Judge Pauley’s opinion in LiquidX v. Brooklawn Capital, LLC is a good example of a company paying a steep price for trying to outwit its creditors.
The Receivables Exchange (TRE), a financial startup that created an exchange for the purchase and sale of accounts receivable, was on the verge of a desperately needed round of financing. But on the eve of closing, TRE lost an important arbitration to a creditor, opening the door to similar creditor claims. The new money evaporated.
Undeterred, one of the potential new financiers and two TRE board members hatched a plan to salvage TRE’s business by acquiring its assets and transferring them to a new corporation, LiquidX—and leaving TRE’s creditors holding the bag while continuing TRE’s business, albeit under a new name. The linchpin of the plan, named after Caerus, the Greek God of opportunity, involved LiquidX buying TRE’s bank loan, and then privately foreclosing on TRE’s assets.
Critically, TRE had to independently appraise its assets at less than its bank loan to cut-off other creditor claims.
Sure enough, with the chief operations officer telling the appraiser that TRE was in the dumps, the appraisal came in low. The private foreclosure went ahead, and TRE’s business immediately re-emerged intact under the name LiquidX, providing a “seamless” transition to its customers. When TRE’s creditors complained, LiquidX (over) confidently sought a court ruling that it was not TRE’s alter-ego, and therefore was free and clear of TRE’s creditors.
That’s when Judge Pauley stepped in. He rejected the argument that the plan was a good-faith effort to save TRE and its employees jobs. He noted that its masterminds, including the two members of the TRE board, hid their interest in LiquidX from the entire TRE board when negotiating the loan purchase. As such, the transaction between the two companies was tainted. “The most significant factor in this case, however, is that the corporations did not deal with one another at arm’s length.” Indeed, the low appraisal of TRE’s assets flew in the face of LiquidX’s own optimism about its future.
Judge Pauley also rejected LiquidX’s argument that it had no alter-ego relationship with TRE because the ownership of the two companies did not overlap. “Ownership…is a proxy for control. It is certainly possible to exercise control over corporate functions without owning the corporation itself….” After finding that LiquidX controlled TRE’s decision making even in the absence of ownership, Judge Pauley had little trouble finding that LiquidX used its control to perpetrate a wrong—leaving TRE’s creditors in the lurch. Therefore, TRE’s creditors could pursue LiquidX as TRE’s alter-ego.
Project Caerus may have seemed quite creative when it was hatched, but Judge Pauley was not impressed. The Greek Gods can be tricky.
Hat tip to Christine Choi for assisting on this post.