Bank of America, N.A. ex rel. Estate of Pethinaidu v. Veluchamy

Citations: 535 B.R. 783; 2015 U.S. Dist. LEXIS 110083Docket: Civil Action No. 15 CV 882; Bankruptcy Case No. 11-33413; Adversary Case No. 12-1715

Court: District Court, N.D. Illinois; August 19, 2015; Federal District Court

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Pethinaidu Veluchamy, alongside his wife Parameswari and children Arun and Anu, transitioned from successful ventures in the direct marketing industry to acquiring a bank, which led to significant financial difficulties. Following an investigation into the bank's solvency by state and federal regulators, the senior Veluchamys guaranteed loans amounting to approximately $43 million, defaulting on these obligations. A creditor-bank obtained a judgment for the deficiency and initiated citation proceedings, prompting the senior Veluchamys to file for bankruptcy. During this process, it was discovered that they had transferred nearly all their assets to their children using fraudulent documentation. The bank, now acting as estate representative, filed an adversary complaint against Arun, Anu, and the senior Veluchamys. The bankruptcy court concluded that the Veluchamys conspired to defraud creditors, resulting in a judgment exceeding $64 million, including additional assets like stock and jewelry. Arun and Anu, along with the bank, filed cross-appeals. The court affirmed part of the bankruptcy court's decision, reversed another part, and remanded the case for an amended judgment.

The Veluchamys, who immigrated from India in the 1970s, built a substantial fortune through fourteen interconnected businesses in the direct marketing sector. They expanded their portfolio by acquiring Security Bank of DuPage in 1995 and later First Mutual Bancorp, merging the two banks in 2004. Following this merger, they faced financial challenges as First Mutual engaged heavily in risky commercial real estate investments and became increasingly reliant on unstable funding sources. Despite securing substantial credit lines and loans from LaSalle Bank (now Bank of America), the bank suffered significant losses from bad loans starting in 2007, culminating in a dire financial situation.

By June 2008, First Mutual faced significant financial distress, evidenced by a rising proportion of non-current loans, prompting regulatory intervention from the FDIC and IDFPR, which issued a cease and desist order due to the bank's undercapitalization. Following defaults on loans from Bank of America (BoA) in November 2008 and June 2009, and after the Veluchamys failed to adequately recapitalize the bank, IDFPR closed First Mutual, appointing the FDIC as receiver.

Subsequently, on August 19, 2009, BoA initiated lawsuits against First Mutual and the Veluchamys, resulting in a December 29, 2010, summary judgment favoring BoA for $39 million plus interest. BoA began asset recovery efforts, discovering that the Veluchamys had transferred over $29 million from their accounts and attempted to claim Fifth Amendment protections to avoid compliance with asset disclosures. This led BoA to seek an emergency motion to compel the Veluchamys to produce bank statements.

On August 16, 2011, just before a hearing regarding the Veluchamys' asset disposition, they filed for bankruptcy, reporting a negative net worth despite previously listing assets exceeding $500 million. BoA responded with an adversary complaint, resulting in a bankruptcy court finding that the Veluchamys engaged in a fraudulent scheme to transfer over $64 million in cash and assets to family members. Arun and Anu Veluchamy, along with BoA, later cross-appealed aspects of the bankruptcy court's decisions, particularly regarding the disposition of VMark stock and real estate in Illinois and India, with BoA specifically contesting the valuation of Appu stock purchased by the Veluchamys. 

Regarding VMark stock, as of July 30, 2009, Mrs. Veluchamy held 700,002 voting shares, while Arun and Anu each held 149,999 shares. On July 31, 2009, VMark's board authorized the creation of a new class of non-voting shares and a stock split.

Post-stock-dividend, VMark's equity structure changed significantly after the issuance of new shares. Following a stock dividend, shares were allocated as follows: Mrs. Veluchamy held 14,000,040 shares (700,002 voting, 13,300,038 non-voting), while Arun and Anu each held 2,999,980 shares (149,999 voting, 2,849,981 non-voting), totaling 20,000,000 shares. On August 19, 2009, VMark's board authorized the issuance of three million new voting shares and thirty-eight million new non-voting shares. The next day, one million voting shares were sold to Arun and Anu for $630,000, resulting in Mrs. Veluchamy's ownership dropping to 66%, while Arun and Anu each increased their share to 1%. 

