Good Faith Transferee Defense in Fraudulent Transfer Actions

If a bankruptcy trustee or creditor is trying to unwind a transaction you received, the good faith transferee defense in fraudulent transfer actions lets you keep the property, or at least recover what you paid for it, by proving two things: that you acted in good faith and that you gave reasonably equivalent value. The defense is codified at 11 U.S.C. § 548(c) for bankruptcy cases and at Section 8 of the Uniform Voidable Transactions Act for state-law claims.¹² The burden sits on you, not on the trustee, and the outcome usually turns less on what you believed at the time than on what you can prove now.

What You Have to Prove

Once a trustee or creditor establishes that a transfer was fraudulent, either by showing the debtor intended to hinder or defraud creditors or by showing the debtor was insolvent and received less than the asset was worth, the case shifts to you. You must prove good faith and value by a preponderance of the evidence. That means it has to be more likely than not that you acted honestly and paid a fair price. Both elements are required. Paying full market value does not save a transfer if you knew the seller was trying to hide assets, and pure ignorance does not save one if you paid pennies on the dollar.

The defense applies to both theories of fraudulent transfer under 11 U.S.C. § 548. Actual fraud claims target transfers the debtor made with intent to hinder, delay, or defraud creditors. Constructive fraud claims target transfers where the debtor received less than reasonably equivalent value while insolvent, undercapitalized, or heading toward debts they could not pay.¹ The good faith defense is available in either case, but actual fraud cases put more weight on what you knew about the seller, and constructive fraud cases put more weight on what you paid.

What Good Faith Actually Means in Court

Good faith is the harder element to prove because it has two sides. Courts ask whether you subjectively believed the transaction was legitimate and whether an objective observer in your position would have had reason to suspect something was wrong. The objective side is where most defenses fail.

Courts apply what is often called inquiry notice. If the circumstances around the deal would have prompted a reasonable person to ask questions, you were expected to ask them. A seller who insists on closing within 48 hours, demands cash, or routes funds through unusual accounts is waving a flag. Ignoring the flag is not the same as never seeing it. The question is not whether you actually uncovered fraud but whether you looked hard enough to find what a reasonable person would have suspected.

Certain fact patterns draw scrutiny almost automatically. Deals between family members or affiliated businesses face a near-automatic presumption that the buyer knew about the seller’s financial troubles. Buying assets from someone you know is being sued or is behind on debts creates the same problem. If the debtor was visibly missing payments, facing collection actions, or scrambling to liquidate, courts will not accept a claim that you had no idea anything was wrong. Under the Uniform Voidable Transactions Act, a debtor who is not paying debts as they come due is presumed insolvent, and if the insolvency was that obvious, your good faith claim has already been undercut.

Professional buyers are held to a higher standard. If you regularly purchase real estate, businesses, or financial instruments, courts expect you to follow industry-standard due diligence. Skipping a title search, ignoring the seller’s financial disclosures, or failing to verify clear ownership can all be treated as evidence of bad faith. The cost of a professional title search or basic background check is trivial compared to what you lose in avoidance litigation.

Willful ignorance is not a defense. Courts have consistently held that closing your eyes to obvious warning signs is treated the same as seeing them. “I didn’t want to ask too many questions” does not qualify as good faith.

What Counts as Value

The second element requires showing that you actually paid for what you received. Under 11 U.S.C. § 548(d)(2)(A), value means property given in exchange or the satisfaction of a debt the debtor already owed you.¹ A promise to provide future support, a handshake agreement to take care of the seller later, personal affection, or unperformed promises of future services do not count. The benefit has to be concrete, measurable, and delivered at or before the time of the transfer.

Cash payments are the easiest form of value to prove. Bank records, wire transfer confirmations, and canceled checks create a clear trail. Undocumented cash payments receive little credit, because courts see enough fabricated cash claims to be skeptical.

