Filed: Feb. 21, 2014
Latest Update: Mar. 02, 2020
Summary: PUBLISHED UNITED STATES COURT OF APPEALS FOR THE FOURTH CIRCUIT No. 13-1058 In Re: VIJAY K. TANEJA, Debtor. - H. JASON GOLD, Chapter 11 Liquidating Trustee, Plaintiff – Appellant, v. FIRST TENNESSEE BANK NATIONAL ASSOCIATION, Defendant - Appellee. Appeal from the United States District Court for the Eastern District of Virginia, at Alexandria. Anthony J. Trenga, District Judge. (1:12-cv-01097-AJT-TRJ; 08-13293-RGM; 10-01225- RGM) Argued: October 29, 2013 Decided: February 21, 2014 Before KEENAN,
Summary: PUBLISHED UNITED STATES COURT OF APPEALS FOR THE FOURTH CIRCUIT No. 13-1058 In Re: VIJAY K. TANEJA, Debtor. - H. JASON GOLD, Chapter 11 Liquidating Trustee, Plaintiff – Appellant, v. FIRST TENNESSEE BANK NATIONAL ASSOCIATION, Defendant - Appellee. Appeal from the United States District Court for the Eastern District of Virginia, at Alexandria. Anthony J. Trenga, District Judge. (1:12-cv-01097-AJT-TRJ; 08-13293-RGM; 10-01225- RGM) Argued: October 29, 2013 Decided: February 21, 2014 Before KEENAN, ..
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PUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
No. 13-1058
In Re: VIJAY K. TANEJA,
Debtor.
-----------------------
H. JASON GOLD, Chapter 11 Liquidating Trustee,
Plaintiff – Appellant,
v.
FIRST TENNESSEE BANK NATIONAL ASSOCIATION,
Defendant - Appellee.
Appeal from the United States District Court for the Eastern
District of Virginia, at Alexandria. Anthony J. Trenga,
District Judge. (1:12-cv-01097-AJT-TRJ; 08-13293-RGM; 10-01225-
RGM)
Argued: October 29, 2013 Decided: February 21, 2014
Before KEENAN, WYNN, and THACKER, Circuit Judges.
Affirmed by published opinion. Judge Keenan wrote the opinion,
in which Judge Thacker concurred. Judge Wynn wrote a separate
dissenting opinion.
ARGUED: Kenneth Oestreicher, WHITEFORD, TAYLOR & PRESTON, LLP,
Baltimore, Maryland, for Appellant. Clarence A. Wilbon, BASS,
BERRY & SIMS PLC, Memphis, Tennessee, for Appellee. ON BRIEF:
Todd M. Brooks, Baltimore, Maryland, Christopher A. Jones,
WHITEFORD, TAYLOR & PRESTON, LLP, Falls Church, Virginia, for
Appellant. Annie T. Christoff, BASS BERRY & SIMS PLC, Memphis,
Tennessee; Sheila DeLa Cruz, HIRSCHLER FLEISCHER, PC, Richmond,
Virginia, for Appellee.
2
BARBARA MILANO KEENAN, Circuit Judge:
In this bankruptcy case, the trustee for the bankruptcy
estates of Vijay K. Taneja and Financial Mortgage, Inc. (FMI)
filed an action to avoid and recover certain payments made by
FMI to First Tennessee Bank, National Association (the bank, or
First Tennessee). In the complaint, the trustee alleged that
the payments were “fraudulent transfers” under 11 U.S.C. § 548,
and were part of a fraudulent scheme carried out by FMI and
Taneja. After a trial, the bankruptcy court determined that the
bank proved the affirmative defense of good faith in accordance
with Section 548(c) and dismissed the trustee’s action. The
district court affirmed that decision, and the trustee appeals.
The primary question presented is whether the bank proved
its good-faith defense based on the testimony of two bank
employees. Upon our review, we conclude that the bankruptcy
court and the district court correctly applied the objective
good-faith standard in determining that the bank employees’
testimony provided competent objective evidence that satisfied
the bank’s burden of proving its affirmative defense under
Section 548(c). We further conclude that the bankruptcy court
did not clearly err in holding that the bank accepted the
payments from FMI in good faith. Accordingly, we affirm the
district court’s judgment.
3
I.
In the 1990’s, Taneja began operating FMI, a legitimate
business engaged in originating home mortgages and selling those
loans to investors (secondary purchasers), who aggregated the
mortgage loans and often securitized them for sale to different
investors. To carry out its business, FMI worked with numerous
financial institutions known as “warehouse lenders.” Typically,
these lenders extended lines of credit and advanced funds to
FMI, in order that FMI could extend mortgage loans to individual
mortgagees. The warehouse lenders required FMI to sell the
mortgage loans to secondary purchasers within a certain time
period. After the sale, the warehouse lenders’ lines of credit
were “replenished according to the terms of the agreement.”
The record shows that at some point after 1999, FMI and
Taneja had difficulty selling their mortgage loans to secondary
purchasers. As a result, FMI and Taneja began engaging in
fraudulent conduct, which included selling the same mortgage
loans to several different secondary purchasers and conspiring
with other business entities controlled by Taneja to have them
serve as intermediary parties to conceal the fraud. The
fraudulent conduct continued during 2007 and 2008, when the
market for “mortgage-backed securities” declined significantly.
