Category Archives: Receivership

April 28, 2015

Minnesota Supreme Court Rejects the “Ponzi Scheme Presumption” in Connection with the Uniform Fraudulent Transfer Act

Rejecting the reasoning of a number of opinions by federal courts, the Minnesota Supreme Court has held that the “Ponzi Scheme Presumption” does not apply to claims brought under the Minnesota Uniform Fraudulent Transfer Act (“MUFTA”).  Patrick Finn and Lighthouse Management Group, Inc. v. Alliance Bank et al, 2015 WL 672406 (Minn. 2015).  The case involved the fraudulent lending operations of First United Funding, which was placed into receivership.   First United operated a Ponzi scheme, but also ran other legitimate business operations.  The receiver brought actions against Alliance Bank and others seeking to recover funds under the MUFTA.  The receiver argued that the “Ponzi Scheme Presumption” entitled him to a judgment on the following key elements of his claims:  (1) the transfers in question were made with actual intent to hinder, delay or defraud any creditor of First United, (2) First United was insolvent on the dates of the transfers in question and (3) the recipients of the transfers did not provide reasonably equivalent value in exchange for the transfers.  The Minnesota Supreme Court rejected the presumption in all three instances.

The court began its analysis by noting that the “Ponzi-scheme presumption, by operation of its three components, allows a creditor to bypass the proof requirements of a fraudulent-transfer claim by showing that the debtor operated a Ponzi scheme and transferred assets ‘in furtherance of the scheme.’”  However, the court then stated that the statute “neither mentions nor defines a ‘Ponzi scheme.’”  In reviewing the statute, the court noted that it contains no provision allowing a court to make any presumptions based on the existence of a Ponzi scheme.  The court interpreted the statute as one which deals with transfers on a transfer-by-transfer basis and not the structure of the entity making the transfer in question.  Next, the court noted the statute contains a list of “badges of fraud” which a court may rely on to determine if the debtor transferred assets with the intent to hinder, delay or defraud any creditor, and that the operation of Ponzi scheme is not one of those badges.  The court stated: “[T]he Legislature’s enumeration of a specific list of badges of fraud, none of which are conclusive, precludes an interpretation that it intended a non-enumerated badge of fraud to be conclusive.”  (emphasis in original).  As a result, the court concluded that, while the existence of a Ponzi scheme may allow the court to draw a rational inference that a transfer was made with fraudulent intent, the existence of such a scheme does not relieve the creditor from his burden of proof under the statute. 

The court also rejected the notion that a Ponzi scheme presumption conclusively establishes that a debtor was insolvent on the date the transfer was made.  Again, the court noted that the statute does not define insolvency with a view to whether the debtor was operating a Ponzi scheme.  Instead, the court noted the statute provides that “a debtor is insolvent if the sum of the debtor’s debts is greater than all of the debtor’s assets, at a fair valuation.”  In addition, the court noted that the statue does contain a presumption on insolvency if the debtor is not generally paying debts as they become due.  Adding a presumption of insolvency based on the existence of a Ponzi scheme would, in the court’s words, require it to “add language to MUFTA, something we cannot do.”  Further, since some perpetrators of Ponzi schemes also run legitimate businesses, and since some Ponzi schemes start out as legitimate businesses and only degenerate into a Ponzi scheme at a later point in time, the court concluded that a conclusive presumption of insolvency when a debtor operates a Ponzi scheme “may be incorrect, both as a matter of law and as a matter of fact.” 

