On August 11, 2014, the US Court of Appeals for the Third Circuit, in SB Liquidation Trust v. Preferred Bank (In re Syntax-Brillian Corp.), vacated a bankruptcy court's dismissal of an adversary proceeding to avoid and recover fraudulent transfers under the Bankruptcy Code and the Delaware Uniform Commercial Code (UCC), holding that a transferee's knowledge of a debtor's alleged fraudulent scheme is not a prima facie element of a fraudulent transfer claim (573 F. App'x 154 (3d Cir. 2014)). However, if the transferee had no knowledge of the scheme, it may assert a good faith defense if it took for value and in good faith.

Syntax Groups Corporation (Syntax) was a California corporation that distributed electronic products manufactured in Asia to customers in the United States. Syntax shared several board members with an Asian manufacturer named Taiwan Kolin Company, Ltd. (Kolin). The parties referred to the shared board members as the Kolin Faction. In 2004, the companies entered into an agreement under which Syntax would sell Kolin-manufactured products to US consumers. At the urging of the Kolin Faction, the companies also entered into incentive agreements which allowed Kolin to overcharge Syntax in exchange for certain rebates. This scheme was designed to bolster Kolin's credit rating and increase its access to US markets.

In November 2004, Syntax entered into a loan agreement with Preferred Bank (Preferred) for $3.75 million and a credit agreement, under which Syntax received letters of credit from Preferred and used them to purchase inventory from Kolin. Syntax merged with Brillian Corporation (Brillian) in 2005 and became a wholly owned subsidiary of Brillian, which renamed itself Syntax-Brillian Corporation (SBC).

On July 8, 2008, SBC filed for Chapter 11 relief. The liquidation plan created the SB Liquidation Trust (Trust) to administer the bankruptcy estate. In 2010, the Trust filed an adversary action against Preferred, alleging that:

Among other things, the Trust sought to avoid:

The bankruptcy court used the "collapsing" doctrine to analyze the actual and constructive fraudulent transfer claims. Under this doctrine, a court may collapse multiple seemingly innocuous transactions for the purpose of examining the economic reality of a series of transactions as a whole (see Practice Note, Fraudulent Conveyances: Issues and Strategies for Lenders and Private Equity Sponsors: "Collapsing" Transactions). Concluding that the collapsing doctrine requires that both the debtor and the transferee have knowledge of the fraudulent scheme, the court dismissed the claims at the pleading stage because the Trust failed to sufficiently allege that Preferred had knowledge of the Kolin Faction's scheme. The court dismissed the complaint, holding that the claims could not stand unless it could collapse the transactions.

The Trustee appealed to the Third Circuit, arguing that its claims for actual fraudulent transfer required only evidence of the debtor's intent and could be avoided without applying the collapsing doctrine. Alternatively, the Trust argued that a transferee's knowledge of the fraudulent scheme is not required to apply the collapsing doctrine.

The Third Circuit vacated the bankruptcy court's dismissal of the actual fraudulent transfer claims against Preferred because neither the Bankruptcy Code nor the Delaware UCC refer to the intent of the transferee as a factor in determining whether a transfer is fraudulent and avoidable. Therefore, the Trust was not required to allege Preferred's knowledge of the fraudulent scheme to withstand a motion to dismiss. However, the Third Circuit noted that this interpretation will not necessarily result in liability for defendants who unwittingly participated in a debtor's fraudulent scheme because under both section 548(c) of the Bankruptcy Code and Section 1304 of the Delaware UCC, a good faith defense is available for those transferees who took for value and in good faith.

The Third Circuit began by examining the clear and unambiguous statutory text of section 548(a)(1)(A) of the Bankruptcy Code, which states that a transfer may be avoided if the debtor made the transfer or incurred the obligation "with actual intent to hinder, delay or defraud any creditor of the debtor." Because neither the Bankruptcy Code nor the Delaware UCC refer to the transferee's intent, the Court held that a transferee's intent is not relevant when pleading an intentional fraudulent transfer claim. The Third Circuit further supported its holding by citing cases from the US Courts of Appeal for the Fifth and Ninth Circuits and the US Bankruptcy Court for the Southern District of New York.

The Third Circuit went on to address the concern that an unwitting participant in a fraudulent scheme may be liable to the debtor in an avoidance action, noting that both the Bankruptcy Code and Delaware UCC have good faith defenses against fraudulent transfer liability. Reading a bad faith element into a fraudulent transfer claim would only result in shifting the burden on the good faith defense, requiring the trustee to prove that the transferee did not act in good faith, contrary to the statutory language of section 548(a)(1) of the Bankruptcy Code or Section 1304 of the Delaware UCC.

Because the Trust prevailed on its first argument, the Third Circuit did not consider its alternative argument concerning the requirements of the collapsing doctrine.

This decision affirms that only a debtor's intent is relevant in asserting an actual fraudulent transfer claim. While a transferee's bad faith is not a prima facie element of an actual fraudulent transfer claim, its good faith can serve as an affirmative defense to this claim, ensuring that innocent transferees that took for value and in good faith are protected from fraudulent transfer liability.

For more information on fraudulent transfers, see the following Practice Notes: