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Determining "value" given by good faith transferee in fraudulent transfer action

The Bankruptcy Code allows a trustee to recover fraudulent transfers made by the debtor prior to bankruptcy. 11 U.S.C. § 548(a). An innocent recipient of a fraudulent transfer is not without a defense, however. The Code allows a transferee that takes in good faith to retain what it received from the debtor in a fraudulent transfer “to the extent that such transferee . . . gave value to the debtor in exchange for such transfer.” 11 U.S.C. § 548(c). The appeal to the Fifth Circuit of a bankruptcy court's proposed findings in the Positive Health Management bankruptcy (Case No. 12-20687; Bankr. S.D. Tex.) that allowed the innocent recipient of fraudulent transfers to retain all the funds it received under the affirmative defense in section 548(c) turned on the meaning of “value” in the statute.

The Fifth Circuit previously held that value must be assessed from the perspective of what the transferee gave up, rather than what the debtor received. Jimmy Swaggart Ministries v. Hayes (In re Hannover Corp.), 310 F.3d 796, 799–802 (5th Cir. 2002). The unresolved question is what happens when a transferee gave less value to the debtor than it received. Is the transferee allowed to keep all that it received so long as it gave “reasonably equivalent” value in exchange? Or is "netting" required so that the transferee keeps only the value that it gave to the debtor?

In Positive Health Management, First National Bank had a loan owed by the principal of Positive Health. The loan was secured by a building in Garland, Texas, which Positive Health used for office space. Despite having no direct obligations under the loan, Positive Health made a series of payments to First National totaling $367,681.35. After Positive Health filed a bankruptcy petition, the Chapter 7 trustee brought an adversary proceeding to recover the payments made to First National as fraudulent transfers under 11 U.S.C. § 548.

The bankruptcy court found Positive Health received "reasonably equivalent value" for the transfers, noting that the "reasonable rent" for the office space was $253,333.33, and that First National had acted in good faith. The bankruptcy court reasoned that First National, as transferee, had given up the chance to foreclose and find a new tenant, and had given up an opportunity cost in the form of foregone market rent. The bankruptcy court found First National was entitled to the good faith for value defense and could keep all of the funds received. The district court adopted the bankruptcy court's proposed findings of fact and conclusions of law.

On appeal, the Fifth Circuit affirmed the district court's decision that First National was entitled to the section 548(c) defense, but reversed the take-nothing judgment in favor of First National.

The Court first noted that the bankruptcy court wrongly equated the terms "value" (as used in section 548(c)) and "reasonably equivalent value" (as used in section 548(a)(1)(B)). Instead, the Court reasoned that the text of section 548(c) supports a netting approach. The Court noted that the last clause of the statute, beginning with "to the extent," makes clear that a transferee is entitled to keep only the amount of a fraudulent transfer that equals the amount it gave up in exchange. Because consideration may be disproportionately small, to hold that a transferee who merely gives "good consideration" in exchange for a fraudulent transfer may keep the entire amount would allow it to benefit at the expense of the debtor's creditors.

The Fifth Circuit concluded that when a good faith transferee receives a fraudulent transfer the value of which exceeds the consideration it gave up in return, section 548(c) requires netting. Accordingly, the Court determined that the Chapter 7 trustee was entitled to recover the $114,348.02 difference between the payments First National received and the value it gave in return.