Brian Bash v. Textron Fin. Corp. ( 2021 )

RECOMMENDED FOR PUBLICATION
Pursuant to Sixth Circuit I.O.P. 32.1(b)
File Name: 21a0216p.06
UNITED STATES COURT OF APPEALS
FOR THE SIXTH CIRCUIT
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IN RE: FAIR FINANCE COMPANY,
│
Debtor, │
___________________________________________ │
BRIAN A. BASH, Chapter 7 Trustee, > No. 20-3351
│
Plaintiff-Appellant, │
│
v. │
│
│
TEXTRON FINANCIAL CORPORATION, │
Defendant-Appellee. │
┘
Appeal from the United States District Court for the Northern District of Ohio at Akron;
No. 5:12-cv-00987—Patricia A. Gaughan, District Judge.
United States Bankruptcy Court for the Northern District of Ohio;
No. 1:10-bk-50494—Jessica E. Price Smith, Judge; No. 1:12-ap-05101—Arthur I. Harris, Judge.
Argued: June 10, 2021.
Decided and Filed: September 10, 2021
Before: COLE, BUSH, and NALBANDIAN, Circuit Judges.
_________________
COUNSEL
ARGUED: Daniel R. Warren, BAKER & HOSTETLER LLP, Cleveland, Ohio, for Appellant.
Mitchell A. Karlan, GIBSON, DUNN & CRUTCHER LLP, New York, New York, for Appellee.
ON BRIEF: Daniel R. Warren, Scott C. Holbrook, Michael A. VanNiel, Jeremy S. Dunnaback,
BAKER & HOSTETLER LLP, Cleveland, Ohio, for Appellant. Mitchell A. Karlan, Lee G.
Dunst, Nancy Hart, Timothy Sun, GIBSON, DUNN & CRUTCHER LLP, New York, New
York, Quintin F. Lindsmith, BRICKER & ECKLER LLP, Columbus, Ohio, for Appellee.
No. 20-3351 Bash v. Textron Fin. Corp. Page 2
_________________
OPINION
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NALBANDIAN, Circuit Judge. Can a party’s later—arguably bad-faith—actions
undermine its earlier perfected security interest so that payments made in connection with that
security interest are fraudulent transfers under Ohio law? That’s the main question here.
Fair Finance Company entered into a $22 million revolving loan agreement with Textron
Financial Corporation and another bank in 2002. The agreement created, and Textron perfected,
a security interest in all Fair Finance assets.
Around that same time, new owners (later convicted criminals) bought Fair Finance and
began to run it into the ground by using the company to perpetuate a Ponzi scheme. In 2003,
Textron began to express concerns internally about what it thought was going on at Fair Finance.
Regardless, when the revolver was set to expire in 2004, Textron and Fair Finance renewed and
extended the revolver with conditions designed to protect Textron’s interests. But the other bank
exited, and the remaining parties contracted for several alterations, including decreasing the
revolver limit to $17.5 million. The loan relationship ended in 2007 with Textron paid in full.
Not surprisingly, Fair Finance entered involuntary bankruptcy in 2010. And the federal
government later charged and convicted its owners of crimes in connection with the Ponzi
scheme.
The bankruptcy trustee now seeks to avoid payments from Fair Finance to Textron as
fraudulent transfers under Ohio’s Uniform Fraudulent Transfer Act, Ohio Rev. Code § 1336.01,
et seq. (“OUFTA”). The district court rejected the trustee’s attempt to unwind the transfers. The
trustee appeals, arguing that the district court mistakenly rejected its arguments at summary
judgment and erroneously instructed the jury at a trial on a related claim. We AFFIRM.
No. 20-3351 Bash v. Textron Fin. Corp. Page 3
I
A
At one time, Fair Finance was a legitimate Ohio factoring company—a company that
buys discounted accounts receivable from merchants in exchange for immediate payment and
then tries to collect the full amount. The company raised capital for accounts-receivable
purchases by issuing debentures called V-notes.
But in 2002, Tim Durham and Jim Cochran bought the business and began using it to
perpetrate a Ponzi scheme. Using V-note funds, the owners would pay off old investors and
“loan” themselves and their other entities money.
Around the same time that Durham and Cochran bought the company, Textron and
another bank entered a $22 million revolver with Fair Finance. The owners used revolver money
to fund their factoring activities—a front for their fraudulent scheme.
