Practice Areas

Causes of Action

3.01 In General

The typical appointment order issued by a Receivership Court will grant authority to the Receiver to marshal and protect the assets of the Estate and to engage in litigation in the discharge of his duties.  Often, the defendant in such an action brought by the Receiver will attempt to challenge the standing of the Receiver, either based upon the assertion that the cause of action, if any, belongs to the investors, not the Receiver, or that the Receiver may not bring the action due to the impact of in pari delicto or the “clean hands” doctrine.

Certainly, where the damage has been done directly to the investors, rather than the Receivership Entities, it is the investors who must bring the action.  However, in many instances, the Receivership Entities will have been directly injured by the conduct of the defendants.  And, while still subject to argument, the majority of cases have held that in pari delicto/clean hands is not a defense, nor establishes a lack of standing, once the “zombie” Receivership Entities have been freed of the control of their zombie master by the appointment of an independent Receiver.  See Chapter 5.

Since a court-appointed receiver is “an officer of the court,” the doctrine of laches is not available as a defense against claims brought by the Receiver.  Warfield v. Alaniz, 2006 WL 2190563 (D.Ariz. 2006), *11.

Principals of an entity that has been placed in Receivership cannot file pleadings on behalf of/in the name of the Receivership entity without the consent of the Receiver.  CFTC v. Foremost Investments Corp., 2007 WL 2155739 (E.D.Va. July 25, 2007), *2.

If a parallel action has been filed in another court, the receivership action does not necessarily have priority in determining claims to the receivership assets:  “the court which first obtains jurisdiction and constructive possession of the property…is entitled to retain it.…”  Gradel v. Piranha Capital, 2007 WL 2120319 (7th Cir. March 18, 2007), *2.  Also, by intervening in a parallel action, the receiver submits to the jurisdiction of that court.  Id. 

3.02 Fraudulent Transfer Actions

Quite commonly, a wrongdoer who has defrauded others through a Ponzi or other fraudulent scheme wishes to — and does — transfer a portion of his ill-gotten gains to third parties.  If the transfer was made for full value, and with no intent to defraud or hinder others, it may be perfectly legitimate.  However, in many instances the defrauding of others was a key motive for the transfer.  Thus, the Receiver can frequently substantially increase the assets of the Estate by having such “fraudulent transfers” set aside.

The rules concerning what constitutes a “fraudulent transfer” vary from state to state.  Forty-two states have adopted variations of the Uniform Fraudulent Transfer Act (“UFTA”) while four states have adopted variations of the older Uniform Fraudulent Conveyance Act, which are both codifications of common law applying the English Statute of 13 Elizabeth.  Under Section 4 of the UFTA, a transfer will be considered fraudulent if the debtor made the transfer (i) with actual intent to hinder, delay or defraud any creditor of the debtor (“actual fraud”); or (ii) without receiving a reasonably equivalent value in exchange for the transfer and the debtor was or was rendered insolvent after the transfer (“constructive fraud”).  In the case of actual fraudulent intent, which is subjective and often difficult to prove, Section 4(b) of the UFTA lists 11 indicia of fraud, often referred to as “badges of fraud”, which if present will assist in proving fraudulent intent.  A copy of the UFTA is attached as an apprendix.

Fortunately, in the context of a Ponzi Scheme, once the existence of a Ponzi Scheme is proved, the fraudulent intent of the fraudster will be presumed.  In In re Independent Clearing House, 77 B.R. 843, 860 (D. Utah 1987) the bankruptcy court held that intent to defraud can always be inferred when a Ponzi scheme is involved, because such schemes must, as a matter of scientific necessity, eventually collapse and leave some creditors unpaid. 

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 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, … and a debtor's knowledge that future investors will not be paid is sufficient to establish his actual intent to defraud them.

77 B.R. at 860 (citations omitted, emphasis added).¹⁹

Similarly, courts have widely held that once the existence of the Ponzi Scheme is proved, the presumption of the transferor’s insolvency is established.  As stated in the Independent Clearing House case at 860, “[b]y definition, an enterprise engaged in a Ponzi scheme is insolvent from day one”²⁰ and the authorities are clear that Ponzi Scheme perpetrators are deemed insolvent from the moment of its inception, as a matter of law.²¹

Once the receiver has shown the actual fraudulent intent of the transferor under Section 4(a) of the UFTA, under Section 8(a) of the UFTA, the transfer is not voidable if the transferee can show that he took the property in good faith and for a reasonably equivalent value.  The transferee bears the burden of proof on both of these elements.  See e.g., Terry 432 F. Supp. 2d at 641 and cases cited therein.  In order to meet this burden, “the transferee must show not that he was subjectively unaware of the transferor’s fraudulent intent, but rather that he did not have knowledge of facts that should have reasonably put him on notice that the transfer was made in order to delay, hinder, or defraud creditors of the debtor.” id²²  Thus, it will be harder for an insider to establish this defense.