Even though FMI and Taneja also continued to conduct certain
legitimate business activities, their fraudulent conduct
4
resulted in losses of nearly $14 million to warehouse lenders,
and of about $19 million to secondary purchasers. 1
FMI’s relationship with First Tennessee, a warehouse
lender, began in 2007 when the bank received a referral
concerning FMI from another warehouse lender. Before extending
FMI a line of credit, the bank analyzed financial statements and
tax returns submitted by FMI and Taneja. The bank also
conducted research using “a private mortgage database” that
contained various information regarding mortgage irregularities,
reports of fraud, and material suspicions of fraud.
Additionally, the bank contacted FMI’s references and examined
FMI’s “quality control plan.” The bank’s investigation did not
reveal any negative business information involving FMI or
Taneja.
On July 2, 2007, the bank and FMI executed an agreement in
which the bank provided FMI with a line of credit in the amount
of $15 million (the lending agreement). However, their lending
relationship was short-lived, and the bank ultimately made
advances to FMI for a period of only about four months, between
August and early November 2007.
1
These figures represent the losses that Taneja admitted in
connection with his individual criminal conviction arising from
these activities.
5
The lending agreement obligated the bank to send funds
directly to an insured title agent. After each mortgage loan
closed, FMI was required to send certain documents to the bank
within two business days, including the mortgagor’s promissory
notes associated with the loans originated by FMI. Although FMI
periodically did not meet this two-day timeline, FMI eventually
provided to the bank the original promissory note for each loan,
which was the most critical security document underlying each
transaction.
In September 2007, FMI submitted three repayments to the
bank, totaling about $1 million. However, by mid-October 2007,
FMI owed about $12 million of funds advanced on its line of
credit with the bank. Thereafter, the bank suspended payment of
any additional advances to FMI.
On November 1, 2007, Robert A. Garrett, the bank’s
executive vice president of mortgage warehouse lending, and
Benjamin Gaither Daugherty, III, the bank’s vice president and
relationship manager of the bank’s warehouse lending group, met
with Taneja at FMI’s place of business. Garrett and Daugherty
explained to Taneja that FMI needed to sell its mortgage loans
to secondary purchasers and “clear” the line of credit. In
response, Taneja informed the bank’s representatives that FMI’s
failure to produce timely, adequate documentation to complete
mortgage loans sales to secondary purchasers was caused by the
6
unexpected departure of one of FMI’s loan processors. In the
absence of such mortgage loan documentation, a secondary
purchaser would not purchase the mortgage obligations,
especially during the difficult market conditions in 2007.
After this meeting, Garrett further investigated FMI’s
“dragging” mortgage loan sales by contacting a representative of
Wells Fargo, FMI’s chief customer and secondary purchaser, to
inquire about FMI’s unsold loans. Garrett reviewed each
outstanding loan with the Wells Fargo representative, who
informed Garrett that Wells Fargo had not purchased FMI’s
outstanding loans because the supporting documentation had not
been provided.
In November and December 2007, FMI made six principal
payments and one interest payment to the bank, in the total
amount of about $2.8 million. In January 2008, Garrett and
Daugherty met again with Taneja at FMI’s office to address the
outstanding balance of advanced funds. According to Garrett, he
and Daugherty planned to obtain the files from FMI for its
unsold mortgage loans to sell the loans directly to secondary
purchasers. However, Taneja proposed that the parties engage in
a “collateral swap,” in which Taneja would sell other real
estate to “pay the bank off.” Taneja represented that the
mortgage loans had lost value, and that Taneja did not want to
sell them until their value increased.
7
During the January 2008 meeting, Taneja’s attorney informed
Garrett, “You don’t want these loans.” Garrett immediately
asked Taneja’s attorney whether FMI’s loans were valid, and
whether there was “any fraud involved in these loans.”
Taneja’s attorney assured Garrett that there was “no problem,”
and that the mortgage loans were “good” and represented “arms-
length transactions.”
After this meeting, Garrett and Daugherty visited numerous
properties that served as security for FMI’s mortgage loans.
They also reviewed appraisals for some of the properties, and
confirmed that FMI was listed as the mortgagor on the deeds of
trust placed on those properties. After reviewing these
materials, Garrett and Daugherty again met with Taneja’s
attorney and reiterated the importance of confirming that the
mortgage loans were “real.” Taneja’s attorney represented that
“there is not a problem.” The bank ultimately approved a
forbearance agreement with FMI, in which Taneja agreed to
provide additional collateral to secure the bank’s interests.
In February and March 2008, FMI transferred to the bank two
interest payments, in the total amount of about $76,000, which
were the final payments at issue in this appeal. In April 2008,
the bank learned that the deeds of trust securing the mortgage
notes held by the bank were not valid and had been falsified.
8
The bank immediately declared FMI in default under the lending
agreement.
As a result of the bank’s relationship with FMI and Taneja,
the bank lost more than $5.6 million. Taneja’s conduct later
resulted in his conviction for conspiracy to engage in money
laundering in violation of 18 U.S.C. § 1956(h). He received a
sentence of 84 months’ imprisonment and was ordered to pay
restitution in the amount of $33,162,291. See Gold v. Gateway
Bank, FSB, No. 1:12-cv-264, 2012 U.S. Dist. LEXIS 109337 (E.D.
Va. July 3, 2012).
In June 2008, Taneja and his corporate affiliates,
including FMI, filed voluntary petitions for relief under
Chapter 11 of the Bankruptcy Code. H. Jason Gold, who was
appointed as the trustee for the debtors (the trustee), filed an
adversary proceeding in the bankruptcy court against the bank in
accordance with 11 U.S.C. §§ 548(a) and 550(a). In the
complaint, the trustee sought to avoid and recover the funds
that FMI transmitted to the bank in the twelve payments
described above, which totaled nearly $4 million, on the ground
that the funds were conveyed fraudulently.
