Substantially Equivalent Value Not Required to Defeat Equitable Disgorgement

Receiverships have advantages and disadvantages when it comes to the recovery of fraudulent transfers.

Although the doctrine of in pari delicto can prohibit a bankruptcy trustee from recovering a fraudulent transfer, equity receivers have an advantage over bankruptcy trustees because receivers’ fraudulent transfer suits are immune from the in pari delicto defense. Compare, e.g., Jones v. Wells Fargo Bank, N.A., 666 F.3d 955 (5th Cir. 2012), with Anderson v. Morgan Keegan & Co. (In re Infinity Business Group Inc.), 21-1536, 022 BL 191132 (4th Cir. April 19, 2022). To read ABI’s report on Infinity, click here.

On the other hand, the recipient of a fraudulent transfer isn’t required to show payment of “reasonably equivalent value” to fend off recovery by the Securities and Exchange Commission in an enforcement action.

In an appeal to the First Circuit, a couple had divorced in 2009. In 2016, the couple modified their child support and spousal support agreements because the husband took up permanent residence in Mexico. The amended support agreements gave the wife sole legal and physical custody of their son and increased the husband’s child support obligations. In addition, the wife waived certain claims against her ex-husband, and he agreed to provide her with an expensive car.

In 2017, the former husband purchased a luxury car for his former wife and replaced it with a new one in 2020.

In 2021, the SEC brought an enforcement action against the former husband, alleging he committed securities fraud. The suit named the wife as a so-called relief defendant but did not allege that she had participated in any wrongdoing. Indeed, the husband’s allegedly fraudulent conduct began six years after the couple divorced.

However, the SEC sought $170,000 from the former wife as equitable disgorgement, representing the cost of the car plus pre-judgment interest. The district court agreed with the SEC and directed the former wife to disgorge $170,000. The district court reasoned that the wife had not shown the provision of “substantially equivalent value in the bankruptcy sense.”

The former wife appealed and won in a December 7 opinion by First Circuit Judge Julie Rikelman. She undertook a “clear error” review of the district court’s factual finding that the former wife gave nothing of value.

Judge Rikelman said it was an issue of first impression in the First Circuit about the evidence necessary to prove that a relief defendant has a legitimate claim “to property purchased with ill-gotten funds.” Other circuits, she said, have adopted a rule with two critical showings before a relief defendant is subject to equitable disgorgement.

The wife admitted that she had received ill-gotten funds but claimed that she had a legitimate claim to the expensive car.

Equitable disgorgement, Judge Rikelman said, is a remedy permitted by 15 U.S.C. § 78u(d) to address unjust enrichment as a result of a securities law violation. Because the remedy is in equity, she cited the Ninth Circuit for saying it’s applied against someone who has no rightful claim. “If, by contrast, a relief defendant has a rightful claim to the funds,” she said, “disgorgement is inappropriate,” again citing the Ninth Circuit.

Judge Rikelman turned to the question of whether the former wife had a “legitimate claim” to the expensive car and said she was persuaded by the reasoning of “sister circuits.” She cited the Second Circuit for holding that “a relief defendant must provide something of value in exchange.” [Emphasis added.] Citing the Seventh Circuit, she said that value can take the form of giving up a legal claim, but a gift isn’t a legal claim.

Citing the Restatement (Third) of Restitution, Judge Rikelman said that “a relief defendant must provide more than nominal value to demonstrate a legitimate claim.” On the other hand, she found “no federal disgorgement precedent suggest[ing] that the value must be substantially equal.” As long as the consideration is more than nominal, she said that “courts generally refrain from inquiring into the adequacy of the consideration.”

Judge Rikelman found no “support for the application of this bankruptcy-law framing to SEC disgorgement motions [and] no basis for it in the language of the operative federal statute or in precedent.”

Applying the facts to the law, Judge Rikelman noted how the former wife took on additional expenses in raising the couple’s son, assumed sole custody and waived claims. Concluding that the former wife “conveyed much more than nominal value,” she ruled that the district court “clearly erred in holding otherwise.”

Reversing the disgorgement order, Judge Rikelman held that the “district court erred as a matter of law by evaluating if that value was ‘substantially equivalent’ in the bankruptcy law sense.”