JENKINS, Chief Judge.
On September 30, 1985, this court, sitting en banc, heard cross-appeals from the decision and judgments of the United States Bankruptcy Court for the District of Utah in numerous adversary proceedings brought by the trustee in bankruptcy of the debtor entities against named defendants.
These consolidated adversary proceedings arose out of the collapse of an alleged Ponzi scheme.
The "undertakers" signed contracts by which they committed to one of the clearinghouses a specified sum of cash, credit or other commodities for a period of nine months. The funds committed to the clearinghouse were to remain under the clearinghouse's custody and control until the end of the nine months, at which time the principal amount was to be repaid to the undertaker. Under the terms of the contracts, undertakers assumed the debts of ASC's clients, and ASC assigned to the undertakers the right to receive payment from its clients. Thus, in addition to the return of his principal, an undertaker was also to receive additional sums purportedly representing "revenues" from the client companies. An undertaker could elect to receive revenues or "earnings" in fixed monthly payments over the nine months or in a lump sum at the end of the nine-month period. If an undertaker chose to be paid monthly, he was to be paid at a rate of .0015 times his investment per business day for twenty business days each month. If he chose to be paid at the end of the nine months, he was to be paid at a rate of .004 times his investment per business day, which worked out to $84 per month per $1,000 invested. See 41 B.R. at 994 (statement of undisputed facts); Bagley affidavit ¶¶ 9-12 & ex. A. The clearinghouses were to retain full control of the right to revenues assigned to undertakers. Bagley affidavit ex. A.
The bankruptcy trustee has alleged, without contradiction, that ASC had no clients. Bagley affidavit ¶ 15. Apparently, the money supplied by undertakers went into a common fund, from which "earnings" were paid and principal repaid. Later undertakers supplied the money to pay "earnings" and repay principal of earlier undertakers. Id. ¶¶ 16-20.
On September 16, 1981, ICH and UCH filed petitions for relief under chapter 11 of the bankruptcy code.
The defendants in these actions were all undertakers who received some payments from the debtor trusts within one year of the debtors' filing their bankruptcy petitions, either as "earnings" or repayment of principal or both. The defendants for the most part fall into two categories: (1) those who advanced money early and received "earnings" and repayment of principal in excess of their initial advance, and (2) those who advanced money and received some payments of "earnings" or repayments of principal or both but no more than their initial advance.
The trustee's complaint set out four claims for relief. The first claim sought to avoid as preferences under section 547 of the Code transfers of money that the debtors had made to a defendant within ninety days prior to the filing of the debtors' bankruptcy petitions. The second claim sought to avoid as fraudulent conveyances under sections 548 and 544 transfers of money that the debtors had made to a defendant in excess of his advance and within one year before filing their petitions. The third claim sought to avoid on the same grounds all transfers of money that the debtors had made to a defendant within one year of filing their petitions.
On March 30, 1984, the bankruptcy court entered default judgments against some of the defendants. It later denied the defendants' motions to set aside those judgments.
The trustee appealed from the bankruptcy court's dismissal of his third claim for relief, and many of the defendants appealed from the court's grant of summary judgment to the trustee on his first and second claims for relief.
On June 5, 1985, this court ordered all pending appeals from these proceedings— including the appeals from the bankruptcy court's entry of summary judgment and the appeals from the orders denying motions to set aside default judgments—consolidated for purposes of briefing and oral argument.
Some of the defendants argue that the bankruptcy court lacks subject matter jurisdiction in this case because the debtor entities cannot qualify as "debtors" under the bankruptcy code. A motion to dismiss for lack of subject matter jurisdiction can be made at any time in a proceeding, including for the first time on appeal. Generally, an appellate court will not reverse a lower court's findings of jurisdictional facts unless "clearly erroneous." See Eaton v. Dorchester Development, Inc., 692 F.2d 727, 732 (11th Cir.1982); Williamson v. Tucker, 645 F.2d 404, 413 (5th Cir.), cert. denied, 454 U.S. 897, 102 S.Ct. 396,
Some defendants argue that the debtors in this case do not qualify for relief under title 11. Section 301 of the Code provides that only an entity that can qualify as a "debtor" under a chapter of title 11 can file a voluntary case under that chapter. The Code further provides that only "persons" can be debtors under chapter 11. See 11 U.S.C. § 109(a), (b) & (d). It defines a "person" to include an "individual, partnership, and corporation," id. § 101(30), and further defines a "corporation" to include a "business trust," id. § 101(8)(A)(v). The defendants argue that the debtor enterprises (Massachusetts trusts) are not "business trusts" and are therefore not eligible for relief under the Code. If the debtors are not eligible for relief under the Code, then the statutory source of the bankruptcy court's exercise of jurisdiction in these adversary proceedings is lacking, and they must be dismissed.
This court has previously considered this argument in a related case. Merrill v. Allen (In re Universal Clearing House Co.), 60 B.R. 985, 990-93 (D.Utah 1986). For the reasons stated in that opinion, we conclude that the debtor trusts qualify as business trusts under the Code. The defendants' motions to dismiss for lack of subject matter jurisdiction based on the trusts' alleged lack of status as debtors are denied.
Several defendants argue that the bankruptcy court also lacks subject matter jurisdiction because the debtors filed their bankruptcy petitions in "bad faith." The defendants raise this issue for the first time on appeal in the mistaken belief that good faith in filing is a prerequisite to the existence of subject matter jurisdiction in the bankruptcy court. This court has previously considered that argument and rejected it. See id. at 993-94. For the reasons stated in Allen, we reaffirm that position.
Although a good faith standard continues to exist under the Code, as Allen demonstrates, dismissal of a bad-faith filing is a matter of court discretion under 11 U.S.C. § 1112(b)—not a matter of jurisdiction.
In short, the bad faith question requires a discretionary, equitable determination under section 1112(b) and must be considered in the first instance by the bankruptcy court. The question of jurisdiction is a separate question and has nothing to do with bad faith. Jurisdiction exists here as a matter of law, regardless of any bad faith on the part of the debtors. The defendants never raised the bad faith issue in the bankruptcy court, and, as a general rule, this court will consider on appeal only those issues raised before the bankruptcy court. In re Pikes Peak Water Co., 779 F.2d 1456, 1459 (10th Cir.1985). The bankruptcy court did not abuse its discretion by failing to dismiss the petitions sua sponte.
MOTION FOR PERMANENT INJUNCTION
Before reaching the merits of the trustee's claims, we must address one other issue. On March 19, 1986, after oral argument on these appeals but before this court had rendered its decision, Daniel W. Jackson, on behalf of the defendants he represents, see appendix A, filed a motion for an order permanently enjoining the trustee from attempting to recover any property or the value of any property that the debtors had transferred to the defendants. The defendants argue that the adversary proceedings in the bankruptcy court, from which these appeals were taken, merely avoided certain transfers to the defendants as fraudulent or preferential— they did not authorize the trustee to "recover" the avoided transfers. Because more than a year has passed from the time the bankruptcy court avoided the transfers, the defendants argue, the trustee is barred from now recovering them.
Sections 544, 547 and 548 of the Code state that the trustee "may avoid" any transfer of an interest of the debtor in property that meets certain conditions. Section 550 states that, to the extent a transfer is avoided under one of those sections, "the trustee may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property, from," among others, "the initial transferee of such transfer or the entity for whose benefit such transfer was made." However, section 550 includes a limitations provision: "An action or proceeding under this section may not be commenced after the earlier of—
The defendants argue that the trustee's complaint in these adversary proceedings did not contain any cause of action brought under section 550 and that to date he has not commenced any action or proceeding under section 550. Because more than a year has passed since the bankruptcy court avoided the transfers, the defendants argue, the trustee is now barred from recovering the transfers under section 550.
The complaint filed in each of these adversary proceedings states the "general nature of the trustee's claims" as follows:
Complaint ¶ 5 (emphasis added).
Each of the trustee's first three claims ended with the same prayer for relief:
Complaint at 8, 12 & 16 (emphasis added). Moreover, the judgments entered against the defendants read: "[I]t is hereby ORDERED, ADJUDGED AND DECREED that plaintiff, Robert D. Merrill, as trustee of the estates of the above-named debtors, recover from defendant [name] the sum of [amount]." (Emphasis added.)
As the parties recognize, avoiding a transfer and recovering the property transferred (or its value) are separate concepts. See H.R.Rep. No. 595, 95th Cong., 1st Sess. 375 (1977), reprinted in 1978 U.S.Code Cong. & Admin.News 5787, 5963, 6331. However, we believe the allegations of
True, the complaint does not include a separate claim based solely on section 550, nor does the complaint even mention section 550. But in this day of notice pleading, such technical deficiencies (if they are indeed deficiencies) should not be fatal. The defendants have pointed to nothing in the Code requiring a trustee to file separate actions or even to state separate claims for avoiding and recovering transfers, and this court has found no such requirement. Cf. Beneficial Fin. Co. v. Lazrovitch, 47 B.R. 358, 361 (E.D.Va.1983) ("§ 550 does not set up any procedural method for recovery of the debtor's property interest" but merely tells from whom the trustee can recover a transfer); 4 Collier on Bankruptcy ¶¶ 550.02 at 550-5 n. 5 (L. King 15th ed. 1987) ("Normally the trustee's action to avoid a transfer will be coupled with an action for recovery of the property transferred or its value") & 550.03 (the trustee "usually will file a consolidated action to avoid the transfer and recover the property transferred or its value"). Nor is this court inclined to read such a requirement into the Code or the rules of procedure.
When, as here, the action is against the initial transferee of an avoidable transfer, we believe that it is enough if the complaint, read as a whole and construed so as to do "substantial justice," see Fed.R.Civ.P. 8(f); Bankr.R. 7008, gives the defendant fair notice that the trustee seeks not only to avoid a particular transfer but also to "recover" the property transferred or its value. We find that the complaint in these adversary proceedings meets that requirement. Therefore, the defendants' motion for a permanent injunction is denied.
The trustee, as he is wont to do, see infra part VI, has moved for sanctions against the defendants for filing their motion. Specifically, he has asked for his court costs and attorney's fees incurred in responding to the motion. Although this court finds for the trustee on the merits of the defendants' motion, the law in this area—and the trustee's complaint—are not so clear as to make the defendants' motion frivolous, nor does that motion multiply these proceedings "unreasonably and vexatiously." See 28 U.S.C. § 1927 (1982). Therefore, the trustee's request for sanctions is also denied.
THE TRUSTEE'S CLAIMS
Our conclusion that the bankruptcy court had subject matter jurisdiction over the bankruptcy cases and hence these adversary proceedings and that the debtor entities were "persons" within the meaning of the Code and hence entitled to bankruptcy relief brings us to the question of whether the trustee in bankruptcy could properly recover prepetition payments to undertakers through the exercise of his statutory avoiding powers.
The trustee asserted three principal claims. The bankruptcy court allowed him to recover, under his first claim, all transfers to undertakers made within ninety days of the debtors' filing of their petitions in bankruptcy, on the grounds that the payments constituted preferences voidable under section 547(b) of the Code. The trustee was also allowed to recover, under his second claim, all transfers the debtors made to a defendant within one year of the debtors' filing of their petitions to the extent the transfers exceeded an amount equal to the original principal the defendant advanced.
A. "Property" of the Debtor
A trustee's powers to avoid prepetition transfers by the debtor are statutory. As with any case of statutory interpretation, our starting point must be the language of the statute itself. See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 756, 95 S.Ct. 1917, 1935, 44 L.Ed.2d 539 (1975) (Powell, J., concurring). Section 547(b) empowers the trustee to avoid "any transfer of property of the debtor," and section 548(a) empowers the trustee to avoid "any transfer of an interest of the debtor in property" if the transfers meet certain conditions.
This court has previously considered and rejected the defendants' argument that the money the debtors transferred to others was not "property" of the debtors. Merrill v. Allen (In re Universal Clearing House Co.), 60 B.R. 985, 994-97 (D.Utah 1986); Merrill v. Dietz (In re Universal Clearing House Co.), 62 B.R. 118, 122-24
Having concluded that we are dealing with "property" of the debtors, we shall now address the trustee's arguments for why he should be allowed to avoid each transfer and recover the property. The trustee asserted three principal claims. As did the bankruptcy court, we shall consider them in reverse order.
B. The Trustee's Third Claim
Under his third claim the trustee sought to recover all payments made to undertakers within one year before the filing of the bankruptcy petitions.
We conclude that the bankruptcy court correctly denied the trustee's motion for summary judgment on his third claim because genuine issues of material fact existed. Those same factual issues made it error, however, for the bankruptcy court to grant, as it did, summary judgment to the defendants on the trustee's third claim. We therefore reverse the bankruptcy court's judgment as to those claims and remand them as more fully explained below.
The trustee first argued that the bankruptcy court has the inherent equitable power to avoid all transfers to undertakers in a Ponzi scheme. The bankruptcy court summarily rejected this argument, and properly so. The bankruptcy court concluded that "[t]o undo all of these transactions would cause incalculable harm to hundreds of people, at a staggering cost, for which no commensurate benefit would lie." 41 B.R. at 1005-06 n. 20. But the trustee's first theory must fail for an even more basic reason: The bankruptcy law does not sanction the relief sought.
Although in theory the most equitable resolution of these cases may well be for each undertaker to return all the money he received from the debtors so that the money could be redistributed pro rata, see Eby v. Ashley, 1 F.2d 971, 973 (4th Cir.1924), cert. denied, 266 U.S. 631, 45 S.Ct. 197, 69 L.Ed. 478 (1925), the bankruptcy court is a court of limited jurisdiction. As the bankruptcy court stated:
41 B.R. at 1005 (citations omitted). See also Johnson v. First Nat'l Bank of Montevideo, Minn., 719 F.2d 270, 273 (8th Cir. 1983), cert. denied, 465 U.S. 1012, 104 S.Ct. 1015, 79 L.Ed.2d 245 (1984), and cases cited therein.
The trustee has failed to direct us to any statutory or judicial precedent expressly authorizing the result he seeks.
Abrams arose out of the collapse of Young's fraudulent investment program. Abrams had invested a total of $4,000 in the program but had withdrawn $2,000 of his principal and had received fictitious profits of some $2,797 before the case arose. When Young went into bankruptcy, Abrams asserted a claim against the bankrupt estate for $2,000, the remainder of his original investment. The court disallowed the claim on equitable grounds, noting that Abrams had already received some $797 in excess of his original investment while other investors had received nothing.
