The Bottom Line

The District Court for the Northern District of Texas recently held in Segner v. Ruthven Oil & Gas, LLC, No. 3:12-CV-1318-B, 2018 WL 3155827 (N.D. Tex. June 28, 2018) that failure to comply with a disclosure law when documenting a transaction does not deprive a defendant in a fraudulent transfer action from asserting a good faith defense.

What Happened?

The defendant was hired by a contractor of the debtor to acquire mineral interests in Oklahoma. The defendant received approximately $21 million for its work. After the debtor filed for bankruptcy, the trustee sought to avoid these payments as fraudulent transfers. The court found the payments were avoidable under Section 548 of the Bankruptcy Code.

The defendant argued, however, that it was not liable to the trustee because it had received the money in good faith in exchange for value and without knowledge of the voidability of the transfers. After trial, the jury found that the defendant had received the funds in good faith and returned a verdict for the defendant. The trustee then moved to set aside the jury verdict, arguing that because the defendant had misrepresented the value of the mineral rights in violation of Oklahoma law, the court should find, as a matter of law, that the defendant knew or should have known the transfers were avoidable.

The court disagreed. Under Section 548 of the Bankruptcy Code, the trustee may avoid a transfer of an interest in property of the debtor that is actually fraudulent as to creditors or if the debtor is insolvent and does not receive fair value in exchange. 11 U.S.C. § 548. Once a transfer is avoided, Section 550 of the Bankruptcy Code allows the trustee to recover the property or the value of the property from the transferee. 11 U.S.C. § 550(a). However, the trustee may not recover from a transferee if the transferee took the property in exchange for value, in good faith, and without knowledge of the voidability of the transfer. 11 U.S.C. § 550(b). This is commonly referred to as the good faith defense.

The “good-faith inquiry looks to whether the transferee was on notice of the debtor’s insolvency or the fraudulent nature of the transaction.” Segner, 2018 WL 3155827 at *2. The inquiry turns on what the transferee knew or should have known about the transaction. The trustee argued that the defendant’s misrepresentations of the value of the mineral interests showed that it knew or should have known about the fraudulent nature of the transactions. The jury had rejected this claim, and the court declined to find that this constituted bad faith as a matter of law.

The court characterized the trustee’s argument as proposing “a rule under which, if a party violates a law in the process of entering into a transaction, a court must find as a matter of law that the party did not enter into that transaction in good faith.” Id. at *3. The court noted that a rule this broad was untenable. It does not make sense to deprive a transferee of the good faith defense for any violation of law whatsoever, no matter how minor or irrelevant. As the court noted, “Surely a contracting party who violated the speed limit while driving to a contract closing would not transact [in] bad faith by driving too fast.” Id. Where the law imposes a specific duty on the transferee, failure to comply with that law can result in bad faith. However, the law here did not impose any such duty.

Why This Case Is Interesting

The court declined the opportunity to adopt a per se rule that any violation of law in relation to transaction shows a lack of good faith on the part of the transferee. The good faith defense allows an innocent transferee who provides value to the debtor to avoid liability for fraudulent transfers. The rule proposed by the trustee in this case would have potentially expanded fraudulent transfer liability for minor, technical violations of the law.