When Textron entered the agreement and perfected its security interest, it did not know
about the Fair Finance owners’ scheme. But that soon changed. As early as 2003, Textron
officials knew that Fair Finance was a “house of cards”; its related-party loans were “shaky at
best”; use of debentures to fund those loans might be problematic based on Fair Finance
representations about the use of those funds; and Fair Finance’s financials reflected “one of the
defining features of a Ponzi scheme,” the “raising [of] new capital in order to pay off old
investors.” (R. 323-21, Infante Email, PageID 62552; R. 323-20, Giulioli Dep., PageID 62542.)
Yet Textron continued to loan money to Fair Finance. Not only did it continue to lend
money, Textron sought to ensure that revolver money would stay out of Fair Finance’s shaky
loans. And it made a side deal with Fair Finance under which Fair Finance agreed to offset each
new insider loan with an increase in V-note funding. When the revolver was set to expire in
2004, Textron and Fair Finance renewed, extended, and altered the revolver, allowing the other
bank to exit and decreasing the revolver limit to $17.5 million. And Textron helped prevent
public exposure of Fair Finance’s precarious financial condition by doing things like waiving
contractual provisions requiring audited financials and encouraging Fair Finance to inject more
No. 20-3351 Bash v. Textron Fin. Corp. Page 4
insider-loan money into failing related entities to avoid forcing Fair Finance to write off those
loans.
The loan relationship ended in 2007. Fair Finance paid Textron in full.
In 2009, Fair Finance’s Ponzi scheme was exposed. See United States v. Durham,
766 F.3d 672, 676 (7th Cir. 2014) (criminal appeal); see also United States v. Durham, 630 F.
App’x 634 (7th Cir. 2016) (order). And Fair Finance was forced into involuntary bankruptcy.
Durham, 766 F.3d at 676.
B
Fair Finance’s bankruptcy trustee brought an adversary proceeding against Textron. He
sought to avoid millions of dollars in transfers to Textron under the revolver agreement as
fraudulent transfers under OUFTA. That act creates an avenue for unwinding fraudulent
transfers of “assets,” but it excludes property encumbered by a valid lien from the definition of
asset. Ohio Rev. Code §§ 1336.01(B), 1336.01(L), 1336.04(A).
Relying on its 2002 security interest, Textron moved to dismiss under Rule 12(b)(6) for
failure to state a claim. The district court granted Textron’s motion. It concluded that Fair
Finance’s payments to Textron did not qualify as “transfers” under OUFTA because the 2002
agreement created a valid security interest that encumbered the transferred funds, survived the
non-novation 2004 modifications, and was unaffected by Textron’s troubling post-lien-creation
conduct. It also rejected the argument that the trustee could avoid as fraudulent the new
“obligations” incurred by Fair Finance when some aspects of the loan relationship shifted in
2004.
The trustee appealed and prevailed. Bash v. Textron Fin. Corp. (In re Fair Fin. Corp.),
834 F.3d 651 (6th Cir. 2016). We held that there was an unresolved factual question about
whether the 2004 agreement modifications were a novation that extinguished the 2002 agreement
and security interest. Id. at 667-70. We remanded for the district court to revisit the novation
question. Id. at 667. And we invited the district court to revisit the trustee’s other theories for
recovery on remand as well. Id.
No. 20-3351 Bash v. Textron Fin. Corp. Page 5
On remand, the trustee argued that Textron’s post-lien-creation bad faith could invalidate
its 2002 security interest under OUFTA’s definition of “valid lien.” He also argued that he
should be able to avoid the “new” obligations created by the 2004 agreement. And he argued
that the 2004 agreement was a novation. The district court rejected the first two theories upon
Textron’s motion for summary judgment. And a jury rejected the trustee’s novation argument.
The trustee appealed again.
II
The trustee now argues that we should reverse the district court’s summary judgment
decisions on his post-lien-creation-bad-faith argument and his new-obligation theory. We review
those decisions de novo. Biegas v. Quickway Carriers, Inc., 573 F.3d 365, 373 (6th Cir. 2009).
He also argues that a jury instruction on novation contained a reversible error.
We review “[t]he legal accuracy of jury instructions . . . de novo.” Smith v. Joy Techs., Inc.,
828 F.3d 391, 397 (6th Cir. 2016). But a judgment may be reversed based on an improper jury
instruction “only if the instructions, viewed as a whole, were confusing, misleading, or
prejudicial.” United States v. Kuehne, 547 F.3d 667, 679 (6th Cir. 2008) (citation omitted).1
III
Without the protection of a “valid lien,” Fair Finance’s loan repayments might be
avoidable as fraudulent transfers under OUFTA. Ohio Rev. Code §§ 1336.01(B), 1336.01(L),
1336.04(A). But if a “valid lien” encumbered the transferred assets, then the payments are not
avoidable. Id.