Tedlock Cattle merely relied on Abrams in holding that the bankruptcy trustee could measure the claims of investors in a Ponzi scheme by their out-of-pocket loss rather than by the lost benefit of their bargain. The court concluded that the trustee could properly deny recovery for anticipated or "paper" profits investors had lost. In neither case was the trustee trying to recover money that the investors had already received.
It is one thing to say that the trustee can object to claims for more than one's original investment; in such a case, he is merely protecting the property of the estate. It is quite another thing to say that he can avoid what the investors might justifiably have believed was a legitimate transaction and recover the payments; in such a case, the trustee is exercising extraordinary powers to enlarge the bankruptcy estate. Those powers are conferred only by statute. Without such a statute, the trustee has no avoiding powers. The trustee's exercise of those powers is circumscribed by the very statute that creates them, and the statute in this case does not allow the trustee to recover all transfers made within a year of filing the bankruptcy petition, fraudulent or otherwise.
If the cited cases support the trustee's theory, they do so only to the extent that
Thus, at best, Abrams and Tedlock Cattle support the trustee's second cause of action, not his third. In fact, in neither case were investors even required to give back fictitious profits they had received, let alone any part of their original investment.
2. Section 548
Our conclusion that the trustee's power to recover transfers is defined and circumscribed by statute brings us to the plaintiff's second theory, namely, that the transfers were avoidable under section 548 of the Code as fraudulent conveyances. Section 548 authorizes the trustee to avoid certain transfers "of an interest of the debtor in property" if they fall within two broad categories.
a. Section 548(a)(2)
The trustee first argues that payments to the defendants were fraudulent under section 548(a)(2) because the debtors were insolvent when the transfers were made and "received less than a reasonably equivalent value in exchange for" the transfers. It is undisputed that the debtors were insolvent when they made the transfers, so the only question under section 548(a)(2) is whether the debtors received a reasonably equivalent value for the transfers.
Section 548 defines "value" as "property, or satisfaction or securing of a present or antecedent debt of the debtor." 11 U.S.C. § 548(d)(2)(A). The Code defines a "debt" as "liability on a claim," 11 U.S.C. § 101(11), and a "claim" includes any "right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured," id. § 101(4)(A).
The bankruptcy court concluded that all transfers to defendants "were payments on contractual debts" and hence "value" within the meaning of section 548. 41 B.R. 1007.
We conclude that the debtors received a "reasonably equivalent value" in exchange for all transfers to a defendant that did not exceed the defendant's principal undertaking but, to the extent a defendant received more than he gave the debtors, the debtors did not receive a reasonably equivalent value.
From the time a defendant entrusted his money to the debtors, he had a claim against the debtors for the return of his money. We believe that the Code's definition of "debt" and its related terms is broad enough to cover the debtors' obligation to return a defendant's principal undertaking, whether that obligation was based on the contract between the debtors and the defendant or was based on the defendant's right to restitution.
Transfers in excess of a defendant's undertaking are another matter. The defendants argue that such transfers also satisfied an antecedent debt of the debtors. The only liability the debtors had for payments of so-called earnings was their contractual liability. Thus, whether the debtors were indebted to a defendant for amounts in excess of his undertaking depends on whether or not the defendant had a valid, enforceable right under his contract with the debtors to receive payments of so-called earnings.
The trustee has not argued that the contract between each defendant and the debtors was illegal or otherwise unenforceable on its face. Courts' refusals to enforce an illegal bargain generally rest on "the elementary principle that one who has himself participated in a violation of law cannot be permitted to assert in a court of justice any right founded upon or growing out of the illegal transaction." Gibbs & Sterrett Mfg. Co. v. Brucker, 111 U.S. 597,
However, in some cases "the interest of the public, rather than the equitable standing of individual parties, is of determining importance." 14 S. Williston & W. Jaeger, A Treatise on the Law of Contracts § 1630A at 22-23 (3d ed. 1972) (quoting Parish v. Schwartz, 344 Ill. 563, 176 N.E. 757, 761 (1931)). We believe that this is such a case. To allow an undertaker to enforce his contract to recover promised returns in excess of his undertaking would be to further the debtors' fraudulent scheme at the expense of other undertakers.
In determining whether a contract is unenforceable because it is against public policy, the court may look beyond the terms of the contract itself to the underlying facts. Tri-Q, Inc. v. Sta-Hi Corp., 63 Cal.2d 199, 404 P.2d 486, 497, 45 Cal.Rptr. 878 (1965). It is undisputed that the debtors here had no legitimate source of earnings but were operating a Ponzi scheme. Therefore, any money that a defendant might recover in excess of his undertaking in an action on the contract could not come from the debtors but would have to come from money that rightfully belonged to other, defrauded undertakers. Enforcement of a contract such as those involved here would therefore hurt the debtors' other creditors by depleting the pool of assets to which they could look for payment. Cf. J.M. Deutsch Co. v. Robert Paper Co., 13 A.D.2d 768, 215 N.Y.S.2d 939 (contract to secretly prefer one creditor over others was contrary to public policy), reargument and appeal denied, 14 A.D.2d 531, 218 N.Y.S.2d 938 (1961).
Moreover, enforcement would further none of the policies generally favoring enforcement by an innocent party to an illegal bargain. It would not deter the debtors' fraudulent conduct because it would not hurt the debtors at all. Any recovery would not come from the debtors' own assets because they had no assets they could legitimately call their own. Rather, any award of damages would have to be paid out of money rightfully belonging to other victims of the Ponzi scheme.
One could argue that denying enforcement would unjustly enrich the debtors, but if they are enriched unjustly, it is because they are allowed to keep money that rightfully belongs to other creditors—not to the party seeking to enforce the contract. If the contract were enforced, the party who received the benefits of his contract would be unjustly enriched at the expense of other defrauded undertakers. In short, to enforce the contract as to fictitious profits would only further the debtors' fraudulent scheme.
We therefore conclude that, as a matter of public policy, the contracts involved in this case were unenforceable to the extent they purported to give the defendants a right to payments in excess of their undertaking.
"Value" must be determined by an objective standard. See Pereira v. Checkmate Communications Co. (In re Checkmate Stereo & Elecs., Ltd.), 9 B.R. 585, 591 (Bankr.E.D.N.Y.1981). If the use of the defendants' 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. See also Lawless v. Anderson (In re Moore), 39 B.R. 571, 573 (Bankr.M.D.Fla.1984) (the court "would be hard pressed to determine what would constitute reasonably equivalent value" for transfers in furtherance of a Ponzi scheme). But see Larrimer v. Feeney, 192 A.2d at 354 (implying that transfers were not fraudulent to the extent they did not exceed the legal rate of interest).
In theory, the trustee is not allowed to avoid transfers made for reasonably equivalent value because creditors are not hurt by such transfers. See 5 Debtor-Creditor Law ¶ 22.03[D][b] (T. Eisenberg ed. 1986). If the debtor no longer has the thing transferred, either he has its equivalent, in which case his creditors can reach the equivalent to satisfy their claims, or his liabilities have been proportionately reduced. In either case, creditors have not been prejudiced. But if all the debtor receives in return for a transfer is the use of the defendant's money to run a Ponzi scheme, there is nothing in the bankruptcy estate for creditors to share. In fact, by helping the debtor perpetuate his scheme, the transfers exacerbate the harm to creditors by increasing the amount of claims while diminishing the debtor's estate. In such a situation, the use of the defendant's money cannot objectively be called "reasonably equivalent value." Cf. Consove v. Cohen (In re Roco Corp.), 701 F.2d 978 (1st Cir.1983) (the debtor corporation received less than a reasonably equivalent value for redemption of its stock where redemption significantly increased its liabilities without adding to its assets); Glosband v. Watts Detective Agency, Inc., 21 B.R. 963, 971 (D.Mass.1981) ("property" for purposes of the fraudulent conveyance statute incorporates "anything of value which but for the transfer might have been preserved for the trustee to the ultimate benefit of the bankrupt's creditors").
We therefore conclude that the debtors did not receive "value" in exchange for transfers to a given defendant to the extent the transfers exceeded the amount the defendant had advanced to the debtors. A fortiori, the debtors did not receive a "reasonably equivalent value" in exchange for those transfers. Accord Eby v. Ashley, 1 F.2d 971, 973 (4th Cir.1924), cert. denied, 266 U.S. 631, 45 S.Ct. 197, 69 L.Ed. 478 (1925); Lawless v. Anderson (In re Moore), 39 B.R. 571, 573 (Bankr.M.D.Fla.1984). Such transfers may therefore be avoided under section 548(a)(2) unless the transferee has a good defense to the trustee's claim. See infra part IV-B-2-c.
b. Section 548(a)(1)
Our conclusion that transfers to a defendant that merely repaid his principal undertaking were made for a reasonably equivalent value and hence are not avoidable under section 548(a)(2) brings us to the trustee's next argument, namely, that such transfers are avoidable under section 548(a)(1). A transfer made for reasonably equivalent value can still be fraudulent and hence avoidable if it was made "with actual intent to hinder, delay, or defraud" persons to whom the debtor was or later became indebted. 11 U.S.C. § 548(a)(1). The bankruptcy court gave little attention to the trustee's claim that the payments to undertakers were fraudulent under section 548(a)(1), holding simply that "the trustee has not carried his burden of proof to show that the monthly payments to defendants
Our role in an appeal from the grant or denial of summary judgment is to determine whether there was a genuine issue of material fact and, if not, whether the moving party was entitled to a judgment as a matter of law. 10 C. Wright, A. Miller & M. Kane, Federal Practice and Procedure § 2716 at 643 (2d ed. 1983). Although intent is often a disputed factual question, we conclude that in this case there was no genuine issue of material fact concerning the debtors' intent to hinder, delay or defraud creditors.
The evidence before the bankruptcy court on the question of the debtors' intent consisted of the affidavit of Ron N. Bagley, the original trustee and trustee Merrill's accountant. That evidence shows that the debtors conducted no business operations, never generated any profits or earnings, paid all monthly disbursements to undertakers solely from other undertakers' investments, were insolvent from the moment the first investment contract was executed, became more insolvent with each successive contract, and ran their business as a Ponzi scheme. In addition, the Bagley affidavit sets out fourteen material representations —many of them allegedly false— that the debtors made regarding the nature of their business and the nature of the investments to induce undertakers to invest in the program. None of the defendants introduced any evidence to dispute the assertions in the Bagley affidavit. Thus, it was undisputed that the debtors' business "was conducted as a `Ponzi' scheme. . . ." 41 B.R. at 994.
To be fraudulent under section 548(a)(1) a transfer need not be made with the intent to hinder, delay or defraud the transferee. The trustee need only show that the transfers were made with the intent to hinder, delay or defraud "any entity to which the debtor was or became [indebted], on or after the date that such transfer occurred." 11 U.S.C. § 548(a)(1) (emphasis added). Those persons who invest on the eve of a Ponzi scheme's collapse are entities to whom the debtor becomes indebted when they entrust their money to the debtors. Therefore, if at the time the debtors made transfers to earlier undertakers they had the actual intent to hinder, delay or defraud later undertakers, transfers to earlier undertakers may be fraudulent within the meaning of section 548(a)(1).
One can infer an intent to defraud future undertakers from the mere fact that a debtor was running a Ponzi scheme. Indeed, no other reasonable inference is possible. A Ponzi scheme cannot work forever. The investor pool is a limited resource and will eventually run dry. The perpetrator must know that the scheme will eventually collapse as a result of the inability to attract new investors. The perpetrator nevertheless makes payments to present investors, which, by definition, are meant to attract new investors. He must know all along, from the very nature of his activities, that investors at the end of the line will lose their money. Knowledge to a substantial certainty constitutes intent in the eyes of the law, cf. Restatement (Second) of Torts § 8A (1963 & 1964), and a debtor's knowledge that future investors will not be paid is sufficient to establish his actual intent to defraud them. Cf. Coleman Am. Moving Servs., Inc. v. First Nat'l Bank & Trust Co. (In re American Properties, Inc.), 14 B.R. 637, 643 (Bankr. D.Kan.1981) (intentionally carrying out a transaction with full knowledge that its effect will be detrimental to creditors is sufficient for actual intent to hinder, delay or defraud within the meaning of § 548(a)(1)).
Although the question of the debtors' intent would ordinarily present a factual question, we conclude that, from the undisputed evidence in the record, only one inference is possible—namely, that the debtors had the intent to hinder, delay or defraud creditors. The trustee's undisputed evidence is that the debtors were engaged in a Ponzi scheme and therefore must have known that undertakers at the end of the line would lose their money. That is the only evidence there is. We conclude that it was sufficient to establish, as a matter of law, the debtors' actual
c. Section 548(c)
The bankruptcy court concluded that, even if the debtors had the actual intent to hinder, delay or defraud, section 548(c) made the defendants "immune" from the trustee's power to avoid fraudulent conveyances under section 548. 41 B.R. at 1007.
Section 548(c) provided:
In other words, even if the payments to the defendants were fraudulent conveyances, the defendants are protected, to the extent they gave the debtors "value" in exchange for the transfers, if they took the money in "good faith."
The extent to which a defendant "gave value" for a particular transfer is essentially the flip side of the question we have already discussed under section 548(a)(2), namely, whether the debtor received a "reasonably equivalent value" in exchange for the transfer. What the defendants gave the debtors in exchange for transfers in excess of their undertaking was the use of their money to further a Ponzi scheme. For the reasons previously stated, we conclude that what the defendants gave the debtors in exchange for such transfers was not "value" within the meaning of section 548. Therefore, to the extent the trustee seeks to recover transfers in excess of a defendant's undertaking, section 548(c) provides no defense.
On the other hand, we have also concluded that, to the extent transfers to a defendant did not exceed the amount of the defendant's undertaking, the debtor received a "reasonably equivalent value" for the transfer. The converse is also true: To the extent that a defendant received amounts less than or equal to his undertaking, he "gave value" to the debtor in exchange for the transfers. The consideration for the transfers was satisfaction of the debt created when the defendant advanced the debtor money or other property, and, under section 548(d), satisfaction of an antecedent debt is "value."
Our conclusion that the defendants "gave value" for transfers that merely repaid their undertaking brings us to the question of whether they also took the transfers in good faith. If they did, section 548(c) protects them from the trustee's power to avoid those transfers under section 548.
This court is troubled with the bankruptcy court's blanket finding, unsupported by the record, that all defendants took in good faith.
