Litigation by and Against the Receiver and the Receivership Estate

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 does it establish 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, 453 F. Supp. 2d 1118 (D. Ariz. 2006), aff’d, 569 F.3d 1015 (9th Cir. 2009). This is in line with the analysis in Scholes v. Lehman, 56 F.3d 750 (7th Cir. 1995), which makes it clear that the claims and defenses applicable to the entity before the receiver is appointed are not necessarily applicable to the receiver. See Wing v. Gillis, 2:09-CV-314, 2012 WL 994394 (D. Utah Mar. 22, 2012), aff’d, 12-4071, 2013 WL 2169321 (10th Cir. May 21, 2013) (citing Wing v. Kendrick, 2009 WL 1362383 (D. Utah May 14, 2009)).

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.Commodity Futures Trading Comm’n v. Forefront Investments Corp., 3:07 CV 152, 2007 WL 2155739, at *2 (E.D. Va. July 25, 2007).

Generally, courts will include in the order appointing a receiver a stay provision, which would prevent suits against the receiver; the Barton Doctrine would also provide a stay on litigation without leave of the court. The authority of the court to enter an order is broad and extends to any action involving receivership assets, and may enjoin non-parties from instituting actions against assets subject to the receivership. S.E.C. v. Byers, 592 F. Supp. 2d 532, 536 (S.D.N.Y. 2008), aff’d, 609 F.3d 87 (2d Cir. 2010) (explaining the basis for the court’s authority to enjoin non-parties from filing involuntary bankruptcy petitions against any receivership entity). However, there are limitations on the power of a court to enter a stay of litigation in a receivership. The Eighth Circuit explained in Ritchie Capital Mgmt., LLC v. Jeffries, 653 F.3d 755 (8th Cir. 2011), as the equitable powers of the court exist to protect receivership assets, a stay of any litigation which would involve the interpretation of documents in a receiver’s possession, for instance, would go too far, unless it threatened the receivership assets.

A claimant may also file a motion seeking relief from the stay of litigation against the receivership entities. In S.E.C. v. Wencke, 742 F.2d 1230, 1231 (9th Cir. 1984), the Ninth Circuit listed the following as factors to be considered in granting or denying such a motion:

(1) whether refusing to lift the stay genuinely preserves the status quo or whether the [movant] will suffer substantial injury if not permitted to proceed; (2) the time in the course of the receivership at which the motion for relief from the stay is made; and (3) the merit of the [movant’s] underlying claim.Wencke, 742 F.2d at 1231.

See also United States v. Petters, CIV 08-5348 AMDJSM, 2008 WL 5234527, at *2-4 (D. Minn. Dec. 12, 2008).

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, because “the court which first obtains jurisdiction and constructive possession of the property…is entitled to retain it.…” Gradel v. Piranha Capital, L.P., 495 F.3d 729 (7th Cir. 2007). Also, by intervening in a parallel action, the receiver submits to the jurisdiction of that court. Id. However, before a suit is brought against a receiver, the leave of the court by which he was appointed must be obtained (the “Barton Doctrine”). Standifer v. S.E.C., 542 F. Supp. 2d 1312 (N.D.Ga. 2008); Le v. S.E.C., 542 F. Supp.2d 1318 (N.D.Ga. 2008); Krell v. S.E.C.,1:07-CV-2285-WSD, 2008 WL 513375 (N.D. Ga. Feb. 22, 2008).

A receiver must use judgment in litigating potential claims by or against the estate. There is no automatic immunity for the receiver. See New York Life Ins. Co. v. Waxenberg, 807-CV-401-T-27TGW, 2009 WL 632896, at *2-5 (M.D. Fla. Mar. 11, 2009) (awarding attorney fees against the receiver for, the failure of the receiver to respond to an offer of judgment).

Creditors will not be permitted to file separate actions against the defendants that are duplicative of actions filed by the receiver. Gustin v. Hoffman,608-CV-57-ORL-31DAB, 2008 WL 2949443, at **2-3 (M.D. Fla. July 29, 2008).

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 a key motive for the transfer was to defraud others. 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-three states along with the District of Columbia and the United States Virgin Islands have adopted variations of the Uniform Fraudulent Transfer Act (“U.F.T.A.”),61while a handful of 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 U.F.T.A., 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 U.F.T.A. lists 11 indicia of fraud, often referred to as “badges of fraud,” which if present will assist in proving fraudulent intent.

