International Management Associates, LLC, and several related entities (the “Debtors”) were operated as the instruments of a Ponzi scheme. A receiver ultimately filed voluntary petitions in the bankruptcy court seeking relief for each of the Debtors under Chapter 11 of the Bankruptcy Code.
The Trustee then instituted a number of adversary proceedings in the bankruptcy court seeking to avoid and to recover distributions that had been made to the investors in the Debtors. The Trustee claimed that transfers to the investors prior to the collapse of the Ponzi scheme were “fraudulent transfers”. The investors asserted an affirmative defense claiming that the transfers were “for value.” The Trustee moved for partial summary judgment. The bankruptcy court denied the motion, effectively upholding the availability of the investors’ affirmative defense.
The Debtors were formed purportedly to manage and operate them as hedge funds, each of which was structured either as a limited liability company or a limited partnership. In reality, the Debtors were used to operate a fraudulent Ponzi scheme whereby capital contributions made to the Debtors by later equity investors were used to repay earlier investors more than their investments were actually worth, as well as fictitious profits. This was done to perpetuate the illusion that the Debtors had positive investment gains, to keep existing investors from seeking recovery of their equity investments, and to induce prospective investors to make new equity investments.
The Court’s acceptance of that assumption should not be interpreted as a ruling on any factual or legal matter other than the “for value” issue of law: the sole issue argued and before us.
Each of the investor defendants made a capital contribution through execution of a limited liability company agreement, a limited partnership agreement, and/or a subscription agreement with one or more of the Debtors such that each investor defendant held an equity interest in one or more of the Debtors, denominated as a membership unit or limited partnership interest. At some point during the operation of the Ponzi scheme, each investor defendant received one or more transfers of property from one or more of the Debtors, representing returns of principal and/or purported profits on their equity investments.
With respect to Ponzi schemes, transfers made in furtherance of the scheme are presumed to have been made with the intent to defraud for purposes of recovering the payments.
However a transferee with an affirmative defense where the transferee acts in good faith and “[gives] value to the debtor in exchange for such transfer . . . .” The term “value” is defined to include “satisfaction or securing of a present or antecedent debt of the debtor.”
In the case of Ponzi schemes, the general rule is that a defrauded investor gives “value” to the Debtor in exchange for a return of the principal amount of the investment, but not as to any payments in excess of principal.
Any transfers over and above the amount of the principal — i.e., for fictitious profits — are not made for “value” because they exceed the scope of the investors’ fraud claim and may be subject to recovery by a plan trustee.
The Trustee hangs his hat on a line of cases holding that transfers to redeem an equity investment in an insolvent entity (initially made free of fraud) cannot constitute a transfer “for value.
In each of these decisions, investors exchanged shares of stock for other security interests, notes, or real property, all at a time when the corporations were insolvent. The courts held that the exchanges constituted fraudulent transfers because the stock returned to the corporations as part of the exchange was, at that time, virtually worthless due to the corporate insolvency.
The Trustee contends that these decisions should apply here because the Debtors were all insolvent at the time the transfers to the investor defendants were made, and any such transfers served only to redeem their worthless equity interests. The court disagreed, and found the argument to be unpersuasive for the simple reason that none of these decisions involved Ponzi schemes. Stated differently, none of the stockholders in those cases were fraudulently induced into making their initial investments so that none possessed fraud claims that would be satisfied in whole or in part by virtue of the later transfers.
Sidney Turner
www.SidneyTurnerllc.com
