No. 10-10683-BB UNITED STATES COURT OF APPEALSFOR THE ELEVENTH CIRCUITWILLIAMS F.PERKINS,PLAN TRUSTEE FOR INTERNATIONAL MANAGEMENT ASSOCIATES,LLC Plaintiff-Appellant, v.ANEA Y.HAINES, ET AL. Defendants-Appellees. On Appeal from the United States Bankruptcy Court for the Northern District ofGeorgia, No. 06-62966-PWB (The Honorable Paul W. Bonapfel, District Judge) BRIEF OF DEFENDANTS -APPELLEES GEORGE R.CURTIS,SR.LIVING TRUST,GEORGE R.CURTIS,SR.,BETTY CURTIS,DAVID LAIRD FAMILY TRUST,DAVID LAIRD,DEBORAH H.LAIRD,KEITH O.BURKS,JAMES H.SHELTON,JAMES SHELTON,III,CORNELL SHELTON,TBCCAPITAL INC.,X-SPURTS INVESTMENT CLUB OF ATLANTA,LLC,JOHN L.CARTER,DEXTER M.PAGE,WILLIAM L.HUTCHINSON,JR.,RICARDO A.ARZU,PHILLIP E.HADLEY,ERICH G.RANDOLPH,LAVERNE HAMILTON-JONES,MARTIN D.JEFFRIES ,MARCO D.COLEMAN,DAVID WISNESKI,MICHELE F.WISNESKI ,LAWRENCE HOOPER,GREGORY HOOPER,ATLANTA PERINATAL ASSOCIATES,P.C., SYRETHA ANDREWS,ALICIA DORSEY,CAROL GRONE,BRADFORD BOOTSTAYLOR,WILLIE J.CLAY,RAYSHAWN F.CLAY,CARTOPIA,LLC,DECKO QUALITY SERVICES ,LLC,CLAY REAL ESTATE HOLDINGS ,INC.,ANNETTE K.BOND,MT.NEBO BAPTIST LIFE CENTER,INC. AND VALERIE PEOPLESTIMOTHY W.MUNGOVANNIXON PEABODY LLP 100SUMMER STREETBOSTON,MASSACHUSETTS 02110 PH.617-345-1000;FAX 617-345-1300 FOR GEORGE RUSSELL CURTIS,SR.LIVINGTRUST ,GEORGE RUSSELL CURTIS,SR.,BETTYCURTIS,DAVID LAIRD FAMILY TRUST,DAVID LAIRD, AND DEBORAH H.LAIRDJuly 1, 2010 Case: 10-10683 Date Filed: 07/01/2010 Page: 1 of 74 www.floridalegalblog.org
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WILLIAMS F. PERKINS, PLAN TRUSTEE FOR INTERNATIONAL MANAGEMENT
ASSOCIATES, LLCPlaintiff-Appellant,
v.
ANEA Y. HAINES, ET AL.
Defendants-Appellees.
_______________________
On Appeal from the United States Bankruptcy Court for the Northern District of Georgia, No. 06-62966-PWB (The Honorable Paul W. Bonapfel, District Judge)
_______________________
BRIEF OF DEFENDANTS-APPELLEES GEORGE R. CURTIS, SR. LIVING TRUST, GEORGE R. CURTIS, SR., BETTY CURTIS, DAVID LAIRD FAMILY TRUST, DAVID
LAIRD, DEBORAH H. LAIRD, KEITH O. BURKS, JAMES H. SHELTON, JAMESSHELTON, III, CORNELL SHELTON,TBC CAPITAL INC., X-SPURTS INVESTMENT
CLUB OF ATLANTA, LLC, JOHN L. CARTER, DEXTER M. PAGE, WILLIAM L.
HUTCHINSON, JR., RICARDO A. ARZU, PHILLIP E. HADLEY, ERICH G. RANDOLPH, LAVERNE HAMILTON-JONES, MARTIN D. JEFFRIES, MARCO D. COLEMAN, DAVID WISNESKI, MICHELE F. WISNESKI, LAWRENCE HOOPER,
GREGORY HOOPER, ATLANTA PERINATAL ASSOCIATES, P.C., SYRETHAANDREWS, ALICIA DORSEY, CAROL GRONE, BRADFORD BOOTSTAYLOR, WILLIE
J. CLAY, RAYSHAWN F. CLAY, CARTOPIA, LLC, DECKO QUALITY SERVICES, LLC, CLAY REAL ESTATE HOLDINGS, INC., ANNETTE K. BOND, MT. NEBO
BAPTIST LIFE CENTER, INC. AND VALERIE PEOPLES _______________________
TIMOTHY W. MUNGOVAN
NIXON PEABODY LLP100 SUMMER STREET BOSTON, MASSACHUSETTS 02110PH. 617-345-1000; FAX 617-345-1300FOR GEORGE RUSSELL CURTIS, SR. LIVING TRUST , GEORGE RUSSELL CURTIS, SR., BETTY CURTIS, DAVID LAIRD FAMILY TRUST, DAVIDLAIRD, AND DEBORAH H. LAIRD July 1, 2010
Case: 10-10683 Date Filed: 07/01/2010 Page: 1 of 74
100169)MARK A. KELLEY (GA. BAR # 412325)KITCHENS KELLEY GAYNES, PCELEVEN PIEDMONT CENTER, SUITE 9003495 PIEDMONT ROAD, N.E.ATLANTA, GA 30305404.237.4100
ATTORNEYS FOR DEFENDANT –
APPELLEE MARTIN D. JEFFRIES
SHARON M. LEWONSKI (GA. BAR #
451818)EPSTEIN BECKER & GREEN, P.C.945 EAST PACES FERRY RD., SUITE 2700ATLANTA, GA 30326-13805404.923.9000
ATTORNEYS FOR DEFENDANT – APPELLEE
MARCO D. COLEMAN
CHRISTOPHER D. PHILLIPS (GA. BAR #
575913)LAMBERTH, CIFELLI, STOKES,ELLIS & NASON, P.A.3343 PEACHTREE ROAD, N.E.EAST TOWER, SUITE 550ATLANTA, GA 30326-1022
ATTORNEYS FOR DEFENDANTS –
APPELLEES DAVID WISNESKI AND
MICHELE FRANCINE WISNESKI
SBLEND A. SBLENDORIO (CA. BAR #
109903)
CATOSHA L. WOODS (CA. BAR # 228640)
HOGE, FENTON, JONES & APPEL, INC.4309 HACIENDA DRIVE, SUITE 350PLEASANTON, CA 94588TELEPHONE: 925.460.3365
ATTORNEYS FOR DEFENDANTS –
APPELLEES LAWRENCE HOOPER AND
GREGORY HOOPER
ADMITTED P RO H AC V ICE
WILLIAM R. LESTER (GA. BAR #
447725)SEGAL, FRYER, SHUSTER &
LESTER, P.C.1050 CROWN POINTE PKWY., SUITE 410ATLANTA, GA 3033877.668.9300
ATTORNEYS FOR DEFENDANTS –
APPELLEES ATLANTA PERINATAL
ASSOCIATES, P.C., SYRETHA
ANDREWS, ALICIA DORSEY, CAROL
GRONE, DEXTER M. PAGE AND
BRADFORD BOOTSTAYLOR
PAUL M. SPIZZIRRI (GA. BAR # 672752)SPIZZIRRI LAW OFFICESMIDTOWN PROSCENIUM CENTER, 1170 PEACHTREE STREET N.E., SUITE 1200ATLANTA, GA 30309800.714.7471
ATTORNEYS FOR DEFENDANTS –
APPELLEES WILLIE J. CLAY, RAYSHAWN
FRANCIS CLAY, CARTOPIA, LLC, DECKO
QUALITY SERVICES, LLC, AND CLAY
REAL ESTATE HOLDINGS, INC.
