## Facts

- Northern Merchandise, Inc. sold general merchandise to grocery stores and was later placed into involuntary Chapter 7.
- Frontier Bank made a $60,000 secured loan directly to Northern in February 1998, perfected by a UCC filing.
- In October 1998, Northern sought an additional $150,000 for working capital; Frontier declined to lend directly to Northern based on Northern’s financial performance.
- Frontier instead loaned $150,000 to Northern’s shareholders, with the understanding that the funds would be used in Northern’s business.
- Frontier deposited the October loan proceeds directly into Northern’s checking account.
- Although the shareholders were the formal borrowers, Northern granted Frontier a security interest in Northern’s assets to secure the October loan.
- Northern ceased operations in March 1999 and transferred substantial inventory to an insider-owned entity for $125,000; the $125,000 was paid to Frontier to reduce the October loan.
- The Chapter 7 trustee sought to avoid (i) Northern’s grant of the security interest and (ii) Frontier’s receipt of the $125,000 as constructively fraudulent transfers under 11 U.S.C. § 548(a)(1)(B), and argued Frontier lacked a § 548(c) defense.
- The bankruptcy court granted partial summary judgment to the trustee that Northern did not receive reasonably equivalent value; the Bankruptcy Appellate Panel affirmed as to the security interest.

## Issues

1. Whether a debtor receives “reasonably equivalent value” under 11 U.S.C. § 548(a)(1)(B) when it grants a security interest to secure a loan formally made to third parties, where the loan proceeds are deposited into and used by the debtor.
2. Whether a good-faith transferee may invoke 11 U.S.C. § 548(c) by showing it gave value to the debtor through an indirect economic benefit associated with the challenged transfer.

## Decision

- The Ninth Circuit reversed the Bankruptcy Appellate Panel.
- The court held Northern received reasonably equivalent value for granting Frontier a security interest securing the October loan because Northern received the loan proceeds and used them as working capital.
- The court held “value” for § 548 purposes can be conferred indirectly; the inquiry focuses on the net economic effect on the debtor’s estate rather than the transaction’s formal structure.
- Because Frontier gave value to Northern and acted in good faith, Frontier was entitled to the protection of § 548(c) as to the security interest.

## Legal Principles

- Constructive fraudulent transfer analysis under § 548(a)(1)(B) turns on whether the debtor received reasonably equivalent value in exchange for the transfer or obligation.
- “Value” may be established by indirect economic benefits to the debtor, including where consideration flows to a third party but results in a real benefit to the debtor’s estate.
- In determining reasonably equivalent value, courts assess the economic substance and net effect on the debtor’s estate, not merely the form of the transaction documents.
- Under § 548(c), a good-faith transferee may retain an interest transferred to the extent it gave value to the debtor, including value conferred through indirect benefits such as enabling the debtor to obtain working capital.

## Conclusion

The Ninth Circuit held that a debtor can receive reasonably equivalent value through indirect benefits when loan proceeds are funneled to and used by the debtor, even if third parties are the formal borrowers, and that a good-faith lender that provided such value may retain the security interest under § 548(c).


In re Northern Merchandise, Inc., 371 F.3d 1056 (9th Cir. 2004)