Reverse Fraudulent Transfer Claim: Venezuela and Disputes Over Gold

May 10, 2018

Donald L. Swanson
Koley Jessen P.C., L.L.O.; Omaha, Neb.

Millenia ago, advanced civilizations flourished around the Mediterranean, across east Asia, and in portions of the Western Hemisphere. Mediterranean and east Asia civilizations communicate and trade along the Silk Road, but they remain isolated from the Western Hemisphere.

That isolation continued for a very long time — until 1492. In the century that followed, Spaniards arrived in the Western Hemisphere looking for gold, and they begin shipping large quantities of gold back home, while Spain’s European enemies turn to pirating such treasures.

Fast-forward to the current millennium, and the relationship between gold and outsiders is still an issue in South America.

 

The Problem

Venezuela is said to have the second-greatest gold reserves in the world. In 1998, Venezuela and Canada signed an investment treaty. Relying on it, a Canadian gold-producing company, Crystallex International Corp., spent more than $640 million developing Venezuela’s gold resources. However, in 2011 Hugo Chavez’s government rejected Crystallex’s efforts, nationalized all gold production in Venezuela, and expropriated Crystallex’s investments without compensation. This pushed Crystallex into bankruptcy in Canada.

 

The Arbitration

Crystallex, in response, brought an arbitration proceeding against Venezuela, as authorized in the treaty, at the World Bank’s International Center for the Settlement of Investment Disputes. The arbitration resulted in a $1.202 billion, plus interest, award for Crystallex against Venezuela.[1] The U.S. District Court for the District of Columbia affirmed the arbitration award and entered judgment thereon against Venezuela.[2] Crystallex then pursued collection efforts in U.S. courts.[3]

 

The Reverse Fraudulent Transfer

Meanwhile, Venezuela insisted that the Crystallex judgment would never be paid (according to Crystallex’s Complaint), so it engineered a “reverse fraudulent transfer” to take assets out of the U.S. and back to Venezuela to avoid creditor claims. While fraudulent transfers typically move assets from the debtor to a nondebtor to shield such assets from the debtor’s creditors, Venezuela instead moved its nondebtor subsidiary’s assets out of the U.S. and back to itself in Venezuela to shield these assets from its creditors.

The reverse fraudulent transfer details looked like this (according to Crystallex’s Complaint): (1) Venezuela owns a Venezuelan company (its alter ego), which owns a second company incorporated in the U.S., which owns Citgo Holding, Inc., also incorporated in the U.S. Citgo Holding has substantial value that might be reached through U.S. courts to satisfy Crystallex’s judgment and claims of other creditors, so (2) Venezuela causes Citgo Holding to borrow money and pay a $2.8 billion dividend to its U.S. owner, which passes the dividend on to its owner in Venezuela, all of which occurs without fair consideration or a legitimate business purpose and leaves Citgo Holding insolvent.

 

Fraudulent Transfer Lawsuit

In response, Crystallex brought a fraudulent transfer claim in U.S. district court against Citgo Holdings, its U.S. owner, and the owner’s Venezuelan owner for a return to the U.S. of the $2.8 billion dividend and satisfaction of Crystallex’s judgment.[4]

 

District Court Ruling

The defendants moved to dismiss the fraudulent transfer Complaint for failing to state a claim upon which relief could be granted. While the district court recognized that the reverse fraudulent transfer claim “strains” the fraudulent transfer law’s “structure,” it denied the motion to dismiss for these reasons:

  • A fraudulent transfer includes “every mode, direct or indirect,... of disposing of or parting with an asset or an interest in an asset”;
  • A transfer to be fraudulent must be made “by a debtor,” and the meaning of the word “by” includes “through the agency or instrumentality of” and “on behalf of”; and
  • Although Venezuela was the only “debtor” of Crystallex, none of Venezuela’s subsidiaries qualified as a “debtor,” and Delaware law “does not lightly disregard the separate legal existence of corporations,” Crystallex’s Complaint did state a claim because:
    • The dividend transactions were, allegedly, “an extraction of funds orchestrated by and carried out under the orders from Venezuela” — i.e., “made in every meaningful sense ‘by a debtor’”;
    • The dividend transfers “allegedly involve the ultimate extraction” of value “by the ‘debtor’ itself”; and
    • Multiple “badges of fraud” were present.

