Fraudulent transfer law allows creditors and bankruptcy trustees, under certain circumstances, to sue transferees to recover funds received where a debtor’s transfers to the transferees actually or constructively defrauded its creditors. Under both the Uniform Fraudulent Transfer Act adopted by most states and the fraudulent transfer action created by federal bankruptcy law, a transferee of an alleged fraudulent transfer may assert a defense from such liability by establishing that it received the transfer in good faith and for reasonably equivalent value. See 11 U.S.C. § 548(c); Tex. Bus. & Com. Code § 24.009(a). Many courts have held that a transferee lacks good faith if it has “inquiry notice,” that is, if it has knowledge that would make a reasonable person suspicious and suggest a need for further investigation, even if it lacks actual knowledge of the fraudulent nature of the transfer. But some courts have held that even a transferee with inquiry notice can maintain a good faith defense if it establishes that an investigation into the facts would have been futile because it would not have revealed the fraud. In Javney v. GMAG, L.L.C., No. 17-11526, 2019 U.S. App. LEXIS 759 (Jan. 9, 2019), the Fifth Circuit held that such a futility defense was not available under the Texas Uniform Fraudulent Transfer Act (“TUFTA”).
The ruling arose out of a Ponzi scheme by the Stanford International Bank (“SIB”). SIB issued certificates of deposit to investors that purported to pay a high fixed interest rate based on SIB’s securities investments, but in fact derived the returns on the certificates from new investors’ funds. After the SEC uncovered SIB’s scheme in 2009, over 18,000 investors were left with $7 billion in losses. A federal district court appointed Ralph S. Janvey, the plaintiff here, as receiver for SIB to recover its assets and distribute them to the scheme’s victims.
The defendants were Gary D. Magness and several affiliated financial vehicles (“Magness”). Between December 2004 and October 2006, Magness purchased $79 million in SIB certificates of deposit. After Bloomberg reported in July 2008 that SIB was being investigated by the SEC, Magness withdrew funds from his investments in SIB. (The parties disputed whether this decision was the result of skepticism regarding SIB or independent liquidity issues Magness was facing.) Ultimately, in October 2008, Magness borrowed $88.2 million against his accumulated investment in SIB. He repaid part of these loans with accumulated interest and $700,000 in cash.
The receiver sued Magness under TUFTA to recover the funds transferred to him by SIB as a fraudulent transfer. The receiver obtained partial summary judgment as to funds in excess of Magness’ original investment, leaving as the only issue whether Magness was liable for the remaining $79 million transferred to him in October 2008, corresponding to the $79 million he had originally invested. Magness argued the good faith defense, and the jury ultimately held that while he had “inquiry notice” of the Ponzi scheme, he did not have actual knowledge, and an investigation would have been futile. Based on the futility finding, the district court held that Magness had made out a good faith defense and was not liable for the remaining $79 million. The receiver appealed.
The Fifth Circuit began its analysis by noting that while Texas courts have usually adopted an objective definition of “good faith” under which a transferee with inquiry notice cannot establish a good faith defense, they have not adopted a futility exception to the inquiry notice rule. Instead, the district court adopted the futility exception from case law interpreting the analogous provision of the U.S. Bankruptcy Code, section 548(c). The district court relied on authority indicating that the Bankruptcy Code may be used to interpret the Uniform Fraudulent Transfer Act. Courts interpreting section 548(c) have held that a transferee may preserve a good faith defense in the face of inquiry notice by showing that it in fact made a diligent investigation. Some courts have further held that a transferee may preserve a good faith defense by showing that such an investigation would have been futile.
The Fifth Circuit, however, disagreed that federal case law interpreting section 548(c) good faith should be applied in the context of TUFTA good faith. While the Fifth Circuit noted that in Janvey v. Democratic Senatorial Campaign Commission, Inc., 712 F.3d 185 (5th Cir. 2013), it had interpreted TUFTA in accordance with section 548 case law, it distinguished that case on the ground that the ruling had not specifically addressed good faith. The Fifth Circuit also pointed to its decision in GE Capital Commercial, Inc. v. Worthington Nat’l Bank, 754 F.3d 297 (5th Cir. 2014), where it had held that section 548 and its state-law counterparts do not necessarily align. The Fifth Circuit noted that there was no statutory definition for section 548(c) good faith and courts have disagreed about exactly what is required, including if there is a futility defense. This non-uniformity, the Fifth Circuit held, counseled against relying on section 548(c) case law to interpret TUFTA good faith.
Ultimately, the Fifth Circuit emphasized, the central question for the state law good faith defense, as defined by state case law, is whether the transferee had sufficient knowledge to raise suspicions and pursue further investigation. A transferee with such knowledge that fails to actually investigate does not act in good faith, irrespective of the intricacy of the fraud. Thus, the Fifth Circuit reversed the district court and rendered judgment in favor of the receiver.