In response, the bank contended that it received the
payments from FMI for value and in good faith. In accordance
with 11 U.S.C. § 548(c), the bank pleaded good faith as an
9
affirmative defense. The case proceeded to trial in the
bankruptcy court.
During a three-day trial, the bankruptcy court heard
testimony and received substantial documentary evidence
regarding the fraudulent conduct of FMI and Taneja. In
asserting its good-faith defense, the bank relied on the
testimony of Garrett and Daugherty. Although the bank did not
seek to qualify these witnesses as experts, both Garrett and
Daugherty were permitted without objection to testify about
their knowledge of the warehouse lending industry based
primarily on their long careers with the bank and other
institutions.
Garrett, who had worked for the bank for 14 years, and had
worked in the banking business for about 30 years, testified
about his experience initiating “warehouse lending groups” at
the bank and at two other financial institutions. Garrett also
testified about his work developing software used by the bank
and other lending institutions to manage and operate their
warehouse lending businesses.
With regard to the warehouse lending industry, Garrett
stated that as part of his responsibilities at the bank, he
monitors industry publications and often serves as a speaker at
industry conferences. Garrett stated that, in 2007 and 2008,
the secondary mortgage market was “imploding.” He explained
10
that at the end of July 2007, “the secondary market for non-
agency mortgage-backed securities came back no bid,” which meant
that “if you owned a mortgage-backed security you didn’t have a
market on which to sell it.” Garrett further explained that
during this period, secondary purchasers began “constricting
their underwriting criteria.” According to Garrett, these
narrowed criteria created more restrictive standards for
mortgage bankers to meet. Garrett testified that during the
“market meltdown,” successful sales of loans to secondary
purchasers depended on the effective “build[ing] [of] a loan
file,” and on finding parties to purchase the mortgage loans.
Daugherty began working for the bank in 1988. During the
relevant period in 2007 and 2008, he served as the bank’s
primary contact with FMI. Daugherty testified that he was
familiar with the general practices of the warehouse lending
industry, and with the particular market turmoil of 2007 and
2008. Daugherty stated that, during this period, it was common
for a secondary purchaser to spend additional time determining
whether to buy various mortgage loans, and that this additional
review process increased the time required to complete a sale of
those instruments. He also stated that during the “market
meltdown,” more loans remained outstanding on the bank’s
warehouse lines of credit than ever had been the case in
previous years.
11
After trial, the bankruptcy court issued a comprehensive
memorandum opinion, concluding that even if the trustee could
establish that the payments at issue were fraudulent, the bank
had shown that it accepted the payments in good faith. 2 The
bankruptcy court determined that although the bank was concerned
about FMI’s failure to sell its loans quickly in late 2007, the
bank reasonably thought that the lagging secondary mortgage
market, rather than any inappropriate conduct by FMI and Taneja,
was the cause of the delayed sales.
The bankruptcy court also addressed many other details of
the relationship between the bank and FMI, and concluded that
the bank “did not have any information that would [reasonably]
have led it to investigate further, and the bank’s actions were
in accord with the bank’s and the industry’s usual practices.”
With regard to the bank’s witnesses, Garrett and Daugherty, the
bankruptcy court stated that they were
knowledgeable in the bank’s practices, the bank’s
relationship with FMI, the transactions in issue and
the mortgage warehouse industry. [Garrett’s and
Daugherty’s] testimony was credible that at the time
of each transfer, the bank did not have any actual
knowledge of the fraud Taneja was perpetrating on it
and others, did not have any information that would
[reasonably] have led it to investigate further, and
2
The bankruptcy court also determined that the trustee was
not entitled to a “Ponzi scheme presumption,” which would have
relieved the trustee of the burden of proving that each
transaction was made with the intention to hinder, delay, or
defraud creditors.
12
the bank’s actions were in accord with the bank’s and
the industry’s usual practices.
In reaching this conclusion, the bankruptcy court acknowledged
that Garrett and Daugherty were the employees responsible for
the bank’s warehouse lending and transactions with FMI, but
stated that the court had considered these factors in assessing
whether their employment and job conduct may have affected their
credibility. The court concluded that the testimony of Garrett
and Daugherty sufficiently established the required components
of the bank’s good-faith defense.
Having concluded that the bank established its good-faith
affirmative defense under Section 548(c), the bankruptcy court
dismissed the trustee’s adversary action. The district court
affirmed that decision, and the trustee filed a timely appeal in
this Court.
II.
We review de novo the legal conclusions of the bankruptcy
court and the district court. In re Alvarez, 733 F.3d 136, 140
(4th Cir. 2013). Like the district court, we review for clear
error the factual findings of the bankruptcy court.
Id.
A bankruptcy court’s decision that a defendant has met its
burden of proving a good-faith defense is primarily a factual
determination, which is subject to review for clear error. See
13
In re Armstrong, 285 F.3d 1092, 1096 (8th Cir. 2002). Under
this standard, we will not reverse a bankruptcy court’s factual
finding that is supported by the evidence unless that finding is
clearly wrong. In re ESA Envtl. Specialists, Inc.,
709 F.3d
388, 399 (4th Cir. 2013). We will conclude that a finding is
clearly erroneous only if, after reviewing the record, we are
left with “a firm and definite conviction that a mistake has
been committed.” Klein v. PepsiCo, Inc.,
845 F.2d 76, 79 (4th
Cir. 1988) (citation omitted).
