The following is a case update written by the Hon. Meredith Jury (United States Bankruptcy Judge, C.D. Cal., Ret.), analyzing a recent decision of interest:
Ruling on a discrete issue in a Ponzi scheme case with other issues (stay tuned for a second review of this case), the United States Court of Appeals for the Eighth Circuit held that when awarding prejudgment interest on damages awarded for a fraudulent transfer claim brought under Bankruptcy Code § 544, the applicable rate is the federal rate, not that of the underlying state. Kelley v Boosalis, 2020 U.S. App. LEXIS 28811 (8th Cir. 9/11/20).
To view the opinion, click here.
Petters Company, Inc. (PCI) orchestrated a Ponzi scheme causing $3.5 billion in financial losses from 1994 to 2008. PCI purported to run a “diverting” business that purchased electronics in bulk and resold them at high profits to major retailers. PCI associates solicited individual investors to make secured loans to finance specific purported purchases of goods for resale. The loans were documented with notes and usually a security agreement on the purchased inventory. As is typical in a Ponzi scheme, the money loaned was not used to purchase inventory or for any other business purpose but rather was diverted for personal use and to repay interest due on outstanding loans from other investors. The scheme came crashing down in 2008 when a former PCI employee exposed it, the primary instigator was convicted of multiple federal offenses, and PCI filed bankruptcy. Plaintiff here was the Liquidating Trustee for the PCI Liquidating Trust who filed more than 200 cases seeking to recover (“claw back”) PCI’s interest payments to early PCI lenders.
This case involves the Trustee’s claw back claims against lenders Boosalis, Papadimos and Kanios filed under 11 U.S.C. § 544(b)(1) which permits a trustee to “avoid any transfer of an interest of the debtor…that is voidable under applicable law by a creditor holding an unsecured claim.” The applicable law is the Minnesota Uniform Fraudulent Transfers Act (“MUFTA”). The action was filed in 2010 and sought to recover only payments of interest to defendants. A jury trial resulted in a verdict against Boosalis, which was followed by the judge issuing judgment against Papadimos and Kanios based on a summary judgment motion. Both awards added prejudgment interest at the 10% state judgment rate commencing on the 2010 filing date, which added almost 80% to the Boosalis judgment and 47% to the others.
Defendants appealed to the Eighth Circuit, which reversed the judgments on varied grounds which will be discussed in a later review and remanded the cases to the trial court. Despite the reversals, the Circuit addressed the challenge to the application of the state interest rate because it would be relevant on remand. It held that the trial court erred in applying the state rate because the federal rate was proper.
The Circuit noted that in general prejudgment interest presents “a question of federal law where the cause of action arises from a federal statute,” [citations omitted], whereas “in a diversity case, the question of prejudgment interest is a substantive one controlled by state law.” [citations omitted]. The question before the court was whether the Trustee’s § 544 (b)(1) avoidance action was a state or federal cause of action for purposes of prejudgment interest. For the Eighth Circuit this presented a case of first impression on an issue which has divided other courts.
In discussing the issue, the Circuit saw a distinction in fraudulent transfer actions between avoiding the transaction and actually recovering the property or the value thereof. Although avoidance through the tool of § 544 by its nature relies on the underlying applicable law (here, the state of Minnesota), the Circuit found that recovery only occurs under the provisions of § 550 which provides “the trustee may recover, for the benefit of the estate, the property transferred or, if the court so orders, the value of such property.” Because the Trustee’s right to recover from the defendants was possible only under the provisions of § 550, the court saw the district court’s jurisdiction as based on a federal question, not jurisdiction which was supplemental to the avoidance under state law. Since the litigation resulting in the damages judgments was a federal cause of action, it compelled the application of federal law to an award of prejudgment interest. Therefore, the federal rate applied.
The Circuit discussed two reported cases on this subject, Hayes v Palm Seedlings Partners-A (In re Agric. Research & Tech. Grp., Inc.), 916 F.2d 528 (9th Cir. 1990), and Lassman v Keefe (In re Keefe), 401 B.R. 520 (1st Cir. BAP 2009), and rejected their conclusions that the state rate applied. The Ninth Circuit in Hayes, while addressing the issue of whether prejudgment interest ran from the transfer or from the complaint date, without any analysis, flatly said the Hawaiian interest was applicable. The First Circuit BAP held that the state law was the substantive law for the fraudulent transfer judgment and also found the state rate applicable to prejudgment interest. Although the Ninth Circuit decision is no help, I think the BAP case makes more sense and its reasoning would be equally applicable here.
The state law in question under § 544 is MUFTA. Certainly, if a party sues to avoid a fraudulent transfer under MUFTA and wins, its judgment would be for the property or its money value. That would be the damages awarded against the losing wrong doing defendant; i.e. the remedy. For every successful cause of action, there is remedy available if the plaintiff wins. The Eighth Circuit seems to ignore this aspect of the underlying state law. Not only does MUFTA avoid the transfer, it provides a remedy to the plaintiff. Quite simply, the damages are awarded under state substantive law and the state interest rate should apply. I recognize the distinction the Circuit is making and that the Bankruptcy Code seems to separate the remedies for a fraudulent transfer between avoidance and recovery, but, quite frankly, avoidance without recovery is no benefit to the estate whatsoever. To make § 544 not superfluous, a logical reading is that if state law dictates avoidance it also provides a meaningful remedy.
These materials were authored by the Hon. Meredith Jury (United States Bankruptcy Judge, C.D. Cal., Ret.), a member of the ad hoc group, with editorial contributions by Monique D. Jewett-Brewster, an attorney with Hopkins & Carley, ALC, a member of the ad hoc group and 2018-19 Chair of the CLA Business Law Section. 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.