State Courts Re-Balance Fraudulent Transfer Litigation and Ponzi Scheme Presumptions

The basic elements and defenses for fraudulent-transfer claims have a certain elegant balance when combined (see the attached table below). For constructively fraudulent transfers by an insolvent transferor, a defendant who provides reasonably equivalent value will not be held liable. In the rare case of a fraudulent-but-solvent transferor, the transferee who acted in good faith and provided some value will not be held liable. For a fraudulent transfer by an insolvent transferor, the transferee must act in good faith and provide reasonably equivalent value to avoid both constructive and actual fraudulent transfer liability. This seems to balance the interests of innocent transferees and the competing interests of other innocent creditors.

However, judicially created presumptions may be eroding this balance. These presumptions were initially created in the challenging circumstances of unwinding Ponzi schemes, but what began as minor, limited presumptions have grown into a torrent of extra-statutory precedents that drown the merits of subsequent disputes. Federal courts have been sliding down slippery precedents that seem to presume that transfers by Ponzi schemes are made with fraudulent intent and presume that no possible value can be provided in return. These combined presumptions create automatic liability for transferees under categories III and IV in the table, even if the transferee acted in good faith and innocently provided goods, services or other consideration to the transferor in exchange for reasonable payments.

This situation hardly seems just; it can be used to turn anyone into a victim of a Ponzi scheme, even if they were neither investors who voluntarily invested in the Ponzi scheme nor wrongdoers who knowingly aided and abetted fraud. While federal courts have taken the lead in creating and then expanding these presumptions, a few recent state court opinions from the Texas and Minnesota courts may restore some balance to the system.

The Rise of Ponzi Scheme Presumptions

Courts have slowly created a number of presumptions in Ponzi scheme fraudulent-transfer cases. The case law on this subject is confusing because these are emerging principles and many opinions use non-standard terminology and do not clearly differentiate between elements.

The term “Ponzi scheme presumption” appears to have been first used in 2002 regarding the fraudulent intent presumption.[1] Cases going back to at least 1987 have presumed “as a matter of law” that fraudulent intent exists when a debtor has engaged in a Ponzi scheme because the Ponzi scheme perpetrator must have known that its victims and other creditors would lose their money.[2]

According to the Minnesota Supreme Court in Finn v. Alliance Bank, which rejected any Ponzi scheme presumption, “the Ponzi-scheme presumption actually consists of three separate presumptions.”[3] These presumptions are as follows:

(1) The Fraudulent Intent Presumption, which “conclusively establishes that the debtor had fraudulent intent, which means that it treats all transfers from a Ponzi scheme as actually fraudulent.”[4]

(2) The Insolvency Presumption, which holds that “the mere existence of a Ponzi scheme would prove as a matter of law that the debtor was ‘insolvent’ at the time of a disputed transfer, regardless of the transfer’s timing and the actual operations of the debtor.”[5]

(3) The No-Value Presumption, which presumes that “any transfer from a Ponzi scheme was not for reasonably equivalent value, which would both establish the second requirement of a constructive-fraud claim and negate the statutory defense to an actual-fraud claim.”[6]

This article focuses on the fraudulent intent and no-value presumptions.

Problems with Presuming Actual Intent

At least two major questions are unresolved regarding the fraudulent intent presumption: (1) Is the presumption rebuttable or conclusive, and (2) does the presumption apply to all transfers, including ordinary business transactions? As to the first question, courts are divided on whether Ponzi scheme presumptions are conclusive or rebuttable. The majority seems to hold that the presumption of actual fraudulent intent is conclusive.[7] However, other courts disagree: “In this circuit, a Ponzi presumption, if applicable, is rebuttable, and is not conclusive of fraudulent intent.”[8]

The scope of the fraudulent intent presumption is also undecided. Early cases addressed payments to Ponzi scheme investors, as opposed to ordinary vendors. Characterizing the payments of false “profits” to investors as intentionally fraudulent may make sense: “The perpetrator ... makes payments to present investors, which, by definition, are meant to attract new investors.”[9] While some courts have extended this presumption beyond payments to investors, others have stopped short of presuming that all payments are made with fraudulent intent:

[W]‌hen an action is brought to recover payments that were part of the Ponzi scheme, it is reasonable to presume an intent to defraud. Where, as here, however, the individual who is operating the Ponzi scheme conducts ordinary business transactions outside of the Ponzi scheme, the basis for presuming fraud is not present.[10]

Both positions have merit. On one hand, a Ponzi scheme or other criminal enterprise does have an overarching criminal goal: fraud. Parsing between the immediate, seemingly innocuous objectives of the perpetrator and his/her larger, sinister objectives may not make sense. For example, when Allen Stanford paid The Golf Channel to advertise his bogus “investment opportunities,” he seemed to be acting with an ultimately fraudulent intent: conning more victims. “Perpetrating a Ponzi scheme” does seem to be a reliable indicator of fraud, even if it is not included in the traditional badges of fraud.[11] This presumption helps innocent victims obtain recourse against transferees who knowingly aid and abet Ponzi schemes, such as vendors or employees, which seems just.

On the other hand, this presumption could be somewhat harsh if applied to innocent transferees. The Golf Channel did not know about Stanford’s fraud and did not expect anything other than fair payment for its air time, so turning it into a victim does seem unfair.

Fraudulent transfer law balances this harshness by exculpating transferees who act in good faith and provide reasonably equivalent value in exchange  — at least, in theory. As discussed herein, the no-value presumption threatens to undermines this balance.

