Update (February 23, 201): Imagine some scenarios: (1) You own “cabins” in Colorado, you sell “one-week stays” to others, and you sell 200 “one-week stays” in your “cabins” although you only have 100 one-week slots; or (2) You do not own any cabins in Colorado, you nevertheless sell “one-week stays” to others, and you sell 200 “one-week stays” in your non-existent cabins or (3) How about you start with a legitimate business, slide into plan #1, and then get piggy and add plan #2?
You might think of the first scam as an “oversold participation.” There’s a real asset or value that you’re peddling, but you’re over-peddling. The second scam is an out-right “fictitious participation.”
Apparently, a fellow named Corey Johnston was entering into both kinds of deals with Minnesota banks in the early 2000’s through an entity called First United selling interests in commercial loans rather than cabins or phantom cabins.
So, when the entire enterprise collapses and the authorities seize a pot of money from the bad guy to redistribute to creditors, insufficient to refund all the money to all of the victims, should courts treat all of the members of the “oversold participations” and the “fictitious participations” the same?
Do we treat the earliest victims the same as the latest? What if we view the earliest victims as more innocent (having less reason to doubt the scheme’s legitimacy)? The later victims could have googled “fake cruddy cabin” + “bad guy” and they’d have avoided victimization? What if some folks in the “oversold participations” actually got some time in the cabins (again, with the metaphor (work with me))? Are they treated the same as everyone else?
What if some of the cabins were uninhabitable and unfortunate suckers only stayed a day or two and immediately demanded refunds? What if some got refunds or partial refunds? Can the authorities seize those back to be redistributed pro rata among all the victims? Do some recover less money because they actually got to “enjoy” the cabins for a little? What if there were several cabins, some nicer than others, and one actually very nice? In other words, what if our bad guy also ran some legitimate deals? So maybe some of the money was not “ill-gotten gains” but was actual legitimate income?
What if our bad guy borrowed money to buy some cabins and paid lenders back with money from the bad guys “oversold participations” and/or “fictitious participations”? Does that money that our bad guy paid lenders when he was scamming or semi-scamming get “clawed back” for pro rata distribution among all of the victims?
There is no simple way unscramble and redistribute eggs. There is no simply way to untangle these knotty questions. But generally one can adopt clear-cut bright-line rules that give the “clean-up crew” the benefit of easy quick (and less expensive) application (chop up the scrambled eggs into cubes, distribute pro rata based on some simple metric like how much losses each victim suffered regardless of time of loss) or one can require a more nuanced and individualized analysis (slower, fairer, more expensive) (analyze genetic codes in scrambled eggs, separate via DNA, perform genealogy of eggs, send recovered oocytic remains to known heirs or assigns).
In this 37-page decision of the Minnesota Supreme Court decided last week in the case of Finn v. Alliance Bank et al., the Court affirmed, in large part, the decision of the Minnesota Court of Appeals suggesting something more complicated than a “quick and dirty” approach.
The “Ponzi scheme presumption” is one of those clear-cut bright-line rules that give the “clean-up crew” the benefit of easy quick (and less expensive) application. “[T]he Ponzi-scheme presumption, by operation of its three components, allows a creditor to bypass the proof requirements of a fraudulent-transfer claim by showing that the debtor operated a Ponzi scheme and transferred assets ‘in furtherance of the scheme.'” (Op. at pp. 12-13). As foreshadowed by the Court at oral argument, the Court rejected the Ponzi scheme presumption in Finn v. Alliance Bank, et al.
[T]here is no statutory justification for relieving the Receiver of its burden of proving—or for preventing the transferee from attempting to disprove—fraudulent intent. Instead, fraudulent intent must be determined in light of the facts and circumstances of each case…the Ponzi-scheme presumption eliminates the possibility that an investor has a legally enforceable claim against the debtor based on the investment contract.
Update (May 13, 2014): (under the headline: Ponzi Fraud, Fraudulent Transfer, The “Ponzi Scheme Presumption,” and Statutes of Limitation): William Hart argued on behalf of plaintiff appellants. Keith Moheban, counsel for M&I Bank, argued first for the four bank appellees. At issue, under Minnesota law and the Minnesota version of the Uniform Fraudulent Transfer Act (MUFTA), should Minnesota courts apply the “Ponzi Scheme Presumption” and which statute of limitation rule should apply? (Can the analysis of the statutes of limitation for common law fraud claims and statutory fraud claims be different?)
(Under the Ponzi scheme presumption, a Ponzi scheme, once established, demonstrates actual fraudulent intent required for actual fraudulent transfer under Bankruptcy Code. Courts that apply the presumption hold that transfers made in the course of Ponzi scheme could have been made for no purpose other than to hinder, delay, or defraud creditors. The Minnesota Supreme Court appeared quite reluctant to adopt the Ponzi scheme presumption in the context of the MUFTA.)
If you aspire to appellate practice, listen to the Minnesota Supreme Court argument in this case. This was excellent advocacy of a complicated area of law.
(November 18, 2013): If Evil-Doer misappropriates money from Peter to pay Paul, but Peter does not find out that he has been swindled for 10 years, can a receiver, stepping in for Evil-Doer when the scam comes to light, get Peter’s money back from Paul (and other defrauded investors) or would this “claw-back” action be “time-barred”?
One part of the inquiry would be, (1) “What is the statute of limitation for such a claim under the applicable law?” Another part of the inquiry to answer that question might be, (2) “What took Peter so long to figure out he’d been swindled?” Another part of the inquiry could be, (3) “Do the courts count the statute of limitations as starting at the time of the initial misappropriation or from the time that Peter made (or should have made) the discovery?” Yet another part would be, (4) and what, exactly, do you mean by “swindled”? Finally, yet another would be, (5) what do you mean by “Peter’s money” — money is fungible and maybe Evil-Doer paid Paul back with “clean money” in whole or in part?
The first question would appear to be the easiest. You just have to look that up, right? To the disgust of many people, however, and to the frustration of many lawyers, even this threshold question can present more of a problem than one might think. For example, the Minnesota Court of Appeals recently held that “Unlike the Uniform Fraudulent Transfer Act (the UFTA) from which it derives,the [Minnesota Uniform Fraudulent Transfer Act] does not contain a statute of limitations. See Minn. Stat. §§ 513.41–.51.”
Sometimes legislatures serve courts with soup but no spoons. Yum. (Inexcusably frivolous tangent: How was “yum” displaced by “nom” and is there anything right-thinking people can do to stop this verbal virus?)
In fact, all of these questions are difficult and complex. And last week the Minnesota Supreme Court granted cross-petitions for review in the case of Patrick Finn, et al., v. Alliance Bank, et al.
As to one part of the the intermediate court’s 32-page decision, the court had more or less sent the state Supreme Court an invitation to weigh in, holding:
Applying the presumption that profits were not received for reasonably equivalent value to the claims against Alliance would create an exception to the MUFTA’s reasonably-equivalent-value defense against actual-fraud claims and the reasonably equivalent- value element of constructive fraud. … If an exception to the MUFTA is to be adopted in Minnesota in Ponzi-scheme cases, it must be done by the supreme court or the legislature, not this court. This court is an intermediate appellate court, and its role is “primarily decisional and error correcting . . . Adopting a presumption that profits were not received for reasonably equivalent value is not within this court’s authority.
I have no envy of the court’s task: devising the best means of extricating adversaries from the financial collapse these more or less innocent investors find themselves trapped under.