To the extent that the payments were made as part of a Ponzi Scheme and represented payments in excess of principal investment, that is the payments were fictitious Ponzi profits, those payments are voidable, even if the transferee can show he acted in good faith, because a Ponzi Scheme by definition does not produce profits and, therefore, the transferee could not have provided reasonably equivalent value.  See, e.g., In re Independent Clearing House, 77 B.R. 858; Sender v. Buchanan, 84 F. 3d 1286, 1290 (10th Cir. 1996); Scholes v. Lehman, 56 F.3d 759.  However, if the transferee cannot show he acted in good faith and or was otherwise aware of the Ponzi Scheme, he is not entitled to rely on the good faith defense provided in Section 8(a) of the UFTA and he may be liable for all payments received, even to the extent of the transferee’s investment in the Ponzi Scheme.  See, e.g., Terry v. June, 432 F. Supp. 2d 642; Scholes v. Lehman, 56 F.3d 759; Levit v. Spatz (In re Spatz), 222 B.R. 157, 169 (N.D. Ill. 1998); In re Agricultural Research & Tech. Group, Inc., 916 F.2d 528, 538 (9th Cir. 1990).

And a charitable organization is not immune from the requirement that a transfer by an insolvent transferor be supported by consideration.  Scholes v. Lehmann, 56 F.3d 750, 761 (7th Cir. 1995); Stenger v. World Harvest Church, 2006 WL 870310 (N.D.Ga. 2006) at 10.

The existence of the Ponzi scheme can be established by evidence of guilty pleas of the perpetrators in related criminal proceedings. June at 432 F.Supp.2d 639.

For other authority on issues that arise in suits by a receiver to vitiate fraudulent transfers, see the Table of Cases, under “Fraud/Fraudulent Conveyances.”

3.03 Relief Defendants\Disgorgement Applications

Arguably the receiver has the power to institute actions against third parties holding assets which were transferred to them by the defendants in the underlying securities litigation by making application for disgorgement.  SEC v. Wencke, 783 F.2d 829 (9th Cir. 1986 (“Wencke”); see also Warfield v. Alaniz, 2006 WL 2190563 (D.Ariz. 2006) (“Warfield”), **12-13. Generally these would be people who the SEC might have named as relief defendants initially but chose not to for strategic reasons.  This may be the only cause of action the receiver may have against these parties.  The advantage to pursuing these parties for disgorgement is that the receiver should be able to pursue these cases using summary proceedings rather than plenary proceedings (thus reducing litigation costs) as long as the defendants are given due process. Wencke; Warfield.   It would also appear that the defendants would not be entitled to a jury trial in such cases. United States of America v. Arizona Fuels Corporation, 739 F.2d 455, 459 (9th Cir. 1984); Bien v. Robinson, 208 U.S. 423, 427 (1908).

Disgorgement can be ordered against a defendant despite the defendant’s own huge losses in the investment scheme.  SEC v. J. T. Wallenbrock & Associates, 440 F.3d 1109, 1117 (9th Cir. 2006).

3.04 Other Causes of Action

The Scholes case, through dealing directly with a fraudulent conveyance action, is not limited to fraudulent conveyance actions.  As a result, a Receiver may bring breach of contract, negligence, fraud, aiding and abetting, Securities and potentially RICO actions.

As to “show cause” actions for contempt, see Chapter 4.

3.05 Statutes of Limitation

Where a fraudulent transfer statute of limitations is tolled until “discovery,” the time does not begin to run until the receiver is appointed.  WHC, **8-10; Cristell, **6-7.  See, however, Warfield v. Alaniz, 2006 WL 2190563 (D.Ariz. 2006), **8-10, drawing a distinction between statutes of limitation and statutes of repose.

3.06 Summary Proceedings

Proceedings brought by the Receiver before the Receivership Court can be conducted on a summary basis, so long as basic principles of due process are observed.  See Chapter 7.

A receiver need not separately serve process on the various claimants in a receivership claims procedure, so long as the claimants are given adequate notice.  See Chapter 7.