Transferees Must Pay Chapter 7 Trustee "Millions of Dollars" under § 548(a) with Debtor's Plea Agreement As Sole Evidence of His Fraudulent Intent

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com



Johnson v. Nielson (In re Slatkin)
Ninth Circuit Case No. 06-56334
May 6, 2008
Affirmed District Court's affirmation of the Bankruptcy Court's granting of summary judgment to Chapter 7 trustee.

In this opinion the Ninth Circuit Court of Appeals ruled that the appellants must pay back to the trustee "millions of dollars" they had received from debtor as "profits" from their investments in debtor's Ponzi scheme, even though appellants had no knowledge of debtor's fraudulent intent and even though some of these funds may have been based on legitimate investments.

The Circuit Court addressed three issues of interest in this Litigation Report: A) can a debtor's fraudulent intent be based on the sole evidence of his guilty plea and plea agreement in a criminal case, authorizing the trustee's avoidance of transfers arising from such intent; B) can a bankruptcy court deny a transferee's motion for a continuance to conduct further discovery before having the opportunity to depose the debtor-transferor, or to review a transcript of the debtor-transferor's prior testimony; and C) does the bankruptcy court have the authority to grant an award of prejudgment interest if the transferee-defendants have demanded a jury trial?

A) The primary issue was this evidentiary one: could the bankruptcy court grant summary judgment on the issue of debtor's actual intent to "hinder, delay, or defraud" his creditors with the sole evidence consisting of debtor's guilty plea and the plea agreement, thus enabling the trustee to avoid and recover transfers from debtor to transferees under § 548(a) of the Bankruptcy Code and a similar California state statute?

The Circuit Court held:

1) The plea agreement was hearsay, but admissible under the exception in Federal Rule of Evidence 807 because:

• The plea agreement was offered as evidence of the material fact of debtor's operation of a Ponzi scheme and his actual fraudulent in doing so;
• The plea agreement and its admissions were not only more probative than any other evidence that could be procured through reasonable efforts, they were unusual direct proof of fraudulent intent, where usually circumstantial evidence must suffice;
• Admission of the plea agreement into evidence to establish fraudulent intent furthered the purposes of the evidentiary rules and served the interests of justice;
• The plea agreement had "equivalent circumstantial guarantees of trustworthiness" in that it was made under oath, with the advice of counsel and after debtor was advised of his constitutional rights, it subjected debtor to severe criminal penalties (a 14-year prison sentence), and was accepted by the criminal court only after the court determined that the plea was voluntary.

2) The plea agreement "preclusively establishe[d debtor's] intent to defraud in relation to transfers to [the defendants]," as follows:

• Debtor's actual intent to defraud was established by his admissions in the plea agreement, in which he admitted operating a massive Ponzi scheme used to defraud 800 investors of over $593 million, since prior 9th Circuit opinions had established that the mere existence of a Ponzi scheme was sufficient to establish actual intent under § 548(a);
• Debtor's plea agreement provided a sufficient factual basis to support the bankruptcy court's finding that the transfers to the defendants were fraudulent, because once the existence of a Ponzi scheme is established payments received as "profits" by investors (amounts beyond the initial "investment") are deemed fraudulent transfers as a matter of law;
• Debtor's tax return did not raise a genuine issue of material fact in that his reporting of income to the IRS and delineating of capital gains attributable to various investors including the defendants because the tax return was not inconsistent with his operation of the Ponzi scheme.

B) On the matter of the bankruptcy court's denial of a motion for a continuance to conduct further discovery, given the incredible amount of money at stake it is certainly understandable that, before the court's granting of summary judgment on the issue of debtor's intent, defendants wanted to depose the debtor as to his intent regarding the specific transfers at issue. Defendants also wanted to review a transcript of debtor's testimony in a prior proceeding with the trustee (not involving defendants). The Circuit Court followed an earlier 9th Circuit opinion, Bank of America v. PENGWIN, 175 F.3d 1109 (9th Cir.1999), in stating that the defendants had to show that allowing additional discovery would have precluded summary judgment on the issue of debtor's fraudulent intent. Apparently at some point after the summary judgment ruling, defendants did have the opportunity to depose the debtor and to review the transcript of the prior proceeding, but according to the Circuit Court did not identify anything from that deposition or that transcript that contradicted the bankruptcy court's finding of fraudulent intent. So the Court determined that the bankruptcy court did not abuse its discretion in denying time for further discovery before granting summary judgment on the issue of intent.

C) Given the huge amount of the judgment awarded to the trustee, the bankruptcy court's granting of prejudgment interest on this judgment involved much more money than usual. (The Circuit Court's opinion did not provide any specific amounts as to either the transfers or the prejudgment interest, perhaps as a subtle way of indicating that the dollar amounts do not change the legal principles?) The Court looked at the appropriateness of prejudgment interest under California and federal law.

A California statute provided for interest to be awarded in fraud cases "in the discretion of the jury," so defendants argued that only a jury and not the bankruptcy court had the authority to award prejudgment interest. The Court reviewed the state case law and instead held that "when a court has granted judgment as a matter of law on all substantive issues, the court has authority to award prejudgment interest under [that statute]."

As to federal law on prejudgment interest, the Court rejected the defendant's argument that under federal law if they demanded a jury trial they were entitled to have a jury decide this interest issue, and the Court instead held that a bankruptcy court has the authority to award prejudgment, with no discussion other than to briefly distinguish a US Supreme Court case, Osterneck v. Ernst & Whinney, 489 U.S. 169 (1989)

(Note that the Court also determined through a detailed analysis (taking nearly 8 pages of the 24-page opinion on this issue) that the debtor was not a "stockbroker" under the Bankruptcy Code, critical here because under § 546(e) settlement or margin payments by a stockbroker are not avoidable. That analysis is beyond the scope of this Report so please see the opinion itself for that.)

BOTTOM LINE:

1) A debtor's criminal plea agreement can be admitted as evidence under an exception to hearsay if it meets certain conditions, especially if it has "equivalent circumstantial guarantees of trustworthiness."

2) A plea agreement can establish a debtor's intent to defraud for purposes of § 548(a) as to transfers by debtor of "profits" to "investors" if the plea agreement contains admissions of a Ponzi scheme, since as a matter of law the mere admitted existence of such a scheme establishes actual intent.

3) Payments made in a Ponzi scheme to "investors" of any sums beyond the amounts invested are deemed fraudulent transfers as a matter of law.

4) A bankruptcy court does not abuse its discretion if the party, who was, prior to the court's decision on a motion for summary judgment on a person's intent, denied a motion for continuance to conduct further discovery about that intent, cannot subsequently show that the requested additional discovery would have contradicted the court's finding of intent.

5) Bankruptcy courts have authority to award prejudgment interest in a fraudulent transfer case, in spite of transferees' demand for and lack of a jury trial, under both California statute and federal law.

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorney.com

© 2008 Bankruptcy Litigation Support for Attorneys