“Many a small thing has been made large by the right kind of advertising.”
— Mark Twain
Two recent cases suggest that broadcasters who advertise a debtor’s fraudulent business may be vulnerable to § 548 claims. If the broadcaster received notice of the debtor’s fraudulent business practices, it may lack good faith. Yet a recent decision from the Fifth Circuit suggests that even if good faith exists, advertising that grew the debtor’s fraud does not provide reasonably equivalent value. In this first of two articles, good faith is addressed.
Good Faith
The trustee for Taxmasters Inc.[1] recently challenged broadcasters’ good faith in receiving payment for advertisements. Taxmasters blanketed cable networks with advertisements in which it made false promises about instant tax relief. The commercials were so prevalent they were parodied on Saturday Night Live.
The Texas attorney general (AG) sued Taxmasters for deceptive trade practices, and its petition expressly referenced networks broadcasting Taxmasters’s false commercials. The AG also obtained an injunction enjoining Taxmasters from specific false practices and requiring certain disclosures before selling its services. Taxmasters informed each of the networks of the lawsuit, but the networks continued running the commercials. While the case was pending, ABC’s “Nightline” ran a story on Taxmasters’s deceptive trade practices and referred to the still-running commercials. Taxmasters filed for bankruptcy on the eve of trial, but the AG proceeded to trial and obtained a $112 million judgment.
The trustee discovered that Taxmasters paid the networks almost $20M after being sued by the AG. Taxmasters’s officers knew that paying for the advertisements precluded refunds owed to consumers for unperformed work and would prevent payment of the judgment that Taxmasters knew would result from the AG’s lawsuit.[2] In addition, the trustee learned that most of the networks received multiple complaints from their viewers about Taxmasters’s fraud.
The trustee sued seven cable or radio networks, arguing that Taxmasters paid the broadcasters with intent to defraud creditor/consumers as well as the State of Texas, and that the broadcasters lacked good faith in receiving the payments because they were aware of the AG’s lawsuit, but had made no inquiry as to Taxmasters’s intent in purchasing the commercials. The broadcasters moved to dismiss the trustee’s adversary complaints, attacking the plausibility of the claim. The broadcasters argued the absence of any duty to review the content of the commercials, and that notice of the Texas AG’s lawsuit created no duty of inquiry. In addition, the broadcasters argued that the First Amendment protected them from such a duty.
The bankruptcy court denied the motion to dismiss filed by the lead broadcaster and found the trustee’s § 548 claim plausible. The court found that the § 548(c) affirmative defense of good faith governs the existence of a duty. There is no statutory or case law exemption immunizing broadcasters from a duty of good faith. Moreover, the failure to make a diligent inquiry negates good faith if the transferee had notice of facts suggesting the debtor’s fraudulent intent.[3] The highly factual affirmative defense for which the broadcasters had the burden of proof, however, could not defeat the plausibility of the trustee’s claim at the motion to dismiss stage of the proceedings.[4] The sufficiency of notice suggesting Taxmasters’ fraudulent intent and whether the broadcasters satisfied their duty of inquiry in response to such notice were defenses available to broadcasters at a later stage in the case.
The broadcasters also argued in their motions to dismiss that because the injunctions did not prohibit advertising, notice of the injunctions triggered no duty of inquiry. The argument implicitly relied on the absence of a mandate regarding advertising in the injunction, however, and thus the court could not find the absence of a duty of inquiry solely from judicially noticing the existence of the injunctions.[5]
Lastly, the broadcasters argued that the First Amendment defeated the claim by negating any duty of inquiry. No case law, however, supported insulation from a § 548 claim based on the First Amendment. Additionally, false commercial speech receives no First Amendment protection.[6]
Based on the bankruptcy court in the Taxmasters case finding the trustee’s § 548 claim against the broadcasters plausible, a broadcaster’s good faith in receiving a fraudulent transfer should not be presumed. Indeed, where a broadcaster has notice of facts suggesting that its customer is advertising fraudulent services, a duty of inquiry arises regarding the customer’s intent in purchasing the advertising. If the broadcaster makes no inquiry, or its inquiry is limited to assurances provided by its customer, good faith may be absent, exposing the broadcaster to a § 548 claim.
In Part 2 of this article, a recent case from the Fifth Circuit Court of Appeals regarding the affirmative defense of reasonably equivalent value asserted by a broadcaster will be addressed.
[1] Case No. 12-3605 in the U.S. Bankruptcy Court for the Southern District of Texas, Houston Division. J. Mitchell Little of Scheef & Stone, LLP served as lead counsel for the trustee.
[2] Additional badges of fraud, including additional lawsuits pending against Taxmasters, existed at the time of each transfer.
[3] See In re Agric. Research & Tech. Group Inc., 916 at 535 (“[I]f the circumstances would place a reasonable person on inquiry of a debtor’s fraudulent purpose and a diligent inquiry would have discovered that fraudulent purpose, then the transfer is fraudulent” and good faith is lacking). In many instances, the broadcasters simply asked Taxmasters whether the AG’s allegations were true, which was an insufficient inquiry. See SEC v. Credit Bancorp Ltd., 386 F.3d 438, 452 (2d Cir. 2004).
[4] “The element of good faith under section 548(c) of the Code, bearing upon a transferee's motivations, is indisputably a factual question that may not be determined on the face of [a] complaint.” Picard v. Merkin (In re Bernard L. Madoff Inv. Securities LLC) 440 B.R. 243, 255 (Bankr. S.D.N.Y. 2010) (internal quotation omitted).
[5] Kaye v. Lone Star Fund V (U.S.) L.P., 453 B.R. 645, 664 (N.D. Tex. 2011) (judicially noticing pleadings allows only notice of the existence of the pleadings or the undisputed facts in the pleading, nothing more).
[6] See, e.g., McIntyre v. Ohio Elections Comm’n, 514 U.S. 334, 357, 115 S.Ct. 1511, 1524, 131 L.Ed.2d 426 (1995). (“Punishing fraud, whether it be common law fraud or securities fraud, simply does not violate the First Amendment.”); SEC v. Pirate Investor LLC, 580 F.3d 233, 255 (4th Cir. 2009); see also Virginia Bd. of Pharmacy v. Virginia Citizens Consumer Council Inc., 425 U.S. 748, 771, 96 S.Ct. 1817, 1830, 48 L.Ed.2d 346 (1976) (noting that fraudulent speech generally falls outside protections of First Amendment).