United States: Fourth Circuit Affirms Bank’s Good Faith Defense To Fraudulent Transfer Claim

The recipient of funds that a trustee seeks to recover by means of a fraudulent transfer claim may avoid liability by establishing that it took "for value and in good faith," under section 548(c) of the Bankruptcy Code.  The Bankruptcy Code does not define "good faith," and case law does not provide a clear precedent of what constitutes good faith; rather courts generally consider whether the transferee knew or should have known of the debtor's financial distress at the time of the transfer.  In its recent decision in In re Taneja (Gold v. First Tennessee Bank National Association), a divided Fourth Circuit Court of Appeals considered the meaning and proper application of the good faith defense in actions to avoid and recover fraudulent transfers under section 548. No. 13-1058, 743 F.3d 423 (4th Cir. Feb. 21, 2014).  The Fourth Circuit's decision in Taneja does not provide a "bright line" legal precedent, but it does appear to lower the bar with respect to a transferee's factual burden.  In Taneja, the court held that a transferee need not present evidence that its every action concerning the relevant transfers was objectively reasonable in light of industry standards.  Rather, the court's inquiry regarding industry standards serves only to establish the correct context in which to consider what the transferee knew or should have known, and expert testimony is not necessarily required to establish that context.

In Taneja the debtor, Vijay K. Taneja, originated home mortgages through his company Financial Mortgage Inc. ("FMI") and sold them to secondary purchasers who, in turn, aggregated and securitized the loans to create "mortgage-backed securities."1  Taneja and FMI financed these loans by borrowing funds from warehouse mortgage lenders, including the defendant First Tennessee Bank National Association (the "Bank").  Prior to filing for bankruptcy, Taneja and FMI transferred funds to the Bank in repayment of outstanding loans.  The bankruptcy trustee for Taneja and FMI brought an action to void and recover the repaid loan amounts as fraudulent transfers under section 548.  In response, the Bank asserted a good faith defense under section 548(c).  The Bankruptcy Court found that the Bank had accepted the transfers for value and in good faith, and the District Court affirmed.

On the trustee's appeal, the Fourth Circuit considered the proper context in which to evaluate the reasonableness of a transferee in accepting funds later deemed to constitute a fraudulent conveyance.  Both lower courts had relied on the standard articulated in In re Nieves, 648 F.3d 232,237 (4th Cir. 2011), which bifurcated the good faith requirement into two components.  The first, a subjective component, relates to the transferee's "honesty" and "state of mind," while the second, objective, component relates to the transferee's "observance of reasonable commercial standards."  Notably, Nieves made clear that a transferee does not act in good faith if it "fails to abide by routine business practices."

In Taneja, the Fourth Circuit affirmed the application of the binary standard of Nieves compelling the consideration of what the transferee "should have known . . . taking into consideration the 'customary practices of the industry in which [it] operates'."  However, the court held that a transferee relying on section 548(c) is not required to demonstrate that it abided by "routine business practices", stating, "[w]e decline to adopt a bright-line rule requiring that a party asserting a good faith defense present evidence that his every action concerning the relevant transfers was objectively reasonable in light of industry standards."  Instead, the court stated, "our inquiry regarding industry standards serves to establish the correct context in which to consider what the transferee knew or should have known."  Relying on the bankruptcy court's finding that the bank's witnesses presented credible testimony concerning the bank's practices ". . . and the mortgage warehouse industry," the Fourth Circuit held that the district court did not clearly err in holding that the transferee Bank had carried its burden of showing that it received payments from FMI in good faith.2

Practical Implications

While the opinion does not go so far as to pronounce a clear legal standard by which to assess whether a fraudulent transfer is received in good faith, courts following the guidance of the Fourth Circuit's precedent may apply relaxed standards of proving a good faith defense under section 548(c), particularly with respect to the objective component regarding the transferee's observance of reasonable commercial standards.  Significantly, the panel unanimously agreed that the objective component of 548(c) could be satisfied through lay witness testimony from the transferee, and that expert testimony was not required.

Footnotes

1.Details of the fraud are provided in the court's decision inIn re Taneja (Gold v. First Tennessee Bank Nat'l Assoc.), No. 13-1058, 2014 WL 661065 (4th Cir. Feb. 21, 2014).  The Fourth Circuit reviewed the District Court decision for clear error, and as a result concluded it was not required to render any decision regarding whether the trustee was entitled to a 'Ponzi scheme presumption' with respect to the alleged fraudulent conveyances.

2.In re Taneja, 2014 WL 661065 at *12.  Although the objective good faith standard articulated by the Fourth Circuit inTaneja considers the "routine" or "customary" practices of the industry in which the transferee Bank operated, the Bank in Taneja presented scant, if any, evidence of customary industry practices, to the vexation of both the trustee and lone dissenting circuit judge James A. Wynn, Jr.  Instead, the case turned on evidence presented by the Bank of a downturn in the mortgage warehouse industry at the time it received the transfers.

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