Can you have Kay write up a purchase and sales agreement (backdated 4 months ago) to when she gave you Lily, and then you'd be the 'rightful' owner and you could fight for Lily in court? Just a thought. I mean you were GIVEN Lily from Kay who is technically the owner right? Unless when Kay gave Lily back to the breeder, she did paperwork for that. Verbal agreements do not override written documents, if the only written document is the one Kay has when she purchased Lily from the breeder, than that is the legally binding document for ownership. Sorry for your situation, how heartbreaking!