Transfers under the 2002 agreement were encumbered by a perfected security interest—a
“lien” under OUFTA. Ohio Rev. Code § 1336.01(H) (“‘Lien’ means a charge against or an
interest in property to secure payment of a debt or performance of an obligation, and includes a
security interest created by agreement . . . .”). But not all liens shield assets from avoidance.
Only “valid” ones do. Id. §§ 1336.01(B), 1336.01(L), 1336.04(A). And the trustee contends that
1
The trustee also raises an issue regarding how damages should be calculated if he prevails. But we don’t
reach that issue because we reject his liability arguments.
No. 20-3351 Bash v. Textron Fin. Corp. Page 6
Textron’s 2002 security interest is not a “valid lien” because Textron acted in bad faith after it
learned about the Ponzi scheme. Because we disagree under OUFTA’s definition of “valid lien,”
we reject that contention. The payments encumbered by the 2002 security interest are not
avoidable.
A
Under the Bankruptcy Code, a “trustee may avoid any transfer of an interest of the debtor
in property or any obligation incurred by the debtor that is voidable under applicable law by a
creditor holding an unsecured claim.” 11 U.S.C. § 544(b)(2). OUFTA in turn makes fraudulent
transfers—transfers made “[w]ith actual intent to hinder, delay, or defraud any creditor of the
debtor”—avoidable. Ohio Rev. Code § 1336.04(A). And “transfer” under OUFTA includes
“every direct or indirect, absolute or conditional, and voluntary or involuntary method of
disposing of or parting with an asset or an interest in an asset, and includes payment of money,
release, lease, and creation of a lien or other encumbrance.” Id. § 1336.01(L).
But the definition of “asset” creates an important carve-out from transfer’s broad
definition. Although “asset” “means property of a debtor,” it “does not include . . . [p]roperty to
the extent it is encumbered by a valid lien.” Id. § 1336.01(B). And a “valid lien” is one that is
“effective against the holder of a judicial lien subsequently obtained.” Id. § 1336.01(M).
The outcome of the issue here turns on this final definition. If Textron’s 2002
security interest is “effective against the holder of a judicial lien subsequently obtained,” then the
money paid is encumbered by a “valid lien” and falls outside the definition of “asset.”
Id. §§ 1336.01(B), 1336.01(M). Because “transfers” under OUFTA are limited to “asset” or
asset-interest transfers, that would mean that the payments are not “transfers.” And if the
payments are not “transfers,” they cannot be fraudulent ones. So if Textron’s lien is valid,
payments encumbered by the 2002 security interest fall outside the reach of the trustee’s
avoidance powers under 11 U.S.C. § 544(b)(2). But if the 2002 interest is not valid, then the
payments are OUFTA “transfers” and thus potentially avoidable.
By measuring validity by referencing a dispute between two security interests, section
1336.01(M)’s valid-lien definition creates a hypothetical priority dispute between the interest
No. 20-3351 Bash v. Textron Fin. Corp. Page 7
being tested (here, Textron’s perfected interest) and “a judicial lien subsequently obtained.”
Ohio Rev. Code § 1336.01(M). In Ohio, chapter 1309 of Ohio’s Uniform Commercial Code
(“UCC”) governs priority disputes. And that means “the Ohio UCC . . . determine[s] whether
[a creditor has] a ‘valid lien’” under OUFTA—one effective against a later judicial lien. Thermo
Credit, LLC v. DCA Servs., Inc., 755 F. App’x 450, 456 n.4 (6th Cir. 2018); see Comer v. Calim,
716 N.E.2d 245, 249 (Ohio Ct. App. 1998).
The UCC creates priority rules for ranking competing security interests, including a rule
that dictates whether a security interest takes priority over a competing lien creditor’s claim to
collateral. And it imposes an overarching duty of good faith.
The priority rules. Under the UCC, “[c]onflicting perfected security interests . . . rank
according to priority in time of . . . perfection.” Ohio Rev. Code § 1309.322(A)(1).
