Tag Archives: fraudulent

June 23, 2015

Fifth Circuit Holds that “Value” under the Uniform Fraudulent Transfer Statute Requires a Showing of Value to the Transferor’s Creditors Where the Transferor Operated a Ponzi Scheme

In its decision in Janvey v. The Golf Channel, 2015 WL 1058022 (5th Cir. 2015), the Fifth Circuit reiterated its requirement that value for purposes of the Uniform Fraudulent Transfer Act requires a showing of value to the transferor’s creditors where the transferor was operating a Ponzi scheme.  The facts in the case were undisputed.  Stanford International Bank operated a Ponzi scheme over the course of many years.  In order to increase its name recognition, Stanford decided to sponsor the St. Jude’s Championship, a golf tournament broadcast on The Golf Channel.  The Golf Channel offered Stanford an advertising package which included a range of marketing services, and for which Stanford paid The Golf Channel $5,900,000 by the time it was placed into receivership.  The receiver sued to recover these payments on the grounds that they were fraudulent transfers

In light of established Fifth Circuit precedent providing that transfers made by the perpetrator of a Ponzi scheme are fraudulent for purposes of the UFTA, the parties stipulated that the payments by Stanford to The Golf Channel were fraudulent.  The parties also stipulated that The Golf Channel acted in good faith in accepting the payments.  Consequently, the only issue in the dispute was whether, in providing advertising and marketing services to Stanford, The Golf Channel gave reasonably equivalent value in exchange for the payments. 

In finding that The Golf Channel did not give reasonably equivalent value, the court held that the market value of the marketing and advertising services failed to meet the standards for “value” under the statute.  The court held that “value,” for purposes of the UFTA is measured “from the standpoint of the creditors, not from that of a buyer in the marketplace.”  Further, the court held that services—even legitimate services provided by an entity which has no knowledge of the fraudulent scheme—which further the scheme, have no value as a matter of law.  When dealing with a Ponzi scheme, which is inherently illegitimate and insolvent from its inception, the court stated that the “primary consideration . . . is the degree to which the transferor’s net worth is preserved.”  As a result, the fact that The Golf Channel’s services would have been valuable to legitimate businesses in the marketplace was of no moment.  In the context of a Ponzi scheme, they had no value as a matter of law.

June 9, 2015

Seventh Circuit Holds that a Debt Created by Fraud may be Discharged if the Fraud was Perpetrated by the Debtor’s Agent, so long as the Debtor was not Complicit in the Fraud

In the case of Sullivan v. Glenn (In re Glenn), No 14-3213 (7th Cir. 2015), the Seventh Circuit Court of Appeals held that a debt which was incurred as a result of fraud perpetrated by the debtor’s agent is dischargeable, so long as the debtor was not complicit in the agent’s fraudulent conduct.  The facts involved a loan made by Brian Sullivan to the Glenns through the actions of a loan broker by the name of Karen Chung.  Chung and Sullivan knew each other.  In fact, Sullivan, an attorney, had represented Chung on more than one occasion.  In this transaction, however, Chung acted as the agent of the Glenns in seeking a bridge loan of $250,000 pending the closing of a bank loan for $1,000,000.  Chung convinced Sullivan to loan the Glenns $250,000 on a short-term basis at a high interest rate, representing to Sullivan that a bank had agreed to give the Glenns a loan of $1,000,000.  Chung represented to the Glenns that she had negotiated the bank loan and that it had been approved.  Based on Chung’s representations, Sullivan made the loan to the Glenns, and the Glenns signed promissory notes to Sullivan.  As it turned out, there was no bank loan at all.  After the Glenns filed bankruptcy, Sullivan filed an adversary proceeding seeking denial of the discharge of his loan based on fraud.

Sullivan raised two arguments to justify denial of the debtors’ discharge, both of which were rejected by the Seventh Circuit.  First, Sullivan argued that a debtor’s complete innocence in connection with the fraud should not be a defense to nondischargeability.  The court rejected this “debt not the debtor” theory for denying a discharge, even though it agreed the theory was consistent with the language of § 523, stating this argument “just illustrates the limitations of literal interpretation of statutory language.”  The court illustrated this limitation by taking Sullivan’s argument to its logical conclusion:  if Chung, who was jointly liable with the Glenns on the loan, had assigned the debt to an innocent third party who agreed to assume it, and that third party later filed bankruptcy, Sullivan under his theory could obtain a judgment denying the discharge of the debt in that innocent third party’s bankruptcy case.  The court concluded the intent of § 523 did not go that far, and rejected the “debt not the debtor” argument advanced by Sullivan.

