The unfortunate aftermath of a Ponzi scheme is that it leaves investors fighting amongst themselves over what remains and the competing interests of the “net losers” (those who lost money beyond the initial investment) trying to recover some of their losses and the “net winners” (those who made a profit) trying to hold onto distributions they received. Once the scheme is unravelled and the fraudster(s) are held accountable, investors turn to the courts to sort through these battles between those "net losers" and "net winners". When this occurs in the context of a bankruptcy liquidation, the bankruptcy trustee[1] becomes a necessary party to these battles as its agreement to any proposed settlement becomes crucial in whether a settlement of competing claims will be approved by the courts or whether more litigation will ensue.
A recent Canadian decision, Samji (Re[2]) explored the Canadian court's approach to considering a proposed settlement from a small group of “net winners” who had negotiated a resolution with a bankruptcy trustee in respect of their net winnings over the opposition of a group “net losers”.
The alleged scheme was believed to have defrauded investors out of millions of dollars that flowed through the fraudulent investment vehicle over a period of ten years. After the fraud was uncovered, the investment vehicle was assigned into bankruptcy on December 5, 2012, and subsequently the bankruptcy trustee began to take steps to recover funds for the estate, including chasing “net winners”.
Two of the “net winners” offered to return their profits (but keep all of their initial investments) to the bankruptcy trustee, in exchange for a release from any and all claims that the bankrupt or its creditors might have against them and court approval of the settlement. The trustee accepted the offer and obtained the requisite inspector approval[3] of the settlement and brought the matter before the court for approval.
A group of net losers opposed the settlement. In particular, they opposed the proposed release as they believed that the estate had good claims against the settling “net winners” and that they would be materially prejudiced by the granting of the order because it would preclude their ability to bring an action against the “net winners” for fraudulent preferences. They also argued that approving the settlement would establish a precedent for other net winners only having to disgorge their profits. The concern raised was that such a settlement would result in an unfair sharing of the total losses from the alleged scheme amongst the entire group of investors. The trustee maintained that approval of the settlement is in the best interests of all of the creditors, and that any potential prejudice to individual creditors was outweighed by the benefits to the group as a whole.
The trustee submitted that approval of the settlement proposal would avoid potentially lengthy and expensive litigation, which would both expose the bankrupt estate to risk, and may ultimately lead to the recovery of less money for the creditors.
The issues before the court were the approval of the overall settlement and whether the court had the jurisdiction to grant the releases requested. The trustee argued that the Canadian court had to exercise its inherent jurisdiction to grant the releases in the context of proceedings under the Bankruptcy and Insolvency Act (“BIA”)[4], the governing federal statute applicable to the bankruptcy proceedings. In order for a court to exercise its inherent jurisdiction in the context of proceedings under the BIA, two preconditions must be met: (1) the BIA must be silent on a point or not have dealt with the matter exhaustively; and (2) after balancing competing interests, the benefit of granting the relief must outweigh the relative prejudice to those affected by it.
The BIA is silent with regard to the approval of a settlement between the bankrupt and a third party that includes a release of any and all claims made against a third party which the bankrupt and the bankrupt's creditors may have against a third party. With respect to the second precondition, the Court reviewed the terms of the settlement and agreed with the trustee that under the circumstances the return of the two "net winners" profits to the estate was in best interests of all of the creditors, and that any potential prejudice to individual creditors was outweighed by the benefits to the group as a whole.
The Court concluded that attempting to have the “net winners” disgorge their profits in exchange for a release is sound and in keeping with the objectives of the BIA, specifically that the purpose of the BIA is to ensure that bankruptcies are dealt with expeditiously and efficiently. The Court noted that the alternative to approving the settlement would be an even lengthier and potentially more expensive court procedure that could lead to a recovery of less funds. Finally, the Court was of the view that the decision of the trustee (with the approval of the inspectors) to accept the was a legitimate business decision.
A few important practice points can be drawn from this case: i) the court will look to the a proposed settlement in a Ponzi scheme not only from a legal perspective but also from a practical costs-benefit analysis; ii) “net winners” can opt to settle with a trustee and potentially hold onto a greater share in proportion to creditors (i.e. the "net losers"); and iii) the ability and willingness of courts to exercise inherent jurisdiction to grant releases as part of overall settlements continues to expand across more areas of insolvency litigation.
[1] Who, amongst having other duties, is responsible for making decisions that are in the best interests of all the creditors of the bankrupt entity.
[2] Samji (Re), 2013 BCSC 2101 (British Columbia Supreme Court)
[3] S.30 of the BIA (defined below) requires a trustee to obtain inspector approval for certain actions including a compromise or settlement of claims of an estate.
[4] Bankruptcy and Insolvency Act (R.S.C., 1985, c. B-3)