In Whitlock v. Lowe (In re Deberry) (5th Cir. 2019), the Fifth Circuit court of appeals found it obvious that if a transferee gives back fraudulently transferred funds (which the debtor then dissipates), the transferee has a complete defense to liability to the transferor’s bankruptcy trustee. This puts the Fifth Circuit at odds with the Sixth and Seventh Circuits, where the prepetition give-back counted as no defense. This article concludes that a more nuanced position should mediate between these extremes, based on an “innocent donee” defense retrieved from Nineteenth Century precedent. The article emphasizes that if bad faith transferees for value are accorded no defense, bad faith donees who give back voluntarily should have no defense either. The article also distinguishes fraudulent transfers from self-settled resulting trusts. If the facts show a resulting trust in which the transferor retains the beneficial interest, the give-back defense is absolute, since the transferee owes no duty to the creditors of the transferor. Many of the fraudulent transfer give-back cases are actually misdiagnosed. They were really cases of resulting trusts.
This article is an exhaustive analysis of how and when transfers by a debtor can and cannot be undone by giving back the property and should be the textbook for untangling the knots of whether a "give back" of property is sufficient to rectify and protect a transferee.
In consumer bankruptcies, the most common example of this is where a Debtor transfers property to a friend of family member before ever seeking counsel from a lawyer. There is a fraudulent intent, but one that is unnecessary in its ignorance. Only after does the Debtor learn that the transferred asset could have been exempted but for the transfer. Whether the "give back" of that asset allows exemption, is the issue.
It seems pertinent whether the recovery by a bankruptcy trustee is in the actual property itself, for example the gold brick used in the hypotheticals in the article, or in the cash value of the transferred property. Following the recent Anderson v. Bennett-Smith, a court has discretion in how to best “restore the estate to the financial condition it would have enjoyed if the transfer had not occurred.” The factors it considered included:
- Whether the value of the property is contested;
- Whether the value of the property is not readily determinable; or
- Whether the value of the property is not diminished by conversion or depreciation.
Since ordering return of the actual asset is often the appropriate remedy, it is hard to understand why a transferee returning that asset voluntarily prior to the bankruptcy would be insufficient.
This article appeared in the Volume 94, Issue 4 2020 of the American Bankruptcy Law Journal.
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