1. business and industrial
2. company
3. bankruptcy

PONZI SCHEME UPDATE PANEL
2015 CFBLA Seminar
TOPICS OUTLINE
A.
Practical Issues in the Ponzi Scheme Context:
-Address issues such as: discovering and proving the existence of a Ponzi
scheme1; reconstructing financial records; analyzing preference and fraudulent
transfer claims against net winners/net losers; quantifying investor claims; and
distributions to investors.
(See also attached 4 pg. materials re: same from 2012 ABI seminar)
B.
Brief Overview of Avoidance Actions in Ponzi Scheme Context
i.
Actual Fraudulent Transfer: Bankruptcy Code § 548(a)(1)(A)
In the Ponzi scheme cases, a trustee may avoid and recover transfers received by a
defendant within two years of the petition date under § 548(a)(1)(A), which
provides for recovery of transfers that the transferor “made . . . with actual intent
to hinder, delay or defraud….”2 If the transferor made a transfer with fraudulent
intent, section 548(a)(1)(A) is satisfied, the transferee’s intent is not relevant.3 In
cases involving a Ponzi scheme, the transferor’s fraudulent intent is inferred
because transfers made during the course of the Ponzi scheme are made for no
other purpose than to hinder, delay or defraud creditors.4
Once the trustee establishes the transferor’s actually fraudulent intent, all of the
two year transfers are recoverable unless the transferee can prove that it received
the transfers for “value” and in “good faith” under Section 548(c). Because
Section 548(c) is an affirmative defense, the transferee bears the burden of
proving both elements. Defendants who receive fictitious profits do not have a
Section 548(c) defense, as it has been universally held that an investor in a Ponzi
1
In order to prove the existence of a Ponzi scheme, the trustee must establish that: (1) deposits were made by
investors; (2) the debtors conducted little or no legitimate business; (3) the purported business operations of the
debtors produced little or no profits or earnings; and (4) the source of payments to investors was from cash infused
by new investors. See In re Pearlman, 400 B.R. 569, 575 (Bankr. M.D. Fla. 2010) citing Wiand v. Waxemberg, 611
F.Supp.2d 1299 (M.D. Fla. 2009).
2
11 U.S.C. § 548(a)(1)(A).
3
See In re Bayou Group, LLC, 439 B.R. 284, 304 (S.D.N.Y. 2010).
4
See In re World Vision Entertainment, Inc., 275 B.R. 641 (Bankr. M.D. Fla. 2002).
PONZI SCHEME UPDATE
scheme cannot provide value for transfers above the amount invested. Although
investors of principal typically do not, strictly speaking, provide “value” because
their money perpetuated the fraud, a good faith investor generally will,
nevertheless, be entitled to a tort claim of recession to recover the investment
principal.5
Although good faith is not defined in the Bankruptcy Code, cases have explained
that a transferee attempting to prove its good faith is subject to a two-step
analysis: (1) whether the transferee was on inquiry notice of the debtor’s fraud;
and if so, then (2) whether the transferee was diligent in its investigation.6 The
test for good faith is objective: “An objective, reasonable investor standard
applies to both the inquiry notice and the diligent investigation components of the
good faith test.”7 Willful blindness to a fraud constitutes inquiry notice.8
If a defendant is on inquiry notice of the debtor’s fraud, that defendant must
satisfy the “diligent investigation” requirement to establish good faith. This
requirement has been defined as requiring a transferee to demonstrate it “was
diligent in its investigation” of the facts, which is not satisfied by inquiring with
the transferor itself.9 If the defendant was on inquiry notice and failed to conduct
a diligent investigation, the transferee cannot establish a good faith defense under
Section 548(c). Additionally, if a diligent investigation is conducted that would
reinforce, rather than dispel, the concerns creating the inquiry notice, then no
good faith defense is supported. Finally, support for a finding of inquiry notice
can be found in a defendant’s decision to conduct some type of inquiry.10
ii.
Constructive Fraudulent Transfer: Bankruptcy Code § 548(a)(1)(B)
The trustee in a Ponzi scheme bankruptcy may also allege claims against
transferees based on constructive fraud under the Bankruptcy Code, which
provides that a transfer is constructively fraudulent if the debtors transfers
property in exchange for less than “reasonably equivalent value” while the debtor
is insolvent, regardless of the good or bad faith of the transferee.11 Again, as
discussed above, value is never received by the debtor in exchange for fictitious
5
See In re Bayou Group, LLP, 396 B.R. 810, 844 (Bankr. S.D.N.Y. 2008).
See Manhattan Inv. Fund, 397 B.R. 1, 22-23 (S.D.N.Y. 2007).
