Factors and other commercial lenders frequently face the situation where their borrowers default, judgment is entered against the defaulting borrower, and assets must be identified and seized and applied against the loan. Judgment creditors seeking to enforce judgments have a variety of tools at their disposal.

Factors and other commercial lenders frequently face the situation where their borrowers default, judgment is entered against the defaulting borrower, and assets must be identified and seized and applied against the loan. Judgment creditors seeking to enforce judgments have a variety of tools at their disposal: they can serve restraining notices on banks which hold judgment debtors' accounts; direct the local sheriff to "execute" upon, or seize, those assets; and obtain information from the judgment debtor and others about the location of assets through discovery procedures, including a deposition of the judgment debtor.

One particularly powerful tool granted to judgment creditors is contained in New York CPLR (the rules governing procedures in New York state court), section 5525. That provision allows a judgment creditor to commence a proceeding against a third-party possessing a judgment debtor's assets - a "garnishee" - and obtain an order directing that third-party to pay the judgment debtor's assets to the judgment creditor to satisfy the debt.

The turnover order allows judgment creditors to recover their judgments even when the judgment debtor transfers their assets to a third party.

The relevant provision states:

Upon a special proceeding commenced by the judgment creditor, against a person in possession or custody of money or other personal property in which the judgment debtor has an interest, or against a person who is a transferee of money or other personal property from the judgment debtor, where it is shown that the judgment debtor is entitled to the possession of such property or that the judgment creditor's rights to the property are superior to those of the transferee, the court shall require such person to pay the money, or so much of it as is sufficient to satisfy the judgment, to the judgment creditor and, if the amount to be so paid is insufficient to satisfy the judgment, to deliver any other personal property, or so much of it as is of sufficient value to satisfy the judgment, to a designated sheriff." CPLR 5525(b).

Thus, when a judgment debtor's assets are in the "possession or custody" of a third party, New York courts, may order that third party to pay the assets to the judgment creditor to satisfy, in whole or in part, to the judgment creditor.

A recent group of related decisions clarified the scope of this provision and the judgment creditor's ability to reach assets. In Commonwealth of Northern Mariana Islands v. Canadian Imperial Bank of Commerce, 2013 WL 1982816, No. 12-1857-cv (May 15, 2013), the United States Court of Appeals for the Second Circuit affirmed an opinion from the District Court of the Southern District of New York, which held that New York law does not permit courts to order an entity to turn over a judgment debtor's assets, when those assets are in the "possession or custody" of the entity's subsidiary, and not the entity itself.

In 1994, the Commonwealth of Northern Mariana Islands (the "Commonwealth") obtained two separate judgments against William and Patricia Millard. Subsequently, the Millards moved their assets into various offshore banks and accounts.

As part of its efforts to collect on the tax judgments, the Commonwealth initiated a special proceeding in the Southern District of New York, pursuant to CPLR 5525, against Canadian Imperial Bank of Commerce ("CIBC"), which were subject to jurisdiction in New York. The Commonwealth alleged that some of CIBC's Caribbean subsidiaries ("CIBC Subsidiaries") possessed the Millards' assets, and asked the District Court to order CIBC to turn over the assets in the CIBC Subsidiaries' possession to the Commonwealth to satisfy the judgment. Essentially the judgment creditor claimed that because CIBC had control over the assets in their subsidiaries' possession, it could, as practical matter, direct them to be paid into Court, and thus CPLR 5525 would be satisfied.

The District Court, however, held that CIBC did not have "possession or custody" of assets in the possession of CIBC Subsidiaries. It noted that the word "control" does not appear in the statute, which distinguished that provision from others in which the phrase "possession, custody or control" was specifically used. By contrast, the phrase "possession or custody" is contained in the provisions relating to the disposition of property. Id. The District Court held that this statutory contrast was evidence of the intent of New York Legislature to place a "higher" standard on orders to turn over assets.

The District Court applied this higher standard to the CPLR 5525 and held that CIBC could not be compelled to CIBC Subsidiaries' assets. The District Court found that CIBC likely had "practical" control over CIBC Subsidiaries' assets. Id. at 214. However, the Commonwealth did not demonstrate that CIBC had "possession or custody" of CIBC Subsidiaries' Millard accounts.

Accordingly, the District Court denied the Commonwealth's motion and refused to direct CIBC to turn over the Millards' assets in the possession of the CIBC subsidiaries.

The Commonwealth appealed the District Court 's order to the United States Court of Appeals for the Second Circuit.

The Commonwealth appealed the District Court's order to the United States Court of Appeals for the Second Circuit. The Second Circuit requested that New York's highest court, the New York Court of Appeals, opine on the meaning of "possession or custody" in CPLR 5525. In Commonwealth of Northern Mariana Islands v. Canadian Imperial Bank of Commerce, 2013 N.Y. Slip Op. 03018, the NY Court of Appeals endorsed the reasoning of the District Court's opinion, and held that a court may not issue a turnover order to an entity that does not have "actual control" of the judgment debtor's assets, but whose subsidiary might have possession or custody of such assets.

The NY Court of Appeals made the same statutory distinction as the District Court did, noting the difference between "possession, custody, or control" and "possession or custody" in the various sections of the CPLR. The NY Court of Appeals held that, in the CPLR, "possession, custody, or control" meant constructive possession, while "possession or custody" meant actual possession. Id. at 5. So, while a parent corporation might have constructive possession over a subsidiary's assets - such that the parent could effectively control those assets - the subsidiary could be the entity with actual possession of those assets. Accordingly, the NY Court of Appeals held that in order to issue a turnover order pursuant to CPLR 5525, "it is not enough that the banking entity's subsidiary might have possession or custody of a judgment debtor's assets." Id. at 2.

In Commonwealth of Northern Mariana Islands v. Canadian Imperial Bank of Commerce, 2013 WL 1982816, the Second Circuit - in light of the NY Court of Appeals' decision regarding "possession or custody" under CPLR 5525 - affirmed the District Court's ruling denying the Commonwealth's motion for a turnover order against CBIC. The Second Circuit acknowledged that the NY Court of Appeals had "unambiguously confirmed the District Court's conclusion" that the actual possession or custody of the assets was required. Id. at *2. By affirming the District Court's order, the Second Circuit implicitly endorsed that conclusion as well.

How does this development affect the lender? A borrower could place assets with an affiliate of an entity - even a subsidiary effectively controlled by its parent - yet those assets could be out of the judgment creditor's reach. This was the case in the CIBC case. Even though CIBC, which was subject to jurisdiction in New York, controlled the subsidiaries at which the judgment debtor's assets were located, CIBC could not be compelled to turn those assets over to the debtor. One available option is to seek to compel the judgment debtor to bring out of state assets into New York to satisfy the judgment, provided that the debtor is subject to New York jurisdiction (and will comply with an order, not always a given). Yet in order to avoid difficulties in enforcement, the best measure may be consistent monitoring of the debtor's assets and ensuring, as best as possible, that assets potentially available for collection are not transferred beyond the reach of the court, which, as CIBC shows, can occur even within affiliates of the same entity.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.