Fourth Circuit Weighs In On Good-Faith Defense To Avoidance Of Fraudulent Transfer

An important defense in litigation brought by a bankruptcy trustee or chapter 11 debtor-in-possession ("DIP") to avoid a fraudulent transfer is that the recipient provided value in exchange for the transfer and acted in "good faith." Because the Bankruptcy Code does not define "good faith," courts assessing the viability of a good-faith defense typically examine whether, on the basis of the specific circumstances, a transferee knew or should have known that a transfer was actually or constructively fraudulent. Although most courts agree that this test is an objective one, a ruling recently handed down by the Fourth Circuit Court of Appeals may have introduced an element of subjectivity into the analysis. In Gold v. First Tenn. Bank N.A. (In re Taneja), 2014 BL 47157 (4th Cir. Feb. 21, 2014), a Fourth Circuit panel ruled in a split decision that: (i) the same standard applies in assessing good faith under sections 548(c) and 550(b) of the Bankruptcy Code; and (ii) a transferee bank met its burden of demonstrating good faith without introducing evidence of standard practices in the mortgage warehousing industry.

Good-Faith Defense to Avoidance of Fraudulent Transfers

Section 548(a)(1) of the Bankruptcy Code authorizes a trustee or DIP to avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor within the two years preceding a bankruptcy filing if: (i) the transfer was made, or the obligation was incurred, "with actual intent to hinder, delay, or defraud" any creditor; or (ii) the debtor received "less than a reasonably equivalent value in exchange for such transfer or obligation" and was, among other things, insolvent, undercapitalized, or unable to pay its debts as such debts matured.

Section 548(c) provides a defense to avoidance of a fraudulent transfer for a "good faith" transferee or obligee who gives "value" in exchange for a transfer or obligation:

Except to the extent that a transfer or obligation voidable under this section is voidable under section 544, 545, or 547 of this title [dealing with a trustee's power to avoid, respectively, transfers that are voidable under state law, statutory liens, and preferential transfers], a transferee or obligee of such a transfer or obligation that takes for value and in good faith has a lien on or may retain any interest transferred or may enforce any obligation incurred, as the case may be, to the extent that such transferee or obligee gave value to the debtor in exchange for such transfer or obligation.

Thus, the ability of a transferee or obligee to rely on section 548(c) as a defense depends upon whether: (i) the transferee or obligee takes "for value"; (ii) the transferee or obligee acts in "good faith"; and (iii) the transfer or obligation is not otherwise avoidable. Section 550(b) of the Bankruptcy Code similarly provides that, after avoidance of a transfer, the trustee may not recover the property transferred or its value from any transferee "that takes for value, including satisfaction or securing of a present or antecedent debt, in good faith, and without knowledge of the voidability of the transfer avoided."

What Is "Good Faith"?

The Bankruptcy Code defines "value" for purposes of section 548. Section 548(d)(2)(A) states that " 'value' means property, or satisfaction or securing of a present or antecedent debt of the debtor, but does not include an unperformed promise to furnish support to the debtor or to a relative of the debtor."

"Good faith," however, is not defined by the Bankruptcy Code, and courts have sometimes struggled to find a reliable standard to apply in assessing whether it exists under a wide range of circumstances. See generally Jimmy Swaggart Ministries v. Hayes (In re Hannover Corp.), 310 F.3d 796, 800 (5th Cir. 2002) ("[T]here is little agreement among courts as to what conditions ought to allow a transferee [the...