“A perfected security interest . . . has priority over a conflicting unperfected security interest
. . . .” Id. § 1309.322(A)(2). And between two unperfected interests, the “first security interest
. . . to attach . . . has priority.” Id. § 1309.322(A)(3).
Lien creditor interests—whose priority is crucial to the OUFTA’s definition of a valid
lien—are treated the same way as perfected interests. So a “security interest . . . is subordinate to
the rights of . . . a person who becomes a lien creditor before . . . the security interest . . . is
perfected.” Id. § 1309.317(A). Perfection is thus the key to determining priority between a
creditor’s security interest and a competing lien creditor. See id. If person A perfects a security
interest before person B becomes a lien creditor, then person A’s interest defeats person B’s lien.
See id. But if person A’s interest is unperfected or becomes perfected after person B becomes a
lien creditor, then person B’s lien has priority over person A’s interest. See id.
But here, the trustee adds some complexity to this relatively straightforward rule. He
argues that if person A acts in bad faith after perfecting his security interest he, in some sense,
forfeits his right to claim priority over person B—regardless of whether he directed his bad faith
toward person B. He grounds this argument in the UCC’s duty of good faith.
Good faith. The UCC “imposes an obligation of good faith” in the “performance and
enforcement” of “[e]very contract or duty within” several UCC chapters, including the chapter
No. 20-3351 Bash v. Textron Fin. Corp. Page 8
covering secured transactions. Id. § 1301.304. “‘Performance and enforcement’ of contracts and
duties within the Uniform Commercial Code include the exercise of rights created by the
Uniform Commercial Code.” Id. cmt. 2.
The chapter governing secured transactions and priority disputes empowers courts to
“order or restrain collection, enforcement, or disposition of collateral on appropriate terms and
conditions” “[i]f it is established that a secured party is not proceeding in accordance with this
chapter.” Id. § 1309.625(A). And the official comment says that the “principal limitations
. . . on a secured party’s right to enforce its security interest against collateral are the
requirements that it proceed in good faith (Section 1-203), in a commercially reasonable manner
(Sections 9-607 and 9-610).” Id. § 1309.625 cmt. 2. As the trustee points out, some courts
(though none of Ohio’s state courts) have used these provisions to reorder competing creditors’
priorities in priority disputes. See Gen. Ins. Co. of Am. v. Lowry, 412 F. Supp. 12, 14 (S.D. Ohio
1976), aff’d, 570 F.2d 120 (6th Cir. 1978) (equitably reordering priorities because attorney had
only perfected superior interest in collateral because he failed to turn over the collateral to the
plaintiff as contemplated by an agreement that he was, as a party’s attorney, fully aware of);
Farm Credit of Nw. Fla. v. Easom Peanut Co., 718 S.E.2d 590, 599 (Ga. Ct. App. 2011)
(concluding that bad-faith misrepresentations to unsecured peanut farmers by a secured creditor
of a bankrupt peanut broker about the broker’s ability to pay farmers back could support
reordering of priorities); Affiliated Foods, Inc. v. McGinley, 426 N.W.2d 646, 648 (Iowa Ct.
App. 1988) (inducing party to enter sales transaction under false belief about priority level
precluded enforcement of senior security priority).
B
The parties do not debate whether Textron acted inappropriately by knowingly propping
up the Fair Finance Ponzi scheme. But the question here isn’t whether Textron was a bad actor.
The question is whether its actions would render its perfected interest “[in]effective against the
holder of a judicial lien subsequently obtained” in a hypothetical UCC priority contest. Ohio
Rev. Code § 1336.01(M). And the answer to that question is no, meaning Textron enjoyed a
“valid lien” under OUFTA. This conclusion is grounded in the nature of the UCC’s priority test
as well as critical distinctions between normal priority disputes and the OUFTA valid-lien test.
No. 20-3351 Bash v. Textron Fin. Corp. Page 9
The UCC’s priority rules help answer only one question—priority among competing
creditors. See Ohio Rev. Code §§ 1309.322(A), 1309.317(A). And that means two things. First,
for the rules to provide an answer, there need to be at least two competing interests to rank (in
normal circumstances, two actual creditors’ interests). And second, the rules only provide a
relative answer—priority relative to another interest being measured. The rules are not about
validity. Priority contests only tell us where to rank a specific interest in relation to other
specific interests.
These principles apply to section 1309.317(A)’s test for priority between a security
interest and a lien creditor. Like the broader priority framework, to get an answer under section
1309.317(A), we need two competing claims to plug into the rule—a security interest and a
competing creditor lien. Section 1309.317(A)’s test then tells us each party’s relative priority.
