Friday, December 18, 2015

Ponzi Schemes

By Bill Siegel

The Bankruptcy Code allows payments (or transfers) made to creditors to be recovered (or “avoided” in the parlance of the Bankruptcy Code) if the payments have been made by the debtor “with actual intent to hinder, delay or defraud” creditors.  Because it is difficult to prove that a transfer was made with such actual intent, many courts have applied the so-called “Ponzi scheme presumption” which allows a court to assume that a transfer was made with the “actual intent to hinder, delay or defraud” because “it is impossible to imagine any motive for such conduct other than … [such] actual intent….” (1)

 In McFarland v. Gen. Electric Capital Corp. (In re Int’l Mfg. Grp., Inc.), 538 B.R. 22 (Bankr. E.D. Cal. 2015), the bankruptcy trustee filed a fraudulent transfer lawsuit against GECC for the purpose of avoiding four (4) transfers of $500,000.00 each made by Olivehurst Glove Manufacturers, LLC (Olive Grove).  Olive Grove had filed for bankruptcy and was a related entity to another debtor, International Manufacturing Group, Inc. (IMG).  IMG was the Ponzi scheme Debtor and actually owed the debt to GECC.  Importantly, though ancillary to this article, Olivehurst’s bankruptcy case had been substantively consolidated with IMG’s bankruptcy case.  
After being sued, GECC moved to dismiss the complaint alleging that the trustee failed to plead fraud with particularity, a normal requirement in a case alleging fraud, and that the Trustee failed to state a claim under which relief could be granted.  More specifically, GECC alleged the Trustee had failed to sufficiently plead that the transfers were made with the actual intent to hinder, delay or defraud creditors.  The bankruptcy court denied the motion by first noting that the complaint sufficiently alleged that each transfer was made in furtherance of IMG’s Ponzi scheme in that the transfers were made to ensure that the principal of IMG could continue to carry out his scheme.  With this in mind, the court found that these allegations were sufficient to state a claim of actual fraudulent intent.  Secondly, the Court noted that when a Ponzi scheme has been alleged, there is a presumption of actual intent to defraud in all transactions in furtherance of the scheme. Thus, the court found that the trustee adequately alleged sufficient connections between the Ponzi scheme and the payments to GECC, which then triggered the presumption.  

The Fifth Circuit Court of Appeals adopted the Ponzi presumption in Warfield v. Byron, 436 F.3d 551, 558 (5th Cir. 2006) and affirmed its use in Janvey v. Golf Channel, 780 F.3d 641, 645 & n. 6 (5th Cir. March 11, 2015).  However, the presumption has recently been subjected to some criticism.  Whether that criticism was the cause of the Fifth Circuit vacating the Golf Channel decision in June 2015 is speculation; but the court certified a question to the Texas Supreme Court regarding the application of the Texas Uniform Transfer Act’s definition of value.  Indeed, the criticism has arisen in cases where the facts are more attenuated – such as where the specific transfers in question do not meet the classic Ponzi scheme paradigm of payments made to old investors through funds invested by new ones.  In In re Pearlman, 440 B.R. 900 (Bankr.M.D.Fla 2010) and In re Phoenix Div. Inv. Corp., No 10-03005-EPK, 2011 WL 2182881 (Bankr.S.D.Fla. June 2, 2011), both Florida courts did not apply the presumption finding that there was insufficient evidence to show that the transfers were made in furtherance of the Ponzi scheme.

Recently, the Minnesota Supreme Court in Finn v. Alliance Bank, (2)  rejected the Ponzi scheme presumption as well.  In rejecting the presumption, the Finn court stated succinctly that fraudulent transfer claims cannot prevail, under the Ponzi scheme presumption or otherwise, when the facts show that the transfer was part of a legitimate loan with an actual borrower and that repayment was made in the normal course.  

Whether this and cases like it signal a reconsideration of the underpinnings of the presumption remain to be seen.  Nevertheless, in the event a trustee seeks to recover fraudulent transfers made in furtherance of a Ponzi scheme, be advised that it may be difficult to seek dismissal of the case based on whether or not the trustee has sufficiently alleged fraud.  In addition, there may be a presumption that the transferee will have to overcome to show that the transfers were not made with the actual intent to defraud. 


(1)  In re Bayou Group, LLC, 362 B.R. 624, 634 (Bankr. S.D.N.Y. 2007).  The first court to explicitly characterize the presumption was the district court in Bear, Sterns Sec. Corp. v. Gredd (In re Manhattan Inv. Fund Ltd.), 266 B.R. 52, 57 (S.D.N.Y. 2002).

(2)  860 N.W.2d 638 (Minn. 2015).

Return to list.