Minnesota Supreme Court Rejects Use of Ponzi Scheme Presumptions

Creditors, bankruptcy trustees and receivers may not use the so-called Ponzi scheme presumptions in cases brought under the Minnesota Uniform Fraudulent Transfer Act (MUFTA). Recent clawback claims against banks, investors and other financial institutions receiving payments from criminal actors such as Corey Johnston and Tom Petters have often based their claims on such presumptions and a number of federal courts have adopted the presumptions.

In Finn v. Alliance Bank, et. al. (February 18, 2015), the Minnesota Supreme Court determined that the Ponzi scheme presumptions are not found within the language of MUFTA and the Court refused to engraft them. In Finn, the receiver asked the Supreme Court to recognize Ponzi scheme presumptions by which a creditor could prove certain elements of fraudulent transfer claims simply by establishing that the debtor operated a Ponzi scheme and that the transfers were made in furtherance of that scheme. The Ponzi scheme presumptions rejected include:

  • A person or entity running a Ponzi scheme has actual intent to defraud and, thus, all transfers are treated as actually fraudulent;
  • The mere existence of a Ponzi scheme proves as a matter of law that the debtor was insolvent at the time of the disputed transfer, regardless of the transfer’s timing and actual operations of the debtor; and
  • Payments to “investors” in a Ponzi scheme are never for reasonably equivalent value.

MUFTA was designed to prevent debtors from placing property that is otherwise available for payment of their debts out of the reach of their creditors. Achieving equality among creditors, even if they are the victims of a Ponzi scheme, is not the purpose of MUFTA. MUFTA does not prohibit a debtor from making a preferential transfer in favor of one bona fide creditor over another, so long as the transfer is not fraudulent (and the preferred creditor is not an insider.) Creditors may recover assets that a debtor transfers with fraudulent intent, Minn. Stat. § 513.44(a)(1), as well as transfers that the law treats as constructively fraudulent, Minn. Stat. § 513.44(a)(2), 513.45.

As to a claim of actual fraud, a creditor must prove that the debtor made the transfer with the “actual intent to hinder, delay, or defraud any creditor of the debtor.” Minn. Stat. § 513.44(a)(1). To do so, a creditor may rely on various “badges of fraud,” such as whether a transfer was made to an “insider” and whether the transfer was “disclosed or concealed.” Even if fraudulent intent is proven, a transferee may defeat liability by establishing that the transferees “took [the transfer] in good faith and for a reasonably equivalent value.” This affirmative defense is found in Minn. Stat. § 513.48(a).

A claim of constructive fraud does not require proof of actual intent, but rather, proof that the debtor made the transfer or incurred an obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor:

  • Was engaged or was about to engage in a business or transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or
  • Intended to incur, or believed or reasonably should have believed that the debtor would incur, debts beyond the debtor’s ability to pay as they became due.

Minn. Stat. § 513.44(a)(2).

The Supreme Court in its ruling noted that MUFTA does not contain a provision allowing a court to presume anything based on the mere existence of a Ponzi scheme. The word “Ponzi” does not appear in the statute and MUFTA does not address “schemes.” “Ponzi scheme” is not included in the list of badges of fraud. The asset-by-asset and transfer-by-transfer nature of the inquiry under 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. Fraudulent intent must be determined in light of the facts and circumstances of each case. Under the Finn ruling, creditors should be entitled to summary judgment when the transactions in dispute involve loans that are repaid in the normal course and for reasonably equivalent value.

In addition, the Supreme Court held that the statute of limitations (SOL) applicable to actual fraud claims under MUFTA, claims that existed under common law and were codified in the Act, is six years from the discovery of the fraud.

The factual background for the Finn decision began when Corey Johnston, operating through First United Funding LLC, sold loan participations to several area banks. Johnston’s operation included overselling participations and selling participations in loans that did not exist at all. When his scheme collapsed, Johnston and FUF were placed into receivership. The receiver sued many banks seeking to recover the interest the banks received related to their participations and, ultimately, the Supreme Court rejected the Ponzi scheme presumptions and set the six year from discovery statute of limitations. Johnston pleaded guilty to federal charges of bank fraud and filing a false tax return.