You Can't Cheat an Honest Man - James Walsh [128]
Cohen was no stranger to financial frauds. He knew that as he continued to buy high and sell low with the funds provided by the scheme participants that it was doomed to collapse. He knew that his “investors” were his creditors because he owed them either a vehicle or their money back. And he knew that when it collapsed there would be no vehicle and no money left for refunds.
The inevitable collapse landed Cohen in prison and left a number of burned customers—they didn’t think of themselves as scheme participants—who’d paid Cohen money and received nothing. The trustee who took over the pieces of Cohen’s operation sued the scheme participants (that’s what they were, no matter what they considered themselves) who’d taken possession of the cars and the dealers who’d gotten full retail price. He argued that a federal court should avoid all seventeen sales because they were fraudulent transfers.
The bankruptcy estate would recoup the difference between the price Cohen paid and the amount paid to Cohen by the scheme participants to whom the goods were transferred.
The trustee’s theory was that the act of delivering $114,500 vehicles to people who had paid Cohen $80,000 was a transfer distinct from the $114,500 purchase at the dealer.
This second transfer gave Cohen value only to the extent of extinguishing his $80,000 refund obligation to the person who took delivery. So, this did not qualify for the Bankruptcy Code safe harbor that protects transferees, including merchants, to the extent value is given in good faith “to the debtor.”
Seven of the deals had taken place within one year before Cohen filed bankruptcy, so the federal Bankruptcy Code gave the court the power to reverse them. California law and the Uniform Fraudulent Transfer Act (UFTA), which expanded the trustee’s range of options under so-called “strong arm” authority, allowed the court to reverse the other 10 deals.
However, the court chose not to reverse the sales—even though the various laws would have allowed it. It disagreed with the trustee’s theory, concluding instead that there were no fraudulent transfers because Cohen had received value from the dealers equal to the retail price that he paid.
The trustee appealed. The 1996 federal appeals court decision In re Stanley Mark Cohen considered the appeal. In that decision, a Bankruptcy Appellate Panel considered the technical details of the trustee’s argument and held that:
The Bankruptcy Code makes [Cohen’s] purchases from the merchants fraudulent transfers because [he] intended to hinder, delay, or defraud creditors when purchasing goods that were central to the Ponzi scheme. But the merchants have no ensuing liability because they qualify for the safe harbor that shelters transferees who give full value to the debtor in good faith.
UFTA, in contrast, makes the transfers not avoidable against the merchants because, although they were made with actual intent to hinder, delay, or defraud creditors, the merchants took debtor’s money in good faith for a reasonably equivalent value.
Under this concept, Cohen’s payment in full with checks that his bank honored limited any further duty the Mercedes dealers had. Cohen had what is known as “equitable title” in the cars.
When the lucky scheme participants received their cars, a separate transfer occured—in this case, Cohen handed his equitable title in the cars to the participants.
Evidence that the bankruptcy court considered had established that Cohen had the requisite intent to hinder, delay, or defraud creditors when he’d purchased vehicles in furtherance of his Ponzi scheme. So, the transfers were actually fraudulent. However, that didn’t answer everything.
The differences between the Bankruptcy Code and UFTA forced divergent analyses of the avoidability of Cohen’s transactions.
The seven vehicles purchased during the year before bankruptcy could be considered fraudulent transfers under the Bankrupcty Code. Under UFTA, though, the other 10 transfers could not be avoided because the dealers operated