A Trustee May Recover Against a Purchaser when it Acts in Bad Faith

By: Alexa G. Schimp

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff

In general, a trustee or a debtor in possession may avoid a transfer made prior to a bankruptcy filing as an actual fraudulent transfer if the transfer was made “with actual intent to hinder, delay, or defraud any creditor of the debtor.”[1] In Kasolas v. Nicholson (In re Fox Ortega Enterprises, Inc.), the United States Bankruptcy Court for California held that a trustee may avoid a fraudulent transfer when the debtor’s transactions were made with no legitimate commercial purpose, but only to solicit new funds to pay older claims and thereby continue a cycle of concealing a fraud.[2] Nicholson (“Defendant”) purchased wine from Premier Cru (“Debtor”), who withheld the wine until prompted by Defendant to deliver it.[3]  When Defendant received the wine, it was not the precise wine he had ordered and was of lesser value.[4] Consequently, Defendant sued debtor, who thereafter filed a voluntary petition for relief under chapter 7 of title 11 of the United States Code (“Bankruptcy Code”), which resulted in an automatic stay of the litigation. Kasolas (“Trustee”) filed a complaint against Defendant when Defendant sought to recover money from wine orders allegedly owed despite being provided the value of the wine orders already received.[5] Trustee argued Defendant had received payment from Debtor in bad faith.[6] The Court granted Trustee’s motion for partial summary judgment  upon demonstration that Debtor acted with actual intent to hinder, delay, and defraud creditors of Premier Cru.[7]

In determining whether a transfer may be avoided as an actual fraudulent transfer, a court will generally consider the so called “badges of fraud.”[8]  The badges of fraud are whether the: transfer or obligation was to an insider; debtor retained possession or control of the property transferred afterwards; transfer or obligation was disclosed or concealed; before the transfer was made or obligation was incurred, debtor had been sued or threatened with suit; transfer was of substantially all the debtor’s assets; debtor was absconded; debtor was removed or concealed assets; value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred; debtor was insolvent or became insolvent shortly after transfer was made or obligation was incurred; transfer occurred shortly before or shortly after a substantial debt was incurred; debtor transferred the essential assets of the business to a lienor that transferred the assets to an insider of the debtor.[9]  Here, the Court found four badges of fraud present between Defendant and Debtor’s transactions.[10]  In particular: Debtor had been threatened with litigation by Defendant before the transfer; Debtor overpromised and oversold all wine that was transferred to Defendant; Debtor scrambled to fulfill wine orders for Defendant after threat by Defendant to sue; and Debtor overpaid for wine to fulfill Defendant’s order.[11] Finding that the transfer was avoidable under section 550 of the Bankruptcy Code, the Court noted that the Trustee was able to recover the property transferred, or its value, from the initial transferee.[12] In this instance, the initial transferee was Defendant.  Under section 550 of the Bankruptcy Code, the good faith defense is a defense to a finding of liability on transfers that are made with actual fraudulent intent if the transferee is found to take for value in good faith without knowledge of the voidability of the transfer avoided.[13] The Defendant has the burden to prove both that “the transferee took ‘in good faith’ and for reasonably equivalent value;” otherwise the defense fails.[14]  The Defendant attempted to assert he was a good-faith purchaser, but the defense nonetheless failed because Trustee showed that Defendant was aware of Debtor’s fraudulent scheme through evidence of email correspondence between Defendant and Debtor where Defendant accused Debtor of running a Ponzi scheme and threatened to report Debtor.[15]  Because he Court found numerous badges of fraud present, it granted Trustee’s motion .[16]

A transfer can be avoided as actual fraudulent transfer when the transfer was made with actual intent to either hinder, delay, or defraud a creditor of the debtor.[17] To determine whether an actual fraudulent transfer occurred, courts will consider the badges of fraud and the totality of the circumstances.[18] Whether a defendant asserts a good faith defense will be taken in consideration with the badges of fraud found to be present.[19]