On appeal, the trustee challenges the bankruptcy court’s
determination that the bank established its good-faith defense
under Section 548(c). The trustee asserts two related
arguments: (1) that the court erred as a matter of law by
misapplying the objective good-faith standard; and (2) that the
court clearly erred in concluding that the bank presented
sufficient objective evidence to prove that it accepted the
relevant payments in good faith. We address these arguments in
turn.
Under Section 548(a), a bankruptcy trustee can avoid a
transfer of a debtor’s property if the debtor “made such
transfer . . . with intent to hinder, delay, or defraud”
creditors. 11 U.S.C. § 548(a)(1)(A). However, Section 548(c)
provides that:
14
a transferee . . . of such a transfer . . . that takes
for value and in good faith . . . may retain any
interest transferred . . . to the extent that such
transferee or obligee gave value to the debtor in
exchange for such transfer or obligation.
This provision provides a transferee with an affirmative defense
to the trustee’s avoidance action if the transferee meets its
burden to show that it accepted the transfers “for value and in
good faith.” 11 U.S.C. § 548(c); see Perkins v. Haines, 661
F.3d 623, 626 (11th Cir. 2011). Because the “for value” element
is not at issue in the present case, we focus only on the issue
whether the bank satisfied its burden of proving that it
accepted the transfers in good faith.
Although the Bankruptcy Code does not define the term “good
faith,” this Court recently interpreted the term in the context
of an affirmative defense asserted under 11 U.S.C. § 550(b)(1).
See Goldman v. City Capital Mortg. Corp. (In re Nieves), 648
F.3d 232, 237 (4th Cir. 2011). That section provides a good
faith-defense permitting a transferee to bar a trustee from
recovering funds involving transfers that have been deemed
avoidable under Section 548 or certain other provisions of the
Bankruptcy Code. 11 U.S.C. § 550(a), (b)(1); see In re
Nieves,
648 F.3d at 237. In material part, Section 550(b)(1) states
that an affirmative defense is established when a transferee of
avoidable property takes the transfer “for value . . . in good
15
faith, and without knowledge of the voidability of the transfer
avoided.”
In our decision in In re Nieves, we determined that the
proper focus in evaluating good faith in the context of a
bankruptcy avoidance action requires that a court determine
“what the transferee [actually] knew or should have known” when
it accepted the transfers. Id. at 238 (citation omitted). We
observed that general principles of good faith in other areas of
commercial law aided our refinement of this term in the
bankruptcy context, and we concluded that “good faith” has both
“[1] subjective (‘honesty in fact’) and [2] objective
(‘observance of reasonable commercial standards’) components.”
Id. at 239. We articulated the standard for a good-faith
defense in that bankruptcy proceeding as follows:
Under the subjective prong, a court looks to “the
honesty” and “state of mind” of the party acquiring
the property. Under the objective prong, a party acts
without good faith by failing to abide by routine
business practices. We therefore arrive at the
conclusion that the objective good-faith standard
probes what the transferee knew or should have known
taking into consideration the customary practices of
the industry in which the transferee operates.
Id. at 239-40 (citations omitted).
We conclude that the good-faith standard adopted in In re
Nieves is applicable to the establishment of a good-faith
defense under Section 548(c). Therefore, in evaluating whether
a transferee has established an affirmative defense under
16
Section 548(c), a court is required to consider whether the
transferee actually was aware or should have been aware, at the
time of the transfers and in accordance with routine business
practices, that the transferor-debtor intended to “hinder,
delay, or defraud any entity to which the debtor was or became .
. . indebted.” See id. at 238; 11 U.S.C. § 548(a)(1)(A).
In the present case, the trustee does not assert that the
bank actually knew about FMI’s and Taneja’s fraudulent conduct
before April 2008. Thus, we confine our consideration to the
issue whether the bank should have known about the fraudulent
conduct of FMI and Taneja, “taking into consideration the
customary practices of the industry in which the [bank]
operates.” See In re Nieves, 648 F.3d at 240.
Both the bankruptcy court and the district court in the
present case applied the good-faith standard from In re Nieves
in conducting their analyses. The trustee contends, however,
that those courts erred in applying that standard, and asserts
that the bank, as a matter of law, was unable to prove good
faith without showing that “each and every act taken and belief
held” by the bank constituted “reasonably prudent conduct by a
mortgage warehouse lender.” Additionally, the trustee asserts
that such evidence “likely” should have been presented in the
form of third-party expert testimony. We disagree with the
trustee’s arguments.
17
While the trustee correctly observes that the objective
good-faith standard requires consideration of routine business
practices, the trustee’s position well exceeds the requirement
that a court consider “the customary practices of the industry
in which the transferee operates.” See id. We decline to adopt
a bright-line rule requiring that a party asserting a good-faith
defense present evidence that his every action concerning the
relevant transfers was objectively reasonable in light of
industry standards. Instead, our inquiry regarding industry
standards serves to establish the correct context in which to
consider what the transferee knew or should have known. 3
In addition, we decline to hold that a defendant asserting
a good-faith defense must present third-party expert testimony
in order to establish prevailing industry standards. Although
certain cases may warrant, or even require, such specialized
testimony, an inflexible rule that expert testimony must be
presented in every case to prove a good-faith defense
unreasonably would restrict the presentation of a defense that
ordinarily is based on the facts and circumstances of each case
and on a particular witness’ knowledge of the significance of
3
In asserting that the bankruptcy court and district court
misapplied the objective good-faith standard, the trustee relies
heavily on the standard as articulated in Christian Brothers
High School Endowment v. Bayou No. Leverage Fund, LLC (In re
Bayou Group), 439 B.R. 284 (S.D.N.Y. 2010), an out-of-circuit
district court opinion that has no precedential value here.