By September 8, 2009, VMark sold an additional 1,540,000 voting shares and 6,384,610 non-voting shares to Arun and Anu for a total of $4,769,860, further decreasing Mrs. Veluchamy’s ownership to 48.4% and increasing Arun and Anu’s ownership to 27.8%. The bankruptcy court valued VMark at $57,767,275 and determined that the shares were sold to Arun and Anu with intent to hinder, delay, or defraud creditors. The court analyzed the transactions collectively and concluded that the transfer of control to Arun and Anu enhanced VMark's value. Factors influencing the valuation included the removal of the Veluchamys' salaries, reduced estimated capital expenditures, and the less liquid nature of closely-held corporations. 

The court found that the August 20 transaction valued each 500,000 share transfer at $1,375,438, while the September 8 transaction valued the combined share issuance at $7,913,539. Consequently, Arun and Anu were found jointly and severally liable for $18,577,954, equating to $9,288,977 each. Additionally, Count VII of BoA’s complaint addresses the fraudulent transfer of three properties in Downers Grove, Illinois, which were held in land trusts with the senior Veluchamys as 50% beneficiaries.

On October 7, 2009, the senior Veluchamys transferred approximately $2.8 million from their State Bank of India account in Chicago to Mrs. Veluchamy’s account at Cañara Bank in India. On the same day, Arun and Anu established '5300 Katrine LLC.' The following day, Mrs. Veluchamy transferred $1.36 million from her Cañara account into Arun’s and Anu’s accounts. Additionally, Mr. Veluchamy deposited $3,999,890 into a jointly held E*Trade account for Arun and Anu. On October 9, 2009, they transferred $2.8 million from Cañara to their E*Trade account, which, combined with prior transfers, totaled $4 million.

Subsequently, on or around October 20, 2009, Arun and Anu purchased a property at 5300 Katrine Avenue for approximately $4.1 million, funding it with $986,000 from their E*Trade account and a $3.1 million mortgage from Burr Ridge Bank and Trust. The senior Veluchamys used the proceeds to release a $3,070,762.89 mortgage on the property and settled debts from their other enterprises. On October 23, 2009, Arun and Anu formed two additional LLCs and, on December 29, 2009, purchased another property at 1400 Centre Circle from the senior Veluchamys for $3,350,000, financing it with $875,000 cash and a $2,500,000 mortgage from Inland Bank Trust.

On March 3, 2010, they acquired a third property at 5200-5220 Thatcher Road for $3,830,000, with Arun and Anu contributing $1,052,000 and obtaining a $2,681,000 loan from Northern Trust Company. In each transaction, the senior Veluchamys paid off existing mortgages and used the remaining equity to pay off debts. Overall, Arun and Anu contributed about $2.9 million toward these purchases. A bankruptcy court later determined that they paid above the fair market values of the properties, which were assessed at a total of $9,300,000. After deducting the paid-off mortgages, the court ruled that Arun and Anu owed a total of $3,054,900.83 to the trustee.

Additionally, the senior Veluchamys had reported ownership of properties in Chennai, India, valued at $15 million as of December 31, 2007. On December 30, 2010, they transferred their interest in these properties to Arun and Anu without consideration. When questioned about ownership, Arun invoked his Fifth Amendment privilege.

Anu invoked her Fifth Amendment privilege when questioned about her ownership of the Chennai property, which consisted of two parcels. The bankruptcy court deemed a transaction involving these properties a fraudulent transfer aimed at defrauding creditors, ordering Anu and Arun to pay the fair market value. The court relied on a valuation by Berkeley Research Group, which used a third-party assessment from Colliers International. Colliers valued the properties at Rs. 381 million under the comparable sales approach and Rs. 344 million under the income approach, ultimately concluding a value of Rs. 365 million (approximately $8,097,890), which the bankruptcy court adopted for its judgment against Anu and Arun.

In a separate incident, the senior Veluchamys transferred 4,275,777 shares of stock in Appu Hotels to Arun and Anu in February 2010, which the bankruptcy court later found to be fraudulent. The court issued a joint and several judgment of $3,499,593 against them. Additionally, on August 2, 2010, the senior Veluchamys made significant cash deposits into Arun’s and Anu’s accounts, which they quickly transferred to Appu, alongside a transfer from Mrs. Veluchamy. Subsequently, Appu issued shares to Arun and Anu without listing Mrs. Veluchamy as a subscriber. The bankruptcy court noted an imbalance in share issuance and concluded that Mrs. Veluchamy had facilitated the transactions, holding Arun and Anu jointly and severally liable for $310,000. However, the court did not trace the source of an extra Rs. 59 million (approximately $1,262,147) used for purchasing additional shares. The court has jurisdiction to review bankruptcy court decisions under 28 U.S.C. 158(a)(1), applying de novo review for legal conclusions and clear error for factual findings.

