Does "Good Faith" Matter to the Fourth Circuit? Constructive Fraudulent Conveyances Under the UFCA

7 Min Read By: Gabriel Bluestone

IN BRIEF

  • New York and Maryland are the only jurisdictions still applying the Uniform Fraudulent Conveyance Act.
  • In New York, there is little ambiguity on what good faith means in the constructive fraudulent conveyance context.
  • But are the Fourth Circuit and Maryland courts properly interpreting the “fair consideration” definition in the act? A recent case suggests they are not.

The law’s definition of “good faith” is often amorphous, fact specific, and difficult to spell out. No doubt, courts and factfinders have grappled with it for centuries. Yet what explains Maryland’s aversion to interpreting it—or acknowledging it—in the “fair consideration” definition in the Uniform Fraudulent Conveyance Act (UFCA)?

New York and Maryland are the only jurisdictions still applying the UFCA (most other states—43 of them—have moved on to the modernized Uniform Fraudulent Transfer Act), and not surprisingly, New York courts have spilled a lot of ink interpreting and articulating the rights of creditors seeking to void fraudulent conveyances. At this point in New York, there is little ambiguity on what good faith means in the constructive fraudulent conveyance context when insolvent businesses are moving money and assets.

Under the constructive fraudulent conveyance statute of the UFCA,

Every conveyance made and every obligation incurred by a person who is or will be rendered insolvent by it is fraudulent as to creditors without regard to his actual intent, if the conveyance is made or the obligation is incurred without a fair consideration.

“Fair consideration” is provided in exchange for property or an obligation if:

(a) In exchange for such property, or obligation, as a fair equivalent therefor, and in good faith, property is conveyed or an antecedent debt is satisfied, or

(b) The property, or obligation is received in good faith to secure a present advance or antecedent debt in amount not disproportionately small as compared with the value of the property, or obligation obtained.

On a plain reading, the statute permits the avoidance of a transfer as constructively fraudulent even if the debtor receives equivalent value if the plaintiff can prove that the value was not provided in good faith. Striking down such conveyances is permitted regardless of the debtor-transferor’s intent.

In New York, as found in the definition, fair consideration is present when (1) the recipient of the debtor’s property either conveys property in exchange or discharges an antecedent debt; (2) the debtor receives the “fair equivalent” of the property conveyed; and (3) the exchange is undertaken in good faith. See Sharp Int’l Corp. v. State St. Bank & Trust Co. (In re Sharp Int’l Corp.), 403 F.3d 43, 53-54 (2d Cir. 2005). The New York Court of Appeals has identified a few parameters defining “good faith”—an honest belief in the activities in question; no intent to take unconscionable advantage of others; no intent to delay, hinder, or defraud others—and certain circumstances that constitute bad faith as a matter of law; notably, transfers to directors, officers, and shareholders of insolvent corporations in derogation of the rights of general creditors. Farm Stores, Inc. v. School Feeding Corp., 102 A.D.2d 249 (2d Dep’t 1984). Other courts interpreting New York law have interpreted good faith to apply to any transaction between an insolvent corporation and a corporate insider. See Hirsch v. Gersten (In re Centennial Textiles), 220 B.R. 165, 172 (Bankr. S.D.N.Y. 1998) (“under New York law, transfers from an insolvent corporation to an officer, director or major shareholder of that corporation are per se violative of the good faith requirement of DCL § 272 and the fact that the transfer may have been made for a fair equivalent is irrelevant.”); Allen Morris Commercial Real Estate Servs. Co. v. Numismatic Collectors Guild, Inc., No. 90 Civ. 264, 1993 WL 183771, 1993 U.S. Dist. LEXIS 7052, at *28-*30 (S.D.N.Y. May 26, 1993) (“it has been held that transfers from an insolvent corporation to an officer, director and major shareholder of that corporation are per se violative of the good faith requirement of Section 272.”).

Although the fact patterns are often nuanced, it’s undeniable that good faith is of great significance under New York’s UFCA when insolvent businesses are making transfers or entering into transactions with insiders.

Given the robust attention to good faith in New York, it seems safe to assume that the other UFCA jurisdiction—Maryland—might perform a similar test. Or maybe not.