The court finally rejected the third component of the Ponzi scheme presumption – that the recipient can never give reasonably equivalent value in exchange for the transfer.  The court noted that the lack of reasonably equivalent value is an element of proof in a claim for constructive fraudulent transfers, and the existence of reasonably equivalent value is an element of proof in a defense to a claim for actual fraudulent transfers.  Again, the court noted the statute delineated several specific types of reasonably equivalent value – non-collusive foreclosure sales, the execution of a power of sale for the disposition of property on default under a mortgage, deed of trust or security agreement and the satisfaction or securing of an antecedent debt – and that the existence of a Ponzi scheme was not included by the legislature in the statute.  The court also rejected some of the “fairness” and “policy” arguments advanced by the receiver to justify the presumption.  First, the court rejected the policy argument that all contracts between a Ponzi scheme perpetrator and his victims are unenforceable as a matter of public policy.  The court rejected this argument because not every Ponzi scheme – First United’s included – lacks a legitimate source of earnings.  In this instance, while no one argued that First United did not operate a Ponzi scheme, it was also clear that it had legitimate business operations and that the defendants had purchased non-oversold participation interest in actual loans to real borrowers, which provided First United with a legitimate source of earnings from which it could pay the banks which purchased these interests.  Second, the court rejected the policy argument that the Ponzi scheme presumption operates to the beneficial purpose of treating all creditors equally.  The court noted the absence of language in the statute setting out equality of treatment as a goal, and held that the statute does not prevent a debtor from making a preferential transfer in favor of one bona fide creditor over another so long as the transfer is not fraudulent.

September 9, 2013

When an SEC Equity Receiver may, and may not, Use the “Ponzi Presumption” in Fraudulent Transfer Cases

Charles Ponzi’s scheme through which he convinced investors to lend him money which he promised to repay at high interest rates, was completely unsupported from its inception by any assets or legitimate business.  High rates of return were promised to investors, and those returns were financed exclusively from funds raised from new investors.  The payment of these high returns allowed Ponzi to attract new investors. This type of classic Ponzi scheme is insolvent and fraudulent from its inception.  An equity receiver appointed in such a classic case enjoys the “Ponzi presumption,” an evidentiary presumption that establishes, solely on the basis that the perpetrator was operating a Ponzi scheme, that the perpetrator’s transfers during the course of the scheme were made with actual intent to hinder, delay or defraud creditors.  This presumption shifts the
burden of proving the legitimacy and good faith of the transfer to the defendant.

However, throughout the years, other fraudulent schemes which are nevertheless backed in part by some assets or a legitimate business have exhibited characteristics of a Ponzi scheme.   In these cases, is the equity receiver entitled to the same “Ponzi presumption” which applies in classic Ponzi cases?  The United States District Court for the District of Utah has held that an equity receiver in a non-classic Ponzi case cannot avail himself of the Ponzi presumption. Securities and Exchange Commission v. Management Solutions, Inc. et al, 2:11-cv-1165BSJ, Doc. 1215 (D. Utah August 22, 2013). 

In Management Solutions, the receiver filed a number of ancillary actions seeking to recover monies transferred by Management Solutions, Inc. (“MSI”) to various investors.  Seeking to rely on the “Ponzi
presumption” to establish that the transfers were made with actual intent to hinder, delay or defraud creditors, the receiver filed a Motion for Findings Regarding the Existence and Start Date of an Alleged Ponzi Scheme and for Approval to Pool Claims and Assets for administrative purposes of the
receivership.  Several of the defendants targeted in the Motion objected to the relief sought.

In determining the receiver’s request, Judge Bruce Jenkins provided an in-depth examination of the history of Ponzi schemes and their historical treatment by the courts.  Judge Jenkins examined the case law from the various circuits addressing the elements necessary to establish the existence of a Ponzi scheme.  From that examination, Judge Jenkins noted that “courts around the country have defined a Ponzi scheme in various ways.”  However, he also concluded that all of the definitions have a common base:  “a Ponzi scheme is a fraudulent investment scheme in which ‘returns to investors are not financed through the success of the underlying business venture, but are taken from principal sums of newly attracted investments,’” citing In re Independent Clearing House Co., 41 B.R. 985, 994 n. 12 (Bankr. D. Utah 1984). 