Case: 10-10683 Date Filed: 07/01/2010 Page: 3 of 74
TABLE OF CONTENTS........................................................................................... i
TABLE OF CITATIONS.........................................................................................iii
I. STATEMENT OF THE ISSUES ................................................................... 1
II. STATEMENT OF THE CASE ...................................................................... 1
A. PROCEDURAL HISTORY.......................................................................... 1
B. STATEMENT OF THE FACTS.................................................................... 5
C. STANDARD OF REVIEW .......................................................................... 7
III. SUMMARY OF THE ARGUMENT ............................................................. 7
IV. ARGUMENT.................................................................................................. 9
A. AS VICTIMS OF A PONZI SCHEME, THE DEFRAUDED INVESTORS GAVE
“VALUE” WHEN THEY REDEEMED SOME OR ALL OF THEIR INVESTED
PRINCIPAL ACCORDING TO THE “GENERAL RULE.” ................................. 9
1. Under the “general rule,” the Defrauded Investors held a claimfor rescission immediately upon making their investment in the
fraudulent scheme and, when the Defrauded Investors redeemedsome or all of their principal, their rescission claim was reducedby each dollar of principal redeemed......................................... 9
2. The “general rule” is consistent with well settled concepts usedto evaluate whether a transferee gave value............................. 12
3. The definitions of “value”, “claim” and “debt” set forth in theBankruptcy Code and applicable state statutes support the“general rule.” .......................................................................... 15
B. THE DISTINCTION BETWEEN “DEBT” AND “EQUITY” IS IRRELEVANT TO
THE “FOR VALUE” ANALYSIS IN THE CONTEXT OF A PONZI SCHEME. .... 19
1. As the Bankruptcy Court found, “[t]he case law does not makethe distinction the Trustee proposes.”...................................... 19
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2. The Trustee’s distinction based on the form of the DefraudedInvestors’ investment is based on a fundamentalmisunderstanding of Eby.......................................................... 25
3. Terry Manufacturing is inapposite to the facts before this Court................................................................................................... 34
C. THE TRUSTEE’S “POLICY” ARGUMENTS CANNOT OVERCOME HIS CLASH
WITH WELL-SETTLED LAW. .................................................................. 36
1. The Bankruptcy Court’s ruling is premised on bedrock bankruptcy principles of claim priority and equal treatment of similarly situated claimants...................................................... 36
2. The Trustee relies on inapplicable portions of the BankruptcyCode to support his contrived argument. ................................. 37
D. THE TRUSTEE’S PROPOSED MODE OF “REDISTRIBUTION” IS NO FAIRER
THAN THAT IMPOSED BY THE “GENERAL RULE.” .................................. 38
E. THE TRUSTEE’S ARGUMENT IS PRECLUDED BY THE DOCTRINES OF RES
JUDICATA AND ESTOPPEL. ..................................................................... 41
1. The Trustee is barred by the doctrine of res judicata fromclaiming that the Defrauded Investors are not debt-holders. ... 43
2. The Trustee is also barred by the doctrine of estoppel fromclaiming that the Defrauded Investors are not debt-holders. ... 45
V. CONCLUSION............................................................................................. 47
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Atlanta Retail, Inc. v. Eastman Kodak Co. (In re Atlanta Retail, Inc.),294 B.R. 186 (Bankr. N.D. Ga. 2003) ............................................................... 46
Battle v. Liberty Mut. Fire Ins. Co.,623 S.E.2d 541 (Ga. Ct. App. 2005).................................................................. 46
Camp v. Carithers,65 S.E. 583 (Ga. Ct. App. 1909)........................................................................ 11
Daniel v. Dalton News Co.,172 S.E. 727 (Ga. Ct. App. 1934)...................................................................... 11
Dicello v. Jenkins (In re International Loan Network, Inc.),160 B.R. 1 (Bankr. D.C. 1993) .......................................................................... 10
Donell v. Kowell,533 F.3d 762 (9th Cir. 2008) ...................................................................... passim
Hildebrandt v. Ill. Dep't of Natural Res.,347 F.3d 1014 (7th Cir. 2003) ........................................................................... 41
Hovis v. General Dynamics Corp. (In re Hovis),396 B.R. 895 (D.S.C. 2007)............................................................................... 45
In re Chase & Sanborn Corp.,904 F.2d 588 (11th Cir. 1990) ........................................................................... 16
In re Hedged-Investments Associates, Inc.,84 F.3d 1286 (10th Cir. 1996) ............................................................... 31, 32, 33
In re Terry Mfg Co., Inc.,2007 WL 274319 (M.D. Ala 2007) ............................................................. 34, 35
In re USinternetworking, Inc.,310 B.R. 274 (Bankr. D. Md. 2004) .................................................................. 45
In re Young,294 F. 1 (4th Cir. 1923)...................................................................................... 27