7
In re Bayou Grou, LLC, 439 B.R. 284, 304 (S.D.N.Y 2010) (considering the “standards, norms, practices,
sophistication, and experience” of the participants in the defendant’s “industry or class.”).
8
Armstrong v. Collins, 2010 U.S. Dist. LEXIS 28075, at 82-83 (denying good faith defense because facts showed
that investor “could no longer ‘safely turn a blind eye’ to the mounting evidence that [debtor] was not engaged in
legitimate business.”).
9
See e.g. Manhattan Inv. Fund, 397 B.R. 1, 22-23 (S.D.N.Y. 2007).
10
See Manhattan Inv. Fund, 397 B.R. at 23.
11
11 U.S.C. § 548(a)(1)(B).
6
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PONZI SCHEME UPDATE
profits in Ponzi schemes.12 Accordingly, for the same reasons the trustee would
prevail on its actual fraud claim (no value), the trustee would generally also
prevail on its constructive fraud claim to avoid fictitious profits. On the issue of
good faith, “only innocent investors who reasonably believe that they were
investing in a legitimate enterprise are entitled to a claim for restitution” up to the
amount of their investment.
iii.
Fraudulent Transfer Claims Under Applicable State Law
Section 544 of the Bankruptcy Code empowers a trustee to recover fraudulent
conveyances under applicable state law, which often provides a long look-back
period than federal law. For example, Florida law allows a trustee to recover
transfers made within four years of the petition, as well as transfers made beyond
that four-year period based on the discovery rule.13 The underlying analysis
under Florida law is substantially the same as under the Bankruptcy Code – a
transfer may be avoided unless the transfer was taken both for value and in good
faith.
iv.
Preference Claims
Under Section 547, a trustee may bring preference actions to recover funds
transferred out of the Ponzi scheme during the 90 days pre-petition as to all
creditors, and during one year pre-petition as to insiders. To prevail on a
preference claim, the trustee must prove: (1) the transfer occurred during the
applicable preference period; (2) the debtor was insolvent at the time of the
transfer (or rendered insolvent by the transfer); and (3) the existence of an
antecedent debt.
An investment in a Ponzi scheme is considered an antecedent debt up to the
amount of the investment. Thus, the trustee may generally only bring a
preference claim to recover transfers that constituted the return of an investor’s
principal, and not to recover fictitious profits. Because there is no good faith
defense to a preference claim, the trustee is not required to establish the investor
was on inquiry notice to recover preference payments.
Additionally, a Ponzi scheme is considered insolvent as a matter of law since its
inception.14 As a result, establishing a preference action in the Ponzi scheme
context is generally not difficult, but the limited preference look-back period
reduces its usefulness.
12
See In re Bayou Group, LLC, 362 B.R. 624, 636 (Bankr. S.D.N.Y. 2007).
See Fla. Stat. 726.110.
14
In re Carrozzella & Richardson, 286 B.R. 480, 486 (D. Conn. 2002).
13
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PONZI SCHEME UPDATE
C.
Circuit
First Circuit
1995
Second Circuit
2005
Third Circuit
Summary of Circuit Authority on Non-Debtor Releases / Bar Orders
Case
Release?
In re Monarch Life Ins. Co. Probably
v. Ropes & Gray, 65 F.3d
yes
973, 980
In re Bernard L. Madoff Inv. Yes
Securities, LLC, 740 F.3d
81 (2d Cir. Jan. 13, 2014)
In re Continental Airlines,
203 F.3d 203
Maybe
In re A.H. Robins Co., Inc.,
880 F.2d 694
Yes
In re Vitro S.A.B. DE C.V.,
701 F.3d 1031, 1061
No
In re Dow Corning, Corp.,
280 F.3d 648
Yes
In re Airadign
Communications, Inc. v.
FCC, 519 F.3d 640, 655656
Yes
2000
Fourth Circuit
1989
Fifth Circuit
2012
Sixth Circuit
2002
Seventh Circuit
2008
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Position
In “extraordinary circumstances” a bankruptcy
court can grant permanent injunctive relief to
enable formulation and confirmation of a plan.
Affirming approval of Rule 9019 settlement
motion including a permanent injunction
enjoining any claim against certain third
parties “that is duplicative or derivative of the
claims brought by the Trustee, or which could
have been brought by the Trustee against the
[third parties].” See also MacArthur v. JohnsMansville Corp., 837 F.2d 89 (2d Cir. 1988)
(channeling injunction)
Section 524(e) does not automatically bar nondebtor releases, but debtor must establish
specific factual findings that the releases are
fair and necessary; however, debtor failed to
meet burden of proof, therefore unwarranted
under § 105(a).
