Bruce J. Borrus writes:

Bernie Madoff in New York, Tom Petters in Minneapolis, Allen Stanford in Houston, and Darren Berg in Seattle lead a rogues’ gallery of infamous Ponzi schemers.  All are now serving time in prison.  But the civil litigation arising from their Ponzi schemes and the Ponzi schemes of other less notorious fraudsters is not over.  Ponzi schemes have spawned thousands of fraudulent transfer cases.  Anglo-American fraudulent transfer law has a long history dating back four centuries to the Statute of 13 Elizabeth, enacted in 1571, and to the first reported fraudulent transfer case, Twyne’s Case, decided in 1601.  But fraudulent transfer law is far from settled.  In recent years, especially in fraudulent transfer cases arising out of Ponzi schemes, the law developed rapidly in a direction favoring the plaintiffs.  However, in 2015 and 2016, the direction began to turn.

Ponzi Scheme Word CloudIn an effort to obtain funds for the victims of the Ponzi schemes, bankruptcy trustees and receivers have commenced fraudulent transfer cases to recover payments made by the Ponzi schemer.  Many of the defendants had no knowledge of the Ponzi scheme.  The defendants had innocently loaned money or provided goods and services.  These defendants did nothing wrong.  Nevertheless, most of the defendants lost—at least in federal courts.

The federal courts frequently apply Ponzi scheme presumptions that set high barriers for defendants.  In 2015 and 2016, however, opinions issued by the highest courts of Minnesota and Texas rejected the Ponzi scheme presumptions.  Before discussing these recent state court decisions, it is best to put the decisions into context—first by discussing Ponzi schemes and then by describing the federal courts’ Ponzi scheme presumptions.

There is no precise definition of a Ponzi scheme.  The Ninth Circuit describes a Ponzi scheme as:

. . . a financial fraud that induces investment by promising extremely high, risk-free returns, usually in a short time period, from an allegedly legitimate business venture.  The fraud consists of funneling proceeds from new investors to previous investors in the guise of profits from the alleged business venture, thereby cultivating the illusion that a legitimate profit-making business opportunity exists and inducing further investment.

Donell v. Kowell, 533 F.3d 762, 767 n.2 (9th Cir. 2008).

The Fifth Circuit describes a Ponzi scheme as:

. . . a pyramid scheme where earlier investors are paid from the investments of more recent investors, rather than from any underlying business concern, until the scheme ceases to attract new investors and the pyramid collapses.

Janvey v. Democratic Senatorial Campaign Comm., 712 F.3d 185, 188 n.1 (5th Cir. 2013).

In fraudulent transfer cases in which the transferor has been running a Ponzi scheme, many courts apply what have become known as Ponzi scheme presumptions.  All of the reported decisions that have applied the Ponzi scheme presumptions are from federal courts.  The cases typically originate as suits brought by bankruptcy trustees or receivers in cases in which the Ponzi schemer or one of his or her companies is the debtor.  The bankruptcy trustee seeks a judgment in the amount that the Ponzi schemer paid to the defendant.  Even though many fraudulent transfer cases are brought pursuant to a state’s version of the Uniform Fraudulent Transfer Act (“UFTA”), the federal courts that apply the Ponzi scheme presumptions cite as authority other federal cases.  No state supreme court has yet applied the Ponzi scheme presumptions. Continue Reading For the Defense: State Courts Reject the Ponzi Scheme Presumptions in Fraudulent Transfer Actions

A recently issued opinion by the U. S Bankruptcy Court for the District of New Mexico provides some guidance on the relevant date for the transfer of real property for purposes of the statute of limitations applicable to fraudulent transfer claims.

In Gonzales v. Sexton (In re Esquibel), Adv. No. 17-1042-j (Bankr. D.N.M. July 23, 2018) the Bankruptcy Court considered a chapter 7 trustee’s summary judgment motion regarding the trustee’s claims for avoidance and recovery of actual and constructive fraudulent transfers under the Bankruptcy Code and state law.

real estate transferPre-petition, the Debtor owned unencumbered real property (the “Property”).  This Property was transferred to the Defendant on May 19, 2014 via a quitclaim deed.  In exchange for the Property, the Defendant (recipient of the Property) promised to maintain the property, provide the Debtor with a rent-free place to live, and care for Debtor if she was unable to care for herself.  Id. at ¶ 27.

