Eleventh Circuit Decides Ponzi Scheme Case

Once a Ponzi scheme operated by a bankrupt debtor is established, the bankruptcy trustee can avoid the transfers received by the investors which were in excess of their principal investment. Donell v. Kowell, 533 F.3d 762 (9th Cir. 2008). Theses transfers are known as fictitious profits. The fictitious profits are considered fraudulent transfers because the source of the profits was a theft from other investors. Id. at 771. Requiring investors to return the fictitious profits prevents the injustice that would result if the investors were allowed to retain these funds at the expense of other defrauded investors.

Pursuant to 11 U.S.C. § 548(c), a transferee, including a Ponzi scheme investor, has an affirmative defense if the transferee acts in good faith and gives value in exchange for the transfer. The term “value” is defined to include “satisfaction or securing of a present or antecedent debt of the debtor.” 11 U.S.C. §548(d)(2)(A). Accordingly, a good faith, defrauded investor gives “value” to the debtor in exchange for a return of the principal amount of the investment, but not as to any payments in excess of the principal. Id. at 772.

For the first time in the Eleventh Circuit, the issue of whether the “for value” defense can also apply to an investor who has an equity interest in the Ponzi scheme debtor was addressed in the case of Perkins v. Haines, 2011 WL 5103951 (11th Cir.). In Perkins, the Debtor corporations, which operated as purported hedge funds, allowed capital contributions from later equity investors to be used to repay earlier investors more than their investments were actually worth. Id. at 1. A receiver ultimately filed voluntary chapter 11 bankruptcy petitions on behalf of the Debtors. Id. The Chapter 11 Plan Trustee then instituted a number of adversary proceedings seeking to avoid and to recover distributions made to the Debtors’ investors. Id. The Trustee claimed that transfers to the investors prior to the collapse of the Ponzi scheme were “fraudulent transfers” under 11 U.S.C. §548(a)(1)(A) and applicable state law. Id. The Trustee sought to avoid and recover not just the fictitious profits, but all payments to the investors, claiming that all payments were to redeem their equity interests, rather than in satisfaction of a debt. Id. at 2. The investors asserted an affirmative defense under 11 U.S.C. §548(c), claiming that the transfers were “for value.” Id. The Trustee moved for partial summary judgment, which the bankruptcy court denied, effectively upholding the availability of the investors’ affirmative defense. Id. The Trustee appealed to the Eleventh Circuit.

The Circuit Court recognized that the equity investors were fraudulently induced into making their investments and therefore possessed fraud claims that would be satisfied in whole or in part by virtue of the later transfers. Id. at 3. Therefore, in affirming the bankruptcy court, the Circuit Court rejected the Trustee’s attempt to distinguish between equity investments and debt-based claims when applying the general rule to fraudulent transfer actions arising out of a Ponzi scheme. Id.

This article was submitted by Marc P. Barmat, Furr and Cohen, P.A., One Boca Place, Suite337 West, 2255 Glades Road, Boca Raton, FL 33431; mbarmat@furrcohen.com