The Code does not define "good faith." Courts, however, have defined it in various ways. Compare, e.g., Gilmer v. Woodson (In re Decker), 332 F.2d 541, 547 (4th Cir. 1964) (good faith not lacking "unless the transferee knowingly participated in the debtor-transferor's purpose to defeat other creditors or lacked good faith in valuing the property exchanged"), with In re Windor Indus., Inc., 459 F.Supp. 270, 279 (N.D. Tex.1978) (good faith under former 11 U.S.C. § 107 "is not present where the transferee at the time of the transaction had knowledge of facts sufficient to put him on inquiry as to the insolvency or possible insolvency of the debtor"). See generally 4 Collier on Bankruptcy ¶ 548.07 at 548-68 & nn. 10-13 (L. King 15th ed. 1987) and cases cited therein.
The construction to be put on the phrase "in good faith" may depend in large part on the facts as they develop. See Boatman v. McMillan Mach. Co. (In re Bristol Indus. Corp.), 45 B.R. 606, 609 (Bankr.D. Conn.1985). Certainly, if a defendant knew that the debtor was running a Ponzi scheme when he advanced money to the debtor or knew of the debtor's insolvency at the time of the allegedly fraudulent
The test is whether the transaction in question bears the earmarks of an arm's length bargain. Bergquist v. First Nat'l Bank (In re American Lumber Co.), 5 B.R. 470, 477 (D.Minn.1980). The mere fact that the debtors promised exorbitant returns on a defendant's investment, however, does not, without more, mean that the defendant lacked good faith. If a legitimate accounts payable factoring program could have supported the promised rate of return, the promised rate of return may not have put the defendant on notice of the debtors' fraud. Moreover, because the debtors paid the promised returns, at least initially, a defendant may have had no reason to suspect that the debtors were insolvent. Cf. Cunningham v. Merchants' Nat'l Bank (In re Ponzi), 4 F.2d 25, 29 (1st Cir.) (the fact that Ponzi "had, so far, kept his agreements with the bank" belied any knowledge by the bank that Ponzi was insolvent or was running an illegitimate business), cert. denied, 268 U.S. 691, 45 S.Ct. 511, 69 L.Ed. 1160 (1925).
The bankruptcy court itself noted, on the issue of the debtors' intent to defraud, that "[a]s a general proposition . . . summary judgment is inappropriate when issues of motive, intent, and other subjective feelings are material." 41 B.R. at 1007. We feel that the same approach should be taken on the subjective question of whether the defendants took in good faith. From the record it appears that no evidence was taken on this particular question. Thus, this court is unable to determine the basis for the bankruptcy court's finding.
We conclude that a defendant's good faith (or lack thereof) was a genuine issue of material fact. Because the bankruptcy court took no evidence on the issue, it erred in granting summary judgment for the defendants on the trustee's third claim. We therefore remand to the bankruptcy court for factual findings on the question of whether the defendants took payments that did not exceed their principal undertaking in good faith.
3. Section 544(b)
The last theory by which the trustee sought to recover all payments that the debtors had made within a year of filing for bankruptcy was that the transfers were avoidable under state law and hence were avoidable under section 544(b) of the Code.
Section 544(b) authorizes the trustee to avoid "any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an
a. The corporate trust fund doctrine
The corporate trust fund doctrine is a judicially created doctrine that allows a corporation to recover disbursements to equity holders made when there were no profits out of which a dividend could lawfully be declared. Restitution may be enforced by the corporation, by stockholders, by creditors of the corporation and by a trustee in bankruptcy. 12 W. Fletcher, Cyclopedia of the Law of Private Corporations § 5422 at 91 (rev. perm. ed. 1985) (citations omitted). The rationale for the doctrine is that the corporation's
Id. at 91-92 (quoting Hayden v. Thompson, 71 F. 60, 66 (8th Cir.1895)). The doctrine is premised on the idea that a corporation's creditors should have recourse to the corporation's capital for repayment of their claims "since it [was] upon the faith of the corporation's capital stock and assets which the law presumes that credit was given. . . ." 15A id. § 7371 at 52 (rev. perm. ed. 1981).
The doctrine—or at least its rationale— has been widely repudiated. See, e.g., McDonald v. Williams, 174 U.S. 397, 401-05, 19 S.Ct. 743, 744-46, 43 L.Ed. 1022 (1899) (no trust fund at least where corporation is solvent); Central Hanover Bank & Trust Co. v. United Traction Co., 95 F.2d 50, 55 (2d Cir.1938); Hospes v. Northwestern Mfg. & Car Co., 48 Minn. 174, 50 N.W. 1117, 1119-20 (1892). See generally 15A
Regardless of whether Utah law would recognize the doctrine, the plaintiff's argument must fail. We simply find the doctrine inapplicable under the facts of this case.
For the trust fund doctrine to apply here, the debtors (Massachusetts trusts) must be deemed "corporations," the defendants "shareholders" in those corporations, and their undertakings "capital" of the corporation. Even if the debtor enterprises could be considered "corporations" for purposes of applying the corporate trust fund doctrine, a question we do not reach, their relationship to the defendants was that of debtor to creditor, not that of corporation to shareholder.
Although as a general rule certificate holders in a common-law or Massachusetts trust "stand in their relation to the trust as stockholders in a corporation" (that is, they are "equitable owners of the trust property"), Bryan v. Welsh, 72 F.2d 618, 620 (10th Cir.1934), there is no evidence that the defendants in this case were even certificate holders in the debtor trusts. Their relationship was defined by their individual contracts with the debtors and not by any ownership interest in the debtors. The contracts between the defendants and the debtor enterprises state:
Bagley affidavit exhibit A ¶ 8. Thus, the objective intent of the parties, as expressed in the contract, was that the defendants would assume the debts of the debtors' clients in exchange for the right to receive revenues paid by the clients. In other words, the defendants were ostensibly buying accounts receivable, albeit indirectly, through the debtors. The holder of an account receivable is a creditor, not an owner of the debtor business.
Even assuming, however, that the defendants' relationship to the debtors in this case was analogous to that of a certificate holder to a common-law trust, we find that that relationship was a creditor-debtor relationship.
The nature of the relationship between certificate holders in a common-law trust
The relationship of the certificate holders to the trust fund appeared at first glance to be that of equity holders to a corporation. The trust indenture authorized the corporation to issue and sell certificates in multiples of $100. The certificates were labeled "Certificate-Bond," and near the top were the words "No. Shares____." The holders of the certificates received annual payments, which were called "dividends." The certificates could be redeemed in cash at any time after three years from the date they were issued, at the election of either the holder or the corporation. The corporation did not have to redeem the certificates at their face value. Rather, on redemption the holder was entitled to receive only his fractional share of the total value of the fund. 260 F.2d at 921-22.
Nevertheless, the Tenth Circuit rejected the argument that the certificate holders were "merely beneficial owners" of the fund and instead held that a creditor-debtor relationship existed between the certificate holders and the trust. Among the "characteristic earmarks" that distinguished the relationship from that of shareholders to a corporation were the sales practices and distribution policies of the debtors. The debtors' general practice in selling certificates was to tell investors that they were lending money, that they were receiving bonds with a fixed rate of return and that after three years they could cash in the certificates at face value. The corporation treated the annual payments to investors as interest payments. The payments were consistently made, at a fixed rate and without regard to fluctuations in earnings or losses. Some were made out of capital. Despite the terms of the trust indenture, matured certificates were redeemed in cash at face value, without any attempt to determine the holder's distributive share of the trust's assets. Id. at 922. All of these facts
Id. at 923.
The facts here present even a stronger case for finding that the undertakers are creditors of the debtors and not shareholders. Here the relationship between the debtors and defendants has none of the indicia of a shareholder-corporation relationship. It does not appear from the record that the defendants had any right to vote for the officers or trustees of the trusts, any right to compel the calling of stockholders' meetings, any voice in adopting by-laws or making fundamental changes in the trusts, any right to examine the books and records of the trusts or any right to sue as a representative of the trusts. According to the express terms of their contracts, the defendants were not even investing money in the trusts and thus could not be expected to share in the trusts' gains and losses.
As in Duncan, the debtors represented that the defendants would be paid regularly at a fixed rate, and until the enterprises collapsed the payments were consistently made at that rate, without regard to any earnings. The defendants could cancel their commitment at any time on thirty-days' written notice and receive payments at seventy-five percent of the contract rate. The defendants' relationship to the debtors was a contractual one—essentially that of a creditor and not that of an owner. Thus,
Because the trust fund doctrine does not apply under the facts of this case, it cannot provide a basis for the exercise of the trustee's avoiding powers under section 544(b).
b. The Utah Fraudulent Conveyance Act
The plaintiff's second argument for avoiding the transfers under section 544(b) is that an unsecured creditor could avoid them under the Utah Fraudulent Conveyance Act, Utah Code Ann. §§ 25-1-1 through -16 (1984), which is based on the Uniform Fraudulent Conveyance Act and parallels in many respects section 548 of the bankruptcy code.
Sections 25-1-15 and -16 of the Utah Code allow an unsecured creditor to have a conveyance set aside to the extent necessary to satisfy his claim if the conveyance was fraudulent as to him. See also Utah Code Ann. § 25-1-1 ("creditor" defined). Sections 25-1-4 through -7 define the circumstances under which a conveyance is "fraudulent" as to creditors. The party seeking to set aside a conveyance as fraudulent has the burden of proving each element of a fraudulent conveyance by clear and convincing evidence. Furniture Mfrs. Sales, Inc. v. Deamer, 680 P.2d 398, 399 & 400 n. 10 (Utah 1984).
The first type of conveyance that is fraudulent under the Utah Fraudulent Conveyance Act is one made "with actual intent, as distinguished from intent presumed in law, to hinder, delay or defraud either present or future creditors. . . ." Id. § 25-1-7.
The trustee argues that the transfers to investors were made with actual intent to defraud at least later investors and hence were fraudulent conveyances under section 25-1-7. The bankruptcy court concluded that the trustee had not met his burden of proving actual intent to defraud, despite the admittedly fraudulent nature of the scheme. For the reasons discussed above in connection with section 548(a)(1) of the Code, we hold that the debtors' fraudulent intent is established as a matter of law, notwithstanding the trustee's higher burden of proof under the Utah statute.
The defendants argue that, even if the debtors made the transfers with an actual intent to defraud, the defendants come within the bona fide purchaser exception of section 25-1-13. That section states:
Section 25-1-13 provides an exception similar to that of section 548(c) of the bankruptcy code. To avail himself of it, each defendant must show (1) that he was "a purchaser for a valuable consideration" and (2) that he did not have "previous notice of the fraudulent intent" of the debtors "or of the fraud rendering void" the debtors' title to the property conveyed.
The next question is whether the defendants were purchasers "for a valuable consideration." Although the phrase "valuable consideration" is not expressly defined in the statute, the concept is similar to the concept of "value" in section 548 of the Code. We conclude that the term "consideration" includes both a conveyance of "property" and satisfaction of an antecedent debt. Cf. Utah Code Ann. § 25-1-3 ("fair consideration" includes both a conveyance of property and satisfaction of an antecedent debt); 11 U.S.C. § 548(d)(2)(A) ("value" means "property" or satisfaction of a present or antecedent debt). For the reasons previously discussed in part IV-B-2 of this opinion, we conclude that a defendant gave "valuable consideration" for the transfers he received to the extent the transfers did not exceed his undertaking. Such transfers satisfied the debtor's obligation to repay the undertaking. However, for the reasons previously discussed we also conclude that a defendant did not give valuable consideration for a transfer to the extent the transfer exceeded the amount of his undertaking. Therefore, for such transfers, section 25-1-13 is no defense.
The final issue under section 25-1-13 is whether the defendants had notice of the debtors' fraud or fraudulent intent. The bankruptcy court held that, as a matter of law, the defendants "took their payments for value and in good faith," 41 B.R. at 1007.
As previously discussed, the bankruptcy court's finding on the defendants' good faith was not supported by the record. These adversary proceedings must therefore be remanded for a factual determination on the question of whether a given defendant had "previous notice" of the debtors' fraud or fraudulent intent at the time he received each transfer the trustee seeks to avoid.
Under the Utah Fraudulent Conveyance Act, a conveyance can also be fraudulent— regardless of the actual intent of the person making the conveyance—if the following conditions are met:
It is undisputed that the debtors were insolvent when they made the conveyances to the defendants. However, the defendants argue that the payments to them were not constructively fraudulent and hence do not come within sections 25-1-4 through -6 because they were made for "fair consideration."
Under Utah law, "[f]air consideration is given for property" when, among other things, "in exchange for such property . . . as a fair equivalent therefor, and in good faith, property is conveyed or an antecedent debt is satisfied. . . ." Id. § 25-1-3. We have already concluded that, to the extent the transfers to a defendant exceeded a defendant's earnings, the consideration for the transfer was not "a fair equivalent." Thus, such transfers were not made for "fair consideration." On the other hand, we have also held that transfers to a defendant that merely repaid the defendant's undertaking satisfied an antecedent debt of the debtor. Such transfers were also a "fair equivalent" for the debt satisfied.
If that were all that the statute required, we would hold that conveyances to a defendant that merely repaid his principal undertaking were made for "fair consideration." But, unlike the fraudulent conveyance provision of the federal bankruptcy code, the Utah statute also requires "good faith."
Courts and commentators have not always agreed on the content of the good faith requirement under state fraudulent conveyance statutes. One court, for example, has found that a transferee does not take in good faith if he lacks an "honest belief in the propriety of the activities in question," has an actual intent "to take unconscionable advantage of others," or either intends to hinder, delay or defraud others or knows that the conveyance will have such an effect. Sparkman & McLean Co., 4 Wn.App. 341, 481 P.2d 585, 591 (1971) (quoting Tacoma Ass'n of Credit Men v. Lester, 72 Wn.2d 453, 458, 433 P.2d 901, 904 (1967)). See also Cady v. Johnson, 671 P.2d 149, 151 (Utah 1983) (quoting with approval this definition of "good faith" in another context). On the other hand, at least one commentator has argued for a "participation" test, which would attribute bad faith to a creditor only if he obtained the payment for reasons other than protecting the value of his claim. Note, Good Faith and Fraudulent Conveyances, 97 Harv.L.Rev. 495 (1983). Cf. 4 Collier on Bankruptcy ¶ 548.07 at 548-68 & nn. 10-13 (L. King 15th ed. 1987) (discussing "good faith" under § 548(c)). It is not for this court to decide in the first instance how the definition of good faith in section 25-1-3 differs from the good faith requirement of section 548(c) of the Code, if at all. We simply hold that the defendants' good faith or lack thereof raises a genuine issue of material fact that the bankruptcy court may have to resolve on remand.