Judge Jenkins noted that the facts in the MSI case established that MSI was not operating a classic Ponzi scheme because its business operations included substantial real estate business operations which generated substantial revenues.  Because MSI engaged in legitimate business operations, Judge Jenkins found that its scheme was not a “classic” Ponzi scheme in the nature of that run by Charles
Ponzi.  Consequently, in assessing the receiver’s Motion, Judge Jenkins held that, in order to establish that a fraudulent investment scheme is a Ponzi scheme, a receiver must establish by a preponderance of the evidence two things:  (1) that returns to earlier investors were paid by funds from later
investors and (2) that returns to investors could not be paid by the underlying legitimate business venture. 

Judge Jenkins held that the Ponzi presumption is appropriate in classic cases, where the scheme is “fraudulent from the beginning, with no assets other than investor contributions, no legitimate business, commingled investment funds, and preferential transfers to early investors from the
contributions of subsequent investors.” However, he ruled that use of the presumption in cases where the perpetrator’s operations include legitimate business functions but also represent some characteristics of a Ponzi scheme is inappropriate and might actually penalize innocent conduct.  The
court stated that the Ponzi presumption is “but a tool.  It is not a shortcut or substitute for proof.  In the finding of Ponzi schemes, it is applicable where appropriate and if not, then proof of inappropriate activity on the part of a target, not the mere affixing of a label by the Receiver, is required.”  Judge Jenkins ended his Memorandum Opinion by stating that the Ponzi presumption should be of limited use and applied only in those cases “as blatant and as plain as the original Charles Ponzi case and the more recent Madoff case:  assetless and fraudulent from day one.”

August 26, 2013

Tenth Circuit Set Parameters of Application of UFTA Statute of Limitations on SEC Equity Receiver’s Claims for Fraudulent Transfer

In a recent opinion, the Tenth Circuit Court of Appeals addressed several issues relating to the application of the statute of limitations in the Uniform Fraudulent Transfer Act on fraudulent transfer
claims asserted by an equity receiver appointed in an SEC civil enforcement action.  The decision was rendered in Wing v. Buchanan (Tenth Circuit No. 12-4123, August 9, 2013). 

Wing was appointed receiver for VesCor Capital, Inc. and a number of its affiliates in connection with a civil enforcement action brought by the SEC.  Prior to the filing of the SEC action, VesCor Capital, Inc. filed a voluntary bankruptcy petition under chapter 11 of the Bankruptcy Code.  However, the affiliates involved in the receivership proceeding did not file bankruptcy petitions.  The bankruptcy court ordered the appointment of a chapter 11 trustee approximately seven months before the SEC action was commenced and ten months before the receiver was appointed. 

Wing filed an action against Buchanan seeking to recover payments made by VesCor Capital and several of its affiliates under the UFTA, alleging that VesCor operated a Ponzi scheme and, therefore, these payments were “by definition, made to hinder, delay or defraud creditors and/or investors of VesCor.”  The timing of the filing of the receiver’s complaint was a critical fact in the dispute:  it was filed more than four years after the transfers in question, more than one year after the appointment of the bankruptcy trustee, but within one year of the receiver’s appointment.  Buchanan alleged that the complaint was barred by the statute of limitations found at Utah Code § 25-6-10.  That statute provides that an action seeking to recover transfers based on allegations of actual fraud must be filed within four years after the transfer was made or, if later, within one year after the transfer was or could reasonably have been discovered by the claimant.  The district court rejected Buchanan’s argument and entered summary judgment in favor of the receiver.

The Tenth Circuit began its analysis by concluding that Utah would adopt the adverse domination theory so that the discovery period for such transfers would not begin to run until the bad actors controlling the entity were removed.  The adverse domination theory recognizes that control of the transferor by its bad actors precludes the possibility of filing suit because these individuals would have no motivation to reveal their fraud by filing suit to claw back fraudulent transfers.  The Tenth Circuit ruled that limitations did not begin to run until Val Southwick, the bad actor controlling
the VesCort entities, was removed from control.