18
such evidence. See Meeks v. Red River Entm’t (In re Armstrong),
285 F.3d 1092, 1096 (8th Cir. 2002) (no precise definition for
good faith, which should be decided based on case-by-case
basis); Consove v. Cohen (In re Roco Corp.),
701 F.2d 978, 984
(1st Cir. 1983) (same). Accordingly, we decline to consider the
trustee’s argument further and hold that the bankruptcy court
and the district courts applied the correct legal standard in
evaluating whether the bank proved its good-faith defense.
We next address the trustee’s argument that the bank
presented insufficient objective evidence to negate a finding
that, when the bank accepted FMI’s payments, the bank “should
have known” about FMI’s and Taneja’s fraudulent conduct. The
trustee points to several circumstances that it submits should
have alerted the bank to FMI’s and Taneja’s fraudulent conduct.
The trustee also contends that because the bank’s witnesses who
testified about these circumstances were bank employees, the
bank’s evidence of good faith constituted purely subjective
evidence. We disagree with the trustee’s arguments.
We observe, in accordance with our holding above, that the
objective component of the good-faith defense may be established
by lay or expert testimony, or both, depending on the nature of
the evidence at issue. Here, the parties’ dispute centered on
the general practices in the warehouse lending industry and the
19
indicators of fraudulent conduct, if any, that were apparent
from the particular facts known to the bank’s officials.
Both Garrett and Daugherty had extensive knowledge of
industry practices, including the common practices involved in
warehouse lender-borrower relationships, and both were able to
explain their reasons why FMI’s and Taneja’s conduct did not
raise indications of fraud despite FMI’s failure to sell their
mortgage loans in the secondary market in a timely manner.
Their testimony also described the severe decline in the market
for mortgage-backed securities in 2007 and 2008, which provided
additional objective evidence of the state of the warehouse
lending industry during that period. In light of their
extensive experience in the warehouse lending industry and their
knowledge of the particular events at issue, Garrett’s and
Daugherty’s employment status did not affect the admissibility
of their testimony or otherwise indicate that expert testimony
was required on the objective component of the good-faith
defense.
We also observe that the bankruptcy court explicitly stated
that it considered the fact that Garrett and Daugherty were
employed by the bank in assessing the weight to be given their
testimony. Additionally, and significantly, the trustee did not
object to the testimony by Garrett and Daugherty relating to the
warehouse lending industry or the conditions in the market for
20
mortgage-backed securities in 2007 and 2008. 4 See Fed. R. Evid.
103 (a party may not claim error regarding admitted evidence if
he fails timely to object, unless the court plainly erred in
admitting the evidence). Thus, we reject the trustee’s argument
that Garrett and Daugherty, by virtue of their employment with
the bank, did not provide competent evidence regarding the
objective component of the bank’s good-faith defense.
We therefore turn to discuss the evidence cited by the
trustee, which he alleges should have signaled to the bank that
FMI and Taneja were engaged in a fraudulent scheme, and consider
whether the bank presented sufficient objective evidence of good
faith with regard to these circumstances. The trustee first
points to FMI’s delay in providing collateral documents to the
bank in connection with some of FMI’s mortgage loans. However,
Garrett testified that a new borrower’s untimely delivery of
such documents was “common” and was “consistent” with the
practices of other investors and warehouse lending customers at
the inception of their business relationship. Also, Daugherty
stated that borrowers typically had difficulty adjusting to new
warehouse lending relationships, because “different warehouse
4
Although the trustee raised objections regarding certain
aspects of Garrett’s and Daugherty’s testimony regarding
secondary purchasers and the marketability of unsold loans, the
trustee did not object to their general testimony regarding
industry standards or the conditions in the market in 2007 and
2008.
21
lenders require[d] different items.” Critically, the evidence
showed that the bank always received from FMI the most vital
document, the original promissory note that perfected the
holder’s security interest. Thus, the record did not show that
the bank should have known that the notes were fraudulent simply
because they were not submitted within the two-day timeline
required by the parties’ lending agreement.
The trustee also submits that FMI’s failure to sell many of
its mortgage loans in the secondary market should have alerted a
reasonable warehouse lender of fraudulent conduct. However,
substantial evidence in the record refutes this argument. Both
Garrett and Daugherty testified extensively about the
“extraordinary time” that the warehouse lending industry was
experiencing during 2007 and 2008. Not only did Daugherty
explain that a borrower’s failure to sell mortgage loans to
secondary purchasers is “part of the business” of warehouse
lending generally, but he also stated that this was particularly
true during 2007 and 2008 when FMI was unable to sell many of
its loans. Moreover, Garrett explained that it was common for
mortgage bankers intentionally to delay selling their mortgage
loans during this time, because they expected only a temporary
market decline. Therefore, we conclude that the record
contained sufficient objective evidence that FMI’s failure to
22
sell its loans to secondary purchasers did not serve as a signal
to the bank that FMI was engaging in fraudulent conduct.
This testimony concerning the curtailed market for
mortgage-backed securities also refutes the trustee’s argument
that the bank should have known about FMI’s and Taneja’s
fraudulent conduct because FMI, rather than secondary
purchasers, directly made payments to the bank on certain loans.
Under the terms of FMI’s agreement with the bank, FMI was
required to repay the bank regardless whether FMI had sold the
loan obligations to secondary purchasers. And, notably, the
trustee’s key witness, Robert Patrick, who was retained to
investigate FMI’s financial affairs, acknowledged FMI’s
repayment obligation and testified that FMI’s actions making
direct payments to the bank were not an indication of fraudulent
conduct.