Several years later, on September 7, 2016, just 177 days before the Debtor filed her voluntary bankruptcy petition, Defendant recorded the quitclaim deed.  Id. at ¶ 29.  The Trustee brought suit against the Defendant claiming that the transfer of the Property was avoidable under Section 548 of the Bankruptcy Code and state law because it constituted both actual and constructive fraudulent transfers.

The threshold issue for the Court was when the Property was transferred for purposes of statute of limitations – in 2014 when the deed was executed or in 2016 when the deed was recorded.  Section 548 allows a trustee to avoid transfers of estate property that occurred during the 2 years before the bankruptcy.  The Defendant asserted that the transfer occurred when the deed was signed in 2014, and the Court disagreed, finding that the transfer for the purposes of a Section 548 fraudulent transfer occurred when the deed was recorded, in 2016.

The Court looked to Section 548(d), which states “a transfer is made when such transfer is so perfected that a bona fide purchaser from the debtor against whom applicable law permits such transfer to to be perfected cannot acquire an interest in the property transferred that is superior to the interest in such property of the transferee.”  Id. at 10.  The Court further explained that the purpose of 548(d) is to “prevent fraudulent transfers from becoming impregnable to attack by keeping them secret until the limitation period has lapsed.”  Id. (citation omitted).

The Court then looked to New Mexico state law to determine when a real property transfer is perfected and found that such a transfer is perfected “when it is recorded with the county clerk of the state in which the real estate is situated.”  Id. at 11 (citation omitted).  Given this, the Court found that the transfer of the Property occurred upon recording in 2016, which was within 177 days of the chapter 7 filing, and therefore was “within the two-year look-back period under §548(a).”  Id. 

 

David Doty writes:

The U.S. Bankruptcy Court for the Northern District of California recently held that a Hong Kong resident who had made online purchases of wine through a California retailer was subject to personal jurisdiction. See Kasolas v. Yau, Adv. Pr. No. 18-04012 (N.D. Cal. Bankr. May 11, 2018).

The defendant, a Hong Kong resident, had been a frequent customer of the debtor’s California wine-retail business, which made wine shipments to Hong Kong upon the defendant’s request. Though the defendant maintained an active business relationship with the wine-retailer, most of his interactions were conducted online while he was physically present in Hong Kong.

The bankruptcy trustee commenced an adversary proceeding against the defendant for recovery of fraudulent transfers. In response, the defendant moved to dismiss for lack of personal jurisdiction, arguing that he had not purposefully availed himself to the fora of the United States or California because he had never been physically present in either when these transactions took place.

The hallmark guidance for determining personal jurisdiction was expressed in Burger King Corp. v. Rudzewicz, in which the Supreme Court held that the exercise of specific personal jurisdiction over a nonresident defendant is proper if the defendant purposefully directed his activities at the forum, and the litigation results from injuries arising out of those activities. 471 U.S. 462, 472-73 (1985).

The bankruptcy court addressed the defendant’s argument by applying the Ninth Circuit’s three-part test for personal jurisdiction over a nonresident defendant, which considers factors relating to (1) personal availment, (2) relational proximity between the activities and the underlying claim, and (3) the reasonableness of jurisdiction if exercised. Though the bankruptcy court ultimately found all three prongs to be satisfied, it is the bankruptcy court’s discussion and treatment of purposeful availment that merits particular attention for its implications on an ever-growing online market.

Although there was evidence suggesting that defendant had made in-person purchases in California on at least one occasion, the bankruptcy court found his online contacts with the wine-retailer to be sufficient in and of themselves for purposes of asserting personal jurisdiction. First, relying, in part, on Burger King, the bankruptcy court reiterated that physical presence in a forum is not a necessary prerequisite for a court in that forum to assert personal jurisdiction over a nonresident defendant. Second, the bankruptcy court attached significant weight to the notice the defendant had of his activities being directed toward California and, by extension, the United States. The bankruptcy court determined that the defendant not only had personal knowledge of the wine-retailer’s location being in California, but that his knowledge was further bolstered by the terms and conditions on the wine-retailer’s website which indicated that it was indeed a California company.

Here, the bankruptcy court extended personal jurisdiction across borders in an increasingly internationalized online market made possible by technological advances – progress that the bankruptcy court opined only “strengthens the underlying rationale” of Burger King and its jurisprudential lineage. While the practical implications of this decision can be easily imagined, this case nevertheless demonstrates one of many ways in which the law continues to adapt to growing commerce.

