Editor's note: Author Jordan Maglich currently serves as counsel to the Receiver in the below case. The opinions contained herein represent his opinion only, and do not represent the views of his law firm or the Receiver.
The Eleventh Circuit Court of Appeals issued an opinion that, for the first time, addressed an increasingly common argument raised in "clawback" lawsuits related to the recovery of fraudulent transfers and opened the door for an award of prejudgment interest against "net winners." In Burton W. Wiand v. Vernon M. Lee, et al, a three-judge panel issued an opinion affirming an award of summary judgment in favor of the receiver appointed over Arthur Nadel's $350 million Ponzi scheme and against one of Nadel's investors for approximately $1 million in false profits. That investor, Vernon Lee, had appealed the award of summary judgment based on Florida's Uniform Fraudulent Transfer Act ("FUFTA"), arguing the sole issue of whether the false profits he received constituted "property of the debtor" required under FUFTA. The Receiver had cross-appealed, arguing that the district court's refusal to grant prejudgment interest constituted an abuse of discretion.
Justice Mark E. Fuller, a District Judge in the Middle District of Alabama sitting by designation, authored the 20-page opinion. From 2000 to 2008, Lee and his trust received nearly $1 million in false profits from Nadel's scheme, which purported to offer investors lucrative returns through Nadel's purported trading prowess. Following the collapse of Nadel's scheme in early 2009 and the subsequent appointment of a receiver, Lee and other "net winners" were sued for the return of their false profits.
The Receiver sought recovery of the approximately $1 million in distributions made to Lee in excess of his principal, arguing that the transfers constituted violations of FUFTA both under its actual fraud provision and its constructive fraud provision. Under the actual fraud provision, a transfer made or obligation incurred by a debtor is fraudulent as to a creditor if the debtor made the transfer or incurred the obligation "with actual intent to hinder, delay, or defraud any creditor of the debtor." Fla. Stats.
§ 726.105(a). The fraudulent transfer must be of an asset, which is defined as any "property of the debtor," subject to limited exceptions.
Because it is often difficult to show actual intent to defraud, courts conducting an actual fraud analysis typically look to the statutory "badges of fraud" set forth in
§ 726.105(2)(a), including whether the transfer was made to an insider, the debtor retained control, the transfer was of substantially all the debtor's assets, or the debtor was insolvent or became insolvent shortly after the transfer was made. Additionally, other federal courts analyzing transfers made in a Ponzi scheme have held that actual intent is sufficiently demonstrated upon a showing of proof that a transfer was made from an entity used to perpetrate a Ponzi scheme - without any analysis of the statutory badges of fraud. See Donell v. Kowell, 533 F.3d 762, 770 (9th Cir. 2008) (applying California’s UFTA) [an enhanced version of this opinion is available to lexis.com subscribers]; S.E.C. v. Res. Dev. Int’l, LLC, 487 F.3d 295, 301 (5th Cir. 2007) (applying Texas’s UFTA) [enhanced version]; Warfield v. Byron, 436 F.3d 551, 558–59 (5th Cir. 2006) (applying Washington’s UFTA) [enhanced version]. The "Ponzi scheme presumption," as it has become known, has similarly been held applicable to Ponzi schemes in the bankruptcy context.
Expanding on this analysis, the Eleventh Circuit held:
under FUFTA’s actual fraud provision, proof that a transfer was made in furtherance of a Ponzi scheme establishes actual intent to defraud under § 726.105(1)(a) without the need to consider the badges of fraud. The magistrate judge was thus correct to frame the inquiry in terms of whether Nadel operated the receivership entities as a Ponzi scheme at the time he made the transfers to Lee.
"Property of the Debtor"
Next, the Eleventh Circuit addressed the argument advanced by Lee that, even if the transfers were made with the actual intent to defraud, they still could not satisfy FUFTA's requirement that Nadel's transfers to investors must have been "property of a debtor." In other words, because investors received funds from the hedge funds utilized by Nadel to perpetrate his scheme - rather than Nadel himself - investors did not receive "property of a debtor."