But because invalidation is not the object of the inquiry, resolution of the priority contest does
not tell us anything about an interest’s validity. See id. § 1309.317(A) (stating a “security
interest . . . is subordinate to the rights of . . . a person who becomes a lien creditor before . . . the
security interest . . . is perfected” (emphasis added)).
The UCC’s good-faith provisions can impact the answer under the priority rules by
limiting a bad-faith actor’s ability to “enforce” its security-interest-priority rights created by
the UCC. Id. § 1309.625(A) & cmt. 2. But the duty of good faith does not alter the question
that the UCC priority rules answer—relative priority among competing interests. See id.
§§ 1309.322(A), 1309.317(A). And as sweeping as that duty is, it only applies to the
“‘performance and enforcement’ of contracts and duties” (including “rights created by the”
UCC) under various UCC chapters. Id. § 1301.304 & cmt. 2 (emphasis added). That means that
in the context of UCC priority rights, the only enforcement right that bad faith can impact is
enforcement of a senior priority vis-à-vis a junior creditor’s rights—a question of priority, not
validity. See id.
Because of the nature of the right that the UCC priority rules create and the question they
answer—priority between the actual competing interests disputing relative priority rather than
validity—there is necessarily always a directional component to the good-faith reordering
analysis. See, e.g., Affiliated Foods, 426 N.W.2d at 648 (inducing party to enter sales transaction
No. 20-3351 Bash v. Textron Fin. Corp. Page 10
under false belief about priority level precluded enforcement of senior security priority against
junior interest). The question is not whether a party’s bad faith in some abstract sense justifies
invalidation. The question is whether as between two or more specific competing creditor
interests, a junior interest should jump in line. Or otherwise stated, whether a senior interest
should be allowed to enforce its senior interest by “exercis[ing] [priority] rights created by the
Uniform Commercial Code.” Ohio Rev. Code § 1301.304 cmt. 2; see id. § 1301.304 & cmt. 2
(requiring good faith in enforcement of rights under the UCC); id. § 1309.625 cmt. 2 (“The
principal limitations . . . on a secured party’s right to enforce its security interest against
collateral are the requirements that it proceed in good faith (Section 1-203), in a commercially
reasonable manner (Sections 9-607 and 9-610).”).
And the answer to that question necessarily hinges on the shared history and relationship
between those competing creditors because the question is whether shuffling among those
interests, not invalidating any of them, is justified. See id. § 1309.317(A). And that means as a
practical matter that reordering based on bad faith would only ever happen based on a senior
creditor’s actions directed at, or taken within a relationship with, the junior creditor seeking to
jump ahead of the bad actor in line.
The UCC caselaw that the trustee cites supports this directional aspect that we discern in
the bad-faith reordering analysis. Courts have used a party’s bad faith directed “toward” another
creditor to reorder those parties’ interest. Thompson v. United States, 408 F.2d 1075, 1084 (8th
Cir. 1969) (“[L]ack of good faith . . . toward the government” justified “alter[ing] priorities
which otherwise would be determined under Article 9.”); see Lowry, 570 F.2d at 121 (observing
“the good faith provision of the UCC ‘permits the consideration of the lack of good faith . . . to
alter priorities which otherwise would be determined under Article 9’” (quoting Thompson,
408 F.2d at 1084)). But because a priority dispute is not about invalidation, these cases
invariably determine only whether the relationship between the competing interests involved
justifies reordering among those creditors. None of the trustee’s cases support broader
reordering among other creditors who lacked any relationship to the bad acts or actor. And this
makes sense, because, as repeatedly mentioned, the priority test is not about invalidation.
No. 20-3351 Bash v. Textron Fin. Corp. Page 11
Here are a few examples. In Affiliated Foods, the Iowa Court of Appeals held that a
senior secured creditor was “estopped from asserting [its] secured interest prior to the interests
of” a junior creditor because the senior creditor had “induced [the junior one] to believe that [it]
would be given” a higher priority than the senior creditor. 426 N.W.2d at 648. And in Farm
Credit, the Georgia Court of Appeals concluded that a secured creditor’s misrepresentations to
unsecured farmers about a third party’s ability to repay the farmers could support subordination
in favor of the farmers. 718 S.E.2d at 599.
