Fraudulent Conveyances – Ponzi Schemes

Fraudulent Conveyances – Ponzi Schemes

Boale Wood Ltd v Whitmore and Samji Notary 2017 BCSC 1917 involved a Fraudulent Conveyance action brought by a trustee in bankruptcy alleging a fraudulent conveyance.

A notary public was involved in a Ponzi scheme whereby $110 million was received into notary public account from investors and returned to investors using new investment funds. The fraud was discovered, the notary public was convicted of fraud and entered bankruptcy. The defendant was one of a few investors who received more money than he had given to the notary public The Trustee brought action against the defendant for disgorgement of excess received in operation of scheme.
The action was allowed as the disposition was void under the Fraudulent Conveyance Act. The Ponzi scheme was insolvent by nature and constituted fraud.

Ponzi Schemes

46 Canadian courts have described Ponzi schemes similarly. In Titan Investments Ltd. Partnership (Re), 2005 ABQB 637, Justice Hawco held:

[8] Ponzi schemes are fraudulent investment schemes whereby individuals are enticed by a conman or fraudster to make investments in an operation promising an unreasonably high rate of return. Once the first few investments are made, subsequent investors are enticed to invest partly through reported gains and partly through the high payouts of earlier investors. Ultimately, the conman either spends or disappears with the remaining money, or the scheme collapses on itself as funds are exhausted by payouts to earlier investors.

47 In Millard v. North George Capital Management Ltd. (2006), 26 B.L.R. (4th) 231 (Ont. S.C.J.), Justice Cumming, at para. 11, described a Ponzi scheme as:
[a fraud] whereby the source of distributions to the early investors consist primarily of a return of their own capital or moneys obtained from new investors and with the payment ultimately stopping when there are no further investors. The result is that everyone loses money except the perpetrators of the fraud. It is clear, and, indeed, conceded by the defendant that the Excess monies he received came from the investments made by the Investors.

The Fraudulent Conveyance Act (FCA)

48 The FCA provides, in its entirety, as follows:

1. If made to delay, hinder or defraud creditors and others of their just and lawful remedies
(a) a disposition of property, by writing or otherwise,
(b) a bond,
(c) a proceeding, or
(d) an order
is void and of no effect against a person or the person’s assignee or personal representative whose rights and obligations are or might be disturbed, hindered, delayed or defrauded, despite a pretence or other matter to the contrary.

2. This Act does not apply to a disposition of property for good consideration and in good faith lawfully transferred to a person who, at the time of the transfer, has no notice or knowledge of collusion or fraud.

49 In Titan Investments, Hawco J. acknowledged that there was no Canadian authority on the subject of when Ponzi schemes are deemed to be insolvent and adopted the American approach that a Ponzi scheme is insolvent from its inception. I agree with and adopt his reasoning.

50 An intention to defraud creditors may be inferred from that fact that a debtor is operating a Ponzi scheme, as no other reasonable inference is possible: Merrill v. Abbott (In Re Independent Clearing House Co.), 77 B.R. 843, 871 (D. Utah 1987). In that case, the United States District Court for the District of Utah stated, at p. 860 — 861:
One can infer an intent to defraud future [investors] 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 that the scheme will eventually collapse as a result of the inability to attract new investors. The perpetrator nevertheless makes payment to present investors, which, by definition, are meant to attract new investors. [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 . . .
. . . the question of intent to defraud is not debatable given the fact that the debtor was carrying on a Ponzi scheme . . .

51 Even apart from a Ponzi scheme, fraudulent intent to defeat creditors may be inferred from the circumstances surrounding the transaction where “badges” of fraud exist: Ocean Construction Supplies Ltd. v. Creative Prosperity Capital Corp., [1995] B.C.J. No. 1814 (S.C.) at paras. 25 — 28; Firstar Investment & Financial Co. v. Xu, 2017 BCSC 271at para. 39; Botham Holdings Ltd. (Trustee of) v. Braydon Investments Ltd., 2009 BCCA 521at para. 75.

52 The following badges of fraud in this case support the inference that Samji intended to defraud her creditors (the Investors):

a) the Scheme, by its very nature, was insolvent from the outset;
b) the Excess payments made to the defendant were sourced entirely from funds invested by others with the clear objective of defeating their respective investments; and
c) the inference is overwhelming and uncontroverted that Samji knew, or at the very least ought to have known, that each transfer to the defendant had the effect of further defrauding the Investors.