In fraudulent transfer actions, Defendants will often argue that a receiver lacks standing to bring the action. Several courts have, however, upheld the authority of receivers to bring fraudulent transfer actions. Scholes v. Lehmann, 56 F.3d 750 (7th Cir. 1995) is the principle case discussing the issue of receiver’s standing to bring these actions, explaining that the receiver has standing to bring the actions on behalf of the companies whose shoes he stepped into, as those were separate legal entities from which funds were wrongly diverted, and thus they were injured by the transfer. See also Donell v. Kowell, 533 F.3d 762 (9th Cir. 2008) (finding the receiver had standing based on the injuries to the company); Wing v. Dockstader, 482 F. App’x 361, 362-63 (10th Cir. 2012). The Second Circuit agreed with this analysis, however, it noted that the analysis turns on whether the receiver represents the transferor only or whether he also represents a creditor of the transferor. Eberhard v. Marcu, 530 F.3d 122, 133 (2d Cir. 2008). Therefore, where the receiver has only been appointed receiver for the assets of the malfeasor, and not for its subsidiary entities, the receiver may lack standing as a “creditor,” unless the statute permits suits by “creditors and others.” Eberhard, 530 F.3d 122; cf. Stenger v. World Harvest Church, Inc., CIV.A.1:04CV00151-RW, 2006 WL 870310 (N.D. Ga. Mar. 31, 2006). For additional discussion regarding standing, see Chapter 5.

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). This “Ponzi Scheme Presumption,” that the very existence of a Ponzi scheme is enough to establish fraudulent intent, has been overwhelmingly upheld by courts.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 theIndependent Clearing House, case at 860, “[b]y definition, an enterprise engaged in a Ponzi scheme is insolvent from day one.”20 Additionally, 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 U.F.T.A., under Section 8(a) of the U.F.T.A., 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.June, 432 F. Supp. 2d at 641, Wing v. Layton, 2:08-CV-708, 2013 WL 3725267 (D. Utah July 12, 2013). 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.”22 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. This is so 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.Independent Clearing House, 77 B.R. 858; Donell, 533 F.3d 762; Sender v. Buchanan, 84 F. 3d 1286, 1290 (10th Cir. 1996); Scholes, 56 F.3d 759. Additionally, if the transferee cannot show he acted in good faith and/or it can be shown that the transferee 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 U.F.T.A., 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, 56 F.3d 759; In re Spatz, 222 B.R. 157, 169 (N.D. Ill. 1998); In re Agric. Research & Tech. Grp., Inc., 916 F.2d 528, 538 (9th Cir. 1990). See also, Donell, 533 F.3d 762. Furthermore, funds received in connection with the operation of profitable entities are likewise voidable if the entity was still a part of the greater scheme. Wing v. Layton, 2:08-CV-708, 2013 WL 3725267 (D. Utah July 12, 2013).

And a charitable organization is not immune from the requirement that a transfer by an insolvent transferor be supported by consideration. Scholes, 56 F.3d at 761; Stenger v. World Harvest Church, Inc., CIV.A.1:04CV00151-RW, 2006 WL 870310, at *10 (N.D. Ga. Mar. 31, 2006).

In determining the amount of liability of an investor, one court has held that the investor will not be permitted to offset amounts paid as federal income taxes or other expenses in connection with the amounts distributed. Donell, 533 F.3d at 778-779.

The existence of the Ponzi scheme can be established by evidence of guilty pleas of the perpetrators in related criminal proceedings. June, 432 F. Supp. 2d at 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. S.E.C. v. Wencke, 783 F.2d 829 (9th Cir. 1986); see also Warfield, 453 F. Supp. 2d 1118. As to “nominal defendants,” seeS.E.C. v. Ross, 504 F.3d 1130, 1141-42 (9th Cir. 2007). Generally, these would be people whom the S.E.C. might have named as relief defendants initially but chose not to proceed against 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, 783 F.2d 829; Warfield, 453 F. Supp. 2d 1118; but see S.E.C. v. Ross, 504 F.3d 1130 (9th Cir. 2007). It would also appear that the defendants would not be entitled to a jury trial in such cases. United States v. Arizona Fuels Corp., 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. S.E.C. 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.

In one case, a receiver was permitted to sue marketers for recovery of commissions received by them, utilizing “unjust enrichment” as a cause of action, even when the marketers were not aware of the fraudulent scheme. Hays v. Adam, 512 F. Supp. 2d 1330 (N.D. Ga. 2007) (“the defendants’ sales…to investors violated the law, and any commissions or bonuses they received from such sales were thus received unjustly.”)But see Ross, 504 F.3d 1130.