David Doty is a summer associate in the firm’s Philadelphia office.

Recently, the U.S. Bankruptcy Court for the Eastern District of Pennsylvania clarified that funds returned to the debtor are not recoverable as intentional fraudulent transfers.  See Holber v. Nikparvar (In re Incare, LLC), Adv. No. 14-0248 (Bankr. E.D.Pa. May 7, 2018).

The Debtor, Incare, LLC, was a medical care provider that provided services to a variety of hospitals and medical facilities in Pennsylvania.  After Incare filed for bankruptcy in 2013, a chapter 7 trustee brought a fraudulent transfer case against the managing and sole member of Incare, his wife, and related entities seeking to avoid and recover fraudulent transfers pursuant to Sections 544 and 550 of the U.S. Bankruptcy Code.

Liberty Bell
Liberty Bell, Philadelphia, PA

Section 544 allows a trustee to avoid a transfer that would otherwise be avoidable by the debtor’s creditors under applicable state law, in this case, the Pennsylvania Uniform Fraudulent Transfer Act (“PUFTA”), 12 Pa.C.S. § 5101, et. seq.  Like the Bankruptcy Code, PUFTA permits recovery for intentional or actual fraudulent transfers – transfers made with “actual intent to hinder, delay or defraud” creditors.  12 Pa.C.S. § 5104(a)(1).

In Holber, the U.S. Bankruptcy Court for the Eastern District of Pennsylvania considered whether 13 transfers between the Debtor and an entity affiliated with the debtor’s sole member totaling approximately $1.8 million constituted intentional fraudulent transfers.  However, during the same time frame, the debtor received approximately $1.8 million from the same entity.  Holber at 30.

Section 550 of the Bankruptcy Code allows a transfer avoidable under Section 544 to be recovered “for the benefit of the estate.”  11 U.S.C. § 550(a).  The Court explained that Section 550 is remedial and not penal and “the bankruptcy court may reduce or eliminate a trustee’s recovery under §550 where some or all of the transferred property was returned to the debtor pre-petition.”  Id. at 35.

Here, the court applied an “equitable credit” for the money returned to Incare because the Court could not identify how the creditor body was harmed by the transfers that were reversed within the year and to allow the trustee to recover the returned funds would result in a windfall to the estate.  Id. (citing In re Kingsley, 518 F.3d 874, 877-78 (11th. Cir. 2008)).

As the Court recognized, this ruling creates the possibility that a party can avoid the consequences of an intentional fraudulent transfer by simply returning the funds or reversing the transaction.  Holber at 31.  It will be interesting to see if other courts follow suit.

The United States Supreme Court recently issued a ruling in which it held that the Bankruptcy Code’s safe harbor provision § 546(e) does not prevent a trustee from clawing back transfers involving securities and financial institutions in circumstances when such institutions serve as mere pass-through entities for the transfer.  The decision, Merit Management Group, LP v. FTI Consulting, Inc., Case No. 16-784, affirming the Seventh Circuit Court of Appeals, marked a resolution of a circuit split on an issue that will have significant impact in the bankruptcy world.

Lighthouse next to a harbor at sunset

The case involved the sale of stockholder interests by transferor, Merit Management Group, LP, to transferee, Valley View Downs.  Two financial institutions, Credit Suisse and Citizens Bank, were party to the transaction as lender and escrow agent.

The safe harbor defense to the trustee’s avoidance powers exempts transfers that are settlement payments “made by or to (or for the benefit of) a…financial institution.”  The Supreme Court reasoned that the relevant question in determining whether the safe harbor defense applies is the “overarching transfer” the trustee seeks to avoid.  Because the trustee sought to avoid the purchase of stock by Valley View from Merit Management, Credit Suisse and Citizens Bank’s role as conduits, or “component parts” as described by the Supreme Court, were irrelevant to the § 546(e) analysis.  The parties did not contend that either Valley View or Merit Management were covered entities under § 546(e) and accordingly, the transfer was not protected by the safe harbor defense.

The decision throws out previous law made by the Second, Third, Sixth, Eighth and Tenth Circuits on the safe harbor rule and will have significant effects on pending and future bankruptcy proceedings, by enlarging trustees’ avoidance power and narrowing a frequently-used defense by transferee defendants.

