Fraudulent transfer statutes were enacted to protect creditors from improper depletion of a debtor’s assets. They generally accomplish this goal by allowing creditors (or a bankruptcy estate representative) to avoid transactions that are either actually or constructively fraudulent as to creditors, and to recover some or all of the proceeds of the transaction. For example, if a leveraged buyout leaves a company insolvent, amounts paid to pre-buyout shareholders may be clawed back in a constructive fraudulent transfer action, even if those shareholders had nothing to do with orchestrating the buyout.
However, many fraudulent transfer laws contain special protections to limit clawbacks from innocent parties. For example, section 550 of the Bankruptcy Code, which governs recoveries under the federal avoidance actions, provides that a plaintiff may not recover from a subsequent transferee that “takes for value . . ., in good faith, and without knowledge of the voidability of the transfer avoided.”
Legions of cases have addressed what constitutes “value” under the Bankruptcy Code and analogous state law fraudulent transfer actions. Far fewer have directly addressed who must benefit from this “value” for the defense to be available. In the recent case of Janvey v. The Golf Channel, Inc., the 5th Circuit addressed precisely that question.
Janvey v. The Golf Channel: “Value” Exists Only Where Creditors Could Benefit
The facts of Janvey are straightforward: for almost 20 years, Stanford International Bank, Limited ran an enormous Ponzi scheme, which involved selling high yield certificates of deposit to investors and paying the promised yields through deposits received from more recent investors. In order to advertise these certificates of deposit to high net worth individuals, Stanford entered into a marketing agreement with the Golf Channel. In total, Stanford paid the Golf Channel approximately $6 million for advertising services.
When Stanford’s Ponzi scheme was uncovered, the company quickly became the target of lawsuits, and was placed into receivership, with Ralph S. Janvey acting as receiver. When Janvey uncovered Stanford’s payments to the Golf Channel, he commenced suit against the Golf Channel in the United States District Court for the Northern District of Texas to claw back the full amount under the actual fraudulent transfer provisions of the Texas Uniform Fraudulent Transfer Act. After initial discovery, the parties cross-moved for summary judgment, with the Golf Channel arguing that it was entitled to judgment in its favor as a matter of law because it received the payments in good faith and provided value in the form of advertising services. (The Texas Uniform Fraudulent Transfer Act provides that a creditor cannot avoid a transfer if the defendant proves (1) that it took the transfer in good faith; and (2) that, in return for the transfer, it gave the debtor something of reasonably equivalent value.) The district court agreed, and granted summary judgment to The Golf Channel.
On appeal, the 5th Circuit reversed, finding that the Golf Channel’s advertising services could not qualify as value for purposes of the defense. In reaching this conclusion, the Court looked to statements regarding the meaning of “value” contained in the official commentary to the Uniform Fraudulent Transfer Act, which stated:
[A]dapted from § 548(d)(2)(A) of the Bankruptcy Code. . . . The definition is not exclusive [and] is to be determined in light of the purpose of the Act to protect a debtor’s estate from being depleted to the prejudice of the debtor’s unsecured creditors. Consideration having no utility from a creditor’s viewpoint does not satisfy the statutory definition. (emphasis by 5th Circuit)
With these principles in mind, the 5th Circuit concluded that “Golf Channel’s services did not, as a matter of law, provide any value to Stanford’s creditors.” Because Stanford’s business was a Ponzi scheme and thus inherently illegitimate, Golf Channel’s services, regardless of their quality or market value, had no value to Stanford’s creditors. In fact, because Ponzi schemes “by definition create greater liabilities than assets with each subsequent transaction,” any net “investments” generated as a result of Golf Channel’s services actually decreased recoveries to Stanford’s creditors. (Query whether advertising so awful that it actually drives away potential investors could be said to generate value for creditors under the 5th Circuit’s analysis.) Accordingly, the 5th Circuit found that the district court erred in allowing the Golf Channel to rely on the “good faith, for value” defense.
The Lesson: Providing “Market Value” is Not Always Good Enough
The “good faith, for value” defense remains a powerful response to many fraudulent transfer claims. The 5th Circuit was careful to point out that its holding should not be read too broadly, and explicitly stated that even highly-speculative investments or contributions can have value as long as the underlying enterprise is legitimate. The 5th Circuit’s decision nevertheless highlights an important limitation on the defense: it depends on whether the defendant actually provides value to creditors, not whether the consideration provided by the defendant has market value “in the abstract.” Where a debtor’s underlying business is fundamentally fraudulent, value may be particularly challenging to demonstrate.