That holding lead to the next question—whether Southwick was “removed” for purposes of the statute when the bankruptcy trustee was appointed in the VesCor Capital bankruptcy case, or whether it began running when the receiver was appointed in the SEC action.  Because some of the transfers were likely made by entities that had not been included in the bankruptcy proceedings, the Tenth Circuit vacated the summary judgment in favor of the receiver and remanded the case to the district court to determine which of the transfers could reasonably have been discovered by the bankruptcy trustee, thereby triggering the statute of limitations on the trustee’s appointment.

The receiver raised two arguments before the appellate court which were rejected.  First, he asserted that limitations could not begin running on the trustee’s appointment because the
receiver is the “claimant” for purposes of the UFTA.  The court rejected that argument, ruling that
it is the companies in receivership and their creditors who are claimants that benefit from the discovery rule, and if their claims are barred by limitations, a subsequent appointment of a receiver will not resurrect otherwise stale claims.  The court also noted that such an interpretation would enable receivers to manipulate the statute by causing a receivership entity to file a bankruptcy petition and thereby gain the commencement of a new statute of limitations on claims that may be barred in the receiver’s hands.  Wing also asserted that the district had equitable discretion to disregard the statute of limitations altogether, citing the Tenth Circuit’s statement in SEC v. VesCor Capital Corp., 599 F.3d 1189, 1194 (10th Cir. 2010) that a “district court has broad powers and wide discretion to determine relief in an equity receivership.”  The court stated that the receiver had
misinterpreted this prior language. The court explained that a district court sits in equity when determining the distribution of assets already in a receiver’s control, but that a district court does not sit in equity when adjudicating a receiver’s claims against third parties to recover property.

March 30, 2011

Ninth Circuit Determines Applicable Law for Appointment of Receivers in Diversity Cases

by Robert Faucher, Partner
Boise, Idaho

BobFaucherLenders often seek the appointment of a receiver pending foreclosure of deeds of trust against real property.  In Idaho, the appointment of a receiver is governed by Idaho Code § 8-601A, which authorizes the appointment of a receiver where the real property that is the subject of the deed of trust is “in danger of substantial waste or . . . the income therefrom is in danger of being lost, or. . . the property is or may become insufficient to discharge the debt which it secures.”  On the federal side, Fed. Rule Civ. Proc. 66 specifically states that the federal rules of civil procedure apply in an action in which the appointment of a receiver is sought.

Prior to the issuance of the Ninth Circuit’s opinion in Canada Life Assurance Co. v. LaPeter, 563 F.3d 837 (9th Cir. 2009), the law was unclear on whether the appointment of a receiver in a federal diversity action was governed by state law or federal law.

In Canada Life, the borrower brought suit against the lender for breach of a loan commitment which Canada Life had terminated due to misrepresentations made by the borrower.  In a separate action commenced after the borrower defaulted, Canada Life sought the appointment of a state court receiver over its collateral.  LaPeter removed the action on grounds of diversity, and the District Court was required to determine whether the appointment of a receiver in a diversity action is governed by state law or federal law.  In affirming the District Court’s decision that federal law applies, the Ninth Circuit noted that the Eleventh and Eighth Circuits had also determined that federal law applies to a request for the appointment of a receiver in a diversity action.  Because the appointment of a receiver is an ancillary remedy which does not directly affect the outcome of the underlying action, the Erie doctrine is not applicable.  In addition, the Ninth Circuit noted that a federal court sitting in diversity may exercise equitable powers independent of state law.

Upon determining that federal law applies to a motion for the appointment of a receiver in a diversity action, the Ninth Circuit then ruled that an order appointing a receiver in a diversity action is reviewed on an abuse of discretion standard.  The court stated that a trial court has broad discretion in deciding whether to appoint a receiver, and may consider a host of relevant factors, and that no one factor is dispositive.