The Fifth Circuit held that a subsequent recipient of a fraudulent transfer cannot benefit from the so-called good faith defense in Section 550(b)(1) if the subsequent transferee’s agent was aware of the fraud, even when the agent’s conduct was criminal.

In his August 14 opinion for the Fifth Circuit, Circuit Judge Stuart Kyle Duncan recounted how the appeal resulted from an $80 million fraud. Although complex, the fraud amounted to this:

A couple (who later became fraudulent transfer defendants) invested $10 million in equity in an oil and gas business that experienced difficulties. In making the investment, the couple designated the principal of the oil and gas company to be their agent in managing the investment.

The principal of the oil and gas company hatched a plot to transmogrify the equity investment fraudulently into senior debt. When the oil and gas company sold assets before bankruptcy, the couple were paid in full, with interest.

The oil and gas company ended up in bankruptcy, where the confirmed plan created a trust that sued the couple as subsequent recipients of a $10 million fraudulent transfer under Sections 548(a)(1) and 550(a)(2). The defendants admitted that the transaction was a fraudulent transfer, but, as Judge Duncan said, they argued “that they were protected by 11 U.S.C. § 550(b)(1), which bars recovery from ‘good faith’ transferees.”

The bankruptcy court rejected the argument and entered judgment against the defendants for $10 million and the interest they had received. The Fifth Circuit accepted a direct appeal.

By the way, the principal of the bankruptcy oil and gas company was convicted of securities fraud.

The Good Faith Defense

Under Section 550(b)(1), a trustee may not recover from a subsequent transferee of a fraudulent transfer who “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.”

First, the defendants contended that the agent’s knowledge could not be imputed to them. Judge Duncan found the answer in ancient notions of agency.

Judge Duncan said that the defendants “overlook the role of agency principles underlying the bankruptcy code.” In particular, he said that the “traditional linkage between principal and agent is not severed by Section 550(b)(1)’s mere use of the term ‘knowledge.’” He cited caselaw and the Restatement of Agency (Second and Third) to say that knowledge of an agent is imputed to the principal. He also cited Dewsnup v. Timm, 502 U.S. 410, 419 (1992), for the idea that courts should hesitate to read major changes in pre-Code practice because Congress did not write on a “clean slate.”

Judge Duncan cited other circuits for holding that inquiry notice thrust upon agents is also imputed to principals.

Having held that the agent’s knowledge could be imputed, Judge Duncan moved on to the defendants’ contention that the agent’s criminal actions couldn’t be imputed to them because the agent acted “far outside” the scope of his authority.

To counter the argument, Judge Duncan quoted to the agency agreement to show that the agent’s actions were “all directly related to that authority” and were “foreseeable,” given the “broad scope of [the agent’s] authority.”

Judge Duncan upheld the judgment, holding that the agent had “defrauded [the debtor’s] creditors — to the [defendants’] benefit — by manipulating the very . . . investment the [defendants] had authorized him to manage. Accordingly, [the agent’s] knowledge of the transfer’s voidability is imputed to the [defendants], and § 550(b)(1) offers them no help.”

Note

The opinion also has interesting discussions of appellate standing and tracing. Judge Duncan once again stated the Fifth Circuit’s adherence to the “person aggrieved” standard for appellate standing, which some circuits no longer follow.