The following is a case update written by M. Jonathan Hayes, Resnik Hayes Moradi LLP, analyzing a recent decision of interest:
In Kasolas v. Nicholson (In re Fox Ortega Enterprises, Inc.), — B.R. –, 2021 WL 1605169 (Bankr. N.D. Cal. 2021), the bankruptcy court ruled on summary judgment that delivery of product by the debtor to its customer, who had previously ordered and paid for the product, constituted an avoidable fraudulent conveyance because (1) the delivery came after threats by the customer relating to the non-delivery of the product, and (2) the debtor’s principal, later, in a criminal proceeding, conceded that the operation of the business was, at least in part, a Ponzi scheme.
A copy of the bankruptcy court’s decision can be found here.
Two years later, the company filed chapter 7, owing its customers $45 million for unshipped wine. Two years after that, the trustee sued Nicholson to avoid the transfer of the wine to him as a fraudulent conveyance under Bankruptcy Code section 548(a)(1)(A) and California Civil Code section 3439.04(a)(1). The trustee argued that the debtor had actual intent to delay, hinder or defraud its creditors by delivering the wine to Nicholson when it did. The trustee offered the admissions made by John Fox, in the criminal proceeding against him, not long after the bankruptcy case was filed. As part of a “Plea Agreement,” Mr. Fox admitted that:
[the debtor] knowingly solicited orders it never intended to fulfill, diverted the funds obtained to personal uses of its principal, and “satisfied” the demands of insistent and suspicious customers by delivering “their” wines not via pre-arrival orders from famous chateaux, but by obtaining the wines in a “catch as catch can,” ad hoc basis.
The court granted the trustee’s motion for summary judgment explaining his reasoning in a lengthy memorandum. He also entered judgment against Nicholson for $231,447, $151,960 for the wine plus $79,487 for interest.
There was really no factual issue that John Fox ultimately took the Nicholson threats seriously and started “scrambling” to buy the wine needed to fill the orders. In some cases, he even paid more than the price Nicholson paid him for the wine. In some cases, he bought wine that could have been delivered to customers with older orders than Nicholson. There was also no factual issue that the company was insolvent before, during and after the transfers. It clearly was.
Nicholson contended that he was entitled to the good faith defense under California law which states, “A Transfer or obligation is not voidable under paragraph (1) of subdivision (a) of Section 3439.04, against a person that took in good faith and for reasonably equivalent value given the debtor or against any subsequent transferee or obligee.” CUVTA § 3439.08(a). The court discussed “the holdings and the rationales from the Nautilus, Inc. v. Yang, 11 Cal. App. 5th 33 (2017) case.” Nautilius in turn discussed CyberMedia, Inc. v. Symantec Corp., 19 F. Supp. 2d 1070, 1075 (N.D. Cal. 1998) which provided:
Accordingly, this Court holds that, for purposes of the UFTA, a transferee lacks good faith if he or she (1) colludes with the debtor or otherwise actively participates in the debtor’s fraudulent scheme, or (2) has actual knowledge of facts which would suggest to a reasonable person that the transfer was fraudulent. Cybermedia, 19 F. Supp. 2d at 1075. [emphasis in original].
The bankruptcy court found that Nicholson “had no uncertainty whatsoever about what the facts that he knew established about the Debtor’s business and the Subject Transfers, and no hesitancy calling the Debtor out for its fraudulent conduct.” Indeed, the Ponzi scheme threat in the email established that Nicholson had actual knowledge of the purported (at the time) criminal enterprise.
The bankruptcy court closed with a discussion of a recent California case, Universal Home Improvement, Inc. v. Robertson, 51 Cal. App. 5th 116 (2020) which held that “because section 3432 of the California Civil Code expressly provides that a debtor may prefer one creditor over another, the ‘badges of fraud’ do not matter when value is given, such as satisfaction of an antecedent debt.” The bankruptcy court noted that it was required to “apply state law as the state courts have done, as reflected by the decisions of that state’s highest court.” Since the California Supreme Court has not ruled directly on the issue, the bankruptcy court found, after a very thoughtful analysis, that it was “inconceivable” that the California Supreme Court would follow Universal Home Improvement in the case at hand because, for one thing, “we know from the Plea Agreement that, at least on a general level, there is no doubt that John Fox, as the principal of the debtor, intended to commit and did in fact commit fraud.” Further, Universal Home Improvements, “taken to its logical end, would render superfluous or even negate numerous provisions of CUVTA, in a manner that would be contrary to well-established principles of statutory construction, and which the Court believes the California Supreme Court would be unlikely to adopt.”
I have always been bothered by the Ninth Circuit’s ruling in Johnson v. Neilson (In re Slatkin), 525 F.3d 805 (9th Cir. 2008) which affirmed the bankruptcy court’s grant of summary judgment saying:
“We now hold that a debtor’s admission, through guilty pleas and a plea agreement admissible under the Federal Rules of Evidence, that he operated a Ponzi scheme with the actual intent to defraud his creditors conclusively establishes the debtor’s fraudulent intent under 11 U.S.C. § 548(a)(1)(A) and California Civil Code § 3439.04(a)(1), and precludes relitigation of that issue.”
As I recall, there were 300 or so cases pending in the Slatkin matter at the time of the ruling, which resulted in summary judgment in every case, all based on statements made by Reed Slatkin as part of a settlement designed to reduce his time in jail. Suddenly, every dime he spent was “part of the fraud,” and therefore a fraudulent transfer notwithstanding the good faith of the transferee. Remember, the good faith of the transferee is not a defense under section 548 unless the transferee is a subsequent transferee. See section 550(b)(2).
Carlo Ponzi was a penny-ante crook whose “empire” lasted some six to seven months. He made no effort to generate legitimate profits. That has morphed into unsuccessful business owners being routinely threatened with operating a Ponzi scheme when they were simply bad businesspersons. Suddenly everyone doing business with them is subject to having their business transactions reversed – and by summary judgment. When I think up a good response to this, I’ll let you know.