53 Plainly, the Excess constitutes a “disposition of property”. I find that it was paid by Samji with the intent to delay, hinder, or defraud her creditors.

54 However, that is not the end of the enquiry. Section 2 of the FCA stipulates that the Act does not apply to a disposition made for “good consideration and in good faith lawfully transferred to a person who, at the time of the transfer, has no notice or knowledge of” the fraud.
“Good consideration”

55 The courts have stated that, where the disposition was made for “good consideration”, the plaintiff must prove that both the transferor (Samji) and the transferee (the defendant) intended to delay, hinder, or defraud creditors: Chan v. Stanwood, 2002 BCCA 474at paras. 19 — 21.

56 Can it be said, in the context of a claim to recover “profits” paid to Net Winners in a Ponzi scheme, that there was good consideration for the disposition and that the transfer was made “lawfully” and in “good faith”?

57 The defendant submits that the Excess was received by him in the form of the payment of interest pursuant to a pre-existing, legitimate lending agreement and that it, therefore, constitutes “good consideration”. Accordingly, he says, the plaintiff’s claim must fail because there is no evidence of an intent on his part to delay, hinder, or defraud Samji’s creditors.

58 “Good consideration” under s. 2 of the FCA means “valuable consideration” or more than nominal consideration: Liu v. Wang, 2009 BCSC 1792at para. 24; Chan at para. 19.

59 The question of whether a net winner in a Ponzi scheme has provided good consideration for the profits has received only passing mention in Canada. However, United States jurisprudence has held that the perpetrator of a Ponzi scheme does not receive good consideration for payments made to investors in excess of their principal investment, because such payments are merely used to perpetrate and continue the fraud. They are not profits from a legitimate enterprise. One example is the decision of the United States Court of Appeals, Ninth Circuit, in Donell v. Kowell, 533 F. 3d 762 (9th Cir 2008) where the court stated, at p. 777 — 779:
Fifth, Kowell argues that even if [California’s Uniform Fraudulent Transfer Act “UFTA”] applies to this case, he should not be found liable because his initial investment provided “reasonable equivalent value” in exchange for the profits he earned in the scheme . . . Despite the intuitive appeal of Kowell’s argument, we reject it by considering the economic exchange in a Ponzi scheme.
UFTA identifies an avoidable transfer as one made “[w]ithout receiving a reasonably equivalent value in exchange.” . . . Unlike contract law, which requires only that “adequate” consideration be given, UFTA requires that, to escape avoidance, a transfer have been made for “reasonably equivalent value”. The purpose is not to identify binding agreements, but to identify transfers made with no rational purpose except to avoid creditors . . .

Payouts of “profits” made by Ponzi scheme operators are not payments of return on investment from an actual business venture. Rather, they are payments that deplete the assets of the scheme operator for the purpose of creating the appearance of a profitable business venture … The appearance of a profitable business venture is used to convince early investors to “roll over” their investment instead of withdrawing it, and to convince new investors that the promised returns are guaranteed . . . Up to the amount that “profit” payments return the innocent investor’s initial outlay, these payments are settlements against the defrauded investor’s restitution claim. Up to this amount, therefore, there is an exchange of “reasonably equivalent value” for the defrauded investor’s outlay. Amounts above this, however, are merely used to keep the fraud going by giving the false impression that the scheme is a profitable, legitimate business. These amounts are not a “reasonably equivalent” exchange for the defrauded investor’s initial outlay.

In this case, Kowell never actually possessed an interest in a company purchasing account receivables from Malaysian glove manufacturers. The investment strategy promised by Wallenbrock’s officers was a lie to induce Kowell and investors like him to fund Wallenbrock. What Wallenbrock did was return to Kowell his own money, plus money from subsequent “investors,” to persuade Kowell to continue to invest and to secure testimonial evidence from people like Kowell to induce others to invest. Although Kowell was putting real money into Wallenbrock, and was getting what looked like real profits in return, in fact he never received “reasonably equivalent value” for his investment, just cash that moved around in an elaborate shell game.
[Citations omitted.] [Emphasis added.]

Trevor Todd

Trevor Todd is one of the province’s most esteemed estate litigation lawyers. He has spent more than 40 years helping the disinherited contest wills and transfers – and win. From his Kerrisdale office, which looks more like an eclectic art gallery than a lawyer’s office, Trevor empowers claimants and restores dignity to families across BC. He is a mentor to young entrepreneurs and an art buff who supports starving artists the world over. He has an eye for talent and a heart for giving back.

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