The final two circumstances cited by the trustee arose from
conversations that Garrett and Daugherty had with Taneja and his
attorney during their October 2007 and January 2008 meetings. 5
During the first meeting, in which the parties discussed FMI’s
outstanding loans, Taneja explained that one of FMI’s loan
5
We do not address the trustee’s assertion that the bank
should have known about the fraud when the bank discovered FMI’s
fraudulent notes in April 2008. The transfers in question in
this case occurred before April 2008; therefore, what the bank
should have known, beginning in April 2008, is not relevant to
our inquiry.
23
processors had left FMI unexpectedly, resulting in delays in
FMI’s production of its mortgage loan documentation. Contrary
to the trustee’s position, this explanation by Taneja did not
signal fraudulent conduct when the evidence established that
secondary purchasers had tightened their standards for loan
documentation in 2007 and 2008, and that such purchasers would
not purchase mortgage obligations with incomplete documentation.
Additionally, Garrett confirmed with a representative of FMI’s
regular client and secondary purchaser, Wells Fargo, that the
outstanding mortgage loans remained unsold because the loan
documentation was incomplete. Thus, the bankruptcy court did
not clearly err in concluding that the circumstances surrounding
the October 2007 meeting did not show that the bank should have
known about the fraudulent conduct.
During the meeting that occurred in January 2008, when
Garrett asked Taneja’s attorney whether FMI’s unsold loans were
fraudulent, the attorney responded that the loans were valid and
executed in “arms-length” transactions. The bankruptcy court
rejected the trustee’s assertion that this conversation
demonstrated that the bank should have known about the ongoing
fraud. The court determined instead that Garrett properly
accepted the attorney’s response in light of the fact that the
parties were attempting to “work out the problem of the unpaid
advances on the line of credit,” and that the bank was aware
24
that the value of the mortgage obligations had been
significantly impaired. The record demonstrated that the
decrease in the market value of mortgage loans in the secondary
market was an industry-wide problem in 2007 and 2008. Moreover,
after the January 2008 meeting, Garrett and Daugherty conducted
additional investigation into the collateral securing some of
FMI’s loans and did not discover any problems at that time.
Based on this evidence, we conclude that the bankruptcy
court did not clearly err in rejecting the trustee’s position
that the bank should have known about FMI’s and Taneja’s
fraudulent conduct based on the conversation with Taneja’s
attorney at the January 2008 meeting. Rather, when considered
as a whole, the circumstances relied on by the trustee indicated
only that FMI had financial difficulties, which was not uncommon
in the warehouse lending industry during 2007 and 2008. The
bankruptcy court found that Garrett and Daugherty were credible
and knowledgeable witnesses in their testimony about the
warehouse lending industry. Accordingly, the bankruptcy court
accepted their testimony regarding the devastating conditions of
the mortgage-backed security market in 2007 and 2008, when the
relevant payments by FMI were made. “Deference to the
bankruptcy court’s findings is particularly appropriate when, as
here, the bankruptcy court presided over a bench trial in which
witnesses testified and the court made credibility
25
determinations.” Fairchild Dornier GmbH v. Official Comm. of
Unsecured Creditors (In re Dornier Aviation), 453 F.3d 225, 235
(4th Cir. 2006).
On this record, we are not left with a firm or definite
conviction that the bankruptcy court erred in finding that the
bank presented sufficient objective evidence of good faith. See
Klein, 845 F.2d at 79. Thus, we hold that the bankruptcy court
did not clearly err in concluding that the bank accepted the
relevant transfers from FMI in good faith and without knowledge
of facts that should have alerted the bank that the transfers
were part of a fraudulent scheme. 6 See In re
Nieves, 648 F.3d at
238.
III.
In sum, we conclude that the district court and the
bankruptcy court applied the correct legal principles relevant
to evaluating the bank’s good-faith affirmative defense. We
also conclude that the bankruptcy court did not clearly err in
determining that the bank satisfied its burden of proving a
6
We find no merit in the trustee’s assertion that the
bankruptcy court erroneously imposed on the trustee the burden
to disprove the bank’s affirmative defense. The court properly
weighed the entirety of the evidence and rendered its decision
accordingly.
26
good-faith defense under Section 548(c). 7 Accordingly, we affirm
the district court’s decision upholding the bankruptcy court’s
dismissal of the trustee’s adversary action.
AFFIRMED
7
Because we conclude that the bankruptcy court did not
clearly err in accepting the bank’s affirmative defense of good
faith, we need not reach the trustee’s argument regarding
whether the trustee was entitled to a “Ponzi scheme presumption”
of fraudulent conveyances.
27
WYNN, Circuit Judge, dissenting:
Bankruptcy Code Section 548(c) provides an affirmative
defense to transferees who take in good faith. Importantly,
good faith has not just a subjective, but also an objective
“observance of reasonable commercial standards” component. To
succeed with its good faith defense, First Tennessee Bank had to
prove both aspects of good faith. But here, it failed to
proffer any evidence to support a finding that it received
transfers from FMI with objective good faith in the face of
several alleged red flags. Because it was clear error for the
district court to make the unsupported finding that First
Tennessee Bank received transfers from FMI with objective good
faith, I must respectively dissent from the contrary view of my
colleagues in the majority.
I.
We review a district court finding of good faith for clear
error. “A finding is clearly erroneous if no evidence in the
record supports it . . . .” Consol. Coal Co. v. Local 1643,
United Mine Workers of Am., 48 F.3d 125, 128 (4th Cir. 1995).
