Merrill v. Abbott (In Re Independent Clearing House Co.)

Majority - Jenkins, Chief Judge

Yes, a bankruptcy trustee is authorized to avoid payments made to investors by a Ponzi scheme operator as preferential or fraudulent transfers under Sections 547 and 548 of the Bankruptcy Code, but the availability of 'good faith' or 'ordinary course of business' defenses depends on specific factual determinations regarding the transferee's knowledge and the nature of the transaction. The court first affirmed subject matter jurisdiction, concluding that the debtor trusts qualified as 'business trusts' under the Code and that a 'bad faith' filing is a discretionary dismissal matter, not a jurisdictional one. It also determined that money obtained by fraud and commingled by the debtor became 'property of the debtor' for avoidance purposes. The court held that the bankruptcy court's equitable powers are limited by the Code and cannot create new substantive rights to enlarge avoidance powers. Therefore, the trustee could not avoid all transfers solely on general equitable grounds. Regarding fraudulent conveyances under Section 548(a)(2), the court distinguished between payments of principal and fictitious profits. Transfers repaying only the initial principal investment were considered to be for 'reasonably equivalent value' because they satisfied an antecedent debt. However, transfers exceeding the initial principal (fictitious 'earnings') were not for reasonably equivalent value; the underlying contracts for such returns were deemed unenforceable as against public policy in a Ponzi scheme, as their enforcement would further the fraud at the expense of other victims. These 'excess' transfers are therefore avoidable under §548(a)(2). Under Section 548(a)(1) (actual intent to defraud), the court held that an intent to hinder, delay, or defraud future creditors can be inferred as a matter of law from the mere fact that a debtor was operating a Ponzi scheme, as the perpetrator inherently knows the scheme will collapse. This means all payments made by a Ponzi scheme operator are deemed made with actual fraudulent intent. The defense under Section 548(c) protects transferees 'for value and in good faith.' For transfers repaying principal, transferees 'gave value.' However, whether they took 'in good faith' (i.e., without knowledge or inquiry notice of the fraud) was a genuine issue of material fact requiring remand. For transfers exceeding principal, transferees did not give 'value,' so Section 548(c) provides no defense. Applying Section 544(b) (state law), the court found the corporate trust fund doctrine inapplicable as undertakers were creditors, not shareholders. Under the Utah Fraudulent Conveyance Act, the debtors' fraudulent intent was established as a matter of law. Similar to §548(c), the bona fide purchaser exception required 'valuable consideration' and lack of 'previous notice of fraudulent intent,' with these issues requiring factual determination on remand. Concerning preferential transfers under Section 547(b), the court found all elements met for payments made within 90 days of bankruptcy. However, the court reversed the bankruptcy court's blanket rejection of the 'ordinary course of business' defense under Section 547(c)(2). It held that a transfer does not fall outside this exception simply because it was made in furtherance of a Ponzi scheme; the payments could be in the 'ordinary course' of the debtor's (fraudulent) business if consistent with its operations and contractual terms, requiring a factual determination on remand. Finally, the court held that the bankruptcy court abused its discretion in denying motions to vacate default judgments against pro se defendants. It found their failure to respond after their pleadings were stricken constituted 'excusable neglect' or an 'independent reason for relief' under Rule 60(b), especially given the confusing circumstances and the existence of meritorious defenses. Prejudgment interest was affirmed for claims where the trustee successfully recovered, and specific errors in individual defendant cases (Van Sant's recoupment defense, Richards' damages) were noted and remanded.