Forgiving a pre-existing debt qualifies as value, but the debt has to be real. If you accepted a $50,000 asset in exchange for canceling a $50,000 loan, the court wants to see the original promissory note, evidence the loan was funded, and records showing the debt was still outstanding when the transfer occurred. A retroactively created loan document is worse than no document at all. It looks manufactured.

The price also has to be reasonably equivalent to market value. Courts do not require a dollar-for-dollar exchange, but paying a fraction of what an asset is worth will not satisfy the standard. The Durrett decision established that a foreclosure sale price below roughly 70% of fair market value could be challenged, and while courts have debated how rigid that benchmark should be, a deep discount consistently draws suspicion. Getting an independent appraisal before completing a large purchase is the single best way to protect yourself. If a dispute arises years later, that appraisal establishes what the asset was worth at the time you bought it and shows you cared about paying a fair price.

Contemporaneous documentation carries a lot of weight. Contracts, invoices, settlement statements, negotiation correspondence, and evidence you compared the asset to similar properties all help show the deal was conducted at arm’s length. A written record beats testimony about what you remember believing.

What You Keep If the Defense Works

A successful defense does not just save you from losing the asset. It triggers specific statutory protections that reflect how much value you gave and how you treated the property afterward.

If you prove both good faith and full value, the transfer is not avoided at all and you keep the asset outright. Under 11 U.S.C. § 548(c), a transferee who takes for value and in good faith “has a lien on or may retain any interest transferred…to the extent that such transferee…gave value to the debtor.”¹ The phrase “to the extent” is doing real work. If you paid full market value, you keep everything. If you paid less than the asset was worth, you get credit for what you actually paid and the creditors can recover the difference.

This partial protection, sometimes called pro tanto recovery, prevents a windfall on either side. Say you paid $60,000 for a property worth $100,000 and the court finds you acted in good faith. The court might order the asset sold, direct the first $60,000 of proceeds to you, and send the remaining $40,000 to the creditor pool. You lose the bargain but not your investment.

The Uniform Voidable Transactions Act provides parallel protection under state law. Section 8(d) entitles a good faith transferee to a lien on the transferred asset, enforcement of any obligation the debtor incurred, or a reduction in the judgment amount, all measured by the value given. For actual fraud claims under UVTA Section 4(a)(1), a transfer is not voidable at all if the transferee took in good faith and for reasonably equivalent value.²

Reimbursement for Improvements

If the court does avoid the transfer and recovers the property from you, federal law still protects your investment in it. Under 11 U.S.C. § 550(e), a good faith transferee has a lien on recovered property to secure the value of any improvements made after the transfer.³ The lien equals the lesser of what the improvements cost you, minus any profit you made from the property, or how much the improvements actually increased the property’s value.

The statute defines improvements broadly. Physical additions, repairs, property tax payments, payments on a mortgage or senior lien, and general preservation of the property all count.³ If you bought a building, replaced the roof, paid three years of property taxes, and kept up insurance, all of that gets credited to you before creditors see a dollar. Keep every receipt. The improvement lien only helps you if you can document what you spent.

Extra Protection If You Bought Downstream

If you did not buy directly from the debtor but from someone who did, you get an additional layer of protection. Federal law distinguishes the initial transferee, who received the property directly from the debtor, from subsequent transferees further down the chain.

Under 11 U.S.C. § 550(a), a trustee can recover avoided property from both the initial transferee and any subsequent transferee. But Section 550(b) creates a safe harbor: the trustee cannot recover from a subsequent transferee who took for value, in good faith, and without knowledge that the original transfer was voidable.³ The protection also extends to anyone who later acquires the property in good faith from a protected subsequent transferee.

The key difference is the knowledge requirement. An initial transferee defending under Section 548(c) must show good faith and value, and courts evaluate good faith by asking whether the transferee knew or should have known about the debtor’s fraud or insolvency. A subsequent transferee defending under Section 550(b) must show all of that plus the absence of knowledge that the original transfer was voidable. That can actually be easier to meet, because a downstream buyer often has no reason to investigate the finances of someone two or three links up the chain.