If a defendant did not receive payments in good faith, then he did not give "fair
For the reasons stated above, we must remand these cases to the bankruptcy court to determine each defendant's good faith (or lack thereof) under section 25-1-3 and to determine his lack of notice under section 25-1-13. If the bankruptcy court finds that a defendant did not take in good faith, then the trustee may be able to recover all transfers to that defendant under section 544(b) of the Code and the applicable Utah law. On the other hand, if the bankruptcy court finds that a defendant received payments in good faith, the trustee may still be entitled to recover a portion of those payments, either as fraudulent conveyances or as preferential transfers. We will therefore discuss the trustee's other claims to aid the bankruptcy court with its disposition of the case on remand.
C. The Trustee's Second Claim
Under his second claim, the trustee sought to avoid as fraudulent conveyances all transfers to undertakers in excess of their undertaking, that is, all payments of fictitious profits. The bankruptcy court granted the trustee's motion for summary judgment on his second claim, ruling that, as a matter of law, "the debtors received less than a reasonably equivalent value in exchange for these transfers." 41 B.R. at 1009.
We have already rejected the defendants' argument that the transfers were not "of an interest of the debtor in property" and hence not avoidable under section 548. See supra part IV-A.
Case law supports the bankruptcy court's conclusion that payments of fictitious profits to investors in a Ponzi scheme are not made for a reasonably equivalent value and thus are avoidable as fraudulent conveyances. See Eby v. Ashley, 1 F.2d 971 (4th Cir.1924), cert. denied, 266 U.S. 631, 45 S.Ct. 197, 69 L.Ed. 478 (1925); Lawless v. Anderson (In re Moore), 39 B.R. 571 (Bankr.M.D.Fla.1984). See also Rosenberg v. Collins, 624 F.2d 659 (5th Cir.1980) (affirming the decision of the district court, which found that transfers in excess of a defendant's total cash deposits were without "fair consideration" within the meaning of old 11 U.S.C. § 67(d)(1)(c)); Larrimer v. Feeney, 411 Pa. 604, 192 A.2d 351 (1963) (transfers in excess of a defendant's investment
The law allowing a trustee to avoid payments of fictitious Ponzi scheme profits as fraudulent conveyances embodies the principal that no one should profit from a fraudulent scheme at the expense of others. Were the defendants allowed to keep payments in excess of their undertakings, they would be profiting at the expense of those who entered the scheme late and received little or nothing. The fortuity that these defendants got into the scheme early enough to make a profit should not entitle them to a reward at the expense of equally innocent undertakers who entered the scheme later, perhaps as a result of misplaced faith borne of prior undertakers' success. On the other hand, if the trustee is allowed to avoid transfers of fictitious profits the defendants are not hurt but will be in roughly the same position they were in before they entrusted their money to the debtors. They will still have all the funds that they invested (subject, of course, to the trustee's third claim on remand). We therefore hold that, to the extent the defendants received more than their undertaking, the debtors did not receive a reasonably equivalent value in exchange for the transfers, the defendants did not give value in exchange for the transfers, and the trustee can avoid the transfers under section 548(a)(2), as well as under section 548(a)(1).
D. The Trustee's First Claim
Under his first claim the trustee sought to recover as preferential all transfers made within ninety days of the debtors' petitions in bankruptcy under section 547 of the Code.
Section 547(b) provided:
11 U.S.C. § 547(b) (1982).
The purpose of section 547 is twofold: It is meant to discourage creditors "from racing to the courthouse to dismember the debtor during his slide into bankruptcy" and to further the fundamental bankruptcy policy of treating creditors equally by preventing a debtor from preferring one creditor over others on the eve of bankruptcy. H.R.Rep. No. 595, 95th Cong., 1st Sess. 177-78 (1977), reprinted in 1978 U.S.Code Cong. & Admin.News 5963, 6138.
Under the old preference statute, section 60b of the bankruptcy act, 11 U.S.C. § 96(b) (repealed 1978), the trustee could avoid a preferential transfer only if the creditor for whose benefit the transfer was made had reasonable cause to believe, at the time the transfer was made, that the debtor was insolvent. The requirement that the trustee prove the creditor's state of mind proved "nearly insurmountable" to a successful preference action. H.R.Rep. No. 595, 95th Cong., 1st Sess. 178 (1977), reprinted in 1978 U.S.Code Cong. & Admin.News at 6139. Congress therefore
To make it easier for the trustee to recover preferential transfers and to further the twin goals of preference law, section 547 proceeds on the assumption that a debtor is "nearly always" insolvent during the three months before bankruptcy. Id., reprinted in 1978 U.S.Code Cong. & Admin.News at 6138. Thus, the statute creates a presumption (rebuttable only by certain statutory "exceptions") that transfers made on or within ninety days before the debtor files for bankruptcy are preferential. It generally leaves untouched transfers outside the ninety-day period.
One might seriously question whether section 547 should even apply to payments made to undertakers in a Ponzi scheme such as this. For a Ponzi scheme that lasts more than three months, the statute's basic assumption does not go far enough. By definition, an enterprise engaged in a Ponzi scheme is insolvent from day one. Thus, all transfers to investors in a Ponzi scheme are preferential, not just those made within the three months before bankruptcy. Every transfer prefers the transferee to those investors at the end of the line.
The evil of a preferential transfer is that it "unfairly permit[s] a particular creditor to be treated more favorably than other creditors of the same class." Recent Developments, 3 Bankr.Dev.J. 365, 366 (1986). All investors in a Ponzi scheme are creditors of the same class, so in theory all should be treated equally. In effect, though, applying section 547 to a Ponzi scheme such as this favors some creditors over others. Under section 547 the creditors who are most preferred are allowed to keep their preferential payments because the transfers were made outside the statutory period,
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 only question in these appeals is whether the bankruptcy court correctly applied the statute.
The bankruptcy court granted the trustee summary judgment on his first claim. The defendants appeal that ruling on three grounds. The defendants first argue that the property transferred was not property of the debtor and therefore not subject to avoidance under section 547. Second, the defendants contend that the trustee failed to prove all of the elements of a preferential transfer under section 547 and therefore the transfers may not be avoided. Finally, the defendants claim that all payments made within the preferential period fall within the "ordinary course of business" exception of section 547(c)(2) and thus may not be avoided. We have addressed
Section 547(b) establishes five requirements for a preferential transfer. The parties agree that the transfers the trustee seeks to avoid under his first claim were to creditors, were made while the debtors were insolvent, and (with one exception discussed later) were made within ninety days of the debtors' filing for bankruptcy relief. The defendants contend, however, that the trustee failed to carry his burden of proving that the transfers were "for or on account of an antecedent debt," 11 U.S.C. § 547(b)(2), and that the transfers enabled the defendants to receive more than they would have if "the case were a case under chapter 7," 11 U.S.C. § 547(b)(5).
With regard to subparagraph (2) of section 547, the only issue the defendants have raised is whether payments of so-called earnings were for "antecedent" debts.
With regard to subparagraph (5), the defendants argue that the trustee has failed to meet his burden of showing that, because of an allegedly preferential transfer, the transferee received more than he would have received under a chapter 7 liquidation.
The bankruptcy court first set forth the applicable standard for such a determination: The court must construct a hypothetical liquidation of the debtor's estate to determine whether the creditor received more as a result of the alleged preferential payment than he would have received at the time of the bankruptcy (as opposed to the time of the transfer) under a chapter 7 liquidation had the payment not been made. 41 B.R. at 1013 (citing Palmer Clay Prods. Co. v. Brown, 297 U.S. 227, 229, 56 S.Ct. 450, 451, 80 L.Ed. 655 (1936)). The trustee need only show that the defendant received some payment on his claim within ninety days and that a chapter 7 liquidation would result in a distribution to creditors of less than 100 percent of their claims. Under such circumstances, the payment to the defendant enables him to receive more than he would have received under a liquidation had the transfer not been made.
Applying that standard to the facts before it, the bankruptcy court stated:
41 B.R. at 1013 (footnote omitted). We agree.
Finally, the defendants argue that, even if the requirements of section 547(b) have been met, the transfers to them cannot be avoided because they come within the "ordinary course of business" exception for preferential transfers, found in section 547(c). That section states:
11 U.S.C. § 547(c)(2) (1982).
The bankruptcy court concluded that the defendants had not borne their burden of proving each of the four elements of section 547(c)(2).
The trustee introduced no evidence that the transfers he sought to avoid were made other than in the ordinary course of the debtors' financial affairs and according to the contract terms. Rather, he moved for
Apparently, the bankruptcy court agreed. The bankruptcy court concluded that transfers to defendants within the ninety-day preference period were not made "in the ordinary course of business of the debtors and the defendants and made according to ordinary business terms." 41 B.R. at 1014.
We believe that the bankruptcy court read section 547(c)(2) too narrowly. Just because a debtor does not have a legitimate or "ordinary" business does not mean that transfers he makes in the course of that business may not be made in the "ordinary course of business."
As the bankruptcy court noted, the Code does not define "ordinary course of business." In construing the statute, we must be guided by its purpose. See Chapman v. Houston Welfare Rights Org., 441 U.S. 600, 608, 99 S.Ct. 1905, 1911, 60 L.Ed.2d 508 (1979). As we have noted, the purpose of section 547 is to discourage the race to the courthouse and to promote the equal treatment of creditors. Not all transfers by a debtor on the eve of bankruptcy, however, threaten to set off a race to the courthouse or to undermine the equal treatment of creditors. Transfers in the ordinary course of the debtor's business are presumably of this kind. By section 547(c) Congress meant "to leave undisturbed normal financial relations [of the debtor], because [they do] not detract from the general policy of the preference section to discourage unusual action by either the debtor or his creditors during the debtor's slide into bankruptcy." H.R.Rep. No. 595, 95th Cong., 1st Sess. 373 (1977), reprinted in 1978 U.S.Code Cong. & Admin.News 5963, 6329.
We believe that, viewed in light of the statute's purpose, the transfers to defendants in this case may have been made in the "ordinary course" of the debtors' business. The debtors' business was to solicit "undertakings" from investors and to pay the undertakers according to the terms of their contracts, in order to attract new undertakers. There is nothing in the record to indicate that the payments in question were any different from any other payments on the clearinghouse contracts, that they were made according to other terms or that the underlying debts were incurred in other than the ordinary course of the debtors' admittedly fraudulent business. There is nothing to indicate that the transfers were not in conformity with the prior dealings of the parties, with the prior practice of the debtors or with the practices of others engaged in the same type of fraudulent business. Moreover, the payments did not threaten to set off a race to the courthouse. In fact, they had just the opposite effect. The race to the courthouse would have started sooner if the debtors had not made the payments in question.
Of course, preventing the race to the courthouse is just one purpose of the preference statute. It is also meant to minimize the unequal treatment of creditors. The bankruptcy court concluded that, in passing section 547(c)(2), "Congress did not intend to protect one group of investors in a `Ponzi' scheme over the rest." Id. at 1014. Yet by refusing to recognize an ordinary course of business exception in this case, that is exactly what the bankruptcy
Thus, avoiding the allegedly preferential transfers in this case would do little to further the twin goals of preference law. Moreover, avoiding the transfers would do little to deter similar transfers in the future, since in theory such transactions "would have taken place regardless of the debtor's financial straits." Nutovic, The Bankruptcy Preference Laws: Interpreting Code Sections 547(c)(2), 550(a)(1), and 546(a)(1), 41 Bus.Law. 175, 181 (1985). This is especially true of transfers in furtherance of a Ponzi scheme.
This does not mean that the defendants all have a good defense to the trustee's first claim. We do not hold that the ordinary course of business exception applies to every transfer the trustee seeks to avoid by that claim. If a defendant knew of a debtor's financial woes and sought and obtained accelerated payments under the contract, for example, the transfer may not have been made in the "ordinary course" of even the debtors' extraordinary business. Whether any of the transfers at issue here fit that classical preference situation is a matter for the bankruptcy court to determine on remand. We simply hold that the bankruptcy court erred in granting the trustee summary judgment on his first claim. On the state of the record before the bankruptcy court, the trustee was not entitled to a judgment as a matter of law. A transfer does not fall outside the scope of section 547(c)(2) simply because it was made in furtherance of a Ponzi scheme.
On remand the defendants will still have the burden of showing that the transfers in question meet all four requirements of section 547(c)(2), including the requirement that the transfer be made not later than forty-five days after the debt was incurred.
E. Prejudgment Interest
The defendants contend that the bankruptcy court abused its discretion in granting prejudgment interest to the trustee. To the extent we have reversed the bankruptcy court's grant of summary judgment to the trustee, we vacate any award of prejudgment interest. However, to the extent we affirm the bankruptcy court on the merits of the trustee's claims, the propriety of awarding prejudgment interest on those claims is still at issue.
The defendants acknowledge that the court has broad discretion in determining when prejudgment interest should be
The same argument was made in a related case, Merrill v. Allen (In re Universal Clearing House Co.), 60 B.R. 985, 1001-02 (D.Utah 1986). For the reasons stated in that decision, we reject the argument. The bankruptcy court did not abuse its discretion in awarding prejudgment interest from the date of commencement of the adversary proceeding. Thus, to the extent that the court affirms the bankruptcy court on the merits of the trustee's claims, the bankruptcy court's award of prejudgment interest in these adversary proceedings is also affirmed.
DEFENSES UNIQUE TO PARTICULAR DEFENDANTS
A. Defendant Ruby Van Sant
Ruby Van Sant appeals from the bankruptcy court's grant of summary judgment against her on the trustee's first and second claims. As to the trustee's second claim, she contends that the record does not support the summary judgment against her and that the bankruptcy court erred in failing to address the issue of recoupment. We find for defendant Van Sant on both issues. We cannot, however, agree with her contention, under the trustee's first claim, that payments she received within the ninety days before the filing of the debtor's petition in bankruptcy did not come within section 547(b) of the Code.
1. Appropriateness of Summary Judgment
Defendant Van Sant contends that the record does not support summary judgment on the trustee's second claim and that the bankruptcy court erred in determining that there were no material factual issues. She argues that the Bagley affidavit, the only affidavit filed in support of the motion, presented facially inconsistent facts and that the affidavit itself thereby raised a material factual issue.
