By: Donald L Swanson
Question: Must a jury instruction, in a fraudulent transfer lawsuit involving an alleged Ponzi scheme, require a mens rea finding of actual fraudulent intent?
That’s a question addressed by the U.S. Ninth Circuit Court of Appeals in Kirkland v. Rund (In re EPD Investment Co., LLC), Case No. 22-55944 (opinion issued on August 23, 2024).
Kirkland v. Rund arises out of complicated bankruptcy procedures, resulting in the jury trial of a fraudulent transfer claim in the U.S. District Court for Central California, and an appeal therefrom to the Ninth Circuit.
The jury instruction adopted by the District Court at trial contains no mens rea requirement for an actual fraudulent intent finding.[Fn. 1]
Majority Opinion
The Ninth Circuit’s two-Justice majority, in Kirkland v. Rund, affirms the District Court’s jury instruction.
Here are the majority’s reasons.
“The district court’s jury instruction tracks, almost verbatim, how this Circuit has defined a Ponzi scheme for over thirty years” (at 17).
The Defendant’s proposed instruction on a Ponzi scheme “would have required the jury to find that the alleged ‘perpetrator of a Ponzi scheme’ . . . ‘must know that the scheme will eventually collapse as a result of the inability to attract new investors.’” The District Court “disagreed” and rejected that instruction (at 18).
The jury found that Debtor “operated an entity that meets the objective criteria of a Ponzi scheme” and that “implicit” in such finding is that Debtor’s operator “harbored the intent to defraud his investors by operating a scheme that had no legitimate profit-making opportunity.” So, the jury properly presumed an actual intent to defraud creditors (id.).
The District Court’s instruction has two essential elements: (1) the funneling of money from new investors to pay old investors, and (2) no legitimate profitmaking business opportunity exists for investors. Both “are objective factors” that courts and legal scholars rely upon exclusively (id.).
“If those objective elements were present, as the jury found, then the jury could reasonably infer” a fraudulent intent, because the scheme’s operator “must have known that his pyramid scheme would end at some point.” In fact, “no other reasonable inference is possible” (at 20).
“We are unaware of any court decision that has adopted an express mens rea requirement when defining a Ponzi scheme in a civil or bankruptcy action to avoid a fraudulent conveyance, and for good reason”:
- the basis for applying the Ponzi scheme presumption in the first place is that a Ponzi scheme is doomed to fail by virtue of its pyramid structure; and
- so, if the essential elements of a Ponzi scheme are truly present—consistent funneling of money from new investors to pay old investors where in fact no legitimate profit-making business opportunity exists—then the operator’s actual intent to defraud his investors and knowledge that the scheme will eventually fail follows logically and necessarily (at 21).
As a practical matter, the proposed mens rea instruction “could prove unworkable”:
- The purpose of a fraudulent transfer action is to allow trustees to recover assets or funds from profiting Ponzi scheme investors to equitably redistribute and minimize the losses suffered by losing Ponzi scheme investors;
- Objective criteria permit a factfinder to determine from the evidence whether the entity fosters legitimate profit-making opportunities or instead exists as a fraudulent scheme to funnel investments from new investors to old; and
- Trustees are unlikely to find direct evidence of the operator’s subjective intent to operate a Ponzi scheme because, as one bankruptcy court noted, it is “highly unusual” to “have a confession of guilt with respect to the fraudulent nature of the transactions as well as the actual fraudulent intent of the perpetrator” (at 21-22).
The majority opinion concludes:
- “We are satisfied that the district court’s jury instruction contained the essential elements to find that a Ponzi scheme existed”;
- “Because the jury found that [the scheme’s operator] operated an entity that meets the objective criteria of a Ponzi scheme, it properly presumed his actual intent to defraud his creditors”; and
- “No further mens rea instruction was required as a matter of law” (at 22).
The Dissent
A single-Justice dissent reaches an opposite conclusion:
- “[T]he district court’s Ponzi scheme instructions, which never actually required the jury to find wrongful intent on the part of the Ponzi scheme promoter, failed to ‘fairly and adequately cover the issues presented’” (at 42); and
- “Under the facts of this case, a finding of intent to defraud was not inevitable and cannot be presumed” (at 31).
The dissenting Justice is troubled by jury findings that appear inconsistent with an “actual” fraudulent intent. Specifically:
- “the same jury that concluded that [Debtor] was a ‘Ponzi scheme’ also found that [Defendant] received payment from [Debtor] in good faith and for a reasonably equivalent value” (at 41);
- the Defendant/payment recipient “had served as a lawyer” for both the scheme operator and the Debtor, and if the lawyer for the scheme’s operator did not know of the fraud, “it is not out of the question that [the scheme’s operator] did not intend the fraud” (at 41-42);
- the jury specifically “rejected” both of the claims that (i) Defendant “knew about the Ponzi scheme,” and (ii) Defendant “knew that the filing of a security interest on behalf of his family trust . . . and certain payments made” by Debtor “were fraudulent conveyances” (at 41); and
- the Defendant “was found by the jury to have acted in good faith, not knowing of any fraud” (id.)
The dissent makes a lengthy analysis to support the need for including an explicit mens rea element in the jury instruction. The dissent points out, for example, that:
- Debtor had “substantial business investments, including a commercial real estate development, marketing companies, night clubs, and ice rinks, and, in addition, operated a bill-pay service for its investors” and “was not simply a shell taking money in from some investors and repaying it to other prior investors” (at 37); and
- Debtor’s assets “were not held in cash or in other liquid forms but were investments in assets that, it was likely hoped, would appreciate”—which fact, alone, distinguishes Debtor “from the schemes of Charles Ponzi, Bernie Madoff, and others of their ilk” (at 31).
The dissent adds these observations about the economic climate in which Debtor operated:
- “It seems far from obvious to me that [the scheme’s operator] actually knew or intended to run what is understood as a Ponzi scheme”—which “becomes even less certain when viewed as of the time of its operation” (at 37): and
- Debtor’s financial problems arose during the “Great Recession,” when many businesses faced financial hardship and many failed, so that (i) Debtor’s business was not alone in that regard, (ii) “The fact of failure at that time does not establish fraud,” and (iii) the fact that [Debtor] was never profitable between 2003 and 2010 is not enough to establish that it was doomed to failure” (at 38-40).
Conclusion
This is a fascinating issue. And it’s easy to see how judges can hold differing views.
It will be interesting to see how courts in other circuits respond.
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Footnote 1. The jury instruction in question said: “A Ponzi scheme is a financial fraud that induces investment – often by promising high, risk-free returns within a relatively short time period. In a Ponzi scheme, payments are made to investors or lenders from later investments or loans rather than from profits of the underlying business venture. The fraud consists of transferring proceeds received from the new investors to previous investors, thereby giving other investors the impression that a legitimate profit-making business opportunity exists, where in fact no such opportunity exists. Distributing funds to earlier investors from the receipt of monies from later investors or lenders is the hallmark of Ponzi schemes. The mere fact that a company has negative cash flows for several years is not alone sufficient to conclude that a company is a Ponzi scheme.”
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