By: Gabriella B. Zahn
St. John's Law Student
American Bankruptcy Institute Law Review Staff
Adopting a limited view of the “Ponzi scheme presumption,” the Bankruptcy Court for the Southern District of Florida[1] rejected the trustee’s contention that payments made for groceries were avoidable fraudulent transfers because the purchase of groceries was in furtherance of the Ponzi scheme.[2] In In re Phoenix Diversified Investment, the debtor purchased $43,384.37 worth of groceries and other personal items over a four-year period from Publix – a grocery store chain.[3] The trustee sought to avoid the transfers under both state fraudulent transfer law[4] and section 548(a) of the Bankruptcy Code (the “Code”).[5] The trustee argued that the so-called “Ponzi scheme presumption” applied.[6] The presumption allows the court to assume a transfer was made with the “actual intent to hinder, delay, or defraud” if the transfer was made in order to perpetuate a Ponzi scheme or was necessary to the continuance of the scheme. In its classic application, the presumption allows the trustee to recover payments made to early investors in a Ponzi scheme on the theory that those payments kept the scheme hidden. Publix argued that the Ponzi scheme presumption was not applicable.[7]
Both Florida law and section 548(a) of the Code allow a trustee to avoid a transfer as fraudulent if the trustee can demonstrate that the debtor made the transfer with “actual intent to hinder, delay, or defraud any creditor of the debtor.”[8] Because it is difficult to prove that a transfer was made with such actual intent, courts have created, and sometimes apply, the so-called “Ponzi scheme presumption.” However, not all transfers relating to a Ponzi scheme are subject to the presumption. In order for the presumption to apply, the relevant transfer must not merely relate to the Ponzi scheme, but it must also be in furtherance of that scheme. Here, fraudulent intent alone was not enough to show that the money used to purchase the groceries was used to further the Ponzi scheme, and therefore, summary judgment was not appropriate. The court determined that there must be specific evidence to show that the transfers were made in furtherance of the Ponzi scheme for the presumption to apply.[9] Although the debtor admitted to his involvement in the Ponzi scheme, and his use of funds to make personal purchases, the court ruled that this would be an unwarranted extension of the presumption, because all that could be proven was that the debtor used money that should have been used to repay investors.[10]
Phoenix Diversified is an important case because it focuses attention on the fact-specific nature of the court’s inquiry into the types of transfers that, when standing alone, may be subject to the Ponzi scheme presumption, particularly when there is no admission of fraudulent intent.[11] Setting aside the affirmative defense in this case, if, for example, the debtor had used his grocery purchases to hold large dinner parties for potential investors, the court may have reached a different conclusion because that would be a more clear case of furthering a scheme and not just being related to it. This case raises issues that may arise in future cases; unlike the obvious transfer of funds from new to old investors, with the intent to keep the scheme under wraps,[12] transfers such as the one made in this case are of a more questionable nature. This case will likely require courts to analyze each case on a fact-specific basis to clearly determine what transfers qualify under the Ponzi scheme presumption. Applying a bright-line test would be unworkable, as evinced by Phoenix Diversified, and would likely lead to lingering cases and wasted judicial resources on continued litigation. In an age of Ponzi schemes, courts are likely to bring more clarity on this issue in the years to come.
[1] In re Phoenix Diversified Inv. Corp., No. 10-03005-EPK, 2011 WL 2182881, at *4 (Bankr. S.D. Fla. June 2, 2011).
[2] A Ponzi scheme is “any sort of inherently fraudulent arrangement under which the debtor-tranferor must utilize after-acquired investment funds to pay off previous investors in order to forestall the disclosure of fraud.” In re Bayou Group, LLC, 362 B.R. 624, 633 (Bankr. S.D.N.Y. 2007).
[3] In re Phoenix Diversified Inv. Corp., 2011 WL 2182881,at *1.
[4] Id. at *2.
[5] 11 U.S.C. §548(a)(1)(A) (2006). Florida Statutes section 726.105(1)(a) adopts nearly the exact language of section 548 of the Code, but would allow the trustee to make a claim on all 4 years of transactions, as opposed to the two-year maximum under section 548 of the Code.
[6] In re Phoenix Diversified Inv. Corp., 2011 WL 2182881,at *2.
[7] Id. at *6.
[8] Fla. Stat. § 726.105(1)(a). As noted in note 5, the language of § 726.105(1)(a) adopts almost the exact language of section 548(a)(1)(A) of the Code (“actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted”).
[9] In re Phoenix Diversified Inv. Corp., 2011 WL 2182881, at *3 (citing In re Pearlman, 440 B.R. 900, 905 (Bankr. M.D. Fla. 2010)).
[10] Id.
[11] Id. at *1.
[12] See In re Bayou Group, LLC, 362 B.R. 624, 633–34 (Bankr. S.D.N.Y. 2007) (applying Ponzi scheme presumption where redemption payments of non-existent investment account balances and fictitious profits were made to earlier investors requesting redemption using funds invested by subsequent investors).
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