recover damages exceeding $6 million and even assuming, arguendo, that the IRS’ secured tax claim totaling $263,000 is valid and enforceable, the damages that the Trustee seeks dwarfs that claim. The same is true for other unsecured priority claims. The Court found that although there will be expenses of the Trustee and her professionals of administering the estate and litigating the action, there was nothing in the record to support the “insider” defendants’ contention that after factoring in those costs, there would be nothing left for the unsecured creditors.

The Court held that the Trustee had the standing to bring a claim under New York’s “fraudulent conveyance” provisions, N.Y. Debt. & Cred. Law §§ 273, 276, and 278 as she had demonstrated that there was equity in the assets she seeks to recover. The Court denied the defendant’s motion to dismiss the Trustee’s complaint.