Unlike the normal priority-dispute analysis which requires at least two actual competing
security interests, the priority analysis under OUFTA’s definition of valid lien only requires
one—the interest whose validity is at issue. The definition of “valid lien” provides the other
interest—a generic hypothetical later obtained judicial lien. See Ohio Rev. Code § 1336.01(M).
This distinction between the usual priority dispute and the OUFTA definitional one
decides this case. In a priority dispute, Textron’s perfected 2002 security interest would prevail
over a “judicial lien subsequently obtained” absent priority reordering. Ohio Rev. Code
§§ 1309.317(A), 1336.01(M); see also Comer, 716 N.E.2d at 249 (“In order for” a security
interest to be “effective against the holder of a judicial lien subsequently obtained,” “the security
interest must be perfected.”). The UCC duty of good faith can impact the enforceability of a
senior priority interest over a junior one in a priority dispute between two actual competing
interests. See Ohio Rev. Code § 1309.625(A) & cmt 2. But because of the nature of the priority
analysis and the right it creates—a test for priority rather than validity—there is a directional
component built into the bad-faith inquiry. The analysis is necessarily specific to the
relationship between the parties in the priority contest. And that means the type of bad faith
needed to reorder priority is bad faith within a relationship that involves at least two competing
creditors.
But that type of bad faith could never happen under the OUFTA test because that test
requires ranking a security interest’s priority against a hypothetical generic subsequent judicial
lien. See Ohio Rev. Code §§ 1309.317(A), 1336.01(M). In no case would it be possible for a
party to have a relationship with or direct its bad faith at a non-existent entity. And because that
is the case, subordination would never happen. So a perfected interest is by definition a “valid
No. 20-3351 Bash v. Textron Fin. Corp. Page 12
lien” under OUFTA. Cf. Longo Constr., Inc. v. ASAP Tech. Servs., Inc., 748 N.E.2d 1164, 1170
(Ohio Ct. App. 2000) (“In order to be a valid lien, the lien must be ‘effective against the holder
of a judicial lien subsequently obtained by legal or equitable process or proceedings.’ This
ordinarily means that a security interest must be perfected . . . .” (citation omitted)); Comer,
716 N.E.2d at 249 (To be valid, a lien “must be perfected.”); Permasteelisa CS Corp. v. The
Airolite Co., No. 2:06-CV-569, 2007 WL 4615779, at *6 (S.D. Ohio Dec. 31, 2007) (“Generally,
a ‘valid lien’ equates to a perfected security interest.”).
The district court correctly rejected the trustee’s bad-faith-invalidation argument at
summary judgment. We affirm that decision.
IV
In 2004, the 2002 revolver agreement was set to expire, and one of the two lending banks
wanted out. But Fair Finance wasn’t interested in sunsetting its “very profitable” revolver
relationship with Textron. (R. 323-35, Credit Modification Request, PageID 62710.) And so
when the revolver was set to expire, Textron and Fair Finance renewed, extended, and altered the
revolver, allowing the other bank to exit.
Loan payments encumbered by the perfected 2002 security interest are not transfers
under OUFTA and thus cannot be avoided as fraudulent transfers. But if Textron and Fair
Finance’s actions in 2004 novated the 2002 agreement and security interest rather than renewing
them, then Fair Finance may have transferred a new security interest through the 2004
agreement. And that new security interest itself might be avoidable as a fraudulent transfer given
Textron’s knowledge of the Ponzi scheme at that time. That would mean that post-2004
transfers would not have the protection of a valid lien and would thus be avoidable.
A jury, however, determined that the 2004 changes did not amount to novation. The
trustee argues that the jury reached this conclusion because of a faulty jury instruction that
incorrectly stated Ohio law and poisoned the jury verdict on this issue. We disagree with the
trustee. To the extent there was any error, it was harmless.
No. 20-3351 Bash v. Textron Fin. Corp. Page 13
The jury instruction on novation stated:
A contract of novation is created when a previous valid obligation is extinguished
and replaced by a new valid contract. In order to find that a novation occurred,
you must determine if the parties intended, knew of, and consented to, the
creation of a valid new contract.
When a promissory note is executed between the parties, there is a presumption in
favor of finding that a new loan transaction is a renewal of the original debt that
retains the same security interest.
In order to overcome this presumption, the Trustee must prove with clear and
definite evidence that the parties knew of, and consented to, the extinguishment of
the old debt and security interest and the creation of a new agreement.
(R. 469, Trial Tr., PageID 71838.)
