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Eleventh Circuit Holds ''For Value'' Defense To 11 U.S.C. § 548(a) Fraudulent Transfer Action Applicable To Defrauded Shareholders In Ponzi Scheme

Friday, November 4, 2011

Dena Kaufman | Bloomberg Law Perkins v. Haines, No. 10-10683, 2011 BL 278341 (11th Cir. Oct. 27, 2011) The United States Court of Appeals for the Eleventh Circuit affirmed a bankruptcy court's decision denying a motion for partial summary judgment in which the plaintiff argued that a transfer to redeem equity is not a transfer "for value" when made at time when the entity is insolvent making 11 U.S.C. § 548(c)unavailable as an affirmative defense. The Eleventh Circuit agreed with the bankruptcy court, finding that such rule does not apply in the context of a Ponzi scheme where the initial investment in the entity's equity was induced by fraud.

The Ponzi Scheme

International Management Associates, LLC and several of its affiliates (collectively, "Debtors") were formed by Kirk Wright as either limited liability companies or limited partnerships for the supposed purpose of operating as hedge funds. However, Debtors were actually used by Wright to perpetrate a Ponzi scheme whereby investors were induced to invest and/or remain invested in Debtors by paying fictitious profits and using new equity investments to repay earlier investors more than the value of their equity. The defendants were investors in one or more of Debtors. Each defendant made a capital contribution, executed a limited liability company agreement, limited partnership agreement or a subscription agreement and obtained a membership or partnership interest in one or more of Debtors. During the course of the Ponzi scheme, one or more of Debtors transferred property to each of the defendants corresponding to returns of principal and/or fictitious profits.

The Adversary Proceedings

Debtors were placed into receivership, and, thereafter, the receiver commenced chapter 11 bankruptcy cases on behalf of Debtors, which resulted in the confirmation of a plan of liquidation and the appointment of William F. Perkins as the plan trustee (the "Trustee"). The Trustee initiated adversary proceedings in bankruptcy court against Debtors' investors ("Defendants") to recover distributions, as fraudulent transfers pursuant to 11 U.S.C. § 548(a)(1)(A) and applicable state law, made by Debtors prior to the downfall of the Ponzi scheme. As an affirmative defense, Defendants asserted that they were entitled to retain the transfers pursuant to § 548(c) because they were "for value." Trustee sought partial summary judgment arguing that the affirmative defense was not available to Defendants, which motion was denied by the bankruptcy court. Trustee appealed to the Eleventh Circuit.

Affirmative Defense of § 548(c) Is Available To Equity Holder Investors in Ponzi Scheme

On appeal, the Eleventh Circuit affirmed the bankruptcy court's denial of partial summary judgment, noting that this was an issue of first impression in the Eleventh Circuit. Explaining that, for the purposes of this appeal, it is assumed that the elements of § 548(a)(1)(A) and applicable state law have been met since there is a presumption of intent to defraud under 11 U.S.C. § 548(a) with respect to transfers made as part of a Ponzi scheme, the Eleventh Circuit turned to the issue of whether the criteria of § 548(c) had been satisfied. As § 548(c) provides an affirmative defense to a person who receives a fraudulent transfer in exchange for value and in good faith, the Eleventh Circuit analyzed the meaning of the term "value" (which includes "antecedent debt") and pointed out the general rule is that a defrauded Ponzi scheme investor is deemed to have given value to the debtor to the extent of the investor's principal investment but not with respect to any amounts in excess of such principal investment. In support of his position that Defendants did not take "for value" because the transfers were made merely to repurchase worthless equity interests, Trustee cited a number of cases that held that transfers made to buy back equity in an entity that is insolvent cannot qualify as transfers "for value" under § 548(c). The Eleventh Circuit rejected Trustee's position, noting that the cases cited by Trustee were situations where an insolvent entity paid off its stakeholders to the detriment of its creditors, as opposed to a situation where transfers were made to equity holders who had been fraudulently induced into making their investments into a Ponzi scheme giving such equity holders fraud claims that could be satisfied by the subsequent transfers. Thus, while the Eleventh Circuit agreed with the reasoning of the cases cited by Trustee, it found such opinions irrelevant to the case at hand. Lastly, the Eleventh Circuit concluded its analysis with the observation that the only other court of appeals to address this issue was the Ninth Circuit in In re AFI Holding, Inc., 525 F.3d 700 (9th Cir. 2008), and it faced almost identical facts. The Eleventh Circuit noted its agreement with the analysis and the result inAFI Holding, which looked "beyond the 'form' to the 'substance' of the transaction" and held that "[t]he general rule [that a defrauded investor gave 'value' to the debtor in exchange for transfers to the extent of the amount of the principal investment] applies in a Ponzi scheme setting regardless of whether good faith investors have an equity interest in, or some other form of claim against, the legal entity constituting the instrument of the fraud."

Eleventh Circuit Affirms Bankruptcy Court Ruling

Accordingly, the Eleventh Circuit affirmed the bankruptcy court's denial of the partial summary judgment motion and held that defrauded investors who received transfers from Debtors for the redemption of their equity interests (or fictitious profits) gave "value" to Debtors in exchange for such transfers up to the amount of the investor's principal investment, such "value" being the satisfaction of the investors' restitution or fraud claims. DisclaimerThis document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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