 

Third Circuit Majority Opinion

The defendants appealed, and on Jan. 3, 2017, a three-judge panel of the Third Circuit Court of Appeals reversed on a 2-1 vote, requiring dismissal (Case Nos. 16-4012 & 17-1439).[5] The two-judge majority opinion offered these reasons for reversal:

  • None of the fraudulent transfer defendants was directly liable for Crystallex’s judgment against Venezuela and, therefore, do not qualify as a “debtor” under fraudulent transfer laws;
  • The judgment “debtor” in this case, Venezuela, received the dividend transfer; it did not divest itself of anything;
  • Even if Venezuela, as judgment “debtor,” actually devised the transfer scheme, that would not, in itself, create fraudulent transfer liability for its subsidiaries;
  • The district court’s broad definition of “by a debtor” is rejected as being contrary to its plain meaning; and
  • The phrase “by a debtor” cannot include either Citgo Holding or its U.S. owner because they aren’t alleged to be alter egos of either Venezuela or its Venezuelan subsidiary.

 

Third Circuit Dissent

The Third Circuit dissenting judge affirmed that Crystallex’s Complaint adequately stateed a fraudulent transfer claim, because:

  • The U.S. owner of Citgo Holding is “a direct participant in the fraudulent transfer”;
  • The dividend transactions qualify as a “transfer” of debtor property “by a debtor” under fraudulent transfer laws;
  • Fraudulent transfer laws are “firmly grounded in principles of equity” and will not leave a “victim” of “a purposeful and complicated fraud,” such as Crystallex, “without any remedy”; and
  • The two-judge majority opinion “does not comport with — but rather is wholly contrary to — the [fraudulent transfer law’s] broad remedial purpose,” and “I am hard-pressed to conceive of a scenario more worthy of a trial court’s invocation of its broad equitable powers” under such laws “than this one.”

 

Request for Rehearing

Crystallex requested a rehearing by a full Third Circuit panel of judges. Since the case applied Delaware state law (which is unclear on the issues in this case), Crystallex’s request to the Third Circuit included the following:

“At a minimum, this Court should certify a question to the Delaware Supreme Court regarding the proper construction” of the Delaware Uniform Fraudulent Transfer Act.

On Feb. 3, 2018, the Third Circuit Court of Appeals denied the request for a rehearing, and on Feb. 13, 2018, it issued its mandate. The case is now back in the U.S. District Court in Delaware.

 

Conclusion

Thus far, we have two federal judges (one district and one circuit) who would let the case go forward, and two federal judges (both circuit) who would dismiss Crystallex’s fraudulent transfer claims for failure to state a claim. The case is now back in the Delaware District Court.

This should be interesting as the case proceeds![6]

 

[1] Here is a link to the the 273-page “award” issued by the arbitration tribunal.

[2] The judgment confirming the arbitration award appears as Doc. 31, entered on March 25, 2017, in the case of Crystallex International Corp. v Bolivarian Republic of Venezuela, Case No. 16-0661, in the U.S. District Court for the District of Columbia. Here is a link to the district court’s “Memorandum Opinion” supporting its judgment.

[3] For example, here is a link to the district court’s “Order Denying Respondent’s Motion to Stay Execution of Judgment Pending Appeal,” appearing as Doc. 44 in the U.S. District Court case identified in the preceding footnote.

[4] Crystallex International Corp. v. Petroleos De Venezuela, S.A., et al., Case Nos. 15-1082 & 16-1007 (D. Del.).

[5] Here is a link to the Third Circuit Court’s Crystallex opinion, which is reported at Crystallex International Corp. v. Petroleos de Venezuela, 879 F.3d 79 (3d Cir. 2018).

[6] As of this writing, the last filing in the Delaware District Court case occurred on Feb. 20, 2018: a joint status report in which (1) Crystallex says it “intends to seek leave to file an amended complaint” to “ satisfy the jurisdictional standard that this Court announced” and “to address the concerns raised by the Third Circuit’s opinion,” and (2) the defendants say that the case “should be immediately dismissed with prejudice.”

 

 

This article was originally published in the May 2018 edition of the Commercial Fraud Committee Newsletter. Participation in ABI's committees is one of the many benefits of becoming a member.  Committees provide networking and leadership opportunities.  For additional information on how you could become involved in ABI and our Committees please visit membership.abi.org.

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