Developments in Ponzi Schemes in Bankruptcy Cases

The following is a case update written by ILC member John Kim analyzing a recent case of interest:

Summary

In Kirkland v. Rund (In re EPD Inv. Co., LLC), 114 F.4th 1148 (9th Cir. 2024), the Ninth Circuit Court of Appeals affirmed the lower district court’s finding that when a jury determines that a debtor operates an entity meeting an objective criteria of a Ponzi scheme, then the presumption of “actual intent” exists.  No further instructions as to “mens rea” is required.  In other words, transfers from a Ponzi scheme to individuals may be presumed to have been with an “actual intent” to defraud.  To read the full published decision, click here: https://cdn.ca9.uscourts.gov/datastore/opinions/2024/08/23/22-55944.pdf

Facts

The case arises from a complicated and extensively litigated bankruptcy proceeding.  Pressman (and with EPD “Debtor”) owned and operated EPD Investment Co., LLC (“EPD”).  Pressman used EPD to obtain monies from individual lenders in exchange high return notes.  Debtor commingled investment and operating funds.  Debtor would use these commingled funds to pay for personal expenses for himself and his family, and he loaned himself EPD monies in an amount exceeding $6 million.

Before 2010, Attorney Kirkland (“Kirkland”) loaned approximately $2 million to EPD.  Kirkland had represented Debtor-controlled entities and in exchange, EPD made mortgage payments on behalf of Kirkland and/or property interests his wife owned in trust.  Eventually, EPD was unable to pay outstanding notes to investors and operations were not generating sufficient income on a timely basis.  In 2010, EPD’s creditors commenced an involuntary chapter 7 bankruptcy case against EPD and Pressman, which resulted in a joint case.  The bankruptcy trustee then filed an adversary proceeding against Kirkland seeking to avoid “fraudulent transfers” from EPD to Kirkland during the relevant claw back period.

After the reference from the bankruptcy court was withdrawn and a trial was set, the District Court instructed the jury that a Ponzi scheme “consists of transferring proceeds received from new investors to previous investors, thereby giving investors the impression that a legitimate profit-making opportunity exists, where in fact no such opportunity exists.”  The jury was also instructed on a long-standing Ponzi-scheme presumption, which recognizes that a debtor’s actual intent to hinder, delay, or defraud its creditors may be inferred by the mere existence of a Ponzi scheme.

The jury found EPD was a Ponzi scheme and that EPD transferred property to Attorney Kirkland to hinder, delay or defraud creditors.  However, since Attorney Kirkland received the transfers in good faith and for reasonably equivalent value, judgment was in favor of Attorney.

Attorney Kirkland’s wife appealed the judgment as to the finding that EPD was a Ponzi scheme,  since the mere existence of a Ponzi scheme  could be used for preclusive effect by the bankruptcy trustee against Attorney Kirkland’s wife in a separate claim allowance litigation.  The Ninth Circuit affirmed. 

Reasoning

The main question on appeal to the Ninth Circuit was whether the district court erred by failing to include a mens rea jury instruction, which would have required the jury to find that Debtor knew he was operating a Ponzi scheme in order to establish an actual intent to hinder, delay or defraud creditors.

The panel held that a mens rea instruction was not required because, once the existence of a Ponzi scheme has been objectively established, there existed an irrebuttable presumption of fraudulent intent.  In other words, the jury’s finding that EPD was a Ponzi scheme provided an implicit determination that Debtor intended to defraud his lenders by operating a scheme that had no legitimate business.  A separate and additional finding that Debtor knew about the scheme and knew it was going to fail was not required.  The jury instruction had referenced all the essential elements of a Ponzi scheme.  Thus, the jury could reasonably infer that Debtor had fraudulent intent.

The panel majority also found that substantial evidence supported the jury’s finding that Debtor operated a Ponzi scheme between 2003 and 2010.  Evidence existed to find that Debtor managed EPD by funneling money between investors to disguise the absence of a legitimate profit-making business opportunity.

Author’s Commentary

In affirming the District Court, the Ninth Circuit provides practical guidance for jury instructions relating to the “presumption of intent” in the context of Ponzi schemes.  The Ninth Circuit’s ruling is consistent with case law that generally does not require a mens rea finding of fraudulent intent in the context of Ponzi schemes – in either civil or bankruptcy actions.  Therefore, there was no reason for the district court to have provided such an instruction.  A Ponzi scheme was properly defined as a fraud where money flows from new to older investors.  The investors are given the false impression that a legitimate business exists.  A jury does not need to separately find that the perpetrator(s) subjectively knew he was operating a fraud that would ultimately collapse.

These materials were written by ILC member John Kim, Esq., a senior associate with the Brower Law Group based in Irvine, California.  Editorial contributions were provided by Kathleen A. Cashman-Kramer, Esq., a director with the San Diego office of Fennemore LLP and the Hon. Meredith Jury (ret.). 

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