The 'Ponzi Scheme Presumption' Is Dead. Long Live The 'Ponzi Scheme Presumption'

By now, many who follow this site are likely aware of the Minnesota Supreme Court's recent ruling that denied a receiver's efforts to recover assets paid out to an investor on the basis that Minnesota's Uniform Fraudulent Transfer Act ("MUFTA") "does not contain a Ponzi-scheme presumption."  The ruling, which stands alone in contrast to significant state and federal jurisprudence explicitly recognizing a Ponzi scheme presumption, has spawned a growing chorus touting a new "balance of power" in clawback litigation.  However, a closer examination of the case at the middle of this controversy, as well as a primer on the application of fraudulent transfer precedent, demonstrates that this purported seismic shift in the fraudulent transfer landscape is likely nothing more than an isolated blip that will have little effect on a receiver's ability to claw back profits in a Ponzi scheme.


The case at issue involved a clawback lawsuit brought by the court-appointed receiver of First United Funding, LLC ("First United"), which sold "participation interests" in loans it had made to third parties who were to receive a sizeable profit in the form of interest repaid on the loan.  Corey Johnston, who owned and operated First United, is currently serving a six-year prison sentence after pleading guilty to bank fraud and filing a false income tax return.  While some of First United's loans were legitimate in that no more than 100% of the loan was sold via a participation interest to one or more financial institutions, First United caused multiple loans to be oversold to multiple parties - meaning that those investors would not receive legitimate proceeds but rather the redistribution of money provided by other investors - a classic hallmark of a Ponzi scheme. 

In this instance, the receiver sought to recover several million dollars paid to several financial institutions as principal and interest on a $3.18 million loan made to an Arizona businessman.  While the lower court dismissed claims against several of the banks based on the statute of limitations, it entered judgment in favor of the receiver and against Alliance Bank in the amount of $1,235,388 - an amount which appears to be the profits received by Alliance Bank on its "participation interest."  In rendering judgment in favor of the receiver, the lower court referenced the 'Ponzi scheme presumption," which that court characterized as a rule holding that “the profits that good-faith investors enjoy in connection with a Ponzi scheme are recoverable as fraudulent transfers.”

In analyzing the relevant loan in which Alliance Bank and others purchased "participation interests," the Minnesota Supreme Court focused on the statutory interpretation of MUFTA in concluding that

MUFTA does not contain a provision allowing a court to presume anything based on the mere existence of a Ponzi scheme. 

Instead, the Court observed that "MUFTA requires a creditor to prove the elements of a fraudulent transfer with respect to each transfer, rather than relying on a presumption related to the form or structure of the entity making the transfer."  Concluding that it was required to examine the transfer on a case-by-case basis, the Court found that the subject loan was not subject to the presumption nor had the receiver satisfied MUFTA's provisions as the loan was real, was not oversold, and was attacked solely on the basis that it was part of a greater Ponzi scheme. 

The Ponzi Scheme Presumption

The Uniform Fraudulent Transfer Act, which has been adopted by a majority of states including Minnesota, allows a creditor to recover a fraudulent transfer made by the debtor upon the demonstration of an actual or constructive intent to hinder, delay, or defraud the debtor's creditors.  A significant number of courts have found that the showing of the existence of a Ponzi scheme allows the court to presume that, due to the inherently fraudulent nature of a Ponzi scheme, all transactions were made with the intent to hinder, delay, or defraud a debtor's creditors.  See, generally, Perkins v. Haines, 661 F.3d 623 (11th Cir. 2011); Donell v. Kowell, 533 F.3d 762 (9th Cir. 2008).  A basic prerequisite for applying this 'Ponzi scheme presumption' involves a showing that the contested transfer was effected 'in furtherance' of the Ponzi scheme. Bear, Stearns Secs. Corp. v. Gredd (In re Manhattan Inv. Fund Ltd., 397 B.R. 1, 13 (S.D.N.Y. 2007).