Jobin v. Cervenka (In re M&L Bus. Mach. Co.),194 B.R. 496 (D. Colo. 1996)............................................................................ 10
Jobin v. McKay (In re M&L Bus. Mach. Co.),84 F.3d 1330 (10th Cir. 1996) ............................................................... 10, 17, 20
Johnson v. Studholme,
619 F.Supp. 1347 (D. Colo. 1985)......................................................... 31, 32, 41
Kingsley v. Wetzel (In re Kingsley),518 F.3d 874 (11th Cir. 2008) ............................................................................. 7
Kovacs v. Hanson (In re Hanson),373 B.R. 522 (N.D. Ohio 2007)......................................................................... 13
Levine v. Custom Carpet Shop, Inc. (In re Flooring Am., Inc.),302 B.R. 394 (Bankr. N.D. Ga. 2003) ............................................................... 17
Lisle v. John Wiley & Sons, Inc. (In re Wilkinson),196 Fed. Appx. 337 (6th Cir. 2006)................................................................... 13
Case: 10-10683 Date Filed: 07/01/2010 Page: 20 of 74
Mazzeo v. United States (in Re Mazzeo),131 F.3d 295 (2d Cir. 1997)......................................................................... 17, 18
Merrill v. Abbott (In re Independent Clearing House, Inc.),77 B.R. 843 (D. Utah 1987)................................................................... 10, 17, 20
Midwest Holding # 7, LLC v. Anderson (In re Tanner Family, LLC),556 F.3d 1194 (11th Cir. 2009) ......................................................................... 16
Official Comm. of Asbestos Pers. Injury Claimants v. Sealed Air
Corporation (In re W.R. Grace & Co.),281 B.R. 852 (Bankr. D. Del. 2002) .................................................................. 14
Rosenberg v. Collins,624 F.2d 659 (5th Cir. 1980) ............................................................................. 10
Scholes v. African Enter., Inc.,
854 F. Supp. 1315 (N.D. Ill. 1994) .............................................................. 10, 31
Scholes v. Ames,
850 F.Supp. 707 (N.D. Ill. 1994)....................................................................... 31
Southmark Corp. v. Trotter, Smith & Jacobs,442 S.E.2d 265 (Ga. Ct. App. 1994).................................................................. 45
Wootton v. Barge (In re Cohen),875 F.2d 508 (5th Cir 1989)................................................................................ 42
Wyle v. C.H. Rider & Family (In re United Energy Corp.),944 F.2d 589 (9th Cir 1991) ....................................................................... passim
Whether, as a matter of law, defrauded investor defendants who each made
an investment in a debtor entity, which at all relevant times was operated as a
Ponzi scheme, and thereafter received redemptions of their principal investment
received such redemptions “for value” as required to establish a defense to
fraudulent transfer claims under 11 U.S.C. § 548(c) and O.C.G.A. § 18-2-78(a) or
similar state laws.
II. STATEMENT OF THE CASE
A. PROCEDURAL HISTORY
On March 16, 2006 (the “Petition Date”), the substantively-consolidated
debtors (the “Debtors”) each filed voluntary petitions for relief under Chapter 11 of
Title 11 of the United States Code (the “Bankruptcy Code”). On March 27, 2006,
the United States Trustee appointed a committee of investors pursuant to 11 U.S.C.
§ 1102(a) (the “Committee”). On April 20, 2006, the United States Trustee
appointed William F. Perkins (the “Trustee”) as Chapter 11 trustee of the Debtors.
The Defendants-Appellees set forth on Exhibit A hereto are each defrauded
investor defendants (the “Defrauded Investors”)1 in certain adversary proceedings
1 In an effort to streamline the appeal process, and to minimize the burden onthe Court, the Defrauded Investors have agreed to prepare and file a unifiedbrief in response to the Trustee’s Principal Brief. Because the argumentsadvanced in this Brief are common to all Defendants-Appellees – not just the
(Footnote continued on next page)
Case: 10-10683 Date Filed: 07/01/2010 Page: 23 of 74
person who took in good faith and for a reasonably equivalent value.” O.C.G.A. §
18-2-78.
Pursuant to Rule 7056 of the Federal Rules of Bankruptcy Procedure, the
Trustee filed a motion (the “Motion for Partial Summary Judgment”) seeking an
order by the Bankruptcy Court that, as a matter of law, the Defrauded Investors
cannot establish the “for value” element of their affirmative defense on grounds
that redemptions of principal received by the Defrauded Investors were not
transfers of “value.” Doc. 4. For purposes of considering the Trustee’s Motion for
Partial Summary Judgment, the Bankruptcy Court consolidated the Avoidance
Actions into a single Miscellaneous Proceeding.2 Doc. 1. On December 1, 2009,
the Bankruptcy Court entered an Order (the “Order”) denying the Trustee’s Motion
for Partial Summary Judgment. Doc. 38.
In its Order, the Bankruptcy Court recognized the “general rule” in the
context of a Ponzi scheme which “is that a defrauded investor receives ‘value’ to
the extent of the principal amount of its investment but not with regard to any
payments in excess of principal.”3 Doc. 38 at p. 6. The Bankruptcy Court rejected
2 Miscellaneous Proceeding No. 09-MP-601, United States Bankruptcy Courtfor the Northern District of Georgia.
3 The Bankruptcy Court limited its focus to the issue of avoidance and recoveryof principal contributions by the Defrauded Investors and did not address the
(Footnote continued on next page)
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fraudulently induced into unknowingly participating in the fictitious scheme.” Id .
at pp. 12-13.