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 at least the receiver is appointed, as the fraud could not reasonably have been discovered. World Harvest Church, at **8-10; Quilling v. Cristell, CIV.A. 304CV252, 2006 WL 316981, at **6-7 (W.D.N.C. Feb. 9, 2006). Although arguments arise that the limitation period in the U.F.T.A. is a statute of repose rather than a statute of limitation, and thus is not subject to equitable tolling, courts have found this argument invalid. See Dockstader, 482 F. App’x 361 (holding that the U.F.T.A. limitation period applies “to the claimant,” meaning the receiver, and that the fraud could not reasonably have been discovered until after the company ceased being controlled by the wrongdoer); Wing v. Kendrick, 2:08-CV-01002-DB, 2009 WL 1362383 (D. Utah May 14, 2009) (holding that equitable tolling principles apply). But see Warfield, 453 F. Supp. 2d 1118. Although many courts have indicated that the limitations period does begin on the date the receiver is appointed, the Fifth Circuit has explained that the determination of the date on which the Plaintiff should have discovered the fraud is subject to a factual analysis, which must be plead and supported conclusively by the defendant. Janvey v. Democratic Senatorial Campaign Comm., Inc., 712 F.3d 185, 195-96 (5th Cir. 2013) (finding that the defendant did not prove statute of limitations defense, as the evidence reflected that upon the receiver’s appointment, the fraudulent nature of the transfer was not readily evident).

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.


 

19 See, e.g., Donell, 533 F.3d at 770; Quilling v. Schonsky, 247 F. App’x 583, 586 (5th Cir. 2007); Terry v. June, 432 F. Supp. 2d 635, 639-640 (W.D. Va 2006); In re Taubman, 160 B.R. 964, 983 (Bankr. S.D. Ohio 1993); In re Slatkin, 310 B.R. 740, 748-49 (Bankr. C.D. Cal 2004); In re Randy, 189 B.R. 425, 429 (Bankr. N.D. Ill 1995); In re Nat’l Liquidators, Inc., 232 B.R. 99, 102 (Bankr. S.D. Ohio 1999); In re Agric. Research & Tech. Group, Inc., 916 F.2d 528, 535 (9th Cir. 1990); In re Baker & Getty Fin. Servs., Inc., 98 B.R. 300, 308 (Bankr. N.D. Ohio 1989), aff’d, 974 F.2d 712 (6th Cir. 1992); In re C.F. Foods, L.P., 280 B.R. 103, 110 (Bankr. E.D. Pa. 2002); In re World Vision Entm’t, Inc., 275 B.R. 641, 656-67 (Bankr. M.D. Fla. 2002); In re M & L Bus. Mach. Co., 198 B.R. 800, 807 (Bankr. D. Colo. 1996). See also Conroy v. Shott, 363 F.2d 90, 92 (6th Cir. 1966)(given that a Ponzi scheme exists, the “question of intent to defraud is not debatable”).Gordon v. Rogge, 12-11456, 2013 WL 607776 (E.D. Mich Feb. 19, 2013); Wiand v. Mason, 8:10-CV-2146-T-17MAP, 2012 WL 7071455 (M.D. Fla. Dec. 17, 2012), report and recommendation adopted, 8:10-CV-2146-T-EAK, 2013 WL 542857 (M.D. Fla. Jan. 25, 2013).

 

20 Numerous courts have adopted this conclusion. See, e.g., In re Mark Benskin & Co., 161 B.R. 644, 650 (Bankr. W.D. Tenn. 1993); In re Int’l Loan Network, Inc., 160 B.R. 1, 12 n.15 (Bankr. D. D.C. 1993); Taubman, 160 B.R. at 978; In re Ramirez Rodriguez, 209 B.R. 424, 430-31 (Bankr. S.D. Tex. 1997). See also In re Financial Federated Title & Trust, 309 F.3d 1325, 1332 (11th Cir. 2002) (“‘By definition, a Ponzi scheme is driven further into insolvency with each transaction.’”) (citation omitted).

 

21 See Scholes, 56 F.3d at 755; In re Randy, 189 B.R. 425, 441 (Bankr. N.D. Ill. 1995).

 

22 IdSee, e.g., United States v. Romano, 757 F. Supp. 1331, 1338 (M.D. Fla.1989);Plotkin v. Pomona Valley Imports (In re Cohen), 199 B.R. 709, 719 (Bankr.Fed.App.1996); Fisher v. Sellis (In re Lake States Commodities, Inc.), 253 B.R. 866, 878 (Bankr.N.D.Ill.2000); In re Agricultural Research & Tech. Group, Inc., 916 F.2d at 536; Stenger v. World Harvest Church, 2006 WL 870310 (N.D.Ga. 2006) at 10;Stenger v. Rogers, 2006 WL 449151 (N.D.Ga. 2006) at 7.
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