The court then addressed Sullivan’s agency argument, contending that Chung’s fraud should be charged to the Glenns.  Sullivan contended that an agent’s fraudulent conduct must always be binding on his principal, even if the principal had not knowledge of the fraud.  The court rejected this argument, and agreed with the Eighth Circuit’s opinion in In re Walker, 726 F.2d 452, 454 (8th Cir. 1984) that denial of a discharge of a debt based on an agent’s fraudulent conduct requires “proof which demonstrates or justifies an inference that the debtor knew or should have known of the fraud.”  On the facts before it, the Seventh Circuit determined that, as between the Glenns and Sullivan, the Glenns were the more innocent party, and Sullivan was in the better position to protect himself.  As a result, the court affirmed the judgment in favor of the Glenns.

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.

May 23, 2013

Tenth Circuit Holds that Property Transferred by the Debtor Pre-petition and Subject to Avoidance is not Protected by the Automatic Stay

Section 541(a)(1) defines “property of the estate” to include all legal or equitable interests of the debtor in property as of the commencement of the case.  Although this broad definition brings into the estate many assets to which the debtor may claim entitlement, the Tenth Circuit Court of Appeals held in Rajala v. Gardner, 709 F.3d 1031 (10th Cir. 2013) that it is not so broad as to include property transferred by the debtor pre-petition and which is subject to avoidance, but not yet recovered by the trustee. 

The debtor in Rajala owned several wind-generated power projects and entered into a Memorandum of Understanding with Edison Capital to sell three of those projects to Edison.  The debtor’s insiders formed a new entity (“Newco”) which received an alleged fraudulent transfer of the three projects, and which then concluded an agreement with Edison for the sale of the projects.  Eventually Newco brought suit against Edison in federal court in Pennsylvania seeking to recover the last installment due under the contract. 

The debtor was placed into bankruptcy in Kansas after Newco’s Pennsylvania suit was commenced. 
The bankruptcy trustee brought suit in federal district court in Kansas against Newco and the insiders alleging that the transfer of the power projects to Newco was a fraudulent transfer.  The trustee requested the Kansas court to stay Newco and the insiders from pursuing the Pennsylvania litigation, asserting that the proceeds from any judgment would be property of the debtor’s bankruptcy estate and that the automatic stay precluded Newco and the insiders from prosecuting the Pennsylvania action.  The Kansas court denied the motion, and the trustee prosecuted an appeal.

On appeal the Tenth Circuit stated that “the underlying issue we must decide is whether a bankruptcy estate includes fraudulently transferred property that the Trustee has not yet recovered.”  The Tenth Circuit held that such property does not become property of the estate until such time as the trustee recovers it. 

The court arrived at its conclusion by analyzing the plain language of sections 541(a)(1) and 541(a)(3) of the Bankruptcy Code.  The former defined property to include “all legal or equitable interests” the debtor has as of the date the petition is filed, while the latter brings into the estate “interest in property that the trustee recovers under section . . . 550.”  Section 550 empowers a trustee recover transferred property if the transfer is voidable under section 548.  The Tenth Circuit noted a dispute between the Fifth and Second Circuits over whether fraudulently transferred property constitutes property of the estate before it is recovered.  The Fifth Circuit has determined that it is and that the automatic stay protects such property, Am. Nat’l Bank of Austin v. MortgageAmerica Corp. (In re Mortgage America Corp.), 714 F.2d 1266 (5th Circ. 1983), whereas the Second Circuit has determined that it is not and that the automatic stay does not protect such property, Fed. Deposit Ins. Corp. v. Hirsh (In re Colonial Realty Co.), 980 F.2d 125 (2nd Cir. 1992). 

The Tenth Circuit found that the plain language of the statute supported the Second Circuit’s holding in Colonial Realty, and agreed with it.  The court determined that “equitable title” under section 541(a)(1) is such as will give the holder the right to acquire formal legal title. However, interpreting “equitable title” to include an interest in property that has been allegedly fraudulently transferred goes too far and violates concepts of equity.  Further, the court held that interpreting section 541(a)(1) to include property which is recovered by the trustee would render meaningless the provisions of section 541(a)(3).  In addition, because Fed. R. Civ. P. 65 and Fed. R. Bankr. P. 7065 provide a mechanism for a trustee to obtain injunctive relief prohibiting a transfer of property pending the outcome of a fraudulent transfer action, there was no policy reason to justify extending the automatic stay to property which is alleged to have been fraudulently transferred but has not yet been recovered.