In analyzing this argument, the Court first cited to the seminal Seventh Circuit decision in Scholes v. Lehmann, 56 F.3d 750 (7th Cir. 1995), including the infamous analogy recited by Judge Posner likening the companies used by the perpetrator to "robotic tools" that, upon removal of the Ponzi schemer, were no longer "evil zombies" under the "spell" of the Ponzi schemer but rather legal entities entitled to the return of diverted funds. Further expanding on this analogy, the Eleventh Circuit held that Nadel's hedge funds were harmed when Nadel diverted the investor funds they were holding for unauthorized uses. Thus, under Lehmann, these hedge funds became Nadel's "creditors" at the time Nadel diverted their funds to investors because these actions gave them a "claim" against Nadel.
These funds were "property" of Nadel because:
The creditor must demonstrate that “(1) there was a creditor to be defrauded; (2) a debtor intending fraud; and (3) a conveyance of property which could have been applicable to the payment of the debt due.” Nationsbank, N.A. v. Coastal Utils., Inc., 814 So. 2d 1227, 1229 (Fla. 4th DCA 2002) (citation omitted) (emphasis added) [enhanced version]. The third element constitutes Florida courts’ criterion for when something is the property of a debtor under FUFTA. This element is established because the funds that Nadel controlled and transferred to investors could have been applied by him to pay the debt he owed to the receivership entities as a result of his use of funds to perpetrate a Ponzi scheme. With each transfer that Nadel made, Nadel became a debtor of the receivership entities because he diverted the funds from their lawful purpose in violation of his fiduciary duties and was thus obligated to return those same funds to the entities to be used for the benefit of the investors. Therefore, with each transfer, Nadel diverted property that he controlled and that could have been applicable to the debt due, namely, the very funds being transferred. As the Receiver states, “[T]he money transferred to the Defendants is not only ‘applicable to the payment of the debt due,’ but it is the actual money that generated and deepened (in part, along with money transferred to other investors) the debt owed by Nadel to the Investment Funds. In other words, it is the exact same money that generated the debt and gave rise to the claims in this case.”
Thus, the fact that the funds were in the possession of the hedge funds was not a determining factor. Rather, the analysis turned on the fact that the schemer, Nadel, exerted his control over the funds and transferred them in furtherance of his scheme rather than actually use the funds for the promised purpose. By diverting those investor funds to perpetuate his scheme, he violated his fiduciary duties to the funds and was thus required to return those same funds back to the entities to be used for investors' benefit. With each subsequent transfer, the hedge funds' "claim" against Nadel increased.
Next, the Court addressed whether the district court's refusal to award the Receiver prejudgment interest constituted an abuse of discretion. In the decision below, the Magistrate Judge had concluded that an award of prejudgment interest was not warranted as the defendants "had suffered enough." In response, the Eleventh Circuit noted that Florida law governed an award of prejudgment interest, specifically the three factors set forth in Blasland, Bouck & Lee, Inc. v. City of N. Miami, 283 F.3d 1286, 1298 (11th Cir. 2002) [enhanced version]:
Those factors are (1) in matters concerning government entities, whether it would be equitable to put the burden of paying interest on the public in choosing between innocent victims; (2) whether it is equitable to allow an award of prejudgment interest when the delay between injury and judgment is the fault of the prevailing party; (3) whether it is equitable to award prejudgment interest to a party who could have, but failed to, mitigate its damages.
The Eleventh Circuit concluded that the underlying rationale employed constituted an abuse of discretion:
because it fails to identify and apply the equitable factors considered in Blasland to the decision to deny prejudgment interest. The general observation that the Lee Defendants “have suffered enough” does not explain why the Receiver is not entitled to be made whole under Florida law, which holds prejudgment interest is an element of pecuniary damages. Further, that the Lee Defendants will be forced to pay more than the profits they received with the addition of a prejudgment interest award is not an equitable factor weighing against an award, but is a necessary consequence of the loss theory of prejudgment interest.
Noting that other Florida courts had applied prejudgment interest on FUFTA claims, the Court remanded the issue back to the district court for an application of the factors in Blasland.
The Opinion [enhanced version]
For more news and analysis of Ponzi schemes, visit Ponzitracker, a blog by Jordan Maglich, an attorney at Wiand Guerra King P.L.
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