You Can't Cheat an Honest Man - James Walsh [147]
But a trustee has some leeway in reversing payments to Ponzi investors. If all the scheme receives in return for an investment is the use of an investor’s money to continue itself, there is nothing added to the estate for creditors to share. In fact, by helping the scheme perpetuate itself, the investors exacerbate the harm to creditors by increasing the amount of claims. As one federal court observed:
If the use of the [investors’] money was of value to the debtors, it was only because it allowed them to defraud more people of more money. Judged from any but the subjective viewpoint of the perpetrators of the scheme, the “value” of using others’ money for such a purpose is negative.
There’s an exception to this so-called value rule: a lender who accepted scheme assets as security can still collect the money it loaned.
Ponzi investors being forced to give back distributions will often argue against the one-year limit by claiming that the United States Constitution mandates people who are similarly situated receive like treatment under the law (this argument cites the theoretically complex Fourteenth Amendment).
The theory behind this argument is that a statute may single out a class of people for distinctive treatment only if that classification bears a rational relationship to the purpose of the statute. The argument implies that all investors in a Ponzi scheme are predominantly creditors of the same class and should be treated equally.
However, this argument usually relies on non-bankruptcy cases. As one court said, succinctly, “These cases are unhelpful.” The chief judge ruling in In re Independent Clearing House Co. offered a more specific analysis:
All investors in a Ponzi scheme are creditors of the same class, so in theory all should be treated equally.... The equitable solution would be either to apply the statute to all transfers to investors in a Ponzi scheme— without regard to when the transfers were made—or to apply the statute to none of the transfers. Yet this court is no more free to rewrite the statute to bring the early undertakers into its net than it is to ignore the statute to treat later undertakers equally. Courts must apply the statute as written.
The Bankruptcy Code allows some transfers to stand because they are part of “the ordinary course of business.” However, the Code insulates the transferees of an avoided fraudulent transfer who take “for value and in good faith” by providing that such a transferee has a lien, or may retain the interest transferred, to the extent the transferee gave “value to the debtor” in exchange for the transfer.
Judge James H. Williams of the U.S. Bankruptcy Court in northern Ohio wrote a number of decisions revolving around In re Plus Gold, Inc.—a case of a collapsed multi-level marketing Ponzi scheme. Most of Williams’ decisions had to do with burned investors arguing that the court should reverse payments that earlier investors had received.
The investors’ money was spent buying “spots” in the Plus Gold “matrix.” A spot was the designation used for a membership or distributorship; each spot cost $265.00.
However, some spots on the matrix were designated as “APS” or “additional pay spot” spots. Whenever a distributor had recruited fourteen other participants, an additional pay spot would be given to the distributor for free. Periodically, the people who had these free spots would receive the same pay-outs as people who’d paid for theirs.
The trustee in the case—as well as a group of angry investors—wanted the APS people to give back the money they’d taken out. The APS people argued that they were merely being reimbursed for time and money they’d spent marketing Plus Gold’s scheme.
The court ruled that, since Plus Gold had received nothing of value in return for the free spots it gave these people, the money it paid them had to come back.
In