Concurrent with the issuance of its Order, the Bankruptcy Court certified the
legal question presented for immediate review by this Court. Doc. 39. The
Trustee then filed a Petition for Leave to Appeal from the Bankruptcy Court’s
Order, which this Court granted by order dated February 17, 2010. The Trustee
filed his Principal Brief with this Court on April 23, 2010. The Defrauded
Investors now jointly submit this Responsive Brief.
B. STATEMENT OF THE FACTS
In order to address the legal issue before it, the Bankruptcy Court assumed,
for purposes of the Trustee’s Motion for Partial Summary Judgment only, the
Trustee established his prima facie case for the recovery of fraudulent transfers
from the Defrauded Investors.4 Doc. 38 at p. 8. As set forth in the Bankruptcy
Court’s Order and Certification of Direct Appeal, for the purposes of this appeal
the following facts are assumed: (i) Kirk Wright formed the Debtors purportedly to
manage and operate as hedge funds, each of which was structured either as a
4 The Bankruptcy Court’s assumption of these facts, however, did “not
constitute a determination of any of the assumed facts.” Doc. 38 at p. 8.Therefore, even if the Trustee prevails he must still “establish the existence of a Ponzi scheme and, for each [Defrauded Investor], the factual and legal basesfor a determination that each transfer in question is recoverable as a fraudulenttransfer.” Id . at pp. 8-9.
Case: 10-10683 Date Filed: 07/01/2010 Page: 27 of 74
(11th Cir. 1990) (“It is established that ‘debt’ is to be given a broad and expansive
reading for purposes of the Bankruptcy Code”).
This “co-extensive” use of the terms “debt” and “claim” has caused courts to
conclude that a defrauded investor’s claim for rescission constitutes a “debt.”
For example, in In re Independent Clearing House Co., the Court held that:
From the time [an investor] entrusted his money to the debtors, he hada claim against the debtors for the return of his money. We believethat the Code’s definition of ‘debt’ and its related terms is broad
enough to cover the debtors’ obligation to return a defendant’s
principal undertaking, whether that obligation was based on the contract between the debtors and [the investor] or was based on [the
investor’s] right to restitution.
In re Independent Clearing House Co., 77 B.R. at 857 (emphasis supplied); see
also In re M&L Bus. Mach. Co., 84 F.3d at 1340-41; In re United Energy Corp.,
944 F.2d at 595-96 (“The Code does not require that a ‘debt’ be a contractual
liability. Instead, ‘debt’ is defined as a liability on a ‘right to payment, whether or
not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent,
matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured. .
. .’”) (emphasis supplied); accord Mazzeo v. United States (in Re Mazzeo), 131
F.3d 295, 302 (2d Cir. 1997) ("[T]he term 'debt' is sufficiently broad to cover any
possible obligation to make payment.") (emphasis supplied; quotation marks and
citation omitted); Levine v. Custom Carpet Shop, Inc. (In re Flooring Am., Inc.),
302 B.R. 394, 400 (Bankr. N.D. Ga. 2003).
Case: 10-10683 Date Filed: 07/01/2010 Page: 39 of 74
into “debt” because the definition of “claim” is co-extensive with the definition of
“debt.” Under the Bankruptcy Code, they are already one and the same.
B. THE DISTINCTION BETWEEN “DEBT” AND “EQUITY” IS IRRELEVANT
TO THE “FOR VALUE” ANALYSIS IN THE CONTEXT OF A PONZI
SCHEME.
Faced with a “general rule” expressly counter to his position, the Trustee has
labored to present a distinction between this case and the litany of cases reciting
and endorsing the “general rule” based on the form of the Defrauded Investors’
initial investment. This distinction is irrelevant for at least three reasons.
1. As the Bankruptcy Court found, “[t]he case law does not
make the distinction the Trustee proposes.”
The Bankruptcy Court correctly found that “[t]he case law does not make
the distinction the Trustee proposes” concerning “debt” versus “equity” in a Ponzi
scheme context. Doc. 38 at p. 10. Courts have routinely found that a fraudulent
inducement claim lies for each defrauded defendant in an avoidance action,
regardless of whether the investor was induced to invest in a debt instrument or an
equity instrument. For example, in In re Independent Clearing House Co., the
Court held that:
If there was not a valid contract between the debtors and [an investor],before the transfer [the investor] would have had a claim forrestitution, to prevent the debtors’ unjust enrichment. See Restatementof Restitution § 1 (1936). If there was a valid contract that gave the
[investor] an equity interest in the debtors’ business, as the trusteecontends, the [investor] would still have had a right to restitution if
Case: 10-10683 Date Filed: 07/01/2010 Page: 41 of 74
Similarly, the Trustee cites Donell as another example of investors who held
“antecedent debt claims,” rather than equity interests, in a limited liability
company or limited partnership. PBr. at 24-25. The Ninth Circuit, however, never
made such a distinction in its opinion. To the contrary, the Donell Court broadly
stated:
Where causes of action are brought under UFTA againstPonzi scheme investors, the general rule is that to theextent innocent investors have received payments inexcess of the amounts of principal that they originally
invested, those payments are avoidable as fraudulenttransfers[.]
Donell, 533 F.3d at 770. And where innocent investors receive payments that are
less than their respective investments in the fraudulent enterprise, the Ninth Circuit
held that payments are not avoidable, without any characterization of such
payments as dividends, debt service, redemptions, or otherwise:
If the net [of deposits vs. withdrawals] is negative, thegood faith investor is not liable because paymentsreceived in amounts less than the initial investment,being payments against the good faith losing investor’sas-yet unsatisfied restitution claim against the Ponzischeme perpetrator, are not avoidable within the meaningof UFTA.