In PAH Litigation Trust v. Water Street Healthcare Partners, LP (In re Physiotherapy Holdings, Inc.), Case No. 13-12965 (KG), Adv. No. 15-51238 (KG), 2017 WL 5054308 (Bankr. D. Del. Nov. 1, 2017), the debtor entered into bankruptcy after a leveraged-buyout transaction (“LBO”).  After a plan was confirmed, a resulting litigation trust brought actual and constructive fraudulent transfers against the defendants (seller shareholder in the LBO) seeking $248 million for actual fraud and at least $228 million for constructive fraud – funds that the defendants allegedly took from the debtors in connection with the LBO).

Cash in U.S. $100 bills, indicating litigation damages

The Defendants (seller/shareholder) to the litigation argued that the litigation trust should not be able to recover a windfall by recovering amounts in excess of the unpaid claims in the case.  Id. at *1.  The Litigation Trust claimed that it can “recover the full amount of the fraudulent transfers” because Section 550 of the bankruptcy code allows the trustee to recover “for the benefit of the estate, the property transferred, or, if the court so orders, the value of the transferred property.”  Id. at *4 (quoting 11 U.S.C. 550).  Here, the property transferred to the defendants and the value of it are the same – the millions of dollars sought to be recovered.

The Court considered various cases from other jurisdictions that have held that “Section 550 damages are not capped to permit creditors to receive only the amount of their claims,” noting that the Third Circuit Court of Appeals appeared not to have ruled on this issue.  PAH Litigation Trust, 2017 WL 5054308 at *4, *7(collecting cases).

The Court ultimately agreed with this line of cases because “[w]ere the Court to rule otherwise, it would mean that if Defendants are in fact liable for the fraudulent transfer, they would keep most if not all of the transferred money. The Court cannot countenance such an inequitable result if liability exists.”  Id. at *7.  Given the great quantity of bankruptcy cases filed in Delaware, it will be interesting to see if this holding is followed by other courts in the Third Circuit.

The Bankruptcy Court for the Southern District of Florida recently held that a chapter 7 trustee is not bound by a debtor’s pre-bankruptcy waiver of its jury rights for fraudulent transfer claims brought by the trustee under Section 548 of the Bankruptcy Code.  In Bakst v. Bank Leumi, USA (In re DIT, Inc.), 575 B.R. 534 (Bankr. S.D. Fla. 2017), the chapter 7 trustee sued to recover alleged fraudulent transfers related to certain payments by a corporate debtor to its lender and included a jury demand.  The lender moved to strike the trustee’s jury trial demand, claiming that the debtor had waived the right to a jury in certain contracts entered by the debtor before it filed for bankruptcy.

Court Pillars
Copyright: bbourdages / 123RF Stock Photo

The Bankruptcy Court for the Southern District of Florida considered a variety of arguments made by the lender but ultimately found that the even if the face of a pre-petition contractual jury waiver by the debtor, the trustee still retained the right to a jury.  The Court explained that there is an important distinction between litigation claims “owned by the debtor prior to the bankruptcy and that became property of the estate under section 541” of the Bankruptcy Code and litigation claims “that may only be brought by the estate under the avoidance provisions of the Bankruptcy Code, such as the fraudulent transfer claims presented here under section 548” of the Bankruptcy Code.  Id. at 536.

Under Section 541 of the Bankruptcy Code, the bankruptcy estate created by the filing of bankruptcy includes “all legal and equitable interests of the debtor in property as of the commencement of the case.”  11 U.S.C. § 541(a)(1).  These pre-existing litigation claims owned by the debtor under Section 541 are subject to all the defenses that would have otherwise been available pre-petition.  Bakst, 575 B.R. at 536.  However, for claims created by the Bankruptcy Code – such as fraudulent transfer avoidance actions – the Bankruptcy Court for the Southern District of Florida held that the trustee is not bound by the debtor’s contractual jury waiver that occurred prior to bankruptcy.  Id.

This may also arise with respect to agreements to arbitrate, for which the Court explained that “a debtor’s pre-bankruptcy agreement to arbitrate disputes with a particular creditor is binding on the estate with regard to claims held by the debtor that are later pursued by the estate representative, as such claims become part of the estate under section 541.  But, the estate is not bound by a debtor’s pre-bankruptcy arbitration agreement when the estate seeks relief under the Bankruptcy Code itself.”  Id. (citing Hays & Co. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 885 F.2d 1149, 1155 (3d Cir. 1989), among other cases).