The “Good Faith” Transferee – The Flip Side of Fraudulent Conveyances of Real Estate
The case of Tramiel v. Decker (in re: JTS Corp) came down this month and it is a ruling on a pretty ancient bankruptcy—from 1999!
JTS Corp., here in my own backyard, was a hardware company in Silicon Valley. They ran low on cash and merged with Atari(!) in 1996. JTS approached Jack Tramiel, who was on the board of directors for Atari, to loan JTS some working capital and structured it as a purchase and sale of some real estate that JTS acquired as part of the Atari merger. Tramiel bought 8 parcels in California and Texas from JTS for $10M. JTS retained an option to buy it back for the same price in 1 year.
JTS went under and filed for Chapter 11 bankruptcy in the Northern District of California, San Jose division in 1998. Eventually the debtor converted to a Chapter 7 (which I jokingly refer to as a Chapter 18), in 1999. In 2003, the Chapter 7 Trustee, Suzanne Decker, sued Tramiel and other board members for fraudulent conveyance to try to avoid the sale to Tramiel. The other board members settled out for $4.5M.
Tramiel took it to trial and the Court found that the “reasonably equivalent value” of the property was $11.8M—this was after they factored in discounts for bundling the 8 parcels in one transaction and a “quick sale” and other market considerations. Otherwise, the fair market value of those 8 parcels was $15.7M.
The court also weighed lost rental income, and valued the option and concluded that Tramiel’s $10M purchase was actually worth $10.4M, so after subtracting that amount from $11.8M, Tramiel had a liability of ~$1.4M, plus interest.
Well, under California Code of Civil Procedure Section 877, a party can move for an offset, or credit by other defendants who settled out. The two directors had already kicked in $4.5M in settlement so the trial court held that Tramiel owed nothing (zip, zero, zilch, nada) to the Trustee. What an amazing victory for Tramiel!
However, many millions were at stake so the Chapter 7 Trustee appealed and the U.S. District Court (presiding judge Jeremy Fogel) swung to the other end of the pendulum and concluded the fair market value of the property plus rents was actually $17.1M, and after crediting Tramiel’s purchase price and option at $10.4M that his liability was $6.7M. Yikes!
Even worse, the District Court concluded that Tramiel was not entitled to the $4.5M credit from the co-defendants who settled out!
What happened here? Why the $6M swing? Well, apparently the battle in the lower court trial came down to a battle of the experts, with Tramiel’s expert applying a deep discount range of 20-30% of the fair market value to get to a value for a bundled sale of multiple parcels. The trustee’s expert gave an estimate of 5.5% and the court found Tramiel’s expert more believable.
The important thing to note, is that in both cases, the courts found that Tramiel was a good faith transferee under California Civil Code Section 3439.08(3), ie, that the sale was NOT a fraudulent conveyance to hinder, defraud, delay creditors.
Obviously Tramiel appealed to the Ninth Circuit and the Ninth Cir. concluded that the district court should not have set aside the trial court’s weighing of expert evidence because it was not clearly erroneous. That restored the find of FMV to $11.8M.
Additionally, the Trustee challenged the findings that Tramiel was a “good faith” transferee, ie, that he should be allowed a credit of $10M against the liability. That’s a pretty outrageous position—that Tramiel could pay $10M, and then have to pay another $11.8M for a total payment of $21.8M for a property worth $11.8M? Essentially she was challenging not California’s Fraudulent Conveyance statutes, but using her avoidance powers under Section 544(b) and 550(a) of the Bankruptcy Code. She lost--kinda.
On the one hand, the Court found that there was constructive fraudulent transfer under 544(b). However, the Court also said there was no double dipping on recovery—the liability is capped at the amount needed to restore the estate to the prior condition (like it had land still but no purchase funds). Accordingly the Court held that California’s good faith transferee exception applies to this bankruptcy action.
This ruling satisfies the traditional notion of equity—that a transfer is fraudulent to a creditor if it was made with intent to defraud or without receiving a reasonably equivalent value in exchange. Here, the fact that Tramiel paid $10M (not an insignificant sum) obviously benefited the debtor at a time that it desperately needed a cash infusion, weighed in his favor.
Additionally, the Court looked at joint tortfeasor liability and concluded that Tramiel was entitled to the $4.5M offset by the settled out defendants as well.
That concluded a 14 year old real estate transaction and 6 years of litigation. Can you imagine what the attorneys fees and costs for both sides must have been like?