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Home / Case News / Texas Apex Court Deliberates ‘Good Faith’ In $79M Stanford International Bank Ponzi Clawback

Texas Apex Court Deliberates ‘Good Faith’ In $79M Stanford International Bank Ponzi Clawback

October 8, 2019, Texas – The Texas Supreme Court is deliberating on the interpretation of “good faith” as it relates to the Texas Uniform Fraudulent Transfer Act. The litigating parties recently finished the oral arguments on the question certified by the Fifth Circuit.

The apex court will opine on the issue, bringing a long-pending discussion to a conclusion. The Fifth Circuit has urged the apex court to determine – whether Gary D. Magness, a Stanford International Bank Ltd. investor, who suspected fraud but didn’t diligently enquire it before a $7 billion Ponzi scheme unraveled, could be deemed to have acted in good faith in a dispute with a court-appointed receiver for the Stanford fraud. Earlier this year, the Fifth Circuit certified the following question to the Supreme Court of Texas in this regard:

“Is the Texas Uniform Fraudulent Transfer Act’s “good faith” defense against fraudulent transfer clawbacks, as codified at Tex. Bus. & Com. Code § 24.009(a), available to a transferee who had inquiry notice of the fraudulent behavior, did not conduct a diligent inquiry, but who would not have been reasonably able to discover that fraudulent activity through diligent inquiry?”

By way of background, the SEC uncovered the Stanford International Bank (“SIB”) Ponzi scheme in 2009. As per the court papers, for close to two decades, SIB issued a fraudulent deposit (“CDs”) that purported to pay fixed interest rates higher than those offered by US commercial banks. However, SIB was operating a Ponzi scheme, and the new investors’ funds were used to provide returns to the existing investors. The Ponzi scheme leftover 18,000 investors with $7 billion in losses. The district court appointed Ralph S. Janvey as the Receiver to recover SIB’s assets and distribute them to the scheme’s victims.

Defendant Gary D. Magness and several entities in which he maintained his wealth (collectively, “Magness”) were among the most significant US investors in SIB. Between December 2004 and October 2006, Magness purchased $79 million in SIB CDs. As of November 2006, Magness’s family trust’s investment committee monitored his investments; including the SIB CDs. The news in July 2008 reported that the SEC was investigating SIB. At an October 2008 meeting, the investment committee persuaded Magness to take back, at minimum, his accumulated interest from SIB. Later that month, Magness’s financial advisor approached SIB for a redemption. On October 9, 2008, SIB instead agreed to loan Magness $25 million on his accumulated interest. Subsequently, Magness repaid $24.3 million of the $25 million loans with “paper interest” and $700,000 with cash. During October 24 and 28, 2008, Magness borrowed an additional $63.2 million from SIB. In total, Magness received $88.2 million in cash from SIB in October 2008.

The Receiver sued Magness to recover funds under theories of (1) fraudulent transfer under the Texas Uniform Fraudulent Transfer Act (“TUFTA”) and (2) unjust enrichment. The Receiver obtained partial summary judgment as to funds over Magness’s original investment, and Magness returned this $8.5 million in fraudulent transfers to the Receiver.

The Receiver moved for partial summary judgment, to seek a ruling that the remaining amounts at issue were also fraudulent transfers. Magness moved for summary judgment on his TUFTA good faith defense and the Receiver’s unjust enrichment claim. The district court granted the Receiver’s motion and denied Magness’s motion. However, just before trial, the district court sua sponte reconsidered its denial of Magness’s motion for summary judgment and rejected the Receiver’s unjust enrichment claim.

The Receiver moved for judgment because (1) Magness was estopped from claiming he took the transfers in good faith, and (2) no reasonable jury could conclude Magness established TUFTA’s good faith defense. The district court did not rule on the motion.

The jury determined that Magness had inquiry notice that SIB was engaged in a Ponzi scheme, but not actual knowledge. Inquiry notice was defined in the jury instructions as “knowledge of facts relating to the transaction at issue that would have excited the suspicions of a reasonable person and led that person to investigate.” The jury also determined that an investigation would have been futile. The Receiver moved for entry of judgment on the verdict, arguing that the jury’s finding of inquiry notice defeated Magness’s TUFTA good faith defense as a matter of law. The Receiver also renewed his motion for judgment as a matter of law. The district court denied the Receiver’s motions and held that Magness satisfied his good faith defense. The Receiver takes nothing aside from his prior receipt of $8.5 million.

