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.
In 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.