By his second claim the trustee sought to recover all transfers to a defendant that exceeded the defendant's undertaking. The bankruptcy court granted summary judgment in favor of the trustee on his second claim but did not allow him to recover payments that did not exceed a defendant's undertaking. Thus, a crucial factual issue in the bankruptcy court was whether Van Sant had suffered a net loss or received a net gain.
Taken together, the Bagley affidavit and its exhibits asserted that Van Sant (a) "withdrew from the . . . program and thereby received from the debtors the full amount of [her] deposit, together with additional sums representing ostensible `profits' or `earnings,'" and (b) "received payments representing ostensible `profits' or `earnings' from the debtors but realized net losses on [her] investments."
A material factual issue was presented not only by the apparent factual inconsistency of the only affidavit submitted in support of the trustee's motion, but also by both the answer to the complaint and the answers to interrogatories. Defendant Van Sant consistently stated in both of those documents that she had not received payments from the debtors in excess of her investment but rather suffered a net loss. Record on Appeal in No. C-84-1225W at 46, 15-16.
Rule 56(c) of the Federal Rules of Civil Procedure, made applicable to the bankruptcy court by Bankruptcy Rule 7056, governs the granting of summary judgment. It requires the court to render judgment "forthwith if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Under this standard, the record did not support the judgment.
Defendant Van Sant's second argument is that the bankruptcy court erred in failing to consider her recoupment defense to the trustee's second claim.
Record on Appeal in No. C-84-1225W at 46 (emphasis added). Although defendant Van Sant's answer did not set forth the factual basis for her recoupment defense, her answers to the interrogatories did. Answer number 7 reads as follows: "All payments received by me were used to purchase new contracts except for the months of May, June and July." Id. at 15.
Recoupment is defined as "the setting up of a demand [or defense] arising from
Although this case may not be the typical recoupment case, the same underlying policy applies. If Van Sant can prove that her total investment with the debtors was one transaction and that she did not retain payments made to her by the debtors but rather reinvested those funds with the debtors, she is entitled to either a reduction in or an abatement of the damages. In other words, Van Sant should not have to return more than she actually received from the debtors. For example, if she ostensibly received $100,000 but $50,000 of that amount went to purchase other investment contracts from which she received nothing, she should only be liable for at most the $50,000 she received and not the whole $100,000.
The documents Van Sant submitted with her answers to interrogatories indicate that she may be able to prove the elements of the recoupment defense. Several of the contracts do not bear her signature but were apparently prepared and signed on her behalf by an agent of the debtors. Record on Appeal in No. C-84-1225W at 19, 23, 25, 27, 29, 31, 35, 38 & 40. This implies that payments the debtors purportedly made to Van Sant may never have reached her but rather may have been applied by the sales agent directly to the purchase of new investment contracts on her behalf.
The trustee maintains that Van Sant's sixth defense did not specifically raise the recoupment defense. He argues that it was nothing more than an empty lamentation of the unfairness of the debtors' scheme. We cannot agree. Rule 8(f) of the Federal Rules of Civil Procedure, made applicable to adversary proceedings by Bankruptcy Rule 7008(a), provides that "[a]ll pleadings shall be so construed as to do substantial justice." This court has long been bound by the rule that justice requires especially liberal construction of the pleadings of pro se litigants. Conley v. Gibson, 355 U.S. 41, 47-48, 78 S.Ct. 99, 102-03, 2 L.Ed.2d 80 (1957). Under these rules of construction, we must find that Van Sant raised the recoupment defense despite the inartfulness of her pleading.
The trustee further argues that the doctrine of recoupment does not apply to defendant Van Sant's case because her claim does not arise from the same transaction as does the trustee's claim. Although the trustee cites cases in which the recoupment defense did not prevail because a series of transactions were involved and also maintains in another section of his brief that Van Sant's investment with the debtors consisted of several separate and distinct investment contracts, see supra note 51, this is not the basis of his argument. Rather, he argues that
Reply Brief of Appellee and Cross-Appellant, Robert D. Merrill, Trustee, at 17-18. We find this argument to be without merit.
The trustee further maintains that the policy of equality of distribution embodied in the bankruptcy code precludes the assertion of the recoupment defense in a case involving a Ponzi scheme. The trustee bases his argument on the assumption that Van Sant's recoupment claim is based on nothing more than having suffered a net loss on her investment. Such an assumption is incorrect in this case. Defendant Van Sant's recoupment defense arises from the reinvestment of funds she received from the debtors. Under such circumstances, the equitable principles of the bankruptcy code do not preclude but rather support Van Sant's assertion of the recoupment defense. She must be allowed the opportunity to prove, if she can, that payments purportedly made to her by the debtors actually remained part of or were reintroduced into the debtors' estate. They were simply "rolled over." The debtors have them. She does not.
The factual basis for Van Sant's recoupment defense also makes the trustee's argument concerning preferential payments unnecessary. Van Sant's answer to interrogatory number 7 indicates that she ceased reinvestment prior to the preference period. She stated, "All payments received by me were used to purchase new contracts except for the months of May, June and July." Record on Appeal in No. C-84-1225W at 15. As indicated above, the date of filing in this case was September 16, 1981. 41 B.R. at 991. Therefore, the ninety-day preference period began on approximately June 18, 1981. There is no indication in the record that Van Sant reinvested any payments that she may have received during the preference period. In fact, she indicates in her brief that she received no payments after July 1981. Opening Brief of Appellant at 16. The recoupment defense is therefore inapplicable to any payments she may have received during the preference period.
In light of the Tenth Circuit Court of Appeal's recent decision that the recoupment doctrine applied to a contract for the sale of petroleum, Ashland Petroleum Co. v. Appel (In re B & L Oil Co.), 782 F.2d 155 (10th Cir.1986), we believe that the bankruptcy court is required to consider Van Sant's recoupment defense.
3. Section 547(b)
Finally, Van Sant claims that payments she received from the debtors within the ninety days before Universal Clearing House (UCH) filed its petition in bankruptcy were not preferential transfers avoidable under section 547(b) of the Code. We have already considered the defendants' common arguments for why transfers within the ninety-day preference period should not be avoided. The only argument we need address here is Van Sant's argument that the payments to her were made outside the preference period because an order for relief was not granted against Payable Accounting Company (PAC) until August 16, 1982.
This argument is based on the premise that Van Sant dealt with PAC, not UCH. Our review of the record leads us to conclude that this claim borders on the frivolous. Van Sant entered into at least fourteen contracts that very clearly establish her contractual relationship with both PAC and UCH. See Record on Appeal in No. C-84-1225W at 17-43. Van Sant's answers to the complaint and to interrogatories also indicate that she dealt with UCH. Id. at 14-15, 44-46. See also Van Sant's sixth defense as set forth above. On the record before us, we must conclude that Van Sant dealt with UCH and that payments she received within the ninety days before UCH filed its petition were made within the preference period. However, for the reasons stated in part IV-D of this opinion, we reverse the summary judgment entered
B. Defendant Thomas Richards
Thomas Richards appeals from the bankruptcy court's grant of summary judgment against him and in favor of the trustee. Defendant Richards's sole contention is that the amount of damages awarded was erroneous. Richards argues that the judgment against him should order recovery not of $8,633.60 but of no more than $1,533.60.
Considering that approximately two thousand adversary proceedings were filed in this case, 41 B.R. at 990-91, and that most if not all of them were disposed of summarily, it is unfortunately all too probable that error concerning the amount of damages might occur in one of those proceedings. Our review of the record, as outlined below, indicates that just such an error did occur in Richards's case.
The judgment against Richards, for $8,633.60, was entered on March 22, 1985, pursuant to the Order Respecting Summary Judgment. See Record on Appeal in No. C-85-0437W at 241-42, 236-40. The order granted the trustee's motion for summary judgment on his second claim.
Richards stated in his answer to the complaint that "$8,634.00 . . . is not the amount received by Thomas D. Richards in excess of deposits made to Independent Clearing House." Id. at 156. In his answers to the trustee's first set of interrogatories, Richards spelled out his dealings with the clearinghouse:
January 9th $ 340.80 February 6th 596.40 March 10th 596.40 ________ Total received $1533.60
Id. at 32. All six documents submitted with his answers support Richards's accounting. The contract, the statement of the contract account and the document entitled "Commitment to Assume Debt" show that the amount invested was $7,100.00. Id. at 33A-35. The statements accompanying the payments that ICH made to Richards, dated January 9, 1981, February 6, 1981, and March 10, 1981, indicate that Richards received payments of "earnings" of $340.80, $596.40 and $596.40 respectively and that his "undertaking" was $7,100.00. Id. at 36-38. That undertaking was repaid on March 10, 1981. The repayment conforms with the terms of the contract, which specified that the investment was for a period of not less than two nor more than nine months, id. at 35, and with the notice at the bottom of each statement that the "contract expires February 29, 1981 [sic]," id. at 36-38.
From the bankruptcy court's decision, it is clear that the trustee sought and the court intended to grant recovery on the trustee's second claim only for an amount equal to what a defendant received in excess of his undertaking. Richards's answer to the complaint, answers to interrogatories and accompanying documents not only disputed the amount of damages the trustee sought but in fact demonstrated that the correct amount was $1,533.60 rather than $8,633.60. For that reason, the amount of the judgment entered against defendant Richards should be reduced to $1,533.60.
MOTIONS TO VACATE DEFAULT JUDGMENTS
We next address the appeals from the bankruptcy court's order denying motions to vacate default judgments. These particular appeals raise the issue of whether the bankruptcy court abused its discretion by denying certain defendants' motions to vacate default judgments earlier entered against them. This issue is complicated by the unique circumstances underlying the entry of the default judgments.
As has been made evident above, the collapse of the clearinghouses, the filing of the bankruptcy petitions, the bringing of some two thousand adversary proceedings against investors, many of whom had already lost substantial sums, and the substantial confusion that followed—all overshadowed by a major criminal investigation against the clearinghouse principals—distinguish this case from the ordinary bankruptcy proceeding. Many of the undertakers were unsophisticated in investment matters and had invested a substantial portion of their savings on the strength of advice from friends. When the scheme was uncovered and the clearinghouses collapsed, the investors understandably felt betrayed, confused and anxious about their money. The initial appointment and subsequent reorganizations of a creditors' committee did nothing to clear up the confusion. The sheer number of adversary proceedings and the unorganized way in which many were handled made it virtually impossible for the investors to know who was doing what to whom.
During this time of uncertainty and strong feelings, the defendants, many of whom had lost most of their initial investments, learned that they stood to lose the little they had received. Yet, judging from the large number who appeared pro se, they either could not afford an attorney or did not recognize the need for one.
Against this backdrop, shortly after the filing of the adversary proceedings some of those investors against whom adversary proceedings had been filed composed a letter and mailed it to "all creditors of Universal Clearing House and Independent Clearing House." Pertinent portions of the letter are as follows:
Attached to the letter was a form answer and counterclaim, the essence of which many defendants, acting pro se, filed with the bankruptcy court.
The trustee responded by moving to dismiss the counterclaim, by moving to strike the counterclaim and answer as sham and false and for lack of good faith, and by moving for the imposition of sanctions against those who had filed the form pleadings. In support of these motions, the trustee pointed to the "prohibition against laymen practicing law" in our society and asserted that, because the "defendants entrusted the preparation of their legal defenses to individuals who are not lawyers," the answers and counterclaims constituted "sham pleadings and an abuse of the federal judicial system." The trustee further asserted that "[b]y their rash and frivolous course of action, defendants have knowingly and intentionally compounded and multiplied these proceedings and have caused considerable and unnecessary expense to the trustee, his accountant and attorneys, for which the imposition of sanctions is appropriate and necessary." Memorandum of Points and Authorities in Support of Motion to Dismiss Counterclaim at 7.
The trustee noticed a hearing on the motions to strike the form answers and counterclaims, but the defendants did not attend. Accordingly, by order dated December 29, 1983, the bankruptcy court granted the trustee's motion and ordered the pleadings stricken. The court further ordered that each defendant be required to pay a $100 sanction to the trustee and that, until such sum was paid, any pleading filed in response to the complaint would be deemed a nullity.
After the ruling of the bankruptcy court, the defendants did nothing. Accordingly, upon motion of the trustee, the bankruptcy court entered default judgments against the defendants in March 1984.
In support of their motion to set aside the default judgments, the defendants contended that the trustee's response to the filing of the form pleadings was wholly unjustified. They pointed to the unique circumstances present and stressed that many of the investors were unsophisticated, were not represented by counsel and were merely trying to protect themselves from what they perceived to be unjust claims. They urged that the stricken pleadings coupled with their dismay, disbelief and discouragement with the bankruptcy court explained why they did not file any further pleadings in these matters.
After reviewing the facts underlying the entry of the default judgments and the law regarding the setting aside of such judgments, counsel for defendants asked the court to consider the defendants' failure to respond to the complaints a second time "a product of confusion or ignorance on behalf of the defendants." Counsel also pointed to the August 6 opinion, which rejected the trustee's third claim for relief, presumably in an attempt to demonstrate the existence of a meritorious defense to at least one of the trustee's claims.
In January 1985, the bankruptcy judge denied the defendants' motion to vacate the default judgments, finding that "no grounds have been shown warranting the vacating of said judgment[s], nor has any meritorious defense been shown." It is this order that is currently on appeal before this court.
Appellants contend that the bankruptcy court abused its discretion by refusing to vacate the default judgments and advance several rationales to support their contention. They begin with the proposition that, because default judgments are generally disfavored, any doubt should be resolved in favor of granting a motion to set aside a default judgment so long as the motion is timely and the movant has a meritorious defense. They point out that the rules governing the setting aside of judgments are to be liberally construed and argue that proper application of those rules to these appeals requires reversal of the bankruptcy court's decision.
The trustee disagrees. He reasons that because motions to set aside default judgments lie within the sound discretion of the trial court, the trial court's ruling should not be disturbed absent a showing by appellants that such discretion was clearly abused. The trustee stresses that the movants have the burden of demonstrating a justification for relief from the judgment or order involved. He argues that appellants failed to allege any justifiable grounds for vacating the default judgments and that the bankruptcy court therefore did not abuse its discretion in denying their motion.
