Contributed by Debra McElligott
The Uniform Fraudulent Transfer Act (UFTA), which has been adopted by the majority of states, provides a good faith defense to fraudulent transfer actions so that parties innocently conducting business may be protected where a debtor engages in a fraudulent transfer. The United States Court of Appeals for the Tenth Circuit recently demonstrated the limits of this defense in Klein v. King & King & Jones, where the transferee was unable to successfully assert the defense despite acting in good faith. Additionally, the opinion discusses the requirements for the subsequent transferee defense, which the transferee in Klein similarly could not successfully claim despite the debtor’s payment of a third party’s expenses.
Ponzi Scheme and Fraudulent Transfer
In Klein, a Ponzi corporation named Winsome Investment Trust paid King & King & Jones, a law firm, $25,000 in funds derived from the Ponzi scheme to defend a third party on criminal charges. The relationship between Winsome and the third party does not appear in the record. The Commodities Futures Trading Commission filed an action against Winsome, and, subsequently, a receiver was appointed to, among other things, recapture and return investor funds. The receiver filed a fraudulent transfer action under the Utah UFTA against KKJ to recover Winsome’s $25,000 payment to KKJ.
The United States District Court for the District of Utah held that the payment was both an actual and constructive fraudulent transfer that should be returned to Winsome’s investors. KKJ conceded that the transfer was actually fraudulent under the UFTA, as Winsome made it “with actual intent to hinder, delay, or defraud” its creditors. KKJ, however, asserted the good faith defense available under the UFTA, which provides that a transfer is not voidable against a person who “took in good faith and for a reasonably equivalent value.” KKJ also claimed to be a “subsequent transferee,” against whom transfers are unavoidable.
Good Faith Defense
The District Court held that KKJ could not successfully assert either defense. In reviewing this holding, the Tenth Circuit first considered whether KKJ “took in good faith and for reasonably equivalent value.” Because the receiver conceded that KKJ acted in good faith, the court considered whether the firm provided “reasonably equivalent value” in exchange for Winsome’s payment. The Tenth Circuit upheld the District Court’s decision that KKJ failed to meet this requirement, as the record showed that the firm’s legal services only benefitted a third party, not the debtor. The court relied on the Fifth Circuit’s holding in Securities and Exchange Comm’n v. Resource Development Int’l, LLC that a payment made solely for the benefit of a third party does not furnish reasonably equivalent value to the debtor. Additionally, the court cited to Dietz v. St. Edward’s Catholic Church (In re Bargfrede), in which the Eighth Circuit similarly interpreted the phrase “reasonably equivalent value” in section 548 of the Bankruptcy Code (from which the same phrase in the UFTA was derived).
Subsequent Transferee Defense
The Tenth Circuit also upheld the District Court’s decision that KKJ could not successfully assert the UFTA’s exception for subsequent transferees. KKJ was the “initial transferee” of funds wired from Winsome’s account, as the funds traveled directly from Winsome’s account to KKJ’s. The Tenth Circuit relied on its decision in Rupp v. Markgraf, in which it concluded that under section 550 of the Bankruptcy Code, an individual who had caused a debtor to make fraudulent transfers to his own creditors through his role as corporate principal, but who never personally had actual dominion and control of funds, was not the initial transferee. The court suggested that in order for KKJ to demonstrate that the third party was the initial transferee in this case, it would have had to show that the wire transfer to Winsome gave the third party “actual dominion or control over the funds.”
The opinion in Klein and the cases cited within show that the good faith defense may not be viable for a transferee even if it can prove that it was acting in good faith in accepting the transfer. To that end, the opinion highlights the transferee’s burden to develop the facts in the record to show that the debtor received reasonably equivalent value (which the transferee did not do in Klein). Additionally, the opinion shows the importance of the identity of the parties actually in control of the assets at any given time and how such control may affect a transferee’s ability to assert either the good faith or subsequent transferee defenses.
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