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The plaintiffs’ alleged that after being barred by the Georgia Lottery Commission, the company’s founder and its COO secretly siphoned assets and contracts from the company and caused it to repurchase them at inflated values. They further alleged that after acquiring control, the new owner joined the scheme by leveraging these inflated financials to raise debt and fund over $400 million in distributions to insiders, ultimately saddling the company with unsustainable debt that led to its bankruptcy.

The defendants responded to the plaintiffs’ fraudulent transfer claims by contending that the company’s lenders ratified the challenged transfers, and that the plaintiffs failed to state a claim because they did not plead fraud with particularity. This excerpt from Debevoise’s memo on the case explains the court’s refusal to dismiss the plaintiff’s fraudulent transfer claims:

The Court declined to dismiss the actual fraudulent transfer claims, demonstrating the relative ease with which such claims might survive a motion to dismiss even in the face of what may be strong defenses to those claims on the merits: ratification and the failure to state a claim.

Ratification posits that a lender’s authorization, or “ratification,” of a transfer estops the lender, or those suing on its behalf, from later challenging the transfer. The Plaintiffs rebutted this theory by alleging that material facts were withheld from the lenders at the time of authorization. The Court agreed, holding that dismissal would require a fuller examination of the totality of the facts and circumstances of what the lenders knew at the time they authorized the transfer.

The Court also rejected the Defendants’ second argument, that the complaint failed to state a claim. As the Court noted, “[b]ecause debtors rarely admit fraudulent intent, courts must usually infer it” through circumstantial evidence. Such circumstantial evidence is typically pleaded through “badges of fraud, i.e., circumstances so commonly associated with fraudulent transfers that their presence gives rise to an inference of intent.” Although at least some Defendants argued that Federal Rules of Civil Procedure Rule 9(b)’s (“Rule 9(b)”) heightened pleading standard for fraud claims should apply, the Court did not take up this line of argument or even mention Rule 9(b) in its opinion, instead appearing to adopt Federal Rules of Civil Procedure Rule 8’s more lenient pleading standards.

The Court declined to dismiss the claim based on the presence of two badges of fraud: (1) the transfers occurred while the debtors were insolvent; and (2) the transfers involved a substantial portion of the debtors’ assets. Together, these were sufficient to survive a motion to dismiss.

The memo says that the decision suggests that some courts might not require plaintiffs to satisfy the higher pleading standard that generally applies to fraud claims in federal court when addressing fraudulent transfer claims at the motion to dismiss stage. However, it also points out that while these claims may be relatively easy to plead in courts that take this approach, proving an actual fraudulent transfer has proven to be much more difficult.

– John Jenkins