Trustee Services FAQ’s
- What is a Ponzi Scheme?
- Why is it important to prove a Ponzi scheme in the bankruptcy avoidance context?
- What is the definition of “insolvent” in the bankruptcy context?
- How can a trustee use the UFTA as an avoidance tool?
- What is the correct date to use when measuring transfers for purposes of Chapter 5 avoidance actions?
A: There is no precise definition of a Ponzi scheme. Courts look for certain patterns and characteristics in determining whether an enterprise should be labeled a Ponzi scheme. Generally, a Ponzi scheme is an inherently fraudulent arrangement where after acquired investment funds must be used to pay off previous investors to forestall disclosure of a fraud. Key factors include: (1) new investors are required to keep the operations afloat; and (2) new monies are used to pay off old investors. In most cases an enterprise is a fraudulent Ponzi scheme from its inception, but even a formerly legitimate business can become a Ponzi scheme at the point where new investors are required to pay off old investors and keep the business in operation. Determining whether an enterprise is a Ponzi scheme or when an enterprise became a Ponzi scheme usually requires detailed investigation and analysis of someone trained in the area of forensic accounting.
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Q: Why is it important to prove a Ponzi scheme in the bankruptcy avoidance context?
A: Having a Court determination that a business is a Ponzi scheme is extremely helpful when it comes to a trustee exercising his avoidance powers. Court’s have found that a Ponzi scheme is insolvent from the date of its inception. Thus placing the burden of proof on the debtor or transferee to prove solvency. The finding of a Ponzi scheme, at least in some circumstances, widens the scope of recovery against a transferee for trustee seeking to avoid transfers from an operating Ponzi scheme.
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Q: What is the definition of “insolvent” in the bankruptcy context?
A: The Bankruptcy Code defines “insolvent” as the “financial condition such that the sum of such entity’s debts is greater than all of such entity’s property, at fair valuation …” 11 USC § 101(32)(A). This is a code specific (Bankruptcy Code) definition and may not be consistent with other theories or definitions of insolvency. This definition requires a specific “fair market” valuation of the subject’s property. Historical, book, GAAP, or tax values (the traditional methods of valuation) are not appropriate when attempting to prove insolvency in a bankruptcy context.
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Q: How can a trustee use the UFTA as an avoidance tool?
A: Along with the specific avoidance powers given a trustee in sections 547, 548, and 549 of the Bankruptcy Code, the trustee also has the ability to bring avoidance causes of action based on state and other federal statutory and common law. Section 544(b) of the Bankruptcy Code allows the trustee to succeed to the rights of an unsecured creditor and initiate avoidance actions under the laws that aid an unsecured creditor in avoiding transfers made by a debtor. The most common tool employed by a trust under this section is the state’s Uniform Fraudulent Transfer Act (UFTA).” This usually extends a trustee’s look back period from two years to four years.
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Q: What is the correct date to use when measuring transfers for purposes of Chapter 5 avoidance actions?
A: In bankruptcy, a trustee is empowered to avoid, or reclaim for the benefit of the estate, certain transfers of Debtor’s property that occurred within certain statutory time frames. Therefore, it becomes very important to understand and calculate correctly the transfers that fall within the timeframe of the trustee’s avoidance powers. Particularly vexing may be the determination of the time of transfer for checks and other transfers from independent third party holders. Courts have determined that the transfer date for items such as checks, wire transfers, etc. is the date the transaction cleared the bank or brokerage house, not the date the debtor wrote the check, deposited the check in the mail, manually delivered the check to the transferee or requested the transfer. Understanding the actual date of transfer is an invaluable tool in prosecuting avoidance actions.
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