B. Standard of Review
The setting aside of judgments or orders, including default judgments, is governed by rule 60(b) of the Federal Rules of Civil Procedure, made applicable to bankruptcy proceedings by Bankruptcy Rule 9024. Motions for relief under rule 60(b) lie within the discretion of the trial court. Otoe County Nat'l Bank v. W & P Trucking, Inc., 754 F.2d 881, 883 (10th Cir.1985). See also Falk v. Allen, 739 F.2d 461, 462 (9th Cir.1984); Cessna Fin. Corp. v. Bielenberg Masonry, 715 F.2d 1442, 1445 (10th Cir.1983). However, such discretion may not be exercised capriciously. Ledwith v. Storkan, 2 F.R.D. 539 (D.Neb.1942). In the case of motions to vacate default judgments, a trial court's discretion is limited by three important considerations:
Schwab v. Bullock's, Inc., 508 F.2d 353, 355 (9th Cir.1974) (citations omitted). See also Falk, 739 F.2d at 463. These factors must be kept in mind when considering whether the bankruptcy court abused its discretion in denying defendants' motions.
Rule 60(b) provides in pertinent part:
Rule 60(b) requires that the motion be made "within a reasonable time," which may not exceed one year if the motion is based on subsection (1). In addition to the requirements specified in the language of rule 60(b), the courts have uniformly required that one seeking relief from a default judgment demonstrate the existence of a meritorious defense. Barta v. Long, 670 F.2d 907, 909 (10th Cir.1982).
We turn first to the requirement that defendants must have made a diligent effort to seek relief within a reasonable time. The record shows that the rule 60(b) motions were filed within six or seven months after the entry of the default judgments. The trustee has not argued that the appellants failed to meet the timeliness requirement. We therefore find that the appellants met the first requirement for relief under rule 60(b).
The second element a movant must demonstrate in a motion to vacate a default judgment is an acceptable reason for the default.
The defendants' memoranda in support of their motions to set aside the default
The final element a movant must demonstrate in order to justify relief under rule 60(b) is the existence of a meritorious defense to the claim against him. The trustee alleges that the defendants failed to meet their burden of demonstrating a meritorious defense. A review of the record, however, leads to the contrary conclusion.
In their memoranda supporting their motion to vacate the default judgments, the defendants relied on the August 6 decision of the bankruptcy court in related cases to demonstrate the existence of a meritorious defense to the trustee's claims.
The trustee argues that the August 6 decision is not relevant to the rule 60(b) motion and that, by relying on the decision as a ground for vacating the default judgments, the appellants are trying to use rule 60(b) as a substitute for appeal. He further argues that a change in the law or in the judicial view of a rule of law is not an extraordinary circumstance alone justifying relief under rule 60(b).
We hold that the trial court failed to exercise sound discretion when it denied the defendants' motion to set aside the default judgments. The defendants clearly made the requisite showing to justify a ruling in their favor on the rule 60(b) motions. This, in combination with the unusual factual situation that resulted in the default judgments and the well-recognized policy favoring the resolution of cases on their merits rather than by default, mandates a holding at odds with the holding of the bankruptcy court. These cases are
ILLEGALLY SEIZED EVIDENCE
The defendants-appellants represented by Edwin F. Guyon also allege, for the first time on appeal, that their constitutional rights were violated by the use of evidence that was obtained through searches violative of the fourth amendment. The evidence in question is business records of the debtors seized in connection with the criminal investigation of the debtors' principals. We hold that the defendants' argument is without merit. We further question the defendants' standing to raise such a claim.
The most glaring defect in the defendants' argument is the fact that the Tenth Circuit has determined that the evidence was not improperly seized. United States v. Cardall, 773 F.2d 1128 (10th Cir.1985). But even if a fourth amendment violation had occurred, the defendants' argument would still not be well taken because they have not demonstrated the "expectation of privacy" necessary for standing to challenge the legality of the searches involved. In Rakas v. Illinois, 439 U.S. 128, 99 S.Ct. 421, 58 L.Ed.2d 387 (1978), the Supreme Court held that in order to challenge the legality of a search or seizure, a person must show that he had a "legitimate expectation of privacy in the invaded place." 439 U.S. at 143, 99 S.Ct. at 430. See also Rawlings v. Kentucky, 448 U.S. 98, 105, 100 S.Ct. 2556, 2561, 65 L.Ed.2d 633 (1980); United States v. Salvucci, 448 U.S. 83, 90, 100 S.Ct. 2547, 2552, 65 L.Ed.2d 619 (1980). There has been no showing, and we believe the defendants would be hard pressed to demonstrate, that the defendants in this case had an expectation of privacy in the business offices of the clearinghouses or in the business records seized.
Not only is the defendants' argument without merit, it is also untimely. The constitutionality of the searches was not raised in the bankruptcy court and thus "need not be considered on appeal." Kenai Oil & Gas, Inc. v. Department of the Interior, 671 F.2d 383, 388 (10th Cir.1982).
In summary, this court holds as follows:
1. The debtor entities—Independent Clearing House Company, Universal Clearing House Company and Accounting Services Company—are "debtors" within the meaning of section 301 of the Code and hence are entitled to bankruptcy relief.
2. The debtors' allegedly bad-faith filing of their petition in bankruptcy did not deprive the bankruptcy court of subject matter jurisdiction over these cases.
3. Section 550(e) does not bar the trustee from recovering the avoided transfers.
4. The money the trustee seeks to recover was "property" of the debtors within the meaning of sections 547 and 548 of the Code.
5. The trustee can recover, under sections 548 and 544 of the Code, the value of all transfers to a defendant made within one year of the debtors' filing for bankruptcy to the extent the transfers exceeded the defendant's undertaking.
6. All other transfers to a defendant made within one year of the debtors' filing for bankruptcy were made with the actual intent to hinder, delay or defraud creditors and hence are avoidable under section 548 (except to the extent the defendant can prove that he took in good faith) and under section 544 and the Utah Fraudulent Conveyance Act (except to the extent the defendant did not have previous notice of the debtors' fraudulent intent).
7. All transfers to defendants made within ninety days of the debtors' filing their petitions in bankruptcy were preferential under section 547(b).
9. To the extent the bankruptcy court properly granted summary judgment to the trustee, it did not err in also awarding him prejudgment interest.
10. The record did not support the grant of summary judgment in the case of appellant Van Sant (and any other defendants whose names appear in both exhibit D and exhibit E of the Bagley affidavit).
11. The bankruptcy court erred in failing to recognize appellant Van Sant's recoupment defense.
12. The bankruptcy court erred in granting summary judgment against appellant Thomas Richards in the amount of $8,633.60. The amount should be $1,533.60.
13. The bankruptcy court erred in denying the motion of certain defendants to set aside the default judgments entered against them.
14. The use of the debtors' records as evidence did not violate any constitutional right of the defendants.
This court has earnestly sought to do justice among all the parties to these actions as well as among those creditors who are not parties but whose interests the trustee is charged with representing. The perfidy of the perpetrators of this scheme, however, has made that goal virtually impossible of achievement.
The ideal solution, of course, would be for all undertakers to get back their original undertaking. But that solution presupposes that the original undertakings are still around to be gotten back, and it is clear that they are not. Some of the money has gone to pay the debtors' administrative expenses, the living expenses of the debtors' principals, commissions to the debtors' salespeople and fictitious profits to early undertakers who are outside the reach of the bankruptcy code. Moreover, any attempt to retrieve these monies (or their equivalent) must necessarily involve resort to the courts, which does not come cheaply.
The next best solution would be for everyone to share pro rata in the inevitable losses. In theory, this solution is what the trustee sought by his third cause of action: all undertakers would put back on the shelf what they had received, and the trustee would redistribute the money equitably. In fact, however, many undertakers who received payments before September 1980 are not parties to these actions, so even if all the defendants returned their money, it would not represent all payments to undertakers.
Unable to do perfect justice, this court must do the only thing it can do—namely, apply the applicable law to the facts of the case, on the assumption that that law will best approximate justice.
The applicable law in this case is the bankruptcy code. That law is premised on certain assumptions that may not be true in a case such as this. For example, the Code establishes an arbitrary date before which transfers by the debtor are conclusively presumed to have been legitimate—namely, one year before the debtor files for bankruptcy. Such a bright-line standard, like a statute of limitation or repose, gives certainty and finality to business transactions. However, the presumption simply does not apply to a Ponzi scheme, where, by definition, all transfers by the debtor are fraudulent. Arguably, therefore, the trustee should be able to recover all transfers without regard for the one-year limitation period. But under the current Code, in an adversary action he cannot. Moreover, by definition all transfers in furtherance of a Ponzi scheme are preferential, yet under
Because of the immensity of the bankruptcy proceedings and the complexity of the issues on appeal, these adversary proceedings have already been in the judicial mill a long time. Now we must send them back to the bankruptcy court for further proceedings, further delaying the process. We can only offer the consolation that Mr. Vholes offered Richard Carstone in other protracted litigation: "The suit does not sleep; we wake it up, we air it, we walk it about. That's something. . . . Nobody has it all his own way now, sir. And that's something, surely." C. Dickens, Bleak House 559 (Signet ed. 1964).
AFFIRMED in part, REVERSED in part and REMANDED for further proceedings consistent with this opinion.
Bankruptcy District Court No. Court No. Defendant (Merrill v.)
