[1]On June 17, 2014, the U.S. Bankruptcy Court for the Northern District of Illinois addressed the defense to fraudulent transfer liability under § 548(c) of the Bankruptcy Code.[2] Section 548(c) provides a defense for otherwise fraudulent transfers if the transferee accepts the transfer in good faith, and provides value in exchange for such transfer.[3] Thus, there are two prongs to this defense: good faith and value.[4] The court held that the value that a defendant must provide in exchange for the fraudulent transfer can be directed to the debtor or third party because the defense looks at value from the defendant’s perspective, rather than focusing on whether the debtor received value.[5]
Equipment Acquisition Facts
The debtor, Equipment Acquisition Resources Inc. (EAR), a market-maker in the semiconductor manufacturing equipment sales and servicing industry, filed for bankruptcy protection after engaging in “massive fraud,” which included inflating equipment values and pledging certain equipment multiple times to secure financing. During this time, one or more of EAR’s officers, directors and shareholders knew that the company was engaging in the fraud.
The plan administrator filed a fraudulent conveyance action under § 548 against Charter Airlines LLC, arguing that EAR made avoidable fraudulent conveyances to Charter Airlines by paying it $161,500 for flights that were allegedly taken by EAR’s officers for personal reasons rather than business trips on EAR’s behalf. Charter Airlines never inquired nor was it informed whether the chartered flights were booked for business or personal purposes. However, EAR paid Charter Airlines by a credit card in the company’s name and by EAR company checks. In addition, at no point did Charter Airlines know that EAR was engaged in a fraudulent scheme. The price that Charter Airlines charged for each flight was the fair market value for a charter airline flight, taking into account the market value of fuel at the time. The issue then became whether the value given to a third party in exchange for a fraudulent transfer could insulate a defendant from liability under § 548(c).
Equipment Acquisition Holding
Section 548(c)’s defense focuses on the value given by the transferee rather than the value received by the debtor. Accordingly, a defendant may evade liability if it received the fraudulent conveyance in good faith and provided value in exchange for it, even if the debtor did not receive any of the value that the defendant provided.
Equipment Acquisition Discussion
To establish a prima facie case for a fraudulent conveyance claim under § 548(a)(1)(B), the movant must prove that (1) the debtor made a transfer of its property or interest; (2) the transfer was made within two years of filing for bankruptcy; (3) it received less than a reasonably equivalent value in exchange for the transfer; and (4) was insolvent or rendered insolvent when the transaction took place. The only element in dispute was whether EAR received reasonably equivalent value.
On cross motions for summary judgment, the plan administrator argued that EAR did not receive reasonably equivalent value from Charter Airlines for the flights because EAR’s officers chartered flights for personal trips that served no business purpose. Conversely, Charter Airlines argued that the EAR officers in fact conducted business on these trips and in the alternative, § 548(c) applied to insulate it from liability because it accepted payment for the trips from EAR in good faith and in exchange for new value. The plan administrator and Charter Airlines submitted competing affidavits regarding the business purpose, if any, for the chartered flights. Finding a material issue of disputed fact regarding whether EAR received a reasonably equivalent value for the chartered flights, the court held that summary judgment was not appropriate for the plan administrator.
The court then addressed Charter Airlines’s argument under § 548(c), which acts as an affirmative defense to fraudulent conveyance actions if the transferee acted in good faith and provided value to the debtor in exchange for such transfer. The court found that the undisputed facts collectively established the element of good faith for purposes of the defense because Charter Airlines was unaware of EAR’s fraudulent conduct, never inquired as to the purpose of the chartered flights, charged EAR the fair market value for such flights, and no facts or circumstances available to Charter Airlines otherwise existed to place a reasonable person on constructive notice of EAR’s fraud.
Turning to the value-exchanged element of the § 548(c) defense, the plan administrator argued that Charter Airlines did not give any value to EAR in exchange for the payments that it received for the chartered flights. The court rejected this argument, noting that it improperly focuses on the value received by EAR rather than on the value given by Charter Airlines. The court explained that unlike the “reasonably equivalent value” analysis in § 548(a)(1)(B), the focus in § 548(c) is on the value given by the transferee, rather than the value received by the debtor. In other words, the defense under § 548(c) focuses on value from the defendant’s perspective. As a result, the court granted Charter Airlines’ motion for summary judgment.
Conclusion
The Equipment Acquisition decision is in line with other precedent,[6] including the Fifth Circuit’s opinion in In re Hannover Corp., where the court explained that § 548(c) focuses on value from the transferee’s perspective, rather than the transferor of the value’s gain.[7] These decisions show that a full fraudulent transfer analysis requires evaluating value from two different perspectives if a transferee raises a § 548(c) defense. Additionally, because courts determine value from the transferee’s perspective rather than the debtor’s, it is possible that the value a transferee provides under § 548(c) may not only be worthless to the debtor, but may actually increase the debtor’s insolvency.[8]
[1] The views expressed herein are those of the author and not necessarily those of Sugar Felsenthal Grais & Hammer LLP or any of its clients.
[2] In re Equip. Acquisition Res. Inc., 511 B.R. 527 (Bankr. N.D. Ill. 2014).
[3] 11 U.S.C. § 548(c).
[4] Equipment Acquisition, 511 B.R. at 536.
[5] Id. at 537.
[6] See, e.g., In re Hill, 342 B.R. 183, 203-04 (Bankr. D.N.J. 2006); In re Peet Packing Co., 233 B.R. 387, 392 (Bankr. E.D. Mich. 1999).
[7] 310 F.3d 796, 802 (5th Cir. 2002).
[8] See, e.g., In re Universal Clearing House Co., 60 B.R. 985, 999 (D. Utah 1986) (“The fact that the services[] performed increased the debtors’ insolvency does not preclude a determination that the appellants gave value.”); see also In re Churchill Mortg. Inv. Corp., 256 B.R. 664, 679-80 (Bankr. S.D.N.Y. 2000).