Problems with Presuming No Value

Under most fraudulent transfer law, a recipient of an actual fraudulent transfer who acts in good faith and provides some value has a defense.[12] The no-value presumption identified in Finn v. Alliance Bank undermines this defense by holding that “any transfer from a Ponzi scheme was not for reasonably equivalent value.”[13] While the no-value presumption is not as well-rooted in case law as the fraudulent-intent presumption, the overall question of the kind of value that a transferee must provide to reduce or avoid fraudulent transfer liability, Ponzi scheme or not, is of vital importance.

Some courts and commentators have held — in Ponzi scheme cases and in other cases — that “value” is to be judged “from the standpoint of creditors.”[14] One also noted that “[t]‌he proper focus is on the net effect of the transfers on the debtor’s estate, and the funds available to the unsecured creditors.”[15] Even the comments to the Uniform Fraudulent Transfer Act explain that “[c]‌onsideration having no utility from a creditor’s viewpoint does not satisfy the statutory definition of value.”[16]

This creditor-oriented perspective on “value” places fraudulent-transfer litigation at the top of a steep, slippery slope; insolvent entities frequently do not generate or retain full value for their creditors from those entities’ business operations and transactions. This principle could apply to both Ponzi schemes and other less-malicious entities. For example, creditors of a bankrupt oil-exploration company may not receive value from that company hiring drillers to drill dry holes. Creditors of an insolvent grocery store may not receive value from the grocery store paying for inventory that the grocery store cannot profitably sell. Should that make the drillers or wholesalers liable? Surely not.

The Golf Channel Gets a Mulligan

Yet “yes” was how a panel of three Fifth Circuit judges first answered this question in Janvey v. Golf Channel Inc.[17] The case presented the factual situation previously discussed: Stanford paid The Golf Channel to promote his Ponzi scheme, but The Golf Channel did not know that Stanford was a conman and only accepted market-rate payments for its advertising time. Under the value-to-creditors test, The Golf Channel lost: “While [The] Golf Channel’s services may have been quite valuable to the creditors of a legitimate business, they have no value to the creditors of a Ponzi scheme,” the court explained.[18]

Stare decisis may have dictated this result: A number of earlier Fifth Circuit decisions interpreting state fraudulent-transfer laws had reached the same conclusion.[19] Still, Fifth Circuit decisions interpreting “value” for the federal fraudulent-transfer laws in the Bankruptcy Code held that “the recognized test is whether the investment [(i.e., value provided)] conferred an economic benefit on the debtor.”[20] The Fairchild decision specifically noted the policy problems with weighing value from the creditors’ perspective: “[A]‌nyone who provides, deals with, or invests in an entity in financial straits would be doing so at his or her peril under [the Bankruptcy Code fraudulent-transfer laws]; which means, of course, that few would be likely to do so.”[21]

In fact, shortly before the first Golf Channel opinion, a different panel had again held that federal law did not employ a creditor-subjective test for measuring value.[22] Given the similarities between the text and underlying policy of these federal and state laws, coherently reconciling these opposite approaches to federal and state law from the Fifth Circuit may be impossible.

Another notable point may be that The Golf Channel did not raise the antecedent debt created by its contract with Stanford as a defense. In subsequently reconsidering this question, the Fifth Circuit grudgingly stated that The Golf Channel had waived the argument “that Stanford’s payments were in exchange for reasonably equivalent value because they satisfied antecedent debt obligations owed pursuant to the advertising contract.”[23] However, the utility of a written contract that establishes an “antecedent debt” may be somewhat reduced because contractual obligations can also be avoided through fraudulent transfer litigation.[24]

After The Golf Channel moved for rehearing, the Fifth Circuit avoided further Eerie-guess problems by asking the Texas Supreme Court to decide what showing of value is sufficient to create a defense to fraudulent transfer under Texas law.[25] The Texas Supreme Court held that while value should be measured from a creditors’ view, value should not be subjectively determined based on value retained by the debtor for its creditors. “Value exists when the debtor took consideration that had objective value at the time of the transfer, even if the consideration neither preserved the debtor’s estate nor generated an asset or benefit that could be levied to satisfy unsecured creditors.”[26]

The court also stated that this result does not change for Ponzi schemes, because if the law “were to presume that transfers from Ponzi scheme operators were not for value, it would ‘effectively negate a transferee’s good-faith defense to an actual-fraud claim.’”[27] The Texas Supreme Court even hinted that it would follow the Minnesota Supreme Court’s lead and reject all Ponzi scheme presumptions if given the chance; its opinion repeatedly sided with Finn v. Alliance Bank, and footnote 27 took care to observe that the Fifth Circuit did not ask for an opinion on other Ponzi scheme presumptions and that the Texas fraudulent-transfer act “provides only one express presumption.”[28] This may imply that other judicially-crafted presumptions in fraudulent-transfer law would not withstand challenge in Texas state court.

Conclusion

There are two key practical points here. First, fraudulent-transfer laws are not set in stone, so litigants should take care to preserve arguments and appellate rights. Litigants may also try to avoid federal courts, which seem to be less favorable to defendants and more favorable to the bankruptcy trustees and receivers that regularly prosecute such claims (for fun and profit).

Second, clients should avoid doing business with any Ponzi scheme or other criminal or fraudulent enterprises. Defendants who knew or should have known the true nature of their customers or business partners will be liable regardless of value provided.

This final point may help illustrate the superfluous nature of Ponzi-scheme presumptions: The law already strongly deters aiding or abetting or otherwise doing business with a criminal enterprise, and provides ample recourse for victims against such abettors or transferees. While the fraudulent-intent presumption may be just, since running a Ponzi scheme or other criminal enterprise is a reliable badge of fraud, combining the fraudulent-intent presumption with the no-value presumption seems to unfairly unbalance fraudulent transfer law.