BANKRUPTCY LAW: Ponzi, Ponzi, Ponzi

A recent bankruptcy opinion illustrates two very important principles in bankruptcy jurisdiction:

1. First, the bankruptcy court does not have original jurisdiction over debts that are not based upon the interpretation of the bankruptcy law. In other words, if an obligation stems from state or federal law, apart from bankruptcy, it is considered a “non-core” matter. And non-core matters may be decided in the district (federal trial) court, not the bankruptcy court.?

2. Second, the US trustee has the ability to challenge debts alleged by the debtor or by a creditor, for example, a debt that is based upon fraud. For example, a debt that stems from the transfer of property in an attempt to deceive other creditors, can be nullified as a fraudulent transfer.?

In In re ?EPD Investment Company LLC &? Jerrold S. Pressman, Debtor, et al., the US Trustee took the position that the debtor ran his business as a Ponzi scheme, and therefore payments to the business by an investor, the interest in the debtor’s real estate taken by the investor’s wife, and payments to the investor, were funds that had to be returned to the estate, or interests that were taken in furtherance of the fraudulent Ponzi scheme. The Trustee wanted the fraudulently transferred monies returned (i.e., he wanted those transactions “avoided), and he wanted the debts to that particular creditor nullified or avoided as well.

The Ninth Circuit Court of Appeals summarized the matter as follows:

Prior to EPD's collapse, John Kirkland made a series of loans to EPD between September 2007 and July 2009 totaling $2,055,000. John was an attorney admitted to practice law in California, and he periodically represented entities controlled or partially owned by Jerrold Pressman. In return, EPD made mortgage payments on John's behalf. John later assigned his credit interest in the EPD loans to the BC Trust, for which his wife Ann is the sole trustee. Ann filed secured claims seeking $3,529,000 from EPD's estate, which included interest on the loans John had assigned to the BC Trust.

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The case is interesting because the trustee sought a jury verdict that the investment operation was fraudulent, as a Ponzi scheme. Generally, there are no jury trials in bankruptcy, but Kirkland did not stipulate to bankruptcy court jurisdiction regarding the fraudulence of the investments, so the district court heard the arguments as part of a “non-core” matter (a matter that is decided on state or federal law, apart from the Bankruptcy Code).?

The US Trustee involved likely does not try many cases, and even fewer are jury trials. But Trustee Rund (or rather, the attorneys representing him) was successful in this case.?

Additionally, the 9th Circuit pointed out that any transaction that is designated a?Ponzi?scheme is by definition fraudulent, and this allowed the trustee to nullify or avoid the transaction.

Ninth Circuit Judge Raymond Clifton dissented, claiming that the jury’s instructions to find fraud were flawed (a claim that could end up in the US Supreme Court), and pointing out that a failed investment operation during the Great Recession did not necessarily equate to fraud.

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In re Kirkland v. Rund, Case No. 22-55944 (9th Cir. Aug. 23, 2024)

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