Id. at 771 (internal citations omitted).8
8 The Ninth Circuit further explains: “Payments of amounts up to the value of the initial investment are not, however, considered a ‘return of principal,’
(Footnote continued on next page)
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Two other Ninth Circuit decisions demonstrate that the critical test for
“value” in a fraud case is not “was it debt or equity?” but rather “was there fraud
and, if so, did the fraud exist at the time of the initial investment?” In In re United
Energy Corp., the Ninth Circuit reasoned that because the investors were duped
into the initial investment, they had acquired a claim for rescission and restitution
at the time they invested. In re United Energy, 944 F.2d at 596 (“[The investors]
clearly had claims for rescission and restitution which arose when they
[invested]”). The United Energy Court explicitly held that the investors’ claims for
rescission and restitution existed at the time of investment “regardless of whether
there existed a contractual right to the return of principal” because the Code does
not require recovery on “a contractual liability” for an exchange of “value.” Id . at
595.
Relying on In re United Energy Corp., the trustee in In re AFI Holdings
sued a limited partner to avoid a fraudulent transfer. See 525 F.3d 700 (9th Cir
2008). The partner argued that he was entitled to keep the funds transferred to him
(Footnote continued from previous page)
because the initial payment is not considered a true investment.” Donnell, 533
F.3d. at 772. Any amounts returned to the investor up to the amount of his orher investment “are considered to be exchanged for ‘reasonably equivalentvalue,’ and thus not fraudulent, because they proportionally reduce theinvestors’ rights of restitution.” Id. (citing In re United Energy Corp., 944F.2d at 595).
Case: 10-10683 Date Filed: 07/01/2010 Page: 44 of 74
of fictitious interest that a defrauded investor receives from a Ponzi scheme
operator is irrelevant to determining whether that investor is entitled to assert a
restitution claim up to the amount of its initial investment.
As demonstrated by In re AFI Holdings, the Ninth Circuit’s most recent
pronouncement on this issue, and In re United Energy Corp., the critical inquiry is
whether Ponzi scheme investors were duped into their initial investment and
acquired a right for rescission and restitution concurrent with their investment. Id.
at 708-709; In re United Energy Corp., 944 F.2d at 596, n. 7. The Trustee attempts
to diminish In re AFI Holding by claiming that it “blithely” applied the “general
rule” and “failed to conduct any reasoned analysis” regarding the Trustee’s
contrived distinction based on the form (i.e., equity or debt) of the subject initial
investment. PBr. at pp. 39-40. This conclusory assertion adds nothing to the
discussion, and is essentially identical to the position that the trustee advanced in
In re AFI Holding. The Ninth Circuit rejected that position, stating:
The Trustee argues that the parties did not expresslyexchange the restitution claim for the $89,824.17, andinstead, AFI transferred the money on account of [thedefrauded investor’s] partnership interest. Althoughcircumstances of the exchange were cloaked in terms of a
partnership interest, we delve beyond the ‘form’ to the‘substance’ of the transaction. See United Energy, 944F.2d at 596.
As noted above, the record demonstrates that Eisenberg’soperation was a Ponzi scheme before [the investor]provided his principal ‘investment,’ and thus well before
Case: 10-10683 Date Filed: 07/01/2010 Page: 46 of 74
the transfers were made from AFI to [the investor].Because of this, [the investor] acquired a restitution claimat the time he bought into Eisenberg’s Ponzi scheme, justas the investors in United Energy acquired a restitutionclaim at the time they bought their solar modules. Id. at
596. It is this restitution claim, in toto, that [the investor]exchanged when AFI returned [the investor’s] principal‘investment’ amount.
AFI Holdings, 525 F. 3d at 708. Consistent with the Ninth Circuit’s reasoning, the
Bankruptcy Court held that “[t]he substance, not the form, of the transaction
properly governs the reallocation of assets in the aftermath of the collapse of [a]
Ponzi scheme.” Doc. 38 at p. 12.
2. The Trustee’s distinction based on the form of the
Defrauded Investors’ investment is based on a fundamental
misunderstanding of Eby.
The holding in Eby is straightforward: that a rescission claim based on
fraudulent inducement arises at the time of a defrauded investor’s initial
investment. Eby, 1 F.2d at 973. This holding directly supports the Defrauded
Investors’ position that the Debtors’ fraud gave rise to a claim for rescission equal
to the amount of their invested capital at the time of the investment and that the
subsequent exchange of such rescission claims upon redeeming their investment
constitutes giving “value” under Section 548(c). The Trustee spends a significant
portion of his brief attempting to “distinguish” the facts in Eby and its progeny
from the present case, and then arguing that those court’s following Eby
“misinterpreted” the decision. The Trustee is wrong.
Case: 10-10683 Date Filed: 07/01/2010 Page: 47 of 74
net profits produced to the customer.”9 Id . at 972. The enterprise made monthly
settlements to each investor and each investor maintained “the right to withdraw all
or any part of his account upon 30 days' written notice.”10 Id .
Young regularly distributed referral “commissions” and “profits” to his
customers despite the enterprise’s substantial actual losses. In re Young, 294 F. 1,
1 (4th Cir. 1923).11 These distributions were “taken from the principal sums
deposited by his customers” in furtherance of Young’s Ponzi scheme. Id . Mr.
Ashley was one such customer. Eby, 1 F.2d at 972. Ashley made payments to
Young totaling $3,000 and received distributions totaling $4,576.68 (his entire
principal investment and $1,576.68 in so-called “profits”). Id . It was the order of
Young’s payments to Ashley, however, which required to Eby Court to issue its
key holding. Ashley received distributions of $1,576.68 in “profit” prior to his
written request for redemption of his principal investment. Id . Subsequently,
9 Under the exemplar documents relied upon by the Trustee here, the Debtorswere similarly entitled to retain a portion of “profits” as an “incentiveallocation,” while the Debtors’ manager collected “management fees” and“performance fees.” See e.g. Doc. 6-3 at pp. 5-6; Doc. 6-4 at p. 15.
10 Here, the Debtors also allowed investors to withdraw all or part of theirinvestments upon 30 days’ written notice to the Debtors. See e.g. Doc. 6-8 at
p. 44; Doc 6-7 at p. 18.11 In re Young is a companion case to Eby, which determined the relative rightsof defrauded investors to distributions from the residual estate, holding thatdistribution to defrauded investors was to be in proportion to their principalinvestment net of any profits they received. See In re Young, 294 F. 1 at 4.