Recently, in United Bank v. Buckingham, 761 F. App’x 185 (4th Cir. 2019), the Fourth Circuit Court of Appeals reversed a decision by the late Judge Roger W. Titus assessing whether fair consideration existed when an insolvent business changed the beneficiary designations on two life insurance policies the company purchased for its CEO.

The judgment creditor bank in the case was owed millions of dollars by the bankrupt debtor business, its CEO, and his wife. Prior to becoming insolvent, the company purchased life insurance policies as an employment benefit to the CEO. Upon the CEO’s death, the company would be reimbursed its premium payments (from the death benefits), and with the beneficiary designated by the CEO receiving the remainder.

After a protracted default by the company, a forbearance agreement between the parties, the CEO diminished by dementia, and his son David appointed guardian, the debtor company’s board approved a sale of the policies. The policies were sold for $110,000—a value determined by the life insurance company pursuant to an IRS formula—to a trust. The trustee of the trust was David, and the beneficiaries were David and his two siblings.

The bank alleged that the transfer of the policies to the trust for only $110,000 was fraudulent because it lacked fair consideration in that the policies were conveyed from the debtor company to the trust despite the fact that the policies were cashed in for $750,000 soon after the sale. The court disagreed with the bank and found that “the $110,000 was a ‘fair equivalent’ for the John Hancock policies.” In short, David—voting for his ill father—and his brother Thomas agreed to transfer the policies from the defunct business to a trust, of which David was both the trustee and a beneficiary, along with his two other siblings, for $110,000 despite evidence that the policies were cashed in for $750,000 after the sale.

The district court’s decision focused solely on fair equivalence and undertook a financial valuation of the policies, ultimately agreeing with David’s position that the policies’ value was $110,000 based on overdue premium payments, negative surrender values, and the fact that the policies were in danger of lapsing and becoming worthless; the policies were also subject to a neutral evaluation from John Hancock based on an IRS-approved formula.

Although the court examined the financial considerations in great detail—and per the “fair equivalent” reference definition—no mention of good faith can be found in the opinion.

In reversing the district court, Judge A. Marvin Quattlebaum, writing for the Fourth Circuit, reversed Judge Titus because there was a genuine factual dispute “concerning the fairness of the consideration” paid for the policies; yet, instead of assessing whether the insolvent business sold the policies for a (1) fair equivalent and (2) in good faith—as the statute requires—the panel held that the trial court had “improperly weighed the evidence” in the defendant’s favor at the summary judgment stage. Indeed, Judge Quattlebaum’s opinion offers no mention of good faith of Maryland’s UFCA (to be fair, he’s not the first to omit it, nor likely the last).

Being on both sides of a transaction is usually a red flag for good faith. See Matter of Bernasconi v. Aeon, LLC, 963 N.Y.S.2d 437 (N.Y. App. Div. 3d Dep’t 2013) (“[W]here . . . a corporate insider participates in both sides of the transfer and the insider controls the transferee, the transfer will be deemed to have been made in bad faith if made to a creditor’s detriment . . . .”) But not here.

Although New York has a robust body of law evaluating good faith and arguably would have denied summary judgment had this case been decided under New York law, the failure of the Buckingham courts to undertake even a minimal good-faith examination of the sale to the trust—and ignore that those voting for the policy would receive the benefits—all raise significant and legitimate doubts as to whether courts are properly interpreting Maryland’s “fair consideration” definition in the UFCA. Although Judge Titus acknowledged Maryland’s deficiency in noting that that there is no dispositive authority as to how to determine fair consideration under specific circumstances, under his and the Fourth Circuit’s interpretation, the “and in good faith” clause may as well have been removed from the “fair consideration” definition found at Md. Code § 15-204. United Bank v. Buckingham, 301 F. Supp. 3d 561 (D. Md. 2018).

Until Maryland’s UFCA “fair consideration” definition is fully interpreted—with at least an acknowledgment to the good-faith clause—creditors may well be advised to seek a nexus to New York law, or a similarly favorable jurisdiction, if they hope to truly enforce their rights.

ABOUT THE AUTHOR

Gabriel Bluestone

Gabe Bluestone is a Partner in the Washington, DC office of Bluestone Law Ltd., where he focuses on all aspects of commercial litigation and arbitration, as well as judgment/award enforcement, including…

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