Janvey v. GMAC, 925 F.3d 229 (5th Cir. 2019)

QUESTION:     Is the “good faith” defense against fraudulent transfer clawbacks available to a transferee who had inquiry notice of the debtor’s fraudulent behavior, did not conduct a diligent inquiry, but who would not have been reasonably able to discover that fraudulent activity through diligent inquiry?
ANSWER:       Maybe. In Janvey v. GMAC,  a case arising out of the infamous Stanford International Bank Ponzi scheme, the federal district court ruled that the “good faith” defense remained available to such an investor who did not conduct a diligent inquiry after inquiry notice. The Fifth Circuit disagreed, and in January 2019, reversed the district court’s ruling and held that a transferee on inquiry notice of a transfer’s fraudulent nature is not entitled to the “good faith” defense codified in the Uniform Fraudulent Transfer Act in Texas. Upon request for rehearing, the Fifth Circuit vacated its January ruling, and in May 2019, the Fifth Circuit certified this open question under Texas law to the Texas Supreme Court. As of this writing, the Texas Supreme Court has not yet answered this important question.
FACTS: For decades, the Stanford International Bank (“Stanford”) issued CDs to investors at above-market rates which were fraudulently funded by capital invested by new investors’ funds. This classic Ponzi scheme left over 18,000 investors with approximately $7 billion in losses. The investor involved in this case, Gary D. Magness and several related entities (“Magness”), was one of the largest U.S. investors in Stanford; between December 2004 and October 2006, Magness purchased $79 million in Stanford CDs. In July 2008, it was publicly reported that the SEC was investigating Stanford. In October 2008, Magness decided to recover its investment in Stanford if possible.  In late October 2008, Magness received $88.2 million in cash from Stanford. Significantly, Magness did not conduct a due diligence review of Stanford before recovering its investment. In 2009, the SEC uncovered the Ponzi scheme and Stanford collapsed. Ralph S. Janvey (the “Receiver”) was appointed the Receiver to recover Stanford’s assets and distribute them to the scheme’s victims.
The Receiver sued Magness to recover funds pursuant to (1) the Texas Uniform Fraudulent Transfer Act (“TUFTA”); and (2) unjust enrichment. Following trial, the jury determined that Magness had inquiry notice that Stanford was engaged in a Ponzi scheme, but not actual knowledge. Further, the jury found that any investigation that Magness would have conducted into Stanford’s practices would have been futile: Magness would not have discovered Stanford’s fraud through any diligence investigation it may have undertaken. Ultimately, the district court held that Magness satisfied its “good faith” defense under TUFTA even though it did not investigate Stanford after receiving inquiry notice of its possible fraud.
On appeal, the Fifth Circuit originally reversed the district court’s ruling and held that Magness was not entitled to the “good faith” defense under TUFTA. Upon request for rehearing, in May 2019, the Fifth Circuit vacated its prior ruling and certified this question to the Texas Supreme Court.
DISCUSSION:      Texas, like most states, has adopted a version of the UFTA, which was designed to prevent debtors from transferring their property in bad faith before creditors can reach it. Texas law, like UFTA, allows the recovery of property transfers made “with actual intent to hinder, delay, or defraud any creditor of the debtor.” Tex. Bus. & Com. Code Sec. 24.005(a)(1). Recipients of fraudulent transfers, like Magness, can prevent clawback actions by proving they received property “in good faith and for a reasonably equivalent value.” Id. The term “good faith” is not defined in either the UFTA or TUFTA; and, to date, the Texas Supreme Court has not interpreted “good faith” as used in TUFTA.
In this case, as a matter of determined fact, Magness had inquiry notice of Stanford’s possible fraud, Magness did not conduct an investigation into this possible fraud before recouping its investment, and that, had Magness undertaken any such effort, its investigation would have been futile. Faced with these specific facts, the Fifth Circuit framed the issue this way: “[D]oes TUFTA good faith require a transferee on inquiry notice to conduct an investigation, and if so, can that transferee retain the good faith defense if he does not conduct an investigation but later convinces the factfinder that such an investigation would not have turned up the fraudulent purpose?” Janvey, 925 F.3d at 233.
After surveying a number of relevant, reported cases from jurisdictions outside of Texas which have attempted to define “good faith” under these circumstances, the Fifth Circuit concluded that this important question has not been addressed by the Texas Supreme Court, but should be before it renders an opinion. Although the Fifth Circuit certainly did not state a firm opinion regarding how the Texas Supreme Court should rule, most of the cases cited by the Fifth Circuit in its ruling tend to suggest that, regardless of whether an investor with inquiry notice would have actually discovered any fraud, the failure to inquire at all is not suggestive of the type of “good faith” contemplated by TUFTA. That is, by not conducting an investigation at all, this fact suggests that Magness was not in “good faith” when it demanded the return of its investment.
Given the significance of this issue, not only in Texas law but in all states which have adopted the UTFA, we will be watching for how both the Texas Supreme Court and the Fifth Circuit ultimately answers this important question in this high-profile case.