The Seventh Circuit's standard for reversing bankruptcy court findings is that a clear error must be as striking as a "5-week-old, unrefrigerated dead fish." In the case of A. VMark (Count III), Arun and Anu raised eleven issues on appeal, with the first five focusing on the bankruptcy court's handling of VMark stock. They argue that VMark's internal stock dilution does not qualify as an indirect transfer from the senior Veluchamys to their children, claiming that since VMark, rather than the Veluchamys, issued the shares, these shares could not be considered part of the Veluchamys' estate and thus were not subject to avoidance. 

According to 11 U.S.C. 548(a)(1)(A), the Bankruptcy Code allows trustees to avoid any transfer of a debtor's property made with intent to hinder, delay, or defraud creditors. The definition of "transfer" is broad and includes any method of disposing of property interests. Although the Seventh Circuit has not specifically addressed whether stock dilution by a majority shareholder constitutes a fraudulent transfer, courts in Texas and Colorado have found it liable under similar circumstances. In one case, a fraudulent transfer was determined when stock dilution occurred, which significantly reduced the value of existing shares. The Colorado Bankruptcy Court noted that issuing new shares effectively transferred majority control of the corporation, impacting the rights and powers associated with majority ownership.

The Court finds no precedent in bankruptcy law that supports internal stock dilutions in closely held corporations as a valid means of asset transfer away from an estate. While fraudulent conveyances are a recognized issue in bankruptcy, cases interpreting the Uniform Fraudulent Transfer Act (UFTA) provide relevant insights due to their alignment with bankruptcy principles. Notably, in *In Reilly v. Antonello*, the court ruled that a majority shareholder's dilution of stock ownership, which reduced their stake from 100% to 2% before a sheriff's sale, constituted a fraudulent transfer under the UFTA. The court emphasized the importance of the actual percentage of ownership transferred over the mere quantity of shares, viewing the corporation as an extension of the majority shareholder rather than a separate entity. 

The Court critiques Arun and Anu's references to *Freeland v. Enodis Corp.* and *In re McCook Metals, LLC* as irrelevant, arguing that *Freeland* involved a parent corporation and its subsidiary, where the subsidiary did not benefit from the transfers, contrasting with the situation involving the Veluchamys, who transferred majority interest in VMark to Arun and Anu. In *McCook*, the focus was on the beneficiary of a transfer rather than the transferee, further distancing it from the current case. Overall, the Court underscores the need to assess the substance of ownership transfer rather than its form in the context of fraudulent conveyances.

Lynch, the principal shareholder of both entities involved, was held liable for the value of a fraudulent transfer, as the court found that he benefited from the asset value and controlled Longview LLC, which acted merely as a conduit for him. In a similar scenario, Arun and Anu, as principal shareholders, benefited from a transfer of controlling interest in VMark, where the senior Veluchamys issued new stock to them, effectively stripping the corporation from the Estate’s assets. The bankruptcy court determined this to be a fraudulent transfer.

Arun and Anu contended that the bankruptcy court misvalued VMark by asserting that the senior Veluchamys only transferred minority interests, which should apply a 35% marketability discount instead of the 15% applied. However, they failed to cite supporting case law, and the court emphasized that substance over form is critical in assessing fraudulent transfers. The court found that the senior Veluchamys executed two transfers to remove VMark from the Estate and its creditors, confirming that a controlling stake was fraudulently transferred.

Furthermore, Arun and Anu argued that the bankruptcy court disregarded the consideration they paid for their shares and misvalued these shares. The court clarified that while transferees may typically receive a setoff for consideration paid if the transfer was for value and in good faith, the fraudulent nature of the transfer negated this entitlement. The bankruptcy court's findings regarding the fraudulent transfer and the valuation of VMark were upheld without error.

The 'for value' requirement for setoff allowance does not necessitate that the value be equivalent to the interest transferred, as established in In re Comm. Loan Corp., which highlights the absence of an equivalence standard in the Code. Good faith is required from the transferee, meaning they must engage in the transaction without awareness of its voidability or fraudulent intent against the transferor's creditors. A recipient may lack good faith if they possess sufficient knowledge that would prompt a reasonable person to investigate. Arun and Anu argue against denying the setoff, claiming it would allow double recovery for BoA, which misinterprets the relationship between the single satisfaction rule under 550(d) and the prohibition of offsets in fraudulent transfers under 548(c). 