The UVTA offers parallel protection. Under Section 8(b), a creditor cannot recover from a subsequent transferee who took in good faith and for value, with the burden of proving these elements resting on the subsequent transferee.²

How Far Back a Claim Can Reach

Do not assume you are safe just because the transaction closed years ago. In bankruptcy, a trustee can challenge transfers made within two years before the petition was filed. One exception extends that window to ten years for transfers to self-settled trusts, meaning trusts the debtor created for their own benefit with intent to defraud creditors.¹

The federal two-year window is not the whole story. Under 11 U.S.C. § 544(b), a bankruptcy trustee can step into the shoes of an actual unsecured creditor and use state fraudulent transfer law to challenge a transaction.⁴ Because state statutes of limitations are often longer, this effectively extends the trustee’s reach. The Uniform Voidable Transactions Act sets a four-year limitations period with a one-year discovery-rule extension for actual fraud claims, so the clock does not start running until the creditor discovered or reasonably could have discovered the transfer. If a government agency holds an unsecured claim, some courts have allowed trustees to invoke even longer limitations periods available to governmental creditors. A trustee wielding state law through Section 544(b) may reach transfers that fall well outside the federal two-year window.

Ponzi Scheme Clawbacks

Ponzi scheme cases put extraordinary pressure on the good faith defense. When a trustee unwinds a Ponzi scheme, intent to defraud is treated as inherent. There is no need to prove the operator meant to cheat anyone, because the structure of a Ponzi scheme makes fraud unavoidable. The entire focus shifts to whether investors who received payments can defend against clawback.

Under a constructive fraud theory, investors can generally keep repayments up to the amount of their original principal. The logic is that by returning the investor’s own money, the operator was satisfying a pre-existing debt, which qualifies as value. Under an actual fraud theory, the trustee can pursue everything paid to the investor, including principal, unless the investor proves good faith.

Courts apply the inquiry notice test strictly here. Consistently above-market returns, or other investors raising concerns you dismissed, can put you on notice. The standard is not whether you actually knew it was a Ponzi scheme but whether you encountered enough warning signs that a reasonable person would have investigated further. Investors whose returns stayed within plausible market ranges and who had no personal relationship with the operator tend to fare better, but even then the defense is fact-intensive and expensive.

How to Actually Win

Record-keeping decides most of these cases. Transferees who kept organized files with contracts, emails, appraisals, bank statements, and proof of due diligence tend to survive summary judgment. Those who rely on oral testimony about what they believed at the time usually do not. A judge hearing “I thought it was a legitimate deal” without any documentation has very little to work with.

Discovery is invasive. Expect to produce all communications with the debtor, every document related to the transaction, your personal financial records showing where the purchase funds came from, and any information you had about the debtor’s financial situation. You will likely be deposed and asked in detail about your relationship with the debtor, how you learned about the asset, who set the price, and whether you had any reason to believe creditors were being harmed. Evidence that you and the debtor used the same attorney, or that the debtor helped arrange your financing, can be devastating.

Expert testimony often plays a central role. An appraiser can testify that the price was consistent with market conditions. A forensic accountant might show that the debtor appeared solvent based on publicly available information at the time. These experts are not cheap. Defending a fraudulent transfer action can cost tens of thousands of dollars in legal fees and expert costs, and complex cases involving business valuations or multiple transactions can run well into six figures. Front-end due diligence, an appraisal, a title search, a look at the seller’s public litigation history, is dramatically cheaper than defending the same deal in court a few years later.

1
Office of the Law Revision Counsel. 11 USC 548 – Fraudulent Transfers and Obligations
2
Uniform Law Commission. Uniform Voidable Transactions Act – Section 8 Defenses, Liability, and Protection of Transferee
3
Office of the Law Revision Counsel. 11 USC 550 – Liability of Transferee of Avoided Transfer
4
Office of the Law Revision Counsel. 11 US Code 544 – Trustee as Lien Creditor and as Successor to Certain Creditors and Purchasers