In a nod to the difficulty of establishing a debtor's actual intent to hinder, delay, or defraud, state fraudulent transfer laws also allow the use of circumstantial evidence to demonstrate actual fraudulent intent through a non-exclusive list of eleven "badges of fraud."  These factors include, but are not limited to, that the transfer was concealed, the debtor removed or concealed assets, or that the transfer occurred shortly before or after a substantial debt was incurred.  Courts routinely recognize that a showing of multiple badges of fraud results in a presumption of fraudulent intent and a burden shift to the transferee to demonstrate a legitimate purpose for the transfers.

An Analysis Of Alliance Bank

A closer look into the Alliance Bank decision shows that the case involved a relatively unique factual situation that is likely to bear little precedential value going forward.  There, the court found (and the receiver did not argue) that the loan at issue was in fact real, not oversold, and was being attacked simply because it was part of a larger Ponzi scheme.  As referenced above, many courts refuse to invoke the Ponzi scheme presumption where the subject transfer was not made "in furtherance" of a Ponzi scheme.  While other relevant details remain unknown, such as the flow of the payments and whether funds used to pay Alliance Bank were commingled with other investor funds, the court concluded that the facts and circumstances known to it could not justify a showing of fraudulent intent. 

The factual backdrop of the First United Ponzi scheme is also illustrative of its uniqueness.  Unlike a majority of other Ponzi schemes, which solicit investors based on a promise that their collective funds will somehow be used to generate massive returns that they will later share, the First United Ponzi scheme essentially allocated participation in the scheme through the sale of "participation interests" in specific loans.  While some of those loans were fraudulent and used to further the Ponzi scheme, some were apparently legitimate.  In the Alliance Bank case, the financial institutions collectively purchased a 100% interest in the subject loan that entitled them to share in and resulting profits based on the loan's performance.  Thus, rather than a dollar-based investment in the schemer's hedge fund, company, or venture, an investment in First United was specifically tied to a distinguishable and distinct loan. As the court found, the loan's legitimacy and the fact that the proceeds from the loan were used to pay the returns were a critical factor in the court's ruling.

Decision's Precedential Effect Is Unlikely

While many are quick to hail the Alliance Bankdecision as a seismic shift in Ponzi scheme litigation, the reality is that the decision is likely to have little or no effect on future cases.  Indeed, while the Ponzi scheme presumption is often used to demonstrate actual intent as required to support a fraudulent transfer claim, it is not the sole avenue afforded to creditors.  Rather, state fraudulent transfer laws also allow a creditor to show actual intent by establishing the existence of badges of fraud.  It is likely that cases involving Ponzi schemes will likely feature a plethora of badges of fraud that can easily satisfy actual intent in the absence of a 'Ponzi scheme presumption.' 

This conviction is shared by Douglas Kelley, the court-appointed bankruptcy trustee tasked with recovering assets for victims of Thomas Petters' $3.65 billion Ponzi scheme, who dismissed the effect of the Alliance Bank decision in a recent interview with the Minneapolis Star Tribune, remarking:

Whether I prove the Ponzi presumtion or use badges of fraud, I can easily prove fraudulent intent.  We have no dearth of direct evidence of fraud in this case.

It is also worth noting that, even assuming the inability to invoke a 'Ponzi scheme presumption,' what further showing of fraud is necessary for an inherently deceptive scheme that by its nature depends on sustained and continuing fraud to perpetuate the scheme?  Whereas various factors can be used to establish "badges" of fraud, the showing that a debtor is operating a Ponzi scheme is itself indicative of fraud.  In other words, while the Minnesota Supreme Court recognized that the operation of a Ponzi scheme was not itself a badge of fraud, the showing that a debtor masterminded a Ponzi scheme is due to be afforded significant weight in determining the existence of the actual intent to hinder, delay, or defraud.

A copy of the Minnesota Supreme Court's decision is below: 

AppellateOpinion (1)