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Good Faith Defense to Fraudulent Transfers

7th Circuit Court Seal

EAR vs. Brandt/Brandt vs. Horseshoe Hammond, 14‐2174
Appeal from District Court (ND IL ED) 12‐cv‐00271
Decided Oct. 13, 2015

Introduction

In an Adversary Proceeding in the Chapter 11 Bankruptcy case of Equipment Acquisition Resources (EAR), Plan Administrator William Brandt (Brand) sought to avoid and recover the so-called “fraudulent transfers” made to EAR’s founder that he subsequently lost gambling at Horseshoe Casino.

Facts

EAR was established in 1997 to manufacture and refurbish machinery for use in creating technology products. Beginning in 2005 however, it also began defrauding creditors through crooked equipment financing activities. As a result, founder Sheldon Player and a company Officer named Malone pocketed about $17 Million each.

It was not until September 2009 that an outside forensic accounting firm hired by EAR’s Board of Directors detected the fraud. In response to the revelation about the wrongdoing, the company’s Board and all Officers resigned. EAR’s shareholders then elected William Brandt as the sole Board Member and Chief Restructuring Officer. Shortly thereafter the company sought Chapter 11 Bankruptcy protection.

Procedural History

Brandt filed an Adversary proceeding against Player and Malone in the Chapter 11 case pursuant to 11 U.S.C. 544, 548, and 550 to avoid and recover the transfers made to them. Brandt prevailed, then had to collect from Horseshoe.

In the ensuing case in the District Court, Horseshoe moved for Summary Judgment under the aegis of the statutory “Good Faith” defense in 11 U.S.C. 550(b)(1). Horseshoe prevailed in the District Court.

Brandt appealed the District Court’s ruling, arguing that it had misinterpreted §550(b)(1) and, in addition, it should have granted his prior Motion to Compel production of documents related to investigations conducted by Horseshoe concerning Player.

7th Circuit Opinion

The 7th Circuit confirmed the District Court’s decision. The Appellate Court found that the District Court had correctly interpreted and applied §550(b)(1), and that Brandt did not suffer prejudice from the  denial of his motion to compel.

The 7th Circuit’s Opinion points out that while transfers deemed “voidable” are generally recoverable pursuant to §550(a), which permits the Bankruptcy Trustee, or one in like circumstances such as Brandt, to recover a transfer to an “initial transferee” or “immediate or mediate transferee;” §550(b)(1) provides a defense for:

a transferee that takes for value, including  satisfaction or securing of a present or  antecedent debtin good faith, and without  knowledge of the voidability of the transfer  avoided

Conclusion

The “good faith” defense articulated in 11 U.S.C. 550(b)(1) applies as long as the transferee: (1) is an immediate or mediate transferee under §550(a)(2); (2) took the transfers for value; (3) took the transfers “in good faith;” and (4) took the  transfers “without knowledge of the voidability of the transfer avoided.”

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