The following is a case update written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, analyzing a recent decision of interest:
In Berman v. Pavano (In re Michael S. Goldberg, LLC), 2020 W.L. 6811222 (Bankr. D. Ct. August 28, 2020) (“Goldberg”), the United States Bankruptcy Court for the District of Connecticut (the “Court”) rejected the defendant’s affirmative defense in a fraudulent conveyance suit brought by the Chapter 7 trustee of Ponzi scheme debtors that the defendant received the subject transfer for value and in good faith, finding that the defendant, a sophisticated businessman, was on at least inquiry notice to conduct a diligent inquiry that would have disclosed the scheme.
Goldberg can be found here.
Over about 10 years, debtor Goldberg conducted a massive Ponzi scheme through his limited liability company (the “LLC” and together with Goldberg, the “Debtors”). The Debtors told investors, either directly or through individuals who were “feeders” (i.e., essentially finders), that the LLC would buy construction equipment and materials at foreclosure sales by lenders on builders and developers at deep discounts prearranged with the lenders, then re-sell the collateral at a substantial profit. The Debtors claimed that investor profits would be 10% or more over periods of mere months. However, the Debtors, in a classic Ponzi scheme, rather than conducting the business they described simply paid the promised returns to investors with funds from new investments.
One investor, LaBonte, was a sophisticated businessman with vast experience in real estate development through his own company, of which he was the senior officer and then the chairman. The company had developed, acquired and/or managed numerous commercial malls in the vicinity, among other things. He knew how to read and assess financial documents and enter into loan and other transactions with banks. With this background, LaBonte invested $300,000 in the LLC through his son in a transaction in which his son clearly was a mere conduit after taking a finder’s fee for himself from the LLC. Despite his sophistication and eminent access to ways to assess the Debtors’ operations, as well as a meeting with Goldberg himself, he essentially performed no due diligence on the business, ignoring the extraordinary returns and the absence in his own career of any examples of the kind of foreclosures on projects and re-sales that the Debtors’ business purportedly involved. In addition, neither he nor his own company had ever purchased such collateral at a foreclosure sale or from a foreclosure sale buyer.
In August of 2008, the LLC made a payment to LaBonte of $425,000 (the “Payment”) through his son. Of that sum, $300,000 was return of LaBonte’s investment and $125,000 was his purported profit on it. At about the same time, the son first expressed some doubts to LaBonte about the legitimacy of the Debtors’ business. Naturally, the Ponzi scheme eventually collapsed. Goldberg himself reported the scheme to the Securities and Exchange Commission. He pled guilty to resulting criminal charges, was sentenced to jail and ordered to pay over $30 million in restitution. Shortly afterwards, in November of 2009, some creditors filed involuntary Chapter 7 petitions against the Debtors, which the Court granted. A trustee was appointed.
In 2011, the trustee filed an adversary proceeding against LaBonte alleging that the $425,000 Payment was an intentional fraudulent conveyance under Bankruptcy Code § 548(a)(1) (“§ 548(a)(1)”). Among the defenses LaBonte raised was that he had given value for the transfer, lacked knowledge of the Ponzi scheme at the time of the transfer and received the transfer in good faith, the affirmative defense permitted by Bankruptcy Code § 548(c) (“§ 548(c)”). The Court finally tried the matter in December 2018 and issued the opinion in August 2020. It found that the Payment was an intentional fraudulent conveyance and ruled against LaBonte on his § 548(c) affirmative defense.
On whether the Debtors made the Payment with actual intent to hinder, defraud or delay creditors under § 548(a)(1), the Court essentially adopted the widespread judicial view that the necessary intent is presumed where there is a Ponzi scheme.
The Court next considered LaBonte’s § 548(c) affirmative defense. On the issue of value, LaBonte evidently argued that he had provided real value in the form of the $300,000 investment he made. However, relying on the case law that indicates that when there is an intentional fraudulent conveyance the entire amount of a subject transfer can be avoided even if part of it represents value given, the Court rejected LaBonte’s theory. That by itself was enough to defeat LaBonte’s § 548(c) defense since it requires the defendant to show both value and good faith. But the Court also discussed the good faith issue, indeed at some length.
The Court observed that good faith requires not merely a lack of actual knowledge of the Ponzi scheme, but also imputes to the defendant knowledge that a reasonably diligent inquiry would have disclosed if there were facts that put the defendant on inquiry notice. On that score, the Court readily found against LaBonte based on the combination of various facts of which LaBonte had knowledge that at least put him on inquiry notice prompting an investigation that would have disclosed the scheme. Among those facts were LaBonte’s financial and business sophistication, his vast experience in real estate-related transactions and development, and the too-good-to-be-true returns (so characteristic of fraudulent schemes in general and Ponzi schemes in particular). LaBonte was no single-store pizza franchisee delivering occasional lunches to the Debtors’ offices.
The result is correct and uncontroversial. But there is a quirk in the opinion. It is the Court’s apparent equation of the scope of the remedy (avoidance of the entire Payment even if some of it was for value) with the issue of whether LaBonte gave value for the transfer as an element of the § 548(c) affirmative defense. To equate the two is to strip the affirmative defense from the statute altogether. For if the remedy for a fraudulent conveyance always encompasses the entire transfer and in principle that renders the transaction without value given by the transferee, no transferee can win on the value prong of the § 541(c) defense even if he satisfies the good faith prong. This means that an innocent transferee (who takes in good faith) can never mount a § 548(c) defense, making the innocent transferee suffer to make defrauded creditors better off. Nor did the Court have to treat the value issue as it did, because LaBonte’s manifest bad faith was fatal to his defense.
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.