Texas Supreme Court to Rule on the ‘Futility’ Defense to a Fraudulent Transfer

On a question certified by the Fifth Circuit, the Texas Supreme Court will decide whether the Texas Uniform Fraudulent Transfer Act, or TUFTA, has a so-called futility defense that may be raised by someone who has received an actually fraudulent transfer.

In a few months, the Texas high court will tell us whether a defendant who was on inquiry notice about the possible existence of fraud, but who did not investigate, is nonetheless absolved from fraudulent transfer liability by proving that an investigation would have been futile.

In its original opinion in January, the Fifth Circuit panel made a so-called Erie guess and found fraudulent transfer liability under Texas law even though the same facts would have given the transferee a complete defense under Section 548(c) of the Bankruptcy Code. Janvey v. GMAG LLC, 913 F.3d 452 (5th Cir. Jan. 9, 2019). The defendant who received the fraudulent transfer filed a motion for panel rehearing and rehearing en banc.

In a per curiam opinion on May 24, the panel granted the motion for panel rehearing and vacated the opinion from January. In a certified question, the panel is asking the Texas Supreme Court to rule on whether a defendant on inquiry notice who did not conduct an inquiry is nonetheless entitled to the good faith defense if inquiry would have been futile.

The Stanford Ponzi Scheme

The appeal arose from the $7 billion Ponzi scheme perpetrated by R. Allen Stanford, now serving a 110-year prison sentence. The Securities and Exchange Commission obtained the appointment of a receiver, who brought lawsuits to aid defrauded investors.

The receiver sued an investor under TUFTA who took out $79 million in principal shortly before the fraud was exposed. The district court ruled that the investor was the recipient of a transfer made with actual intent to hinder, delay or defraud. The only issue was the investor’s good faith defense under TUFTA.

Under TUFTA, the defendant would have no liability if it could prove that it received the property “in good faith and for reasonably equivalent value.” Good faith was the only issue, because repayment of the investor’s principal established reasonably equivalent value.

The parties agreed that the defendant conducted no investigation. The jury was therefore left to decide two questions. First, the jury concluded that the defendant was on inquiry notice regarding the question of good faith. On the second question, however, the jury decided that an investigation would have been futile. A futile investigation was defined in the jury charge as “a diligent inquiry that would not have revealed to a reasonable person that Stanford was running a Ponzi scheme.”

The district court ruled that the defendant was entitled to the defense under TUFTA by having proven that an investigation would have been futile. In the January panel opinion by Chief Circuit Judge Carl E. Stewart, the Fifth Circuit reversed the district court and found the defendant liable by presuming that the Texas Supreme Court would not recognize the futility defense.

The panel resolved the rehearing motion by certifying the question, thus affording an opportunity for the Texas Supreme Court to decide whether there is a futility defense under TUFTA.

ABI will report the Texas Supreme Court’s decision. To read ABI’s discussion on the Fifth Circuit’s panel opinion in January, click here.