Section 550(d) states that a trustee can recover only a single satisfaction from any source for an avoided transfer, while section 548(c) prohibits offsetting funds in a fraudulent transfer unless the transferee acted in good faith and for value. An example illustrates this: if a debtor fraudulently transfers $100 to a knowing transferee who gives no consideration, the trustee can recover only $100, not $180 from multiple parties involved. If the transferee purchases a valuable asset for a nominal amount while knowing of the fraud, that consideration cannot offset the transfer's value. 

The Code aims to prevent rewarding those knowingly participating in fraudulent schemes. Arun and Anu provided value for shares but are ineligible for a setoff due to their lack of good faith. They erroneously believe that payments made to VMark, rather than their parents, justify a setoff, but this argument lacks supporting case law. Established precedents assert that a corporation is disregarded when used as a means for shareholders to commit fraud.

A transferee-shareholder aware of fraudulent transactions cannot benefit from accessing the corporation to further the fraud. The bankruptcy court properly disregarded payments made by Arun and Anu for VMark shares, and this ruling is affirmed. Arun and Anu contested the bankruptcy court's valuation of the transferred VMark shares, arguing that it was mathematically flawed. However, their argument fails to consider the good faith required of a fraudulent transferee under 11 U.S.C. § 548(c). The bankruptcy court evaluated each transaction separately, which the Court supports.

Before an August 2009 transfer, Arun and Anu owned 30% of VMark, while the senior Veluchamys owned 70%. On August 19, 2009, VMark issued 1,000,000 new shares to Arun and Anu, diluting the Veluchamys' interest by 31%. The bankruptcy court valued this transfer at 4.762% of VMark’s total value, equating to $2,750,876. Arun and Anu argued that the bank should only receive 3/6% of the value based on the effective interest transferred, overlooking the nature of the transactions which resulted in a dilution of shares.

The bankruptcy court clarified that accepting newly-issued shares constituted payment in both cash and stock, as the dilution affected all shareholders, including Arun and Anu. Their involvement in the fraudulent scheme disqualified them from receiving a setoff for their share payments. For the September 8, 2009 transaction, where 7,924,600 shares were issued to Arun and Anu, the court again calculated the value based on total shares, leading to a judgment against them for $15,827,078, with each receiving 7,913,539. The total value of VMark stock issued to them was determined to be $18,577,954, reaffirming that they are not entitled to a setoff due to their knowledge of the scheme.

Arun and Anu contest the bankruptcy court's findings on fraudulent transfers concerning real estate owned by the Veluchamys in Downers Grove, Illinois, and Chennai, India. Regarding the Downers Grove properties (Count VII), they argue that their payment exceeding fair market value negates any benefit received, a claim lacking supporting evidence. This argument does not adequately explain why the transfers were not fraudulent and may imply that the properties were undervalued, challenging the court's damage determination. Additionally, they paid $4,000,000 from an E*Trade account for the properties, exceeding the judgment amount for Count VII. Under 11 U.S.C. § 550, the trustee can void transfers made to defraud creditors, and a subsequent transferee may avoid liability if they can prove purchase in good faith and for value. However, these defenses do not apply as Arun and Anu had full knowledge of the fraudulent intent behind the transfers. The bankruptcy court rightly held them liable for the fair market value of the properties minus mortgage payoffs. Arun and Anu also claimed the court erred by not considering all mortgage debt on the properties, but they did not develop this argument, resulting in a waiver. The court found no clear error in the valuation or their liability and upheld the bankruptcy court's ruling.

For the Chennai properties (Count XII), Arun and Anu argue that the court improperly ordered a payment of fair market value instead of transferring title and incorrectly valued the properties by holding them liable for the full value. The court affirmed that a money judgment is appropriate if a fraudulent transfer is successfully avoided.

The trustee has the authority to recover transferred property or its value from the initial transferee to benefit the estate, as outlined in 11 U.S.C. § 550(a)(1). The court reviews bankruptcy court decisions regarding monetary awards in lieu of property transfers for abuse of discretion. In this case, Aran and Anu contend that the bankruptcy court wrongly awarded a money judgment instead of property turnover, asserting they did not benefit from the transfer. However, they failed to provide justification or evidence of how the court abused its discretion.

Regarding the valuation of the Chennai Properties, Aran and Anu challenge the reliance on the Colliers Report by Bank of America’s valuation expert, claiming it is unreliable due to unsubstantiated assumptions. They specifically criticize the report for assuming undisputed ownership and suitable condition for redevelopment without verification. Their broader claims point to alleged deficiencies in the report's methodology, including lack of ownership ascertainment, physical inspection, and environmental analysis.