Case: 10-10683 Date Filed: 07/01/2010 Page: 49 of 74
Ashley received a lump sum payment of his $3,000 principal pursuant to his
written request. Id .
The trustee in bankruptcy sued Ashley to recover all of the payments made
to him through three separate claims:
(1) For the recovery of the payment of $3,000, as apreference within four months of bankruptcy; (2) for therecovery, as a preference within four months, of $1,423.32, the difference between $3,000, the sum paidto Young by Ashley and $1,576.68, the amount paid toAshley by Young under the form of "profits"; (3) for the
recovery of the sum of $1,576.68 paid by Young toAshley as profits, on the allegation that it was paid byYoung to Ashley without consideration as a gratuity, andin fraud of the rights of Young's creditors.
Id . The Eby Court addressed each of the trustee’s claims independently. With
regard to the claim “(3),” the trustee’s claim for recovery of the initial $1,576.68
received by Ashley, the Eby Court determined that this amount “should not be
returned as a preference” because “Ashley had no reason to suppose Young to be
insolvent” at the time. Id . at 973.
The Eby Court then addressed the intuitive notion of simply disposing of
these initial payments of “profit,” where there was no actual profit to be had, as a
fraud upon “the rights of Young’s creditors” (i.e., a fraudulent transfer). Id . at 972-
73. The Eby Court dismissed this notion, holding that, at the time Young paid
$1,576.68 to Ashley, Young owed Ashley $3,000 “which Ashley had a right to
recover from him from the moment that he was deceived into paying it.” Id . at
Case: 10-10683 Date Filed: 07/01/2010 Page: 50 of 74
973 (emphasis supplied). Thus, at the time of that payment “Ashley received the
money in good faith” and “Young’s debt of $3,000 to Ashley was reduced” by the
amount of $1,576.68.12 Id .
Despite the Trustee’s belabored arguments to the contrary, this holding is
anything but “surplusage.” The Eby Court addressed each of the trustee’s claims
independently, including his claim that Ashley’s initial redemption of principal
was “in fraud of the rights of Young’s creditors.” Id . at 972-73. The Eby Court
held this redemption was not “in fraud” on grounds that Ashley maintained a
countervailing rescission claim “ from the moment that he was deceived ” into
investing. Id . at 973. The Eby Court engaged in a separate analysis of Ashley’s
redemption pursuant to his request for return of $3,000 in “principal” and
irrespective of whether that later transfer was made pursuant to an equity or debt
interest. Therefore, Eby’s holding is quite simple and precisely on point – in the
aftermath of a Ponzi scheme defrauded investors have claims for rescission or
12 Based on the same concept, the Eby Court affirmed a jury verdict in favor of Ashley with regard to the trustees’ claim “(2),” allowing him to retain the
remaining $1,423.32 Young later paid to him (as part of a lump $3,000payment). Eby, 1 F.2d at 973. As to claim “(1),” the Eby Court upheld a juryverdict in favor of the trustee, in part, for recovery of the $1,576.68 Youngpaid to Ashley (as part of a lump $3,000 payment) on grounds that it waswithout consideration and “therefore a fraud on Young’s creditors.” Id .
Case: 10-10683 Date Filed: 07/01/2010 Page: 51 of 74
restitution, which arise at the time of their initial investment, and, therefore, they
have given due consideration for any redemptions of principal. See id .
Nothing in the decision supports the claim that investors held a “debt-
based”13 investment claim against Young (as distinct from a debt-based restitution
claim) or that the investors’ principal was not at risk. There is also nothing in the
decision that would support the view that the Eby Court based its holding on a
finding or belief that the investors held debt interests, as opposed to equity
interests, in the debtor. Because there is no basis on which to conclude that the
investors in Eby held debt interests or that Eby’s holding is in any way
“surplusage,” the Trustee’s tortured “claims2” construct collapses.
As with his treatment of Eby, the Trustee attempts in vain to distinguish the
cases that similarly protect distributions of principal to “equity holders” from
avoidance actions in the aftermath of a Ponzi scheme. PBr. at pp. 36-57. The
Defrauded Investors have already discussed above the relevance of AFI Holding
and other Eby progeny and the Trustee’s flawed efforts to distinguish them. The
13 The Trustee mischaracterizes the Eby Court’s reference to “debt.” PBr. at p.19. Rather than using the word “debt” to describe the nature of Ashley’s initial
investment in the fraudulent enterprise, the Eby Court simply characterizesAshley’s rescission claim, arising at the very moment he was deceived intoinvesting, as a “debt” Young owed to him. Eby, 1 F.2d at 973. The Trusteetakes the Eby Court’s reference to “debt” out of context in an effort to give itdeeper meaning.
Case: 10-10683 Date Filed: 07/01/2010 Page: 52 of 74
Trustee also briefly addresses, but fails to diminish, two other cases - Scholes and
In re Hedged-Investments Associates, Inc. PBr. at pp. 36-37.
The first of these two cases, Scholes v. Ames, 850 F.Supp. 707 (N.D. Ill.
1994), involves an equity receiver operating under Illinois law, as opposed to a
bankruptcy trustee. There, the equity receiver sued two investors who purchased
limited partnership interests in what turned out to be a fraudulent Ponzi scheme.
