IN RE TANEJA, NO. 13-1058

Decided: February 21, 2014

The Fourth Circuit, finding that (1) the lower courts applied the correct legal principles relevant to evaluating defendant’s good-faith affirmative defense and (2) the lower courts did not clearly err in determining that defendant satisfied its burden of proving a good-faith defense under the Bankruptcy Code, affirmed the decision of the district court and the bankruptcy court dismissing the bankruptcy trustee’s adversary action.

Vijay Taneja (“Taneja”) operated Financial Mortgage, Inc. (“FMI”), a business engaged in originating home mortgages and selling those loans to secondary purchasers. In carrying out its business operations, FMI worked with numerous financial institutions known as “warehouse lenders.” The warehouse lenders would typically extend lines of credit and advance funds to FMI, thus, enabling it to 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, FMI would replenish the warehouse lenders’ lines of credit according to the terms of the particular agreement. At some point after 1999, Taneja and FMI began selling the same mortgage loans to several different secondary purchasers and conspiring with other business entities controlled by Taneja to conceal the fraud.

FMI began a business relationship with First Tennessee Bank, National Association (“First Tennessee”) in 2007. Before extending a line of credit to FMI, First Tennessee performed a standard investigation of FMI and Taneja. The investigation, however, did not reveal any negative business information involving FMI or Taneja, and the parties entered into an agreement in July 2007, under which First Tennessee agreed to extend to FMI a $15 million line of credit. The lending agreement obligated FMI to send certain documents to First Tennessee within two business days after each mortgage loan closed. Although FMI routinely did not meet this two-day timeline, it eventually provided First Tennessee with the most critical security document underlying each transaction, the original promissory note for each loan. By mid-October 2007, FMI owed nearly $12 million on its line of credit with First Tennessee. As a result, First Tennessee suspended payment of any additional advances to FMI. Thereafter, First Tennessee executives, Robert Garrett and Benjamin Daugherty, met with Taneja at FMI’s place of business in November 2007 to discuss strategies to clear the line of credit. In that meeting, Taneja informed Garrett and Daugherty that FMI’s failure to produce timely, adequate documentation to complete mortgage loan sales to secondary purchasers was caused by the unexpected departure of one of FMI’s loan processors.

Garrett and Daugherty again met with Taneja at FMI’s office in January of 2008 to address the outstanding balance of advanced funds. In that meeting, Taneja proposed 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 Tanenja did not want to sell them until their value increased. Also during that meeting, Garret asked Taneja’s attorney whether FMI’s loans were valid, and free from fraud. Taneja’s attorney assured Garret that there were no issues with the loans. After that meeting, Garrett and Daugherty performed additional research into the properties serving as security for FMI’s loans. Thereafter, the two met once again with Taneja and her attorney. At that meeting, Garret and Daugherty reiterated the importance of confirming that the mortgage loans were real. Again, they were assured that the loans were good, and First Tennessee ultimately approved a forbearance agreement with FMI, in which Taneja agreed to provide additional collateral to secure the bank’s interests. First Tennessee learned otherwise, however, in April 2008, when it discovered that the deeds of trust securing the mortgage notes held by it were fraudulent. Immediately thereafter, First Tennessee declared FMI in default under the lending agreement. As a result of First Tennessee’s relationship with FMI and Taneja, it lost more than $5.6 million.

Taneja and his corporate affiliates, including FMI, filed Chapter 11 bankruptcy in June 2008. The bankruptcy trustee filed an adversary pleading in the bankruptcy court against First Tennessee, seeking to avoid and recover the funds that FMI transmitted to the bank in the twelve payments made under the lending agreement on the grounds that the funds were conveyed fraudulently. In response, First Tennessee contended that it received the payments from FMI for value and in good faith. A three-day trial ensued. At trial, First Tennessee relied on the testimony of Garrett and Daugherty to establish its good faith defense. Ultimately, the bankruptcy court determined that First Tennessee 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 further determined that First Tennessee did not have any information that would reasonably have led it to investigate matters further, and that its actions were in accordance with the industry’s usual practices. In making its determinations, the bankruptcy court acknowledged that Garrett and Daugherty were responsible for the bank’s warehouse lending and transactions with FMI, but stated that it considered these factors in assessing whether their employment and job conduct may have affected their credibility. Having concluded that First Tennessee established its good-faith defense, the bankruptcy court dismissed the trustee’s action. The district court affirmed that decision, and this appeal followed.

On appeal, the Fourth Circuit first addressed the bankruptcy trustee’s contention that both the bankruptcy court and the district court erred in applying the good-faith standard, as articulated in In re Nieves, in conducting their analyses. Addressing this contention, the Court declined 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, the Court noted its inquiry regarding industry standards serves only to establish the correct context in which to consider what the transferee knew or should have known. The Court, additionally, noted that a defendant asserting a good-faith defense is not compelled to present third-party expert testimony in order to establish prevailing industry standards. And, therefore, the Fourth Circuit held that the bankruptcy court and the district court applied the correct legal standard in evaluating whether First Tennessee proved its good-faith defense.

Next, the Fourth Circuit rejected the trustee’s argument that First Tennessee presented insufficient objective evidence to prove its good-faith defense. In so doing, the Court reasoned that, in light of Garrett and Daugherty’s extensive experience in warehouse lending, no third-party expert testimony was required on the objective component of the good-faith defense. The Court further observed 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. Thus, the Court found Garrett and Daugherty provided competent evidence regarding the objective component of the good-faith defense. The Court then addressed evidence cited by the trustee, which he alleged should have signaled to First Tennessee that Taneja and FMI were committing fraud. The Court, however, held that the bankruptcy court did not clearly err in concluding that First Tennessee accepted the relevant transfers from FMI in good faith and without knowledge of facts that should have alerted it that the transfers were part of a fraudulent scheme. Thus, the decisions of the bankruptcy court and district court were affirmed.

Full Opinion

– W. Ryan Nichols

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