However, their argument is undermined by their failure to rebut the assumptions of the Colliers Report. They assert ownership of only 67% of the properties but do not identify the supposed third-party owner or provide supporting evidence. The bankruptcy court highlighted that Aran and Anu, having owned the property since 2010, should possess relevant information about its value but invoked self-incrimination privilege when questioned. Additionally, testimony from Mr. Veluchamy was deemed noncredible and lacked corroboration, further complicating their position. Overall, the challenges to the appraisers' methodology were found to be insufficient.

The appraisers were unable to determine the actual owners of the Chennai Properties due to the Veluchamys withholding necessary documents, citing their privilege against self-incrimination. They also did not perform a physical inspection, believing the optimal use of the properties was redevelopment into condominiums. There were no environmental concerns to consider. Arun and Anu failed to provide evidence supporting a lower valuation, and their claim was weakened by their assertion of privilege, leading to a dismissal of their appeal regarding the valuation and ownership of the properties.

In the case of the fraudulent transfer related to Appu Hotels, both Bank of America (BoA) and Arun and Anu cross-appealed the bankruptcy court's findings. Arun and Anu contended that no fraudulent transfer occurred as Mrs. Veluchamy transferred $310,000 directly to Appu, not them. Conversely, BoA argued that the bankruptcy court undervalued the transfer, pointing to evidence that Arun and Anu received stock worth approximately $1.3 million more than their contributions. 

Arun and Anu also contested the characterization of a $310,000 transfer as fraudulent, asserting that the share amount linked to this transfer was undetermined. However, their invocation of the Fifth Amendment privilege when questioned about parental funds weakened their position. The trustee is entitled to recover transferred property for the estate's benefit under 11 U.S.C. § 550(a)(2), and the court found that while the funds were transferred to Appu, it did not control them, as Mrs. Veluchamy directed Appu to issue stock to Arun and Anu.

Arun and Anu are classified as immediate transferees and acknowledged knowledge of the fraudulent nature of the transfers, failing to provide value for the shares acquired from Mrs. Veluchamy's transfer. Consequently, the affirmative defense under 550(b) does not apply, leading the bankruptcy court to rightfully avoid the transfer and hold Arun and Anu liable for the amount of Mrs. Veluchamy's transfer, totaling Rs. 310,000. 

Bank of America (BoA) asserts that the bankruptcy court overlooked Rs. 59 million (approximately $1.3 million) related to the value of Appu stock issued to Arun and Anu. BoA argues this amount was sourced from the Veluchamys and seeks an amended judgment to recover the full value of the stock. Records indicate that on August 2, 2010, the three parties transferred a total of Rs. 45,900,640 to Appu, yet the subscriber list revealed that Arun and Anu received shares worth Rs. 104,900,640, exceeding their combined transfers by Rs. 59 million. 

Neither Arun nor Anu provided an explanation for this discrepancy and invoked the Fifth Amendment when questioned about the additional funds. They did not dispute BoA’s claim that the subscription was financed with fraudulently transferred money. Mrs. Veluchamy, despite being involved in the transfers, claimed uncertainty regarding whether she and her husband funded Arun and Anu's shares. On appeal, Arun and Anu did not challenge the accuracy of the subscription list nor clarify the source of the excess funds. The combination of their invocation of self-incrimination rights and the subscription list allows the court to infer that the shares were acquired with fraudulently transferred assets. The bankruptcy court determined that the amounts credited to Arun and Anu significantly surpassed their identifiable deposits but only awarded the Estate the amount transferred by Mrs. Veluchamy, failing to address the full value of the issued stock.

The bankruptcy court incorrectly failed to award the full transfer amount of Rs. 59 million related to stock purchased for Arun and Anu. As a result, the judgment in Count XXIII is reversed and amended to award the Estate $1,572,147 against Arun and Anu, jointly and severally. Additionally, the judgments in Counts XX and XXI are amended to reflect a total of $59,119,383, incorporating the increase from Count XXIII. The bankruptcy court's judgment is partially affirmed, partially reversed, and remanded for consistent judgment entry. The court also noted the existence of governmental investigations into the Veluchamys' financial activities. Mr. Veluchamy transferred his 51% interest in VMark to Mrs. Veluchamy for love and affection, despite an imbalance in stock contributions totaling Rs. 59 million. The court emphasized its role in not constructing arguments for the parties and adopted the bankruptcy court's exchange rate for the judgment calculation.