The following is a case update written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, analyzing a recent decision of interest:
In Securities and Exchange Commission v. Marquis Properties, Chad Deucher, and Richard Clatfelter, U.S. Dist. Ct., Dist of Utah, Case No. 2-16-cv-00040-JNP, the United States District Court for the District of Utah rejected the notion that those who do business with a Ponzi scheme in principle do not provide reasonably equivalent value for an intentional fraudulent conveyance and that the avoidability of transfers by the enterprise depends in part on the good faith of the transferee targets of the avoidance action.
SEC v. Marquis Prop. et al. can be found here.
Deucher ran Marquis Properties as a classic real estate investment Ponzi scheme, making distributions to previous investors, paying Marquis’ expenses and living handsomely on the proceeds of new investments. He pled guilty to federal criminal charges of intentional fraud. The SEC had a receiver appointed for Marquis. The receiver sued various defendants in the District Court to recover transfers to them from Marquis as intentional fraudulent conveyances under governing Utah law. In the case of most of the defendants, the transfers were finders fees or commissions, while the transfer for one of the defendants was for IT services. The receiver moved for summary judgment against the defendants. In doing so, the receiver’s only evidence was the plea deal from criminal case. The District Court denied the receiver’s motions.
The District Court agreed with the receiver’s contention that under applicable law, Deucher’s criminal fraudulent intent memorialized in his plea deal established as a matter of law his intent to defraud creditors under the Utah statute. The District Court therefore found for the receiver on the issue of actual intent. However, the receiver’s summary judgment motions foundered on the statute’s affirmative defense that a plaintiff cannot recover from a transferee (either initial or subsequent) who takes for a reasonably equivalent value in good faith.
The court described competing lines of case law on the question whether a transfer by an insolvent transferor in furtherance of a Ponzi scheme can ever be for a reasonably equivalent value. Some cases hold that it cannot because such a transaction only preserves and furthers the ongoing fraud rather than adding value. Others consider that rule too harsh in that, for example, it can punish an innocent counter party to a transaction. It appears that there is a split in the only two circuit level opinions. See Orlick v. Kozyak (In re Fin. Federated Title & Tr., Inc.), 309 F.3d 1325, 1330-330 (11th Cir. 2002) (rejects per se rule); Warfield v. Byron, 436 F.3d 551, 554-55 (5th Cir. 2006) (endorses rule). Finding no controlling authority, and conceding it had itself come down on both sides of the issue in the past, the District Court opted for rejecting the per se rule. Instead, it concluded that whether reasonably equivalent value was given must be determined on a case-by-case basis. The opinion then seems to transmute that issue into the corollary question of whether the transferee took in good faith. A transferee who knows or has reason to suspect untoward conduct by the transferor cannot take in good faith. By contrast, transferees who are ignorant of suspicious facts that at least would put them on inquiry notice may take for a reasonably equivalent value.
Since the receiver had supplied no evidence on the reasonably equivalent value and good faith issues, depending in essence entirely on the fraudulent intent established by the plea deal, the District Court denied the receiver’s motions for summary judgment and set the matter for trial preparation.
The author agrees with the District Court’s decision (and the concurring cases it cited) against a per se rule that there cannot be reasonably equivalent value given to a Ponzi scheme for the reason the opinion gives: such a rule may unfairly punish innocent parties (who were perhaps taken in by the legitimate look of the enterprise as much as, or even more than, the victims of the scheme). There is no justification for remedying damage to innocent creditors, even investors, by imposing liability on innocent vendors such as a landlord or utility (examples used in the Windham opinion) without notice or knowledge. In such cases, the courts must look at the recipient’s good faith in terms of what the recipient knew or should have known by reasonable diligence. And it is worth adding that what inquiry a sophisticated business should make may be a very different matter from that which routine creditor should pursue. Although the opinion’s switch from reasonably equivalent value to good faith somewhat clouds the issue, it is also true that a party raising the affirmative defense must show both good faith and reasonably equivalent value. If a perfectly innocent defendant gave practically nothing for what he got, his good faith may not protect him (putting aside the issue whether a fire sale price and good faith can co-exist in such circumstances).
These materials were authored by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, a member of the ad hoc group, with editorial assistance by Meredith Jury, (bankruptcy judge, C.D. Cal. (Ret.)), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.