(83PA-) (C-84-) [Attorney] 1 Claims2008 0841W *Paul Hurst [EFG] 1, 3 2828 0896G David Abbott, Briant Summerhays, 1, 3 Summerhays Music & Related Cos. Retirement Plan 2100 0927W Juliet Keller [DWJ] 1, 3 2105 0930J Ron or Barbara Kendrick [DWJ] 1, 3 2114 0935W Randall Kilmer [DWJ] 1, 2, 3 2120 0938J Eleanore S. Kinslow 1, 3 2126 0941W Richard Kent Kleffman 3 2135 0943W Gregory or Joyce Knott [DWJ] 1, 3 2144 0944J Merle Krause [DWJ] 1, 3 2177 0950J Veda A. Lemmon [DWJ] 3 2189 0954J Eusebio Limas [DWJ] 3 2190 0955W Linda Hansen or Valorie Jones [GAF] 2 2192 0956J Don Lindley [GAF] 1, 3 2193 0957W Richard Little [DWJ] 1, 2, 3 2208 0959W Debbie Lovejoy and Sherman & Company 1, 3 [RL] 2221 0967W Lowell Lundell [DWJ] 1, 3 2222 0968J Aaron Madsen 3 2225 0969W Maria Madsen [DWJ] 3 2242 0971W Ammon Manning [GAF] 3 2243 0972J Christina Manning [GAF] 3 2244 0973W David K. Manning [EFG] 1, 2, 3 2245 0974J Gary Manning [GAF] 2 2246 0975W Glenn or Thelma Manning [EFG] 1, 3 2250 0976J Clairmont or Marian Margetts [DWJ] 3 2264 0984J J. Lowell Maughn [DWJ] 3 2289 0991W Dr. & Mrs. Dan McKinney [DWJ] 3 2290 0992J Richard McKinney [DWJ] 3 Bankruptcy District Court No. Court No. Defendant (Merrill v.) (83PA-) (C-84-) [Attorney] 1 Claims2293 0993W Harry McMurdie [GAF] 1, 3 2296 0995W Margaret Meakin [DWJ] 1, 3 2298 0996J Mo & Sun Cho Meerza [GAF] 2 2321 1003W Douglas or Ruth Miller [LRM] 3 2324 1005W Flora Miller [DWJ] 1, 3 2335 1008J Dena, Kristine or Jay Mitchell [DWJ] 3 2340 1009W Anna M. Molitor 3 2343 1010J Pres or Linda Montoya [DWJ] 1, 3 2354 1012J Bill Morgan [DWJ] 1, 3 2357 1014J Dave Morris [DWJ] 1, 3 2372 1018J Layne Murdock [DWJ] 1, 3 2373 1019W Leaman E. or Pearl Murphy [DWJ] 1, 3 2378 1021W Homer L. Nabholtz [DWJ] 1, 3 2379 1022J Andrew J. Nabholtz [DWJ] 3 2398 1029W Donna, Corey or Francis Newman [DWJ] 1, 3 2405 1058J Dennis Nichols [DWJ] 3 2431 1064J Cecil or Bobby O'Dell [DWJ] 1, 3 2438 1065W Maeser or Dorene Okerlund [DWJ] 2, 3 2440 1066J Joseph or Carolyn Olschewski [DWJ] 3 2445 1068J Vern T. Olson [DWJ] 3 2479 1077W Cyril or Ada Payne 3 2480 1078J Leon Payne 1, 3 2481 1079W Leon or George Payne [EFG] 2 2485 1080J Paul M. or Della Pease [DWJ] 3 2495 1083W Jose Perez [DWJ] 1, 3 2499 1084J Betty Jean Peterson [GAF] 1, 3 2607 1085W Boyd J. Ricks 1, 3 2628 1094J Paul Robinson [DWJ] 3 2631 1095W Norman or Janice Roehr [DWJ] 3 2638 1097W Norman H. or Velva Lee Rose 1, 3 2639 1098J Jeanetta or Smith H. Rose [GAF] 1, 3 2643 1100J William Roskelly 1, 3 2650 1101W R.J. Rucker [GAF] 2 2652 1102J Cressent, Craig or Brian Rupp [GAF] 3 2653 1103W Duane or Judy Rupp [GAF] 2 2657 1104J Jeanne Ryan 3 2660 1105W Robert or Rula Sacco [DWJ] 3 2661 1106J J. Elmo or Blanche J. Sager [DWJ] 3 2663 1107W Mucio Salazar [DWJ] 1, 3 2667 1108J Clifford or Cleo Samsell [GAF] 1, 3 2685 1116J Virgil N. Sayre [DWJ] 1, 3 2689 1117W Susan or Sherri Schmauderer [DWJ] 1, 3 2694 1120J John Schuler [GAF] 2, 3 2699 1122J Daniel or Nancy Scott [DWJ] 3 0987 1137W George Carpenter and Adam & Truet, a 1, 3 Trust [DWJ] 0990 1139W Al Toronto, Alpine Enterprises [DWJ] 1, 3 0994 1141W Tom Garza, American Investments [DWJ] 1, 3 0995 1142J Ariel Anderson Family Trust 3 0999 1143W Robert Mixdorf, Beecie Enterprises 1, 3 1309 1147W E.M. or Dorothy Blackburn [GAF] 1, 3 1344 1154J Dee C. Brown [GAF] 1, 3 1351 1158J Marvin or Diane Brown [DWJ] 1, 3 Bankruptcy District Court No. Court No. Defendant (Merrill v.) (83PA-) (C-84-) [Attorney] 1 Claims1372 1166J Sheila Bugger [DWJ] 3 1376 1167W L. Ross or Dorothy Burningham [DWJ] 1, 3 1391 1171W Eugene Campbell [DWJ] 3 1397 1175W Jimmy or Kaye Carlile 1, 3 1399 1176J Carol Stafford or Jane Green [DWJ] 3 1500 1177W Clark Colson [DWJ] 1, 3 1501 1178J Ronnie or Inois Colson [DWJ] 1, 3 1520 1184J Josephine or Artie Cox [DWJ] 3 1523 1185W Harold or Dorothy Crays [DWJ] 1, 3 1524 1186J Lori Lea Crays [DWJ] 1, 3 1532 1188J Keig Crook [DWJ] 2, 3 1568 1196J Farrice F. Davidson [DWJ] 1, 3 1579 1199W Wilma Davis 3 1591 1202J Connie Della Lucia [DWJ] 1, 3 1592 1203W Orlando Della Lucia [DWJ] 3 2718 1220J Blair Shaw [EFG] 2 2837 1221W David W. or DeVon Tanton [EFG] 1, 3 2914 1225G Ruby K. Van Sant [GRA] 1, 2, 3 2505 1245W D. Scott Peterson [DWJ] 3 2509 1247W Isobel Peterson 1, 3 2516 1248J Billy or Margie Phillips [DWJ] 1, 3 2517 1249W Brad Phillips [DWJ] 3 2535 1252J William or Johanna Pogue [DWJ] 1, 3 2536 1253W David Pollock [GAF] 2 2541 1255W Garth Porter, Spiders Webb [GAF] 1 2542 1256J Keith C. Porter [GAF] 3 2543 1257W Kenneth S. Porter [GAF] 1, 3 2544 1258J Kent C. Porter [GAF] 1, 3 2545 1259W Mark C. Porter [GAF] 3 2559 1262J Gene G. or Marlene W. Powell [DWJ] 1, 3 2561 1263W Dayna or Don Price [DWJ] 1, 3 2567 1267W Becky Pugh [DWJ] 3 2568 1268J W.E. or Maudine Pugh [DWJ] 1, 3 2574 1270J Madelyn Rapp [DWJ] 1, 3 2582 1272J James or Sybil Raymer [DWJ] 1, 3 2584 1273W G. Scott or Vickie Reading [DWJ] 1, 3 2585 1274J Francis or Doris Rector [DWJ] 1, 2, 3 2587 1275W Arvel or Jene Reese [DWJ] 3 2588 1276J Cindy Reese [GAF] 1, 3 2709 1285W Jay Kay Seymour [DWJ] 3 2711 1286J E.C. Shaffer [DWJ] 1, 2, 3 2712 1287W Dan Shaffer [DWJ] 1, 3 2725 1289W Floyd Sheppick [DWJ] 1, 3 2735 1291W Lois A. or Owen K. Shupe [GAF] 1, 3 2744 1292J Cotton Sims [DWJ] 1, 2, 3 2745 1293W Mickey Simms [DWJ] 1, 2, 3 2767 1298J Larry M. or Rae Ellen M. Smith [DWJ] 1, 3 2774 1300J Yvonne Smith [DWJ] 1, 3 2776 1301W Claine or Helen Snow [GAF] 1 2783 1304J Gerald Sorenson 2, 3 2785 1305W Letitia Sorenson [GAF] 3 2788 1306J Joseph L. or Doris Southworth [DWJ] 1, 3 2791 1307W Vera Sperber [DWJ] 1, 3 Bankruptcy District Court No. Court No. Defendant (Merrill v.) (83PA-) (C-84-) [Attorney] 1 Claims2794 1308J Carol Stafford [DWJ] 1 2796 1309W Robert T. Stancil [DWJ] 1, 3 2801 1312J Richard Stansell [DWJ] 1, 3 2803 1313W William L. Stapleton [DWJ] 3 2805 1314J Rita Starr 3 2813 1315W Owen R. or Dona W. Stokes [GAF] 1, 3 2816 1317W Phyllis & Dean Stonier 1, 3 2821 1318J Della Stringer [DWJ] 1, 3 2838 1321W Jesus Tarin [DWJ] 1, 3 2843 1323W Glen S. or Elizabeth A. Taylor [TST] 3 2844 1324J J. Ross or Ellen S. Taylor [GAF] 3 2845 1325W Lindsey Taylor [DWJ] 3 2848 1327W Ruth Taylor [GAF] 1, 3 2849 1328J Dan E. Telford [DWJ] 1, 3 2858 1330J Rochelle, Doug, June or Frank Thome 3 2860 1331W Bill or Tracy Thompson [GAF] 3 2863 1332J Edwin L. or Janice L. Thompson 1, 3 2864 1333W Gerald Thompson [DWJ] 1, 2, 3 2873 1334J William G. or Laura M. Timmins [GAF] 1, 3 2877 1335W Garth or Beulah Tolboe [GAF] 3 2882 1336J B. Kent or Dorothy Tonnies [DWJ] 1, 3 2888 1338J Dan Trankle [GAF] 2 2895 1339W William Tucker [GAF] 3 3008 1342J Clinton or Peggy Williams 1, 3 3014 1344J Mark Wilson [GAF] 1, 3 3024 1349W Elsie N. Yost [DWJ] 1, 3 3029 1352J Douglas L. Wood 3 3059 1362J Marie T. or Carolyn Yee [DWJ] 1, 3 3060 1363W Robyn York [GAF] 1, 3 3064 1364J Dee B. or Lucille Young [GAF] 1, 3 1002 1366J Cheryl Moffitt, Bertco [JHM] 3 1003 1367W John Dichler, Caernarvon Securities 3 1007 1368J Jerry Ewy, Certified Transmission 1, 3 Rebuilder 1026 1369W Cyril Stevenson, Daws Properties 1, 2, 3 1047 1370J Val Bentley & Hil-Tac Holding Trust 1, 3 1048 1371W Joe Hill, Hilco 3 1082 1372J Mois or Mae Gerson Trust 3 1083 1373W Val Bentley, Motherlode Consultants 1, 3 1091 1374J Novak Company 1, 3 1413 1375W Don J. or Gladys S. Chadwick [DWJ] 1, 3 1414 1376J Julie Ann Chadwick [DWJ] 3 1415 1377W Neil S. Chadwick [DWJ] 1, 3 1416 1378J Reed S. or Sandra M. Chadwick [DWJ] 3 1450 1380J Ellen or Mable Christensen [GAF] 3 1460 1383W Jeanne or Matthew Clarke [GAF] 1, 3 1479 1385W Michelle Colby [GAF] 1, 3 1492 1387W Carl E. Collins [WKG] 1, 3 1705 1389W Madelyn or Joseph Fedor [GBH] 3 1708 1390J Jean Campbell Fenn [DWJ] 3 1751 1397W Jerry Fridenstine 1, 3 1785 1401W Shirley Johns or Gary Bozarth 1, 3 Bankruptcy District Court No. Court No. Defendant (Merrill v.) (83PA-) (C-84-) [Attorney] 1 Claims1795 1404J Frank or Florence Gerner [JD] 3 1830 1406J Marcus or D.L. Graves 3 1848 1407W Mary Gulesserian 3 1875 1409W Gordon Hansen 1, 3 1894 1413W Marilyn Harper [GAF] 3 1895 1414J Rulon Harper 1 1896 1415W Duane or Barbara A. Harris 1, 3 1019 1416J Nora Grayum, D&J, Inc. [GAF] 1, 3 1036 1418J Glenn's Garage [GAF] 1, 3 1062 1421W Dave Manning, Joycom Co. [EFG] 1, 3 1106 1422J Sherm Davidson, Portland Trust [HRK] 1, 3 1113 1424J Rivendale Management Co. [GAF] 2 1116 1425W Rucker Soil Service [EFG] 2, 3 1118 1426J Rulon J. Harper Trust 3 1128 1427W Ray Manning, Spring Hill, a trust [EFG] 1, 3 1131 1428J Dave Manning, Star West Co. [EFG] 1, 2, 3 1150 1430J Patrick O. Nugent (Western Management 1, 3 Consultants) 1170 1432J Chad, Lena or Clay Allen [GAF] 1, 2, 3 1174 1433W Mark D. or Flossie Allen [GAF] 3 1183 1434J Carol or Lee Anderson [DWJ] 1 1200 1440J Don Andrews [DWJ] 1, 3 1201 1441W Donald or Marilyn Andrews [DWJ] 1, 3 1217 1445W David Ashby 2 1219 1446J Kent Ashton 1, 3 1222 1447W Keith or Sue Atkinson 1, 3 1232 1449W Don J. or Maurine C. Baird [GAF] 1, 3 1238 1450J J. Clarence or Vera Mae Ballard [DWJ] 1, 3 1244 1451W Monty P. or Jane P. Banks 1, 3 1247 1452J Allan R. or Erma Barfuss [GAF] 1, 3 1248 1453W Bryce or Sherie Barfuss [GAF] 3 1249 1454J Glenn or Beverly Barfuss [GAF] 1, 3 1278 1459W Thomas E. Beck 3 1284 1460J E. Darwin Belnap [MB] 3 1294 1463W Christopher Bentley 3 1621 1465W DeAnn D. or John W. Doramus [GAF] 1, 3 1623 1467W Kim L. or John W. Doramus 1, 3 1904 1469W Jim Hart [DWJ] 1, 3 1907 1471W Michael Harvey [GAF] 3 1912 1472J John Hawe [GAF] 3 1913 1473W Allen or Faye Hawley [DWJ] 1, 3 1917 1475W Frank Healy 1, 3 1918 1476J Faron or Shirley Heap [DWJ] 3 1931 1481W Daniel Helle [DWJ] 1, 3 1945 1484J Joe Hill 2 1951 1486J Blanche or Clifford Hines [DWJ] 1, 3 1957 1489W C. Hoffman [DWJ] 1, 2, 3 1967 1491W A.A. Holmberg [DWJ] 1, 3 1976 1492J Helen Hoopes [DWJ] 3 1981 1495W Barth Howard [GAF] 1, 3 1982 1496J Clarence or Arlene Howard [GAF] 2 1983 1497W David or Karen Howard [GJE] 1, 2 1984 1498J O. Ellis Howard [GAF] 2, 3 Bankruptcy District Court No. Court No. Defendant (Merrill v.) (83PA-) (C-84-) [Attorney] 1 Claims1986 1500J Sharee Howard [GJE] 1 1987 1501W SueAnn, David, James, Janell, Lynnae & 3 Karen Howard [GJE] 1992 1502J Sandra or Felix Huebner [DWJ] 1, 3 1998 1504J Max F. or Deon N. Hull [GAF] 3 2006 1505W Linda Hunt [DWJ] 1, 3 2019 1508J Casper or Nyla Jacobs [DWJ] 1, 3 2025 1510J Willie James [DWJ] 1, 3 2029 1512J Devon Craig Jarvis [GAF] 3 2030 1513W Kenyon Boyd Jarvis [GAF] 3 2031 1514J LaMont Radell Jarvis [GAF] 3 2032 1515W Terrill Lyn Jarvis [GAF] 3 2042 1517W Harry Ray Jesko [DWJ] 1, 2, 3 2044 1518J Stanley or Corrine Joe [DWJ] 1, 3 2054 1523W Gaylen M. or Alaire L. Johnson [DWJ] 3 2058 1525W John C. or Alice Johnson [DWJ] 1, 3 2064 1526J William A. or Bobbie D. Jolly [DWJ] 3 2066 1527W Cecil or Ann Jones [DWJ] 3 2086 1534J K. Dale or Elizabeth Kartchner [DWJ] 1, 3 2088 1535W Janice Kay Kaupanger 3 2089 1536J Bessie Kay [GAF] 3 2090 1537W Jenifer or Mable Kay [GAF] 3 2091 1538J Lydia L. Kay [GAF] 1, 3 2094 1539W Laurence T. Keene [DWJ] 1, 3 2099 1541W Jim Keller [DWJ] 1, 3 2910 1545W Byron or Jennie Vance [DWJ] 1, 3 2920 1548J Donna H. Vest 3 2923 1549W Rudy or Dorothy Wagner [DWJ] 1, 3 2932 1550J Kristeen Walker 3 2942 1552J Ray H. Walton [DWJ] 1, 3 2945 1553W George W. Ward [DWJ] 3 2952 1556J M.J. Waters [DWJ] 3 2957 1557W Florence Watson [DWJ] 1, 3 2960 1558J Larry O. & Fae Charlene Wayman 1, 2, 3 2963 1559W Howard T. or F. Betty Weaver, Jr. 1, 3 [DWJ] 2975 1561W James L. Werner [DWJ] 3 2983 1563W Cloy Weston [GAF] 1, 3 2986 1564J Walter Wheeler [DWJ] 3 2990 1566J F.C. or A.L. White [DWJ] 1, 3 2992 1567W Dexter W. Whitehead [DWJ] 3 1001 1583W Bella Enterprises [DWJ] 1, 3 1012 1584J Clyde L. or Ada C. Porter Trust [DWJ] 3 1024 1587W Davidson & Bisset [DWJ] 3 1025 1588J Davis & Garret Co. [DWJ] 1, 3 1041 1589W H. Whitney Chapman Family Trust 1, 3 [DWJ] 1043 1591W Havilah [DWJ] 1, 3 1049 1592J Homemaker Enterprises [DWJ] 1, 3 1050 1593W Homes & Short [DWJ] 2 1051 1594J Howard & Grishman Company [DWJ] 1, 3 1054 1595W In G.I.T. [DWJ] 1, 3 Bankruptcy District Court No. Court No. Defendant (Merrill v.) (83PA-) (C-84-) [Attorney] 1 Claims1057 1596J J. Lowell Maughan Family Estate [DWJ] 3 1066 1597W Kilebrew & Feverman Co. [DWJ] 3 1070 1598J Lava I Am Sanctuary [DWJ] 3 1089 1601W New Horizon Company Trust [DWJ] 3 1097 1602J Odyssey [DWJ] 1, 3 1101 1603W Paul H. Robinson Child, Trust [DWJ] 3 1103 1604J Peruvian Missionary Fund [DWJ] 3 1109 1606J Pro Company [DWJ] 1, 2, 3 1130 1608J Stapleton & Associates [DWJ] 1, 3 1147 1610J WACCO Enterprise [DWJ] 1, 3 1151 1611W Wisdom & Howard Company [DWJ] 1, 3 1162 1612J Bobby Dwain & Adelia Milligan [DWJ] 3 1168 1613W Ethel Jane Alexander [DWJ] 