Upon appeal to the Fifth Circuit, the Receiver argued that (1) Magness was estopped from contesting his actual knowledge of SIB’s fraud or insolvency; (2) the jury’s finding of inquiry notice defeated Magness’s TUFTA good faith defense as a matter of law; (3) the district court’s jury instructions were erroneous and reduced Magness’s burden to establish good faith; and (4) the district court erred by granting Magness’s motion for summary judgment on the Receiver’s unjust enrichment claim.

The Fifth Circuit reversed the district court’s judgment and rendered the decision in favor of the Receiver. Since the Supreme Court of Texas had not addressed whether TUFTA good faith required a diligent investigation or a corresponding futility exception, the Fifth Circuit made an “Erie guess” as to the exception’s applicability. SMI Owen Steel Co., Inc. v. Marsh USA, Inc., 520 F.3d 432, 437 (5th Cir. 2008); see also Erie R.R. Co. v. Tompkins, 304 US 64 (1938).

The Court found that the Texas lower courts and federal district courts, which consider TUFTA good faith, rely on Hahn to conclude that transferees having actual knowledge or inquiry notice of fraud cannot claim TUFTA’s good faith defense. The Court stated that to establish that it acted in good faith, [the transferee] must prove by a preponderance of the evidence that it lacked actual and [inquiry] knowledge of the debtor’s fraud. The instructions did not consider whether the transferee investigated his suspicions or whether such an investigation would have been futile. Id

The Defendants-appellees submitted a petition for panel rehearing and a petition for rehearing en banc. The petition requested that the question be certified to the Supreme Court of Texas because interpreting TUFTA’s good faith defense is a significant issue of the first impression. Further, the panel’s interpretation differs from that of other jurisdictions to analyze their own Uniform Fraudulent Transfer Act (“UFTA”) good faith defenses. The Fifth Circuit granted the petition for panel rehearing and vacated the original opinion, substituted it with revised opinion, and certified a question to the Supreme Court of Texas.

There was no dispute that Magness was on inquiry notice of the fraudulent nature of SIB’s transfers. However, Magness did not investigate before accepting the transfers or before redeeming CDs. Thus the question at issue was :

“Does TUFTA good faith require a transferee on inquiry notice to conduct an investigation, and if so, can that transferee retain the good faith defense if he does not conduct an investigation but later convinces the fact-finder that such an investigation would not have turned up the fraudulent purpose?”

The lower court had answered in affirmation to both questions. It acknowledged that “neither TUFTA nor Texas courts explicitly describe a duty to investigate as a required part of TUFTA’s good faith defense Hahn, 321 S.W.3d at 526–27. However, the Court found it reasonable to adopt the approach taken by the Fifth Circuit in interpreting the Bankruptcy Code’s good faith defense. The Court added that while interpreting § 548(c) good faith, the Fifth Circuit, like many other courts, permits transferees to “rebut” a finding of inquiry notice by demonstrating that they conducted a “diligent investigation” into their suspicions. In re Am. Hous. Found. 785 F.3d 143, 164 (5th Cir. 2015). Neither Magness nor the Receiver disputed this case’s application. Thus, the lower court decided that a transferee on inquiry notice must conduct a diligent investigation to retain the TUFTA good faith defense.

The Fifth Circuit had also opined that regardless of the intricate nature of fraud or scheme, failing to inquire when on inquiry notice does not indicate good faith. Their holding aligned with other decisions interpreting TUFTA good faithCitizens Nat’ l Bank of Tex. v. NXS Constr., Inc., 387 S.W.3d 74, 84–86 (Tex. App.––Houston [14th Dist.] 2012, no pet.) (upholding jury’s finding that transferee had either actual or inquiry notice, which defeated the TUFTA good faith defense); Vasquez v. Old Austin Rd. Land Tr., No. 04-16-00025-CV, 2017 WL 3159466, at *3 (Tex. App.––San Antonio 2017)

The case is Ralph S. Janvey in his capacity as court-appointed Receiver for the Stanford International Bank Limited, et al., v. GMAG, LLC; Magness Securities LLC Gary D. Magness, Mango Five Family Inc. .The case No. is 19-0452 in the Supreme Court of Texas