Fraudulent Transfer Claim Meets Forfeiture Proceeding in Ponzi Scheme Case

Fraudulent Transfer Claim Meets Forfeiture Proceeding in Ponzi Scheme Case

It occasionally happens that a trustee seeks to avoid a debtor's prepetition transfer of property as a fraudulent transfer and that property is also subject to a government forfeiture proceeding. In that event, can the trustee still follow the familiar path and file an adversary proceeding in the bankruptcy court, or must the trustee jump into unfamiliar territory and file a petition in forfeiture proceeding in the district court?

A recent opinion coming out of the Scott Rothstein Ponzi scheme case concludes that in these circumstances, the trustee must pursue the fraudulent transfer claim in the forfeiture process and that the trustee's attempt to pursue it in the bankruptcy court after the entry of a final order of forfeiture is barred by res judicata. Stettin v. Alu (In re Rothstein Rosenfeldt Adler, P.A.), 2012 Bankr. LEXIS 4472 (Bankr. S.D. Fla. Aug. 29, 2012). In that case, the trustee in the bankruptcy case of Rothstein's law firm sought to avoid a transfer of $301,000 that the law firm had made to the bodyguard of Rothstein's wife to enable him to purchase a home. The bodyguard and his wife, Joseph and Jody Alu, executed a note and a mortgage to Fifth Court LLC, an entity owned by Rothstein.  The trustee also sought to avoid that note and mortgage.

The assets of Fifth Court, however, were the subject of a district court forfeiture order in Rothstein's criminal case, stating that Rothstein forfeited "[a]ll right, title and interest in Fifth Court and all assets held by or owed to it." In the meantime, the Alus interpled with the bankruptcy court sufficient funds to pay off the mortgage. As a result, the dispute over those funds was really between the trustee and the government - fraudulent transfer claim v. forfeiture order.

The government, relying on the specific language of the forfeiture order, contended that the trustee's claim was a collateral attack upon it. The trustee argued that he was not collaterally attacking the forfeiture order or challenging government's claim to Fifth Court and its assets but rather was asserting that Fifth Court, and therefore the government, had no claim to the interpled funds because the note and mortgage were invalid.

The bankruptcy court found for the government and dismissed the trustee's fraudulent transfer claim. The court held that an ancillary proceeding under 21 U.S.C. § 853(n) "is the exclusive means for a third party to claim an interest in forfeited property." The court also noted that § 853(k) prohibits a third party from commencing an action at law or equity against the government concerning the validity of an alleged interest in the property outside of an ancillary proceeding. Because the trustee could have filed a petition in the ancillary proceeding asserting his fraudulent transfer claim and the invalidity of the note and mortgage but did not, the final order of forfeiture extinguished the trustee's claim.

Interestingly, the trustee had actually filed a petition in the forfeiture action, but only seeking the imposition of a constructive trust over Fifth Court for an amount equal to funds that the law firm had transferred to the Alus. The district court, however, had dismissed that claim. It is unclear why the trustee had not asserted his fraudulent transfer claim in the same petition. According to the bankruptcy court, that is precisely what the trustee should have done.

The bankruptcy court's decision on this issue is not an anomaly. It is consistent with prior case law. See, e.g., Uecker & Assocs., Inc. v. L.G. Hunt & Assocs., Inc. (In re American Basketball League, Inc.), 317 B.R. 121, 128 (Bankr. N.D. Cal. 2004) (holding that upon entry of the final order of forfeiture, the government held good title to sales proceeds as substitute res and no petition had been filed in the ancillary proceedings under 21 U.S.C. § 853(n) so the fraudulent transfer claim to recover the proceeds was barred outside of the forfeiture action under § 853(k)).

The lesson for bankruptcy trustees from these cases is clear: Any avoidance action directed at forfeited property must be made in the forfeiture action under 21 U.S.C. § 853(n) and not in the bankruptcy court. Even though this will obviously be more challenging for trustees and their counsel and probably outside of their comfort zones, their failure to abide this lesson will likely mean the loss of the fraudulent claim to the detriment of the estate.

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Kathy Bazoian Phelps is the co-author of The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes  (LexisNexis 2012), along with Hon. Steven Rhodes.  The Ponzi Book is available for purchase at www.lexisnexis.com/ponzibook, and more information about the book can be found at www.theponzibook.com.

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