Payment of Interest on Investment or Loan: Does it Matter in a Ponzi Scheme?

Payment of Interest on Investment or Loan: Does it Matter in a Ponzi Scheme?

In the consolidated bankruptcy proceeding of Frederick Darren Berg and the Meridian Funds, the trustee filed several fraudulent transfer actions. In one of them, against Jack W. Brown and Margaret A. Heftel, the trustee claimed that fictitious interest payments were constructive fraudulent transfers. Calvert v. Brown (In re Consolidated Meridian Funds), 2013 Bankr. LEXIS, 675 (Bankr. W.D. Wash. Feb. 19, 2013). The defendants had made loans to the Meridian Funds in exchange for promissory notes promising interest between 9.5% and 12.5% per annum.

Brown and Heftel filed a motion for summary judgment. The court had previously denied a different defendant's motion for summary judgment, where, like here, the defendants had received back more than their initial investment and it was recovery of the profits that was at issue. Brown and Heftel argued a different twist on the analysis of whether the debtors received reasonably equivalent value in exchange for their interest payments.

The court had previously ruled in Calvert v. Foster Radford that interest payments were not in "satisfaction of an antecedent debt within the meaning of either the state or federal fraudulent conveyance statutes, and therefore did not constitute reasonably equivalent value." Id. at *10. In their motion, Brown and Heftel contended that the court did not consider the argument that in analyzing the issue of reasonable equivalent value, a lender should be treated differently than an equity investor. "They argue that a debtor's repayment of an equity investment would not qualify as satisfaction of an antecedent debt under the state UFTA, whereas the debtor's repayment of a loan with reasonable interest should qualify as satisfaction of an antecedent debt." Id. at *11.

The court first analyzed the split of authority on whether reasonably equivalent value can ever be exchanged in connection with the payment of interest in a Ponzi scheme case. It noted that most courts find that "any return to a lender or investor in a Ponzi scheme in excess of the principal investment will not be treated as value, and therefore cannot be counted in determining whether the return was 'reasonably equivalent.'" Id. at *14-15; see also, Donell v. Kowell, 533 F.3d 762 (9th Cir. 2008), In re United Energy Corp., 944 F.2d 589, 596 (9th Cir. 1991). On the other hand, the court considered the few decisions that have held that "commercially reasonable interest on an enforceable promissory note should be treated as payment on an antecedent debt and therefore not be recoverable as a fraudulent conveyance." Id. at *13-14 (citing In re Unified Commercial Capital, Inc., 260 B.R. 343 (Bankr. W.D.N.Y. 2001); In re Carrozzella & Richardson, 286 B.R. 480 (D. Conn. 2002).

The court then accurately captured the struggle in trying to do equity in these circumstances:

There is no question that the courts have struggled with the differing facts in these cases, where the consequences of the scheme deprive some investors of their life savings and render other investors defendants in lawsuits where significant sums of money, long since paid to them, are subject to recapture. Acknowledging these harsh results, the Ninth Circuit adopted a rule intended to even out the results as between investors who get paid and those who do not. Investors who get paid are protected by the various statutes of limitation; they may keep those payments made to them outside the statute of limitations, but they must share the pain by giving up anything they received in excess of their investment within the applicable statute of limitations. The case law reflects that the courts are not in agreement as to how the pain should be shared in these unfortunate cases.

Meridian at *16-17.

The court then engaged in analysis of other cases cited by the defendants, distinguishing each of them on the following basis:

  • In re Image Masters, Inc., 421 B.R. 164 (Bankr. E.D. Pa. 2009): Lending institutions had received payments on homeowner loans as part of the scheme, but the court found that none of the debtors had a direct relationship with the lenders. Rather, homeowners refinanced their homes directly with the lenders who took mortgages in the homes, and the homeowners then separately contracted with the debtors regarding wraparound mortgages on their homes. "The court concluded that because the debtors' payments to the lenders reduced the debtors' debt to the homeowners, the debtors received 'value' for those payments, and that because the reduction in the debt was dollar-for-dollar, it was also equivalent." Meridian at *21.
  • In re Financial Federated Title & Trust, Inc., 309 F.3d 1325 (11th Cir. 2002): This case deals with the trustee's claim to recover commissions paid to a former employee of the debtor. The "court followed In re Universal Clearing House Co., 60 B.R. 985 (D. Utah 1986), in concluding that the determination of 'value' should focus on the value of the goods and services provided rather than the impact the goods and services had on the bankrupt entity (i.e., deepening insolvency and furtherance of the Ponzi scheme)." Meridian at 21.
  • In re M&M Marketing, LLC, 2013 Bankr. LEXIS 172 (Bankr. D. Neb. Jan. 15, 2013): The court noted that this court "cited Donell with approval, but noted that other courts, in the right circumstances, might find the repayment of interest equivalent value, citing Carrozzella. The facts in the case before the M&M court, however, did involve what the court thought was an excessively high rate of interest, 25% in 90 days." Meridian at *22.

In the Meridian case, Brown and Heftel argued that they are not were not "investors in the equity sense" but rather were more like traditional lenders. Id. at *18-19. The court noted, however, that "The notes attached to the Brown Declaration and the Heftel Declaration, however, look more like investments than traditional loans" and set forth a few facts in this case which informed that conclusion. Id. at *19. The court found:

  • "The notes refer to disclosure packages and subscription agreements, which are normally associated with investments rather than commercial loans." Id.
  • "The complaints in these cases allege that the sole business of the Meridian Funds was to offer and sell promissory notes to investors and that investors were told that the sole purpose of the investment was to enable the Meridian Funds to invest on their behalf in seller-financed real estate contracts, hard money loans, real estate and mortgage-back securities." Id.
  • "Investors like Mr. Brown and Ms. Heftel were promised rates of return on their investments in the form of interest payments." Id.

Accordingly, the court denied the defendants' motion for summary judgment.

At least in the Ninth Circuit on this issue, the label doesn't matter, and recipients of payments in a Ponzi scheme are more simply characterized as net losers or net winners. As the Meridian court noted: The Ninth Circuit "has not adopted a rule which treats victims of a Ponzi scheme differently depending upon whether their investment can be characterized as a financial investment, equity investment or loan." Id. at *19.

Lexis.com subscribers can access enhanced versions of the opinions cited in this article:

Calvert v. Brown (In re Consolidated Meridian Funds), 2013 Bankr. LEXIS 675 (Bankr. W.D. Wash. Feb. 19, 2013)

Donell v. Kowell, 533 F.3d 762 (9th Cir. 2008)

In re United Energy Corp., 944 F.2d 589 (9th Cir. 1991)

In re Carrozzella & Richardson, 286 B.R. 480 (D. Conn. 2002)

In re Image Masters, Inc., 421 B.R. 164 (Bankr. E.D. Pa. 2009)

In re Financial Federated Title & Trust, Inc., 309 F.3d 1325 (11th Cir. 2002)

In re M&M Marketing, LLC, 2013 Bankr. LEXIS 172 (Bankr. D. Neb. Jan. 15, 2013)

Read additional articles at The Ponzi Scheme Blog

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, recently reviewed by Commercial Crime International, 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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