You Can't Cheat an Honest Man - James Walsh [146]
For a burned investor, the last of these three methods is almost always the fastest...and the most cost-effective.
The Trustee Lays Claim
If—as a burned Ponzi investor—you can convince a bankruptcy trustee to file a lawsuit (what Posner called “an adversary action”) on behalf of everyone, the work has only begun.
By definition, the property of a bankrupt estate is a scarce commodity. The reason companies declare bankruptcy—voluntary or forced—is that their assets are no longer sufficient to repay creditors fully. These creditors, eager to assert their entitlement to whatever assets do remain, will often lay claim to the property by filing claims outside of bankruptcy court.
As the administrator of the bankrupt estate, the trustee is charged with marshalling all available assets of the estate, reducing these assets to money, and distributing this money to the estate’s creditors, in a manner that ensures each similarly situated creditor of the bankrupt debtor an equitable share.
Therefore, the trustee—like the creditor—is concerned with laying claim to any property that could conceivably belong to the estate. This “any property” usually includes lawsuits against the perps who tanked the company in the first place. The trustee’s concern isn’t only for money, though; it’s also for order. As one federal court noted, the trustee wants:
to avoid numerous lawsuits by individual creditors racing to the courthouse to deplete the available resources of the estate and thereby thwart the equitable goals of the bankruptcy laws.
To accomplish these goals, the trustee is given statutory power to sue and be sued as a representative of the estate.
In practical terms, it means that money paid to Ponzi investors is the property of the scheme. The Bankruptcy Code allows “fraudulent transfers made in furtherance of a Ponzi scheme” to be reversed. Specifically, it allows the trustee to avoid a payment made within one year of filing, if the scheme “made such transfer...with the intent to defraud any entity to which the debtor was...indebted.” And all Ponzi payments are made with that intent.
A Ponzi scheme is considered—by definition—to involve fraudulent intent. In the wake of a Ponzi scheme collapse, a bankruptcy court can order the reversal of any transaction that occurred within one year before the bankruptcy filing. This one-year limit is known as the “reachback period.” The court can order any investor who took money out of the scheme within the reachback period to give it back.
Another Way to Overturn Ponzi Payments
The trustee can also void transfers on somewhat different grounds. If the debtor “received less than reasonably equivalent value” in exchange for a transfer of the debtor’s property, the trustee may avoid the transfer if several additional elements are established.
“Value” is defined for purposes of the Code as “property, or satisfaction or securing of a present or antecedent debt of the debtor.” Bankruptcy courts have concluded that a defrauded investor in a Ponzi scheme gives “value” to the debtor in the form of a dollar-for-dollar reduction in other investors’ restitution claims against the scheme.
On this subject, the federal appeals court in the Ponzi scheme case In re Independent Clearing House Co. ruled:
[T]o the extent the debtors’ payments to a defendant [investor] merely repaid his principal undertaking, the payments satisfied an antecedent “debt” of the debtors, and the debtors received “value” in exchange for the transfers. Moreover, to the extent a transfer merely repaid a defendant’s undertaking, the debtor received not only a “reasonably equivalent value” but the exact same value—dollar for dollar. We therefore hold that such transfers are not avoidable....
In theory, the trustee is not allowed to reverse transfers made for reasonably equivalent value because creditors