The following is a case update written by Corey R. Weber, a partner at Brutzkus Gubner Rozansky Seror Weber LLP, analyzing a recent decision of interest:

SUMMARY

The First Circuit reversed a bankruptcy court order granting summary judgment in favor of a college on a constructive fraudulent transfer claim to avoid and recover tuition payments made by parents who were insolvent and pled guilty to operating a Ponzi scheme.  In re Palladino, 942 F.3d 55 (1st Cir. 2019). 

To view the full opinion, click here.

Facts

Steven and Lori Palladino (the Paladinos) filed a chapter 7 bankruptcy case following convictions for fraud.  The Palladinos pled guilty to operating their business, Viking Financial Group, Inc. (Viking), as a Ponzi scheme.  After Viking filed its own bankruptcy case, the court consolidated the bankruptcy estates.

The bankruptcy trustee for the consolidated bankruptcy estates, Mark DeGiacomo, filed an adversary complaint against Sacred Heart University to avoid and recover the $64,656.22 in tuition payments made by the Palladinos for their 18-year old daughter’s tuition as fraudulent transfers based on both actual intent and constructive fraud.

The bankruptcy court heard cross-motions for summary judgment and granted summary judgment in favor of Sacred Heart University because, as to the constructive fraudulent transfer claims, the Palladinos believed that payment of the tuition ultimately provided reasonably equivalent value to the Palladinos by helping to make their daughter self-sufficient.  The bankruptcy court certified its decision for direct appeal to the First Circuit (the appeal was only as to the constructive fraudulent transfer claims).  The First Circuit reversed and remanded the bankruptcy court’s decision.

Reasoning

In reversing the bankruptcy court’s decision, the First Circuit viewed reasonably equivalent value from the perspective of creditors and not from the perspective of the recipient (the college) or the person who benefitted from the transfer (the Palladinos’ daughter).  The First Circuit also focused what it viewed as enforcing the fraudulent transfer provisions in the Bankruptcy Code that were enacted by Congress.

The First Circuit stated at the outset that “[b]ecause fraudulent transfer law’s purpose is to preserve the debtor’s estate for the benefit of unsecured creditors, courts evaluate transfers from the creditors’ perspective.”  The decision makes clear that the result was not a close call, stating that, “[t]o us, the answer is straightforward.  The tuition payments here depleted the estate and furnished nothing of direct value to the creditors who are the central concern of the code provisions.”

Reviewing the categories of transactions providing value in 11 U.S.C. § 548(d)(2), the First Circuit determined that “none are present here, nor are parents under any legal obligation to pay for college tuition for their adult children.”  In a footnote, the court stated that “Sacred Heart invokes a “societal expectation” that parents will pay college tuition for their adult children, but, and again, this does nothing for the creditors.”

Citing to the Supreme Court’s opinion in TVA v. Hill, 437 U.S. 153, 194 (1978), the First Circuit stated that the fraudulent transfer statutes in the Bankruptcy Code were enacted by Congress and that, “[a]bsent constitutional challenge, when confronted with a clear statutory command like the one in the bankruptcy code, that is the end of the matter.”

Author’s Comment

In Ponzi scheme cases, the debtor’s actual intent to hinder, delay or defraud creditors is established as a matter of law.  See, e.g., In re AFI Holding, 525 F.3d 700, 704 (citing In re Agricultural Research and Technology Group, Inc., 916 F.2d 528, 535 (9th Cir. 1990) as to the impact on fraudulent intent of “the mere existence of a Ponzi scheme”).  See also, Donell v. Kowell, 533 F.3d 762, 770 (9th Cir. 2008).  The debtor operating as a Ponzi scheme also establishes the insolvency tests for constructive fraudulent transfer claims.  See, e.g., Donell v. Kowell, 533 F.3d 762, 770–771 (9th Cir. 2008) and In re Maui Indus. Loan & Finance Co., 463 B.R. 499, 503 (Bankr. D. Hawaii 2011).  A bankruptcy trustee’s prima facie case for actual intent fraudulent transfers is therefore proven if it has been established that the debtor operated as a Ponzi scheme. 

The issue in this appeal is limited to whether a transfer for an adult child’s school tuition provides reasonably equivalent value to the debtor (“reasonably equivalent value” is part of the prima facie case for constructive fraudulent transfers in 11 U.S.C. § 548(a)(1)(B) whereas taking the transfer for “value to the debtor” and taking the transfer in good faith are affirmative defenses to actual and constructive fraudulent transfer claims in 11 U.S.C. § 548(c)).  It is unclear in the opinion why the appeal was only taken in relation to the constructive fraudulent transfer claims.

The opinion focused on whether value is reasonably equivalent from the perspective of creditors.  That is the same approach taken in California’s Uniform Voidable Transactions Act in California and related case law.  See, e.g., in relation to fraudulent transfer claims in under the Uniform Voidable Transactions Act in California, California Civil Code § 3439.03 in the Legislative Committee Comments—Assembly, Note 2; see also In re Bay Plastics, Inc., 187 B.R. 315, 329 (Bankr. C.D. Cal. 1995) and In re Maddalena, 176 B.R. 551, 555 (Bankr. C.D. Cal. 1995).  See also, In re Jeffrey Bigelow Design Group, Inc., 956 F.2d 479, 484 (4th Cir. 1992) (“Hence, the proper focus is on the net effect of the transfers on the debtor’s estate, the funds available to the unsecured creditors.”).  Other courts have taken different approaches as to whether tuition payments provide reasonably equivalent value.  See, e.g., In re Michel, 572 B.R. 463, 475-478 (Bankr. E.D.N.Y. 2017) (that case dealt with tuition for minor children, which differs from the situation in the present case regarding college tuition payments). 

The approach to reasonably equivalent value taken in the opinion is well-reasoned and has the practical impact of permitting bankruptcy trustees to avoid and recover tuition payments made while the debtor was insolvent (and, in this case, running a Ponzi scheme).

For discussions of other cases dealing with related issues, see: -2018-29 Comm. Fin. News. NL 58

These materials were written by Corey R. Weber, a partner at Brutzkus Gubner Rozansky Seror Weber LLP, located in Woodland Hills, California, a member of the ad hoc group of the California Lawyers Association (CLA) Business Law Section for the Commercial Finance Newsletter, published weekly on Westlaw. Editorial contributions were made by the Honorable Meredith Jury (United States Bankruptcy Judge, C.D. Cal, Ret.), also a member of the ad hoc group. Thomas 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 Thomas Reuters.