The Unfortunate Expansion of the Ponzi Scheme Presumption

You operate a law firm in Texas. You are hired by a Utah business trust to represent a friend of the trust’s founder, who is facing criminal charges in New Hampshire. You represent the friend, and for your legal services you are paid $90,000 by the trust. More than four years later, you learn that the Commodity Future Trading Commission (CFTC) has brought an action in Utah against the trust, claiming that the trust is a Ponzi scheme. The CFTC has sought and won the appointment of a receiver to marshal the assets of the trust, among which are payments previously made in furtherance of the Ponzi scheme. You are thereafter sued in Utah by the receiver for the trust, who claims, under Utah’s Uniform Fraudulent Transfer Act,[1] that you have to pay the $90,000 back. Obviously, you disagree.

The district court nevertheless grants the receiver’s motion for summary judgment, and the Tenth Circuit Court of Appeals affirms. In finding that Utah’s UFTA authorizes the recovery of the sums due, the Tenth Circuit concludes that “because Ponzi schemes are insolvent by definition, we presume that transfers from such entities involve actual intent to defraud.”[2] Paradoxically, the court also concludes that “there is no cognizable benefit that [the debtor] could have received [from the legal services provided].[3] [The debtor] existed for the purpose of generating profits for its investors, and defending [the debtor’s principal’s] friend in a criminal proceeding had nothing to do with that purpose.”[4]

Definition of a Ponzi Scheme

Courts across the country have recognized that no single definition of a Ponzi scheme exists. Some courts have stated that Ponzi schemes exist only when the “returns to investors are not obtained from any underlying business venture.”[5] Other courts find Ponzi schemes in ventures that involve legitimate investment opportunities.[6] Some courts have stated that Ponzi schemes are always insolvent,[7] while others find a Ponzi scheme exists even it the enterprise began as a legitimate business operation.[8]

The Ponzi Scheme Presumption

Notwithstanding the differences, to provide relief to the victims of Ponzi schemes, courts have authorized receivers (or trustees in bankruptcy) to “claw back” the fraudulent transfer of funds paid in furtherance of the scheme. Both the UFTA and § 548(a) of the Bankruptcy Code generally allow the avoidance of a fraudulent transfer if the trustee or receiver can demonstrate that the debtor made the transfer with “actual intent to hinder, delay or defraud any creditor of the debtor.” In seeking a clawback, courts have often utilized what has been euphemistically referred to as “the Ponzi scheme presumption.” The presumption has allowed courts to presume actual intent to defraud, thus allowing the clawing back of funds paid in furtherance of the scheme, subject to the creditor’s defenses that the transfer was taken in good faith and that, in return for the transfer, the creditor gave value.

But it is this fundamental element — clawing back the funds paid in furtherance of the scheme — that courts, even at the circuit level, seem to have sometimes overlooked. The existence of a Ponzi scheme coupled with transfers by the debtor, without evidence tying the specific transfers to the perpetuation of the scheme, should not implicate the Ponzi scheme presumption.

In In re Pearlman,[9] the court was faced with a bank fraud scheme involving the falsification of due diligence materials designed to con banks into lending the debtor millions of dollars. The trustee relied upon the debtor’s prior statement that the bank fraud was a Ponzi scheme, the funds from which were used in payment of other loans or in payment to investors who were victims of the Ponzi scheme. The court held succinctly that because the bank fraud scheme did not meet the requisite elements of a Ponzi scheme, despite the debtor’s admission, it was not a Ponzi scheme, and the trustee could not rely on the presumption. When the payments are not essential to the scheme, when they are not in furtherance of the scheme, the Ponzi scheme presumption is simply inapplicable.

The bankruptcy court in the Southern District of Florida recognized this fundamental precept.[10] Phoenix Diversified Investment Corp. was a company begun by Michael Meisner. The company was put into bankruptcy through the filing of an involuntary petition, and Meisner, in a plea agreement entered into with the U.S., admitted that a large portion of the investor monies were not used for investments but were instead used to make fraudulent Ponzi-like interest payments to preceding investors or were used to support his family’s apparently luxurious lifestyle. Meisner proffered that $6.8 million in investor funds was used directly for the benefit of his family.

A trustee was appointed, Kenneth A. Welt, who filed “one of many” adversary proceedings against various transferees, including Publix Super Markets, Inc. (Publix), claiming that over a four-year period Publix received payments from Meisner, who was using his bank card, in the aggregate sum of $43,384.37. The payments were for “groceries and other personal items.” The trustee argued that the grocery money was owed to the debtor’s investors but was nevertheless used by Mr. Meisner for the benefit of his family. As a result, argued the trustee, the funds were used to hinder, delay and defraud creditors in furtherance of the Ponzi scheme, a scheme to which Mr. Meisner admitted his role. The court rightly rejected the trustee’s argument. The court stated:

The existence of a Ponzi scheme supports a finding that the debtor had a generalized intent to defraud. But this is not sufficient, by itself, to show that the transfers in question were made with fraudulent intent. Transfers subject to the Ponzi scheme presumption are those that perpetuate the scheme, or that are necessary to the continuance of the fraudulent scheme. This is the reason that case law applying the Ponzi scheme presumption typically involves claims against inventors, brokers, and others who assisted in perpetuating the scheme.

…

While … evidence [that the funds were used for the benefit of Mr. Meisner’s family] may be probative in determining whether the debtor had actual fraudulent intent, these facts alone are not sufficient to support a conclusion of such intent with regard to the specific transfers at issue in this case.[11]

It is axiomatic that the elements of a fraudulent transfer must be met before a fraudulent transfer can be avoided. The Ponzi scheme presumption has historically aided this determination. While some courts have seemingly used the presumption as an apparent shortcut to finding fraud, the recent application of the presumption to claw back payments made to vendors who are unaligned with the Ponzi scheme itself is an unfortunate extension of the presumption, and one that unnecessarily obfuscates the fraudulent transfer analysis.