Picture this: A corporation purchases goods from a retailer using a credit card. Right in the store, an employee for the corporate buyer turns the goods over to an affiliate of the buyer. The affiliate doesn’t pay the corporate buyer. The corporate buyer ends up in chapter 7.

Is the retailer liable for receipt of a fraudulent transfer because the retailer, which gave value to the affiliate but was paid by someone else who was insolvent, didn’t receive value? Does the retailer have a good faith defense under Section 548(c) or 550(b)(1)?

Holding that “[f]raudulent transfer law looks to substance, not form,” Bankruptcy Judge Peter W. Henderson of Peoria, Ill., held in an opinion on February 28 that the retailer gave value in good faith and “should not be liable” for the corporate buyer’s fraud.

The Purchase and the Transfer

The buyer was a corporation with a $300,000 line of credit on a credit card. The buyer’s sole owner had an affiliated corporation in a different line of business. The affiliate didn’t have a line of credit sufficient to purchase goods necessary for conducting business.

Over time, an employee of the buyer went to a retailer, purchased goods worth more than $700,000, and turned the goods over to the affiliate for use in the affiliate’s business. The affiliate never paid for the goods.

After the buyer ended up in chapter 7, the trustee sued the retailer for receipt of $700,000 in actual or constructively fraudulent transfers. Previously in the adversary proceeding, Judge Henderson had held that the retailer was the initial transferee.

A Transferee’s Defenses

The trustee had sued several retailers on the same theory. Three settled and coughed up more than $80,000.

One retailer didn’t settle and filed a motion for summary judgment, founded on the idea that the retailer gave value in good faith and was entitled to the defenses in Sections 548(c) and 550(b)(1). The trustee cross moved for summary judgment. Judge Henderson came down on the side of the retailer and granted judgment dismissing the suit.

In a suit for an actual or constructively fraudulent transfer under Section 548(a), Section 548(c) gives “a transferee . . . that takes for value and in good faith . . .” a defense “to the extent that such transferee . . . gave value to the debtor in exchange for such transfer or obligation.”

When the court has avoided a fraudulent transfer under Section 548, Section 550(b) says that the “trustee may not recover . . .  from . . . a 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.”

Fraudulent Transfer Turns on the Substance of the Transaction

On the merits, Judge Henderson began by noting the retailer’s predicament. He said that the cashiers were not “directed to ask a guest what the guest’s intentions [were] with respect to the goods purchased. Nor did they have any reason to believe that the transactions at issue here involved any type of fraudulent scheme or were for the benefit of third parties.” Likewise, he said that the buyer’s employee didn’t tell the retailer that the goods were for someone other than the buyer.

Judge Henderson saw “awkwardness” in Section 548(c) because it requires “that a good-faith transferee give value to the debtor.” In the case at hand, the retailer arguably had not given value to the corporate debtor because the goods went to the affiliate.

Judge Henderson wasn’t convinced. “Under a proper understanding of § 548(c),” he said, the retailer had given “value to the Debtor,” since the sale was a two-party transaction, not a three-party transaction.

Because a “fraudulent conveyance doctrine is a flexible principle that looks to the substance of a transfer, rather than its form,” Judge Henderson held under Section 548(c) that “a merchant gives value to the debtor when the debtor pays for goods in a present sale, even if those goods are received by a third party.”

The trustee’s idea that the retailer gave value to the affiliate “makes no sense as a matter of fraudulent transfer doctrine,” Judge Henderson said, because it violates “the ancient principle that a good-faith transferee who gives value will be protected.” Otherwise, he said, it would “impose[] unreasonable costs on merchants that have limited ability to monitor debtors.”

Judge Henderson had held that the retailer was the initial transferee, giving the retailer the defense in Section 548(c). He went on the explain that the result would be the same under Section 550(b) if the retailer had been a subsequent transferee, because the retailer had given value in good faith without knowledge of the voidability of the transfer.