The trustee argues that the language describing a “presumption in favor of finding that a
new loan transaction is a renewal of the original debt that retains the same security interest”
misstated Ohio law. He does not, however, contest that Ohio law requires “clear and definite
evidence” of the parties’ intent to novate. Nor does he contest that he had the burden of proof on
this issue.
Textron argues there are four reasons the trustee cannot prevail: (1) the instruction was
the law of the case under our prior decision; (2) the trustee did not preserve a specific aspect of
the argument; (3) the instruction correctly stated Ohio law; and (4) if there was an error, the error
was harmless. We agree with Textron as to harmless error. This is sufficient to affirm.
We note that there is caselaw support, albeit older, for a pro-renewal presumption under
Ohio law. See Madlener v. Greathouse, 31 Ohio Law Abs. 434, 439 (Ohio Ct. App. 1939) (“It is
well settled in Ohio that the giving of a renewal note does not have the effect of creating a new
debt, . . . unless it has been so agreed between the parties; the presumption is that it is
conditional, not an absolute payment of the obligation.”); Kuerze v. W. German Bank, 12 Ohio
App. 412, 418 (Ohio Ct. App.), aff’d, 127 N.E. 924 (Ohio 1919) (“The law is that where a new
note is given to take up an indebtedness, the presumption is that it is in conditional payment and
not absolute payment of the obligation.”). And federal courts applying Ohio law have weighed
in as well. See, e.g., Noland v. Wilmington Sav. Bank (In re D & K Aviation, Inc.), 349 B.R. 169,
177 (Bankr. S.D. Ohio 2006) (“Ohio law . . . provides for a presumption in favor of renewal
No. 20-3351 Bash v. Textron Fin. Corp. Page 14
where a new note has been executed by the parties.”).2 But because harmless error resolves the
issue, we do not need to decide whether the jury instruction was faulty as a matter of Ohio law.
Even if we assume that the jury instruction was faulty as the trustee alleges, no harm
obtains. Neither party disputes that intent to novate is the key to novation under Ohio law. And
neither disputes that the trustee must show intent by clear and definite evidence. The instruction
properly focused on whether “the parties intended, knew of, and consented to, the creation of a
valid new contract.” (R. 469, Trial Tr., PageID 71838.) And although it included a presumption
(assuming here, of course, that was error), it also correctly explained the standard needed to
show novation: “In order to overcome this presumption, the Trustee must prove with clear and
definite evidence that the parties knew of, and consented to, the extinguishment of the old debt
and security interest and the creation of a new agreement.” (Id.) The space between the trustee’s
proposed instruction and the one given is razor thin. He asked for an instruction that said
novation is never presumed but must be shown by clear and definite evidence. What he got was
an instruction that said that novation must be shown by clear and definite evidence. Any possible
error was harmless.
V
Even without novation in 2004, the trustee argues that he can still avoid post-2004
transfers because the 2004 agreement extinguished the 2002 debt and replaced it with a new debt
“obligation.” That new “obligation,” he contends, is avoidable under OUFTA because both a
“transfer made” and “an obligation incurred” are potentially avoidable as fraudulent transfers
under that act. Ohio Rev. Code § 1336.04(A) (emphasis added).
Textron calls this a “semantic re-cloaking of the novation theory.” (Appellee Br. at 44.)
We agree.
2
In the previous iteration of this case before this court, we favorably cited In re D & K Aviation for that
same proposition, explaining parenthetically that case’s holding. In re Fair Fin. Co., 834 F.3d at 667. The district
court looked to that parenthetical on remand in formulating the jury instructions. (R. 468, Trial Tr., PageID 71637
(“I just want the record to be clear that the language I used in the jury instruction on novation was taken verbatim
from the Sixth Circuit opinion.”).)
No. 20-3351 Bash v. Textron Fin. Corp. Page 15
The point of novation is to “extinguish[] by a new valid contract” “a previous valid
obligation” and replace it with a different one. McGlothin v. Huffman, 640 N.E.2d 598, 601
(Ohio Ct. App. 1994) (emphasis added). So if we presume, as the trustee’s argument does, that
the 2004 Agreement renewed rather than novated the 2002 debt, then the 2004 agreement
renewed rather than extinguished the 2002 debt obligation. And that means that there was no
new “obligation incurred” in 2004 that could be avoidable as a fraudulent transfer. The district
court correctly rejected this convoluted argument below.
VI
We AFFIRM.