Seeing no conflict between § 105(a) and §
524(e) and permitting non-debtor releases as
part of a restructuring plan pursuant to §
105(a) under certain factual circumstances if
releases are necessary / appropriate to carry out
the purposes of Chapter 11.
Stating that its prior precedent “seem[s]
broadly to foreclose non-consensual nondebtor releases in permanent injunctions.”
Seeing no conflict between § 105(a) and §
524(e) and permitting non-debtor releases as
part of a restructuring plan pursuant to §
105(a) under certain factual circumstances if
releases are necessary/appropriate to carry out
the purposes of Chapter 11.
Finding that § 524€ does not purport to limit
the bankruptcy court’s powers to release a nondebtor from a creditor’s claims, and that § 105
permits bankruptcy courts to release third
parties from liabilities under appropriate
circumstances. See also In re Ingersoll, 562
F.3d 640, 657 (7th Cir. 2009) (same).
PONZI SCHEME UPDATE
Eighth Circuit
The Eighth Circuit has not
addressed the issue of nondebtor releases, however,
bankruptcy courts within the
Eighth Circuit have
confirmed plans providing
for such
Ninth Circuit
In re Lowenschuss, 67 F.3d
1394
No
In re Western Real Estate
Fund, Inc., 922 F.2d 592
1990
(10th Cir. 1990), opinion
modified, 932 F.2d 898
(10th Cir. 1991)
Eleventh Circuit In re Superior Homes &
Investments, LLC, 521 Fed.
2013
Appx. 895 (11th Cir. 2013)
No
1995
Tenth Circuit
Yes
In re Seaside Engineering &
Surveying, Inc., 780 F.3d
1070 (11th Cir. March 12,
2015)
See e.g. In re U.S. Fidelis, Inc., 482 B.R. 503,
515-521 (Bankr. E.D. Mo. 2012) (explaining
that “[u]nder Master Mortgage, the court may
confirm a plan that includes compelled
releases of non-debtors, if such extraordinary
relief is warranted. Specifically, releases may
be included in a confirmed plan if exceptional
circumstances exist, the releases are widely
supported by the creditor constituency
(including those creditors who will be
restrained), the constituency to be restrained
receives significant benefits, and creditors as a
whole are being treated fairly”) citing In re
Master Mortgage Invest., Fund, Inc., 168 B.R.
930 (Bankr. W.D. Mo. 1994).
Seeing direct conflict between § 524(e) and
any interpretation of § 105(a) that would
permit releases.
Seeing direct conflict between § 524(e) and
any interpretation of § 105(a) that would
permit releases.
In Superior Homes, the Court approved a bar
order as the state-court litigation enjoined by
the bar order had a direct impact on the
bankruptcy case, relying on In re Munford,
Inc., 97 F.3d 449 (11th Cir. 1996. Similarly, in
Munford, the Court approved injunction and
bar order protecting a settling, nondebtor party
from suits by other nondebtors who had
contribution and indemnity claims.1516
15
Middle District: See also In re Land Resource, 505 B.R. 571 (M.D. Fla. Feb.10, 2014) (affirming bar
order/channeling injunction); In re GunnAllen Financial, 443 B.R. 908 (Bankr. M.D. Fla. 2011); In re
Fundamental Long Term Care, Inc., 515 B.R. 352 (Bankr. M.D. Fla. Aug. 15, 2014); In re Fundamental Long Term
Care, Inc., 2015 WL 1286058 (Bankr. M.D. Fla. March 20, 2015); In re Evaluation Solutions, LLC, 2013 WL
3306216 (Bankr. M.D. Fla. 2013); In re Transit Group, Inc., 286 B.R. 811 (Barkr. M.D. Fla. 2002).
16
Southern District: In re S&I Investments, 421 B.R. 569 (Bankr. S.D. Fla. 2009); In re Rothstein Rosenfeldt Adler,
P.A., 2010 WL 3743885 (Bankr. S.D. Fla. 2010)(collecting cases); In re Grau, 267 B.R. 896 (Bankr.S.D. Fla. 2001);
In re Jiangbo Pharmaceuticals, Inc., 520 B.R. 316 (S.D. Fla. 2014); In re Sentinel Funds, Inc., 380 B.R. 902 (Bankr.
S.D. Fla. 2008)
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PONZI SCHEME UPDATE
Circuit
D.C. Circuit
Case
In re AOV Indus., Inc., 792
F.2d 1140
Release?
Probably
yes
1986
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Position
Affirming confirmation of a plan of
reorganization, noting district court held plan’s
releases did not constitute an impermissible
discharge of non-petitioning third parties,
contrary to Bankruptcy Code § 524(e),
rendering
appellants’
challenge
to
confirmation moot.