Thus, we reverse findings of fact that lack evidentiary support—
and that is, in my view, what must be done here.
28
II.
Under Bankruptcy Code Section 548(a), a bankruptcy trustee
can avoid fraudulent transfers occurring within the two years
prior to a bankruptcy petition’s filing if those transfers were
made with intent to defraud or for less than reasonable
consideration. 11 U.S.C. § 548(a). Nevertheless, a recipient
of transferred property can keep the property if it is able to
establish the elements of the good faith defense embodied in
Section 548(c). 11 U.S.C. § 548(c).
In In re Nieves, this Circuit put contours on the good
faith defense. 648 F.3d 232 (4th Cir. 2011). As the majority
notes, we held that to establish the good faith defense, a
transferee needs to show both subjective and objective good
faith:
“Good faith” thus contains both subjective
(“honesty in fact”) and objective (“observance of
reasonable commercial standards”) components. Under
the subjective prong, a court looks to “the honesty”
and “state of mind” of the party acquiring the
property. Under the objective prong, a party acts
without good faith by failing to abide by routine
business practices. We therefore arrive at the
conclusion that the objective good-faith standard
probes what the transferee knew or should have known,
taking into consideration the customary practices of
the industry in which the transferee operates.
Id. at 239-40 (citations and footnotes omitted). In essence,
transferees may not bury their heads in the sand, “willfully
turn[] a blind eye to a suspicious transaction[,]” and then
29
expect to reap the benefits of the good faith defense. Id. at
242 (quotation marks omitted). A transferee “wil[l]ful[ly]
ignoran[t] in the face of facts which cried out for
investigation . . . cannot have taken in good faith.”
Id. at
241.
Importantly, it is the transferee who bears the burden of
proof on the good faith defense. As this Court has stated, “we
agree with the weight of authority holding that [the good faith
defense is] a defense to an avoidance action which defendant
bears the burden to prove.” Id. at 237 n.2 (citing In re Smoot,
265 B.R. 128, 140 (Bankr. E.D. Va. 1999) (collecting cases
holding that the burden of proof rests on the transferee)).
In sum, to establish the good faith defense, First
Tennessee Bank needed to show not only subjective good faith but
also objective good faith. Thus, First Tennessee Bank bore the
burden of showing that its conduct comported with routine
practices in its industry and that its response to potential
“red flags” about FMI’s fraud comported with that of an
objectively reasonable warehouse lender. The record before us
shows that First Tennessee Bank failed to carry its burden.
III.
Preliminarily, I must address several general points that
the majority makes, and with which I take issue, regarding the
30
nature of the evidence required in cases such as this one and
the nature of the evidence actually proffered here.
First, I agree with the majority that First Tennessee Bank
could meet its burden as to the objective component of its good
faith defense without presenting expert testimony on prevailing
industry standards. To be sure, such objective, third-party
evidence would almost certainly be helpful in establishing
industry standards. And one cannot help but wonder why it was
not proffered here.
Regardless, fact witness testimony could suffice. For
example, a fact witness could testify that he attended industry
conferences and drafted the pertinent bank’s policies based on,
and in accordance with, best practice materials received at
those conferences. 8
The problem here is that First Tennessee Bank, which bore
the burden of proving its good faith defense, failed to elicit
such testimony from its fact witnesses. Instead, it relied on
8
That being said, I find the suggestion that expert
testimony might somehow bungle “the presentation of a defense
that ordinarily is based on the facts and circumstances of each
case and on a particular witness’ [sic] knowledge of the
significance of such evidence[,]” ante at 18-19, troubling.
Indeed, that suggestion seems to fly in the face of the very
point of the good faith defense’s objective component—which is
based not on case-specific facts or fact witness views, but
rather on what the transferee knew or should have known, “taking
into consideration the customary practices of the industry in
which the transferee operates.” In re Nieves, 648 F.3d at 240.
31
generalities from those witnesses such as having read the Wall
Street Journal and having worked in the industry for many years.
Further, an executive’s extensive knowledge of an industry
does not necessarily mean that his business comports with
industry standards. Indeed, that very knowledge might be used
effectively for ill, enabling the executive to conceive of and
perpetuate a scheme that turns industry standards on their
heads. Industry knowledge and experience thus shed little light
on whether an executive or his business acted with objective
good faith.
Moreover, it is common knowledge that the economy,
including the mortgage-backed securities industry—was in turmoil
in 2007 and 2008. But that fact does not illuminate, for
example, whether First Tennessee Bank’s attributing FMI’s
problematic conduct to the slowdown was reasonable in light of
industry standards. For it is also common knowledge that frauds
such as Ponzi schemes are particularly vulnerable to implosion
during economic downturns. That FMI’s troubles coincided with
an economic downturn thus does not resolve objective good faith
questions. Objective good faith cannot simply be assumed in
tough times; it remains an affirmative defense that must always
be proven.
Here, Garrett and Daugherty may have explained “their
reasons” why FMI’s conduct did not suggest fraud. Ante at 20.
32
But “their” reasons are evidence of “their” subjective good
faith—not of objective good faith, taking into consideration
industry standards.
Finally, I agree with the majority opinion that Garrett’s
and Daugherty’s employment with First Tennessee Bank did not
affect the admissibility of their testimony or render it
incompetent. But the record is irreconcilable with the majority
opinion’s assertion that the Trustee failed to object to
Garrett’s and Daugherty’s “general testimony” regarding the
industry or economic conditions in 2007 and 2008. Ante at 20-
21. On the contrary, the Trustee repeatedly objected to
Garrett’s and Daugherty’s attempts at “general testimony,” on
the bases that the testimony was overbroad, that neither witness
was tendered as an expert, and that the testimony should be
tethered specifically to First Tennessee Bank, for which both
men were testifying strictly as fact witnesses. See, e.g., J.A.
