Tag Archives: presumption

May 24, 2016

Default Interest Rates are Presumed Reasonable Under Sec. 506(b), and a Bankruptcy Court May Not Use the Fair and Equitable Language of Sec. 1129(b) to Conclude Otherwise

The Ninth Circuit BAP recently discussed on appeal the issue of whether a bankruptcy court may use the “fair and equitable” standard for confirmation in § 1129(b) to deny an oversecured creditor default interest on its claim to which it would otherwise be entitled under § 506(b). In Wells Fargo Bank, N.A. v. Beltway One Development Group, LLC (In re Beltway One Development Group, LLC), 547 B.R. 819 (9th Cir. BAP 2016), the Ninth Circuit BAP concluded that the fair and equitable standards for confirmation deal with treatment of an allowed claim post-confirmation, but that allowance of an oversecured claim is governed by § 506(b). The BAP held the bankruptcy court erred In using § 1129(b) to deny Wells Fargo default interest on its claim.

The facts in Beltway One were straightforward. The value of the bank’s collateral exceeded the amount the bank was owed. The debtor’s plan, however, provided that the bank would not be entitled to any default interest on its claim, and treated the claim by modifying its terms and providing for payment amortized over 30 years. The plan further provided that any pre-effective date defaults would be deemed to have been cured. The debtor’s argument was that the default was “cured” because it was paid with a new loan; therefore, under the Ninth Circuit’s decision in Great Western Bank & Trust v. Entz-White Lumber and Supply, Inc. (In re Entz-White Lumber and Supply, Inc.), 850 F.2d 1338 (9th Cir. 1988), the default had been cured and the bank was not entitled to default interest during the pendency of the case. Wells Fargo opposed confirmation, asserting the plan did not meet the “fair and equitable” test under § 1129(b)(1). The bankruptcy court agreed with the debtor, concluding the new loan under the plan “paid” the debt within the meaning of Entz-White, and confirmed the plan.

The BAP reversed. The BAP noted a major factual difference between the Beltway One plan and the Entz-White plan in that the debtor in Entz-White­ actually cured the defaults on its secured creditor’s debt by paying the debt in full on the effective date of the plan, whereas Beltway One merely restructured the terms of its secured debt with Wells Fargo. Consequently, the BAP concluded Entz-White was not applicable to the present case. The BAP stated that determining post-petition interest on an oversecured claim under § 506(b) “is an issue separate and distinct from the fair and equitable test for plan confirmation under § 1129(b). The BAP held that determination of interest on an oversecured debt is a claim issue, not a confirmation issue.

This holding did not end the inquiry, however. The BAP also concluded that entitlement to default interest during the pendency of the case “is not automatic but may be allowed upon demonstrating that it meets certain requirements.” The BAP stated that the determination is accompanied with a presumption that the contract’s default interest rate is reasonable unless the debtor introduces evidence that it is not. The BAP based its conclusion on the Ninth Circuit’s decision in Gen. Elec. Capital Corp. v. Future Media Prods., Inc. (In re Future Media), 536 F. 3d 969 (9th Cir.), amended 547 F.3d 956 (9th Cir. 2008), which held that, if Entz-White does not apply, then the bankruptcy court must evaluate the viability of the contractual default interest rate by using applicable “substantive law creating the debtor’s obligation, subject to any qualifying or contrary provisions of the Bankruptcy Code.” In other words, the bankruptcy court should apply a presumption of allowability for the contract default interest rate, provided the rate is not unenforceable under applicable non-bankruptcy law. The creditor enjoys a presumption that the contracted for rate is reasonable, and the debtor bears the burden of demonstrating it is not, or that the rate is not enforceable under applicable non-bankruptcy law.

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.”