With the collapse of multiple large scale Ponzi schemes in recent years, Federal courts in Florida and elsewhere have been wrestling with so-called “clawback” suits. The way Ponzi schemes work is that the schemers induce investors to give them money that is supposed to be invested, usually with high returns promised.
But because the promised returns are unsustainable and the schemers syphon off investors’ funds for their own personal use, the schemers cannot pay the promised returns to investors when they seek to liquidate their investments. Thus, the Ponzi schemers recruit additional investors, and instead of investing the funds received, they use the funds to pay the earlier investors the principal and earnings promised.
Typically, Ponzi schemes collapse and are discovered when the new money coming in is insufficient to pay the amount promised to withdrawing earlier investors. Investors that withdraw early often see the return of the principal they invested and also receive “earnings” on that principal. When a Ponzi scheme collapses, there are usually insufficient funds to return the principal given to the Ponzi schemers by the remaining investors, much less the promised earnings.
In a clawback suit, the bankruptcy trustee or receiver appointed to oversee the wind-up of an entity involved in a Ponzi scheme seeks to recover funds paid to the earlier investors in order to achieve a more equitable distribution of funds as between earlier and later investors. The theory of the suits is that the transfers to the earlier investors were fraudulent transfers, which may be recovered under fraudulent transfer statutes, such the Florida Uniform Fraudulent Transfer Act (FUFTA), Florida Statutes §726.101 et seq.
But Ponzi scheme clawback suits aren’t the typical fraudulent transfer suit. In Wiand v. Lee (decided June 2, 2014), the Eleventh Circuit addressed the viability of such suits under FUFTA, and resoundingly endorsed them.
The clawback suit in Wiand resulted from the collapse of a Ponzi scheme run by Arthur Nadel, in which he induced investments into certain hedge funds. Wiand was the receiver for those funds. Lee was an early investor that had withdrawn its investment and was paid back its principal, plus profits. Wiand sought return of the profits.
The 11th Circuit held that a transfer made in furtherance of a Ponzi scheme satisfies the requirements of the “actual fraud” provision of FUFTA. Under the actual fraud provision, a transfer is fraudulent when the debtor made the transfer “with actual intent to hinder, delay, or defraud any creditor of the debtor…” Courts have interpreted that provision to mean there must be “ a creditor to be defrauded,  a debtor intending fraud, and  a conveyance of property which is applicable by law to the payment of the debt due.”
Although the second element, fraudulent intent, is usually determined based on “badges of fraud,” the 11th Circuit held that proof that a transfer was made in furtherance of a Ponzi scheme is sufficient to show fraudulent intent without the need to consider the “badges of fraud.”
The more difficult questions were who was the creditor and debtor and whether the funds received by Lee were “property of the debtor,” as required by FUFTA to recover them. Money from the hedge funds was transferred to Lee by Nadel.
The court of appeals explained that the hedge funds were the creditors, because when Nadel illegally transferred money from them, he became a debtor to them for the funds he illegally removed. It then turned to the issue of whether the funds were “property of the debtor.”
Although “property of the debtor” would appear to mean Nadel’s property given that he was the debtor, the 11th Circuit held otherwise. According to the court, under Florida law, “property of the debtor” means “property which is applicable by law to the payment of the debt due.” Because the funds removed created the debt owed by Nadel to the hedge funds, the funds he removed were “applicable by law to the payment of the debt due.”
Addressing the receiver’s cross-appeal, the 11th Circuit held that pre-judgment interest should be awarded in FUFTA cases as a matter of course, except in limited circumstances where specific equitable factors counsel otherwise. The denial of prejudgment interest was reversed, with a remand for determination of whether any recognized equitable considerations justified the denial of prejudgment interest.