Id. at 709. The equity receiver only sought to recover fictitious profits from those
investors, based on fraudulent conveyance, unjust enrichment, and constructive
trust claims under Illinois law. Id. at 710. The district court in Scholes did not
even discuss, let alone reject, the proposition that the defrauded investors had
claims for rescission and restitution under applicable non-bankruptcy law. It
would appear those claims were unnecessary in Scholes because the equity receiver
never tried to recover the principal sums invested, unlike the Trustee here. The
equity receiver focused solely on the fictitious profits.14
14 The district court in Scholes relied, in part, on another equity receiver case, Johnson v. Studholme, 619 F.Supp. 1347 (D. Colo. 1985). See Scholes, 850F.Supp at 714-715. The Johnson decision provides insight into the inherentproblem with any attempt to re-allocate losses among the various investors,
even as to fictitious profits:Some investors who received ‘fictitious profits’ mayhave spent the money on education or other necessitiesmany years ago. What else in equity and good conscienceshould plaintiffs who received money in good faith
(Footnote continued on next page)
Case: 10-10683 Date Filed: 07/01/2010 Page: 53 of 74
The Trustee’s interpretation of In re Hedged-Investments Associates, Inc., 84
F.3d 1286 (10th Cir. 1996), is similarly flawed. See PBr. at pp. 36-37. In re
Hedged-Investments involved purported equity participation in limited
partnerships, as some of the debtor entities were organized here, and the Tenth
Circuit affirmed the generally accepted principle that an investor has a valid
restitution claim against the defrauding party to recover the amount of principal
that he or she invested. In re Hedged Investments , 84 F.3d at 1289. While
focusing on the Tenth Circuit’s treatment of the subject investor’s fictitious profits,
the Trustee utterly ignores key portions of the decision that debunk the Trustee’s
so-called “transmutation” theory altogether:
(Footnote continued from previous page)
pursuant to an ‘investment contract’ have done? In
contrast, some investors who lost money may have beenspeculators who were prepared to lose their investments.There is simply no neat answer to the various equitiesinvolved here where the investors never knew each otherand were equally at fault for trusting [the Ponzi schemeoperator]. ‘Unexpected gains or losses by equallyinnocent parties may present similar problems, notcapable of resolution by unjust enrichment principles.’
Law of Remedies, § 4.1 (1973). There is no precedent in
law or equity for applying unjust enrichment principlesin these circumstances. In such circumstances the
courts may simply leave the parties where they were
found.
Johnson, 619 F.Supp. at 1350 (emphasis supplied).
Case: 10-10683 Date Filed: 07/01/2010 Page: 54 of 74
Ms. Buchanan [the investor defendant] received thetransfers at issue after already receiving approximately$1 million more than her original $750,000 investment.The district court found that since Ms. Buchananreceived more than she invested she did not have a viableclaim for fraud. In effect, the district court determined
Ms. Buchanan had already received restitution and
therefore was entitled to no remedy. The district court’s
observations are correct insofar as restitution is the
remedy to which Ms. Buchanan would be entitled [.]
Id. at 1289 (emphasis supplied).
In other words, the Trustee completely missed (or ignored) the point that the
Tenth Circuit had determined that an investor who held a limited partnership
interest (as opposed to a promissory note or other debt instrument) has the same
claim of restitution against the Ponzi scheme operator. Id. Because the investor
there had already received payments in excess of her principal investment, she
“had already received restitution [.]” Id. at 1289. The nature of the investment – a
limited partnership interest as opposed to a promissory note – was, is, and should
continue to be immaterial to the investor’s right to restitution.
The Trustee is no more successful in his analysis of the key third case from
the Ninth Circuit, AFI Holding. As the Defrauded Investors discussed in greater
detail above, AFI Holding also involved investment in a limited partnership
operating as a Ponzi scheme and, once again, the Ninth Circuit endorsed and
applied the uniform rule that investors in a Ponzi scheme acquire claims for
rescission at the time of their initial investment and that upon redemption of their
Case: 10-10683 Date Filed: 07/01/2010 Page: 55 of 74
situated creditors. But the Trustee’s avoidance actions are not part of the claims
resolution or plan voting processes. More importantly, the Trustee’s misplaced
reliance on these unrelated provisions of the Bankruptcy Code draws the
fundamental flaw in his position into specific relief; the Defrauded Investors are
not asserting claims or defenses based on an equity interest. The Defrauded
Investors are seeking to establish a defense based on a long-recognized legal claim
for rescission.
D. THE TRUSTEE’S PROPOSED MODE OF “REDISTRIBUTION” IS NO
FAIRER THAN THAT IMPOSED BY THE “GENERAL RULE.”
The Trustee posits that eschewing the “general rule” and subscribing to his
proposed mode of redistribution is the more equitable approach. PBr. at p. 11. In
essence, the Trustee argues that his redistribution scheme is more fair because, in
his view, “it levels the playing field” for all defrauded investors. Not only does
this facile redistribution scheme fly in the face of decades of established law,15 but
there is simply no way to establish that the Trustee’s method produces a fairer
result.
15
A fact not lost on the Bankruptcy Court which considered and dismissed theseeming elegance of the Trustee’s redistribution model, holding to the“general rule” and finding no “sound basis . . . for creating a different rulebased on the equity nature of the fraudulently induced investments.” Doc. 38at p. 13.
Case: 10-10683 Date Filed: 07/01/2010 Page: 60 of 74
liquidation (the “Plan”), as well as by the doctrine of estoppel.16 The confirmed
Plan characterizes the Defrauded Investors as holders of “Investor Tort Claims,” a
defined term in the Plan. See Doc. 6-2. Even without the Plan’s definition, the
meaning of the term is plain on its face; the Defrauded Investors are tort claimants,
in the Trustee’s own words.
Nevertheless, the Trustee continues to urge the Court to find that the
Defrauded Investors be treated as mere equity holders, even though the Plan
mentions nothing about characterizing the Defrauded Investors as equity holders,
nor anything about an “articulation” prerequisite to achieve tort claimant status.
To the contrary, in the Plan and the accompanying Second Amended Disclosure
Statement with Respect to the Trustee’s Plan of Liquidation (the “Disclosure
Statement”), the Trustee expressly “articulates” that the Defrauded Investors are
16 The same principles apply to the positions taken by the Trustee in pursuingpreference claims against the Defrauded Investors in connection with thisbankruptcy. Pursuit of a preferential transfer under Section 547 of theBankruptcy Code requires that the transfer the trustee seeks to avoid andrecover be made on “account of an antecedent debt.” Courts applyingpreference law in the context of Ponzi schemes have held that a defraudedinvestor is a “creditor” holding an “antecedent debt” based on the sameprincipal discussed above that the defrauded investor’s principal investment
gives rise to an immediate claim for rescission or restitution. See e.g. Woottonv. Barge (In re Cohen), 875 F.2d 508, 509 (5th Cir 1989). If the DefraudedInvestors hold “claims” on account of antecedent debt in the Trustee’spreference actions, surely they hold such claims for the purposes of establishing defenses under Section 548(c).
