A developers closing down of a failed construction project can lead to severe consequences

Developers often create separate entities (usually limited liability companies) to own the land upon which a project is located in order to protect assets of their main corporate entities in the event that a particular project fails or sustains significant financial losses. A common practice of developers in cases of a project gone bad is to simply walk away from the project, and the debts incurred by project-specific entity. Some developers will go as far as to place the entity into bankruptcy. Diversification through project-specific entities has obvious benefits to developers, and developers would be misguided if they did not structure their organizations in this manner. This is important because lenders, contractors and suppliers are not going to go away quietly when they are owed thousands, if not millions, of dollars. If a project-specific entity simply runs out of money, there is little that its creditors can do to recoup monies (absent a mortgage, lien or other form of security). In such cases, the developer's main entity, its other project-specific entities and its individual owners would be protected from liability by virtue of New York law, which shields affiliates, shareholders and members from the liabilities incurred by a corporation or limited liability company. However, certain actions taken by developers in "closing down" a project-specific entity, whether innocent or not, can result in the developer's main corporate entity, and the individual who own it, become liable for the project-specific entity's liabilities. Article 10 of New York State's Debtor and Creditor Law makes it unlawful for debtors to convey assets in order to avoid paying creditors. Under the Debtor and Creditor Law, persons and entities are prohibited from making certain transactions if they are: (i) insolvent; (ii) about to incur debts beyond their ability to pay; or (iii) involved in litigation with creditors. At such times, the conveyance of an asset for anything less than what is deemed to be fair consideration is a violation of the Debtor and Creditor Law. Importantly, the law does not only prohibit intentional diversions of assets, such as emptying the debtor's bank accounts or the transferring of equipment and materials to a related person or entity for little or no cost. Certain seemingly innocent actions also can violate the law. For example, using a company's assets to pay back a bona fide loan made by one of its members could be considered a fraudulent conveyance if it results in non-interested creditors not being paid back. Selling personal property (i.e. cars, computers, etc.) for less than fair market value in order to make fast cash and pay down debts also would violate the statue. The reason why developers should fear the Debtor and Creditor Law is not because of the penalties it incurs on the debtor entity; rather, developers should fear the penalties that the statute incurs on the other party to the "fraudulent" transaction. The Debtor and Creditor Law permits creditors to set aside conveyances that violate the statute. Thus, for example, if a developer takes unused and unpaid for building materials from one project and uses it on another project, it would liable to the supplier in the amount of the unpaid for materials. The same holds true if a developer transfers the real property on which the failed project sits from the debtor entity to an affiliated entity for less than fair market value. With respect to monies received from lenders, developers should also be aware of the provisions of Article 3-A of the New York Lien Law, which prohibit an owner from using "lien law trust funds" for any purpose other than to pay persons who provided labor, equipment and materials to the construction project. A violation of this law can lead not only to civil liability against the developer's main corporate entity and its officers, but also criminal liability against the individuals as well. In order to avoid making the problems associated with a failed project worse, developers should think through any transaction which would shed a project-specific entity of assets, if that entity has incurred or will incur debts. Andrew Richards, Esq., is partner at Kaufman Dolowich Voluck & Gonzo LLP, Woodbury, N.Y.