3 1194 1614J John D. Anderson [DWJ] 3 1203 1616J Everett & Tillie Anglin [DWJ] 1, 3 1205 1618J Don or Ruth Anson [DWJ] 3 1253 1623W Thurman Barker [DWJ] 2, 3 1254 1624J Colonel Merrill Barlow [DWJ] 1, 3 1255 1625W Frances Barlow [DWJ] 3 1256 1626J Joel Barlow [DWJ] 1, 2, 3 1272 1628J Eldon Baxter [DWJ] 3 1274 1629W James or June Bearden [DWJ] 1, 3 1288 1630J Bob Bennett [DWJ] 1, 3 1291 1631W Kelly Benson [DWJ] 2 1400 1648J Alvin G. Carpenter [DWJ] 1, 3 1401 1649W George or Opal Carpenter [DWJ] 2 1432 1655W Kenneth R. or Louise A. Chapman [DWJ] 3 1433 1656J R.J. Chapman [DWJ] 3 1434 1657W Vaughn Chapman [DWJ] 3 1435 1658J Vern L. Chapman [DWJ] 1, 3 1438 1660J Thane Chase [DWJ] 3 1444 1662J H.L. or Faun Childers [DWJ] 1, 3 1452 1663W Lee or Sandra Christensen [DWJ] 3 1462 1664J T.J. Clay [DWJ] 2 1469 1665W Alice Cluff [DWJ] 3 1471 1667W C.E. Clutter [DWJ] 3 1613 1691W Sam or Lucille Diele [DWJ] 1, 3 1647 1695W Kilebrew & Feverman Co. [DWJ] 1 1648 1696J Nadean Duran [DWJ] 1, 3 1659 1698J Edith Knapp & Gerald Thompson [DWJ] 3 1693 1701W Joseph C. Eyring [DWJ] 1, 2, 3 1694 1702J K.M. Fackrell [DWJ] 1, 3 1712 1705W Ralph & Shirlee Ferrin [DWJ] 1, 3 1715 1706J Leland or Barbara Fielden [DWJ] 1, 3 1720 1707W Carl Figgins [DWJ] 2 1722 1708J Ronald A. Fish [DWJ] 1, 2, 3 1725 1709W Gary & Kathleen Flair [DWJ] 3 1730 1710J D.J. & Helen Fong [DWJ] 1, 3 1739 1712J Robert K. & Mary B. Fox [DWJ] 1, 3 1742 1714J Charles Frandsen [DWJ] 1, 3 1749 1717W William E. & Betty Jo Freeman [DWJ] 1, 3 1752 1718J Jake Z. Friesen [DWJ] 1, 3 Bankruptcy District Court No. Court No. Defendant (Merrill v.) (83PA-) (C-84-) [Attorney] 1 Claims1768 1721W John Gaines [DWJ] 1, 3 1770 1723W Rosslyn Gaines [DWJ] 3 1772 1724J Hector Gamboa [DWJ] 3 1773 1725W Jorge Gamboa [DWJ] 3 1794 1726J Edward & Kara Gerard [DWJ] 1, 3 1796 1727W Martin & Cleatus Gersch [DWJ] 3 1798 1728J George R. & Edith W. Gibbons [DWJ] 1, 3 1805 1729W Dean & Dollie Glasscock [DWJ] 1, 3 1820 1733W Susie A. Gordon [DWJ] 2 1857 1740J Gloria A. Gutierrez [DWJ] 3 1858 1741W Warner & Elizabeth Hoopes [DWJ] 1, 2, 3 1862 1742J C.W. & Lawana Halbert [DWJ] 1, 3 1872 1743W Bob & Priscilla Hamman [DWJ] 1, 2, 3 2334 1818J Dena & Jay Mitchell [DWJ] 1 2547 1859W Linda Poss [DWJ] 3 2549 1861W Michael Poss [DWJ] 1, 3 2716 1893W Stephen N. & Diane P. Sharp [DWJ] 3 2768 1899W Lilith Smith [DWJ] 1 3035 1940J Hobart & Jean Woods [DWJ] 1, 3 1188 1960W G. Stanley Anderson; David, Karen, 3 Sharee, James D., Lynnae, Janell & SueAnn Howard [GJE] 1625 1964J Craig Pixton or Dorothy Souter [RAB] 3 1644 1965W A.D. Dunlap [JJ] 1, 3 1645 1966J Archie Dunlap [JJ] 1, 3 1646 1967W Fremont Dunlap [JJ] 1, 3 1665 1968J Kevin or Kaylene Elfrink [GAF] 1, 3 1685 1970J Elizabeth W. Evans [GAF] 1, 3 1686 1971W Kimberly Christine Evans [GAF] 3 1760 1976J Dennis or Marsha Fuhriman [GAF] 3 1781 1980J Dorthea Garlick [GAF] 3 1868 1985W Sybil Hambrick [GAF] 1, 3 1876 1986J Daryl J. Hansen [GAF] 3 2906 2072G *Donna Uhrey [EFG] 3 1092 2149J *O.W.L., a trust [EFG] 1, 3 2869 2155G *Reese & Lucy Thomson [EFG] 1, 3 1112 85-0050W *Richard & Stevens [EFG] 1, 3 1633 85-0051G *Edward & Jean Doyle [EFG] 1, 3 2336 85-0052W *Donna Mitchell [EFG] 1, 3 1599 85-0053J *Bryan or Thelma Denson [EFG] 1, 3 1146 85-0112J *Vishlia Properties [EFG] 1, 3 2009 85-0113G *Scott Hurst [EFG] 1, 3 2173 85-0115J *Paul & Louise Leitaker [EFG] 1, 3 2421 85-0116J *George & Anne Noller [EFG] 1, 3 85-0127W *Chad Allen et al. [EFG] 0993 85-0381J American Factoring [DWJ] 1, 3 1053 85-0382W Idaho Mountain Company 3 1111 85-0384W Ruess & Reno [DWJ] 3 1122 85-0385J Sanders & Merrick [DWJ] 3 1129 85-0386W Stanton & Mattes Co. [DWJ] 1, 2, 3 1134 85-0387J Street & Company [DWJ] 1, 3 Bankruptcy District Court No. Court No. Defendant (Merrill v.) (83PA-) (C-84-) [Attorney] 1 Claims1141 85-0388W The Surety National Bank 1, 3 1152 85-0389J 5D Company & Richard Davis [LR] 1, 3 1164 85-0390W Milo Ahlstrand 3 1443 85-0394W Iris Child [DWJ] 2 1641 85-0398W Dalton Dulaney [DWJ] 3 1642 85-0399J Virginia Dulaney [DWJ] 1, 3 1654 85-0400W Eva Peterson & Steven Washburn [DWJ] 1, 3 1690 85-0401J Kelly & Dorothy Ewen 1, 3 1947 85-0405J Monte Scott Hill 2 2095 85-0409J Edwin & Muriel Keeney [DWJ] 1, 3 2224 85-0414W Lawrence & Elsie Madsen [DWJ] 1, 3 2349 85-0415J Rose Farmer for Clarence Moorman 3 2464 85-0416W Alfred & Phyllis Parker [GAF] 1, 3 2520 85-0418W Darlene & Sam Phillips [GAF] 1, 2, 3 2808 85-0421J Leon & Lauralea Stephens 2 3055 85-0428W Thomas Yarbrough 3 2603 85-0437W Thomas D. Richards 2 1009 85-0774W Chuck Henderson or Chumorah 1, 2, 3 Enterprises [EFG] 1336 85-0775G Lois Britland [EFG] 2 2174 85-0776W Brent Lemmon [EFG] 2 2176 85-0777G Marie Lemmon [EFG] 2 1110 85-0778J Wendell Hoffman or Pyramid Trust 1, 2, 3 [EFG] 2175 85-0779W Edward Lemmon [EFG] 2 2695 85-0793G Charles A. Schultz 1, 3 1015 85-0796J Collins, a Trust 3 1056 85-0797J Kim Crowther (J.B. Enterprises) [EFG] 1, 3 1144 85-0798G Universal Life Church 3 1342 85-0799W Steve Prockmeyer 1, 2, 3 1353 85-0800J Monte Brown 2 1411 85-0801G Ralph Cazel 1, 3 1923 85-0802G Dee Hedstrom 3 2411 85-0805J F. Kent Nielsen (Fine Diamonds, Inc.) 1, 3 2490 85-0806W Lara Peck [DWJ] 3 2834 85-0809W T.H. McDonald & R.J. Colton 3 2954 85-0811W Lila Watkins 2 2959 85-0812G Margaret O. & Lamar Wayman [DWJ] 1, 2, 3
GRA Garry R. Appel MB Michael Belnap RAB Robert A. Bentley RHC Richard H. Casper JD John Danch GJE Glen J. Ellis GAF Gary A. Frank WKG William K. Gibson EFG Edwin F. Guyon GBH Gregory B. Hadley DWJ Daniel W. Jackson JJ John Judge HRK H. Ralph Klemm RL Robert Lord LRM L.R. Magee JHM Jack H. Molgard LR Lee Rudd TST Thomas S. Taylor
Merrill v. Abbott (In re Independent Clearing House Company), 41 B.R. 985, 994 n. 12 (Bankr. D.Utah 1984) (citation omitted). For the colorful history of Ponzi schemes, see id. at 994-95 n. 12 and works cited therein.
The Massachusetts trusts are not to be confused with the bankruptcy estate, which is administered by Robert D. Merrill, the bankruptcy trustee. The bankruptcy trustee has sequestered the assets of each of the Massachusetts trusts.
11 U.S.C. § 1112(b). The section was amended by the 1984 and 1986 amendments, but those amendments do not apply to this case. See supra note 5.
"Property of the estate" is a term of art in bankruptcy law. Section 541 defines "property of the estate" in terms of different categories of "property" or "interest[s] in property," but nowhere does it define "property" itself, the very term at issue here. The defendants do not dispute that the money they received was "property." The only question is, Whose property was it? The Code offers no help in resolving that question. Therefore, the bankruptcy court's discussion of section 541 misses the mark.
The problems with the bankruptcy court's approach can be seen in its argument. In essence, the bankruptcy court reasoned that the money becomes "property of the estate" under section 541 if the trustee can recover it, 11 U.S.C. § 541(a)(3), or if it is preserved for the benefit of the estate, id. § 541(a)(4). If the trustee can avoid a transfer, he can recover it, id. § 550, and the money is preserved for the benefit of the estate, id. § 551. The trustee can avoid the transfers if they were preferential or fraudulent. Transfers to investors in a Ponzi scheme are preferential and fraudulent. Therefore, they constitute "property of the estate," and the trustee can recover them. See 41 B.R. at 999 (concluding that "[f]unds obtained from investors in a `Ponzi' scheme are property, and are as susceptible of preferential and fraudulent disposition as other property"); see also id. at 1011 ("Property of the debtor includes preferences and fraudulent conveyances recovered by the trustee").
The bankruptcy court's approach begs the question. Transfers to investors in a Ponzi scheme are only preferential and fraudulent within the meaning of the Code if they were transfers of "property of the debtor" or of "an interest of the debtor in property." The bankruptcy court's approach presupposes that the transfers were of the debtors' property and therefore avoidable. If the transfers are avoidable, they are clearly property of the estate. But if the debtor had no interest in the property transferred, the transfers are not avoidable to begin with.
Despite the bankruptcy court's misstatement of the issue, it correctly concluded that property obtained by fraud does not always escape the debtor's estate.
11 U.S.C. § 548(a) (1982). Section 548(a) was amended in 1984, but the 1984 amendments do not apply to these cases. See supra note 5.
The bankruptcy court's conclusion that no defendant received more than he "deposited" with the debtors is clearly erroneous. At least some defendants received more than they advanced to the clearinghouses. See supra note 18.
The bankruptcy court may also have concluded that the undertakers generally were unsophisticated in investment matters, from the modest amounts some of the defendants advanced, by the jobs some held (as reflected in their answers to interrogatories) and by the fact that many of the defendants appeared pro se, suggesting either that they could not afford a lawyer or did not realize the need for one. The fact that the defendants received payments under their contracts may have allayed any suspicions they had that the debtors were not carrying on any business. We believe that, at best, these facts would raise a genuine issue of material fact and would not support the bankruptcy court's finding of good faith as a matter of law, especially as applied indiscriminately to every defendant. It is possible that at least some of the defendants knew that the clearinghouses were not running a legitimate business. (One might wonder, for example, about the good faith of an investor called "Pyramid Trust.")
Similarly, the Utah Supreme Court's conclusion that a contract similar to those involved here was an investment contract and hence a security subject to the Utah Uniform Securities Act, Payable Accounting Corp. v. McKinley, 667 P.2d 15 (Utah 1983), does not necessarily make the defendants equivalent to shareholders in the clearinghouses for purposes of the corporate trust fund doctrine. A given contract may create a security for one purpose and create a creditor-debtor relationship for another purpose. Different legal standards may apply, depending on the purpose, and a difference in tests may dictate a difference in results.
Lawless v. Anderson (In re Moore), 39 B.R. 571, 574 (Bankr.M.D.Fla.1984).
The trustee's apparent position on these points is inconsistent with the position he took on his third claim, in which he argued that the defendants were holders of an equity interest in the debtors and not creditors of the debtors. If all transfers to the defendants were payments of an antecedent debt, as the trustee argues in support of his first claim, then the defendants would be creditors of the debtors and not owners.
In his motion for summary judgment the trustee argued that the transfers did not qualify for the ordinary course of business exception because they were not made within forty-five days after the debts were incurred. The trustee argued that a debt was incurred when a debtor received a defendant's undertaking. Assuming that the trustee was correct, he was still not entitled to summary judgment on the state of the record because he failed to show how soon each transfer was made after the debtor received a defendant's undertaking. The contract allowed a defendant to choose monthly payments, so it is possible that at least some of the allegedly preferential payments were made within forty-five days after the debtor received the defendant's money. If the forty-five day requirement remains an issue on remand, the bankruptcy court may have to determine for each allegedly preferential transfer whether it was made "not later than 45 days after [the] debt was incurred."