Understanding The Limits Of The Transferee’s Good Faith Defense In Voidable Transaction Law

The so-called transferee’s good faith defense has often befuddled attorneys and judges alike in its application to the Uniform Voidable Transaction Act (UVTA) as the more modern successor to the Uniform Fraudulent Transfer Act (UFTA). This has resulted in a spate of court opinions that are at best confused, and often dead wrong in the reasoning employed. The defense is simply the contemporary incarnation of the same defense which existed in the English common law, an in various ancient law before that. The defense in its current form posits that if the transferee acted in good faith and gave reasonably equivalent value in exchange for the transfer, then the transaction will not be deemed avoidable, and the transferee will escape liability for the transfer.

What makes the defense confusing is that it applies exclusively and only to the Intent Test of § 4(a), which is known by the misdescriptive term actual fraudulent transfer. This limited application is found in the relevant statutory test of UVTA § 8 which provides the defenses of the transferee. Subsection (a) states the defense as follows:

“(a) A transfer or obligation is not voidable under Section 4(a)(1) against a person that took in good faith and for a reasonably equivalent value given the debtor or against any subsequent transferee or obligee.”

“But wait,” some readers might at this point say, “you’ve previously told us that the UVTA has five tests for what is a voidable transaction. Do you mean to say that out of those five tests, the transferee’s good faith defense only applies to Intent Test of § 4(a)(1)?” In the words of the fictional television producer Mike LaFontaine, indelibly played by the late Fred Willard, “That’s right!

To understand why the transferee’s good faith defense applies only to the Intent Test of § 4(a)(1), requires a process of elimination. There are indeed five tests in the UVTA for a voidable transaction, being:

· Intent Test of § 4(a)(1)

· Overextending Insolvency Test of § 4(a)(2)(i)

· Sinking Insolvency Test of § 4(a)(2)(ii)

· Insolvency Test of § 5(a)

· Insider Preference Test of § 5(b)

We’ll work in reverse. The Insider Preference Test of § 5(b) is not really a voidable transaction test at all, but rather a preference test (one creditor preferred by the debtor over another) very similar to the Bankruptcy Code’s preference provisions. The Insider Preference Test has its own specific defense found in § 8(f), and can also take advantage of the defenses found in § 8(e) which applies to termination of leases and enforcement of security interests — but which defenses are not available under the Intent Test of § 4(a)(1). Thus, we can set aside the Insider Preference Test as not needing the § 8(a) transferee good faith defense.

One test down, four tests to go. We’ll take the next three tests as a group, being the three insolvency or insolvency-ish tests, known by the oxymoron constructive fraudulent transfer, being the Insolvency Test of § 5(a), the Overextending Insolvency Test of § 4(a)(2)(i), and the Sinking Insolvency Test of § 4(a)(2)(ii).

Recall that the transferee’s good faith defense of § 8(a) has two elements. First, the transferee must be in good faith, and, second, the transferee must give reasonably equivalent value (known in voidable transaction parlance as “REV”). Both of these elements must be present. It doesn’t matter if the transferee is in good faith if the transferee did not give REV, and it doesn’t matter if the transferee gave REV if the transferee is in good faith.

Looking at the elements of the three insolvency or insolvency-ish tests, we find that an essential element of all of these tests require the creditor to prove that the transferee did not give REV. The upshot is that if REV is not present, then the transaction is not voidable anyway under any of the three insolvency or insolvency-ish tests. Thus, there is no reason to further contemplate whether the transferee gave REV, in good faith or otherwise.

What that leaves is the sole remaining test, being the Intent Test of § 4(a), and that is the reason why the transferee’s good faith defense of § 8(a) applies only to that test and no other.

It may interest readers to know that when we were drafting the UVTA (your humble correspondent was one of the American Bar Association advisers to the drafting committee), there was actually a very brief discussion on whether to axe the § 8(a) defense as being substantially redundant with the good faith defense found in § 8(d), and which provides as follows:

“(d) Notwithstanding voidability of a transfer or an obligation under this [Act], a good-faith transferee or obligee is entitled, to the extent of the value given the debtor for the transfer or obligation, to: (1) a lien on or a right to retain an interest in the asset transferred; (2) enforcement of an obligation incurred; or (3) a reduction in the amount of the liability on the judgment.”

To understand how § 8(d) works, let’s assume that our transferee is in good faith and has given 100% REV for the transaction with the debtor. In that event, the transferee would be entitled to any of a lien for 100% of the value of the asset, enforcement of 100% of the transaction, or a 100% reduction of the transferee’s liability, i.e., the transferee effectively prevails. Since § 8(d) applies to all five of the tests for a voidable transaction, it essentially operates the same way as the § 8(a) defense where the transferee has given 100% REV, and thus § 8(a) really is a statutory redundancy.

Nonetheless, even though the § 8(a) defense is redundant to the § 8(d) defense, we on the drafting committee determined that keeping § 8(a) might make things easier for some litigants and judges, so we left it in.

Notably, the § 8(d) defense works to a lesser degree to protect a good faith transferee even if the transferee is ultimately determined not to have given 100% REV, since it effectively credits the transferee with what REV the transferee did give, even if not 100%. However, only a good faith transferee may take advantage of § 8(d) — a transferee not in good faith is not entitled to any deduction, whether 100% of REV or some lesser amount.

Is all this more complicated in its statutory drafting than it needs to be? Yes. The UVTA’s scheme (which is simply an adoption of the UFTA’s scheme) for providing defenses is simply another part of the chronic mal-organization which characterizes both uniform acts. We on the drafting committee would have fixed some of this, if not all of it, but such was simply not within the scope of our committee. We’ll have to wait for a RUVTA (Revised UVTA) for all that to be fixed. In my lifetime? Doubtful. In the meantime, we’ll have to live with this scheme the way it is, but hopefully this explains the seeming oddity of why the § 8(a) defense only applies to the Intent Test of § 4(a)(1).

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