Case: 10-10683 Date Filed: 07/01/2010 Page: 64 of 74
asserting those claims in later state court action); Battle v. Liberty Mut. Fire Ins.
Co., 623 S.E.2d 541, 543 (Ga. Ct. App. 2005) (Chapter 7 debtor that failed to list
house as asset was precluded by judicial estoppel from bringing claim against
insurer to recover damages to property).
More generally, principles of equitable estoppel also apply to preclude the
Trustee from taking a position inconsistent with his confirmed Plan. Equitable
estoppel applies under the following conditions:
The person against whom the estoppel is to apply musthave actual or constructive knowledge of the facts andmust have induced, through his words or conduct,another to rely upon the purported representation. Theparty seeking to assert estoppel must have neitherknowledge or reasonable means or opportunity of obtaining knowledge of the facts and must have reliedupon the other party’s representation to his detriment.
Atlanta Retail, Inc. v. Eastman Kodak Co. (In re Atlanta Retail, Inc.), 294 B.R.
186, 197 (Bankr. N.D. Ga. 2003) (quoting Choat v. Rome Indus., Inc., 462 F. Supp.
728, 730 (N.D. Ga. 1978)).
Here the Plan clearly characterized the Defrauded Investors as tort
claimants. The Defrauded Investors’ votes were solicited by the Trustee based on
the contents of the Plan and Disclosure Statement. The Bankruptcy Court
confirmed the Plan. The Trustee accordingly should be estopped from denying
that the Defrauded Investors are tort claimants by now claiming that they are mere
“equity” holders. Even ignoring the overwhelming body of case law standing
Case: 10-10683 Date Filed: 07/01/2010 Page: 68 of 74
opposed to the Trustee’s novel theories of fraudulent transfer law, the Trustee’s
Motion should be denied because he is not entitled, given prior positions staked out
in the underlying bankruptcy case, to make it.
V. CONCLUSION
For the foregoing reasons, the Court should affirm the Bankruptcy Court’s
Order finding that the Defrauded Investors, who received redemptions of their
principal investment, received such redemptions “for value” as required to
establish a defense to fraudulent transfer claims under 11 U.S.C. § 548(c) and
O.C.G.A. § 18-2-78(a) or similar state laws.
Respectfully submitted,
/s/ Joshua S. Barlow
/s/ Lee Harrington
/s/ Timothy W. Mungovan____________
Timothy W. Mungovan (Mass. Bar # 600702)
Jonathan Sablone (Mass. Bar # 632998)Lee Harrington (Mass. Bar # 643239)Joshua S. Barlow (Mass. Bar # 667472)NIXON PEABODY LLP100 Summer StreetBoston, MA 02110617.345.1000
Attorneys for Defendants – Appellees George
Russell Curtis, Sr. Living Trust, GeorgeRussell Curtis, Sr. Betty Curtis, David LairdFamily Trust, David Laird, and Deborah H.Laird
Dated: July 1, 2010
Case: 10-10683 Date Filed: 07/01/2010 Page: 69 of 74
I hereby certify that on July 1, 2010, I caused to be served a copy of the
foregoing via the Court’s ECF System and/or first class mail on the following
parties.
John W. Mills, Esq.Colin Bernardino, Esq.Counsel for the Trustee,William F. PerkinsKilpatrick Stockton1100 Peachtree St. NE,Suite 2800
Atlanta, GA 30309-4528
Mark S. Kaufman, Esq.Brian E. Bates, Esq.Counsel for Committee of InvestorsMcKenna Long Aldridge303 Peachtree St. NE, Suite5300
Atlanta, GA 30308-3265
Morgan Bradylyons, Esq.Counsel for Amicus CuriaeU.S. Securities andExchange Commission100 F St. NEWashington, DC 20549-8030
Paul M Spizzirri, Esq.Counsel for Willie J. Clay,et al.Spizzirri Law Offices1170 Peachtree St., Suite1200Atlanta, GA 30309
Sharon M. Lewonski, Esq.Counsel for Marco D.ColemanEpstein, Becker & Green,P.C.945 East Paces Ferry Rd.,Suite 2700Atlanta, Georgia 30326
Jonathan H Fain, Esq.Counsel for X-SpurtsInvestment Club of Atlanta,LLC, et al.Jonathan H. Fain andAssoc., PC66 Lenox PointeAtlanta, GA 30324
Robert J. Mottern, Esq.Counsel for James Bronner,et al.Investment Law Group of Gillett,Mottern115 Perimeter Center PlaceSouth Terraces, Suite 170Atlanta, GA 30346
Thomas M. Byrne, Esq.Angela R. Fox, Esq.Counsel for Keith O. Burks,et al.Sutherland Asbill &Brennan LLP999 W Peachtree St., NWAtlanta, Georgia 30309-3819
Sblend A. Sblendorio, Esq.Catosha L. Woods, Esq.Counsel for LawrenceHooper, et al.Hoge Fenton Jones &Appel, Inc.4309 Hacienda Dr., Suite350Pleasanton, CA 94588
Gregory T. Bailey, Esq.
Counsel for Mt. NeboBaptist Life Center, Inc.571 Culberson StreetAtlanta, GA 30310
Christopher D. Phillips,
Esq.Counsel for DavidWisneski, et al.Lamberth, Cifelli, Stokes &Stout, P.A.3343 Peachtree Rd. NE,Suite 550Atlanta, GA 30326-1428
Kevin A. Stine, Esq.
Joshua Tropper, Esq.Counsel for Erich G.Randolph, et al.Baker, Donelson, Bearman,Caldwell & Berkowitz, P.C.3414 Peachtree Rd. NEAtlanta, GA 30326-1153
Case: 10-10683 Date Filed: 07/01/2010 Page: 71 of 74