1376, 1379, 1383, 1512, 1517. In response to these objections,
First Tennessee Bank reiterated that “[i]t’s just background
information[,]” and that it was “not trying to establish what
every [actor] does[,]” and limited lines of inquiry to First
Tennessee Bank specifically. See, e.g., J.A. 1376, 1384, 1512,
1517. The majority opinion’s suggestion that challenges to any
broad, industry-level testimony were waived is thus misplaced.
33
More importantly, objections aside, looking to the
testimony that First Tennessee Bank proffered on objective good
faith, I must conclude that the scant evidence fails to support
the bankruptcy court’s objective good faith finding.
Specifically, the Trustee identified multiple red flags,
asserting that First Tennessee Bank’s response to those red
flags failed to comport with that of a reasonable warehouse
lender. The Trustee argues that First Tennessee Bank failed to
carry its burden of proof and that the bankruptcy court erred in
finding that “the bank’s actions were in accord with . . . the
industry’s usual practices.” In re Taneja, 08-13293-RGM, 2012
WL 3073175, at *15 (Bankr. E.D. Va. July 30, 2012). After
carefully reviewing the record, I cannot even discern what those
industry practices are, let alone find evidence that First
Tennessee Bank’s actions comported with them.
Turning to some of these red flags, the Trustee asserted,
for example, that at a meeting between First Tennessee Bank and
FMI’s counsel, Mr. Garrett specifically asked whether FMI’s
loans were fraudulent. Mr. Garrett then testified that in
response, FMI’s counsel indicated that the loans were valid, and
that First Tennessee Bank relied on the statement and followed
up by “look[ing] at property, pull[ing] appraisals, [and] saw
FMI listed as the mortgagor on some of them.” J.A. 1489. What
is missing from the record is any shred of evidence that First
34
Tennessee Bank’s reliance and investigation comported with those
of a reasonable warehouse lender in light of industry standards.
In other words, the bankruptcy court had no support for a
finding that despite First Tennessee Bank’s own concerns that
FMI’s loans might be fraudulent, it received all the relevant
transfers in not only subjective, but also objective, good
faith.
A second example: The Trustee highlighted that FMI
belatedly delivered collateral documents it was required to
transmit. As the majority opinion notes, “Garrett testified
that a new borrower’s untimely delivery of such documents was
‘common’ and was ‘consistent’ with the practices of other
investors and warehouse lending customers at the inception of
their business relationship.” Ante at 21. But that experience
was “common” and “consistent” only with First Tennessee Bank’s
customers and “what we’re dealing with . . . .” J.A. 1491. The
testimony centered on “all of your”—i.e., First Tennessee
Bank’s—“customers,” J.A. 1506, and was “[b]ased on your
experience . . . .” Id.; see also, e.g., J.A. 1543 (Q: “Mr.
Daugherty, do most of your customers get you the full collateral
package within two days?” A: “No.” (emphasis added)). Missing
from the record is objective evidence regarding standard
industry practices and how FMI’s delays and First Tennessee
Bank’s response to those compared to those industry practices.
35
A third example: The Trustee asserted that FMI’s
attributing its failure to sell loans to an employee’s having
gone on vacation and then not returning constituted a red flag.
Mr. Daugherty testified that he believed this excuse and had no
reason to suspect that it was not the truth. Even the
bankruptcy court called the explanation “unusual.” In re
Taneja, 2012 WL 3073175, at *13. Yet First Tennessee Bank
offered no evidence about how a reasonable warehouse lender
would have responded or whether its response comported with that
industry standard.
For various red flags the Trustee raised, the majority
opinion ascribes much to the fact that the lending and mortgage
industries were in turmoil in 2007 and 2008. Surely no one
doubts that the entire economy was in a state of upheaval during
that time. But that fact tells us little about whether a
business’s conduct in the face of alleged red flags, even if in
a time of crisis, comported with industry practices and
standards. If economic turmoil gives businesses a free pass on
needing to prove objective good faith, even businesses falling
far short of industry standards but rather “wil[l]ful[ly]
ignoran[t] in the face of facts which cried out for
investigation[,]” In re Nieves, 648 F.3d at 241, could succeed
with a good faith defense so long as their implosion coincided
36
with an economic downtown. This is not, and should not be, the
law.
IV.
In sum, I agree with the majority that “‘[d]eference to the
bankruptcy court’s findings is particularly appropriate when . .
. the bankruptcy court presided over a bench trial in which
witnesses testified and the court made credibility
determinations.’” Ante at 25-26 (quoting Fairchild Dornier GmbH
v. Official Comm. of Unsecured Creditors, 453 F.3d 225, 235 (4th
Cir. 2006)). But the issue here is not that, or how, the
bankruptcy court assessed credibility or weighed testimony.
Instead, the issue is whether First Tennessee Bank, which bore
the burden of proof, failed to proffer any evidence or elicit
any testimony to support a finding that it received transfers
from FMI with objective good faith in the face of certain
alleged red flags. It did. And because findings unsupported by
the record must be overturned on clear error review, I would
reverse the unsupported objective good faith finding, a
necessary component of First Tennessee Bank’s good faith defense
under 11 U.S.C. § 548(c). Accordingly, I respectfully dissent.
37
