THE GOOD FAITH INQUIRY: WHAT ABOUT THE WORKER ANTS?

• Author: Griffin, Katherine

INTRODUCTION

Charming leader, credible scientist, media darling, political icon--each of these terms could be used to describe Wang Fengyou, chief executive officer and chairman of the Yilishen Tianxi Group, which was founded in 1999. (1) Wang Fengyou and his managers advertised an inconceivable investment opportunity for impoverished farmers throughout China. (2) For the meager price of 10,000 yuan, (3) the farmers would receive a box of special ants that necessitated royal treatment for the next ninety days. (4) After about three months of meticulously feeding the ants egg yolk, sugar water, and cake, the company would collect the dead ants from the farmers, and each farmer was promised a thirty percent return profit. (5) The ants were subsequently crushed into a powder to be used as an aphrodisiac, and many well-known political and pop culture figures spread tales of the powder's success throughout the Chinese media. (6) For eight years, hundreds of thousands of farmers were charmed into participating in this get rich quick system, and the scheme collected more than ten billion yuan in total. (7)

Unbeknownst to these farmers and media advertisers, the "magical" effects of the alleged aphrodisiac were illusory, and their promised profits were simply recycled investor deposits--the hallmark of a Ponzi scheme. (8) "At the end of 2007, the Yilishen Tianxi Group filed for bankruptcy," and almost a million investors were stripped of their life savings. (9) "Huge street protests" (10) and riots ensued, and the Chinese government worked rapidly to cover the rampant internet and blog posts that stemmed from the Ponzi scheme. (11) In this tragic instance, clearly Wang Fengyou was culpable for his intentional creation of the fraudulent scheme, meaning he faced criminal charges and was not entitled to any earnings from the illegal scheme. (12) However, should the celebrities and political figures who advertised the elixir be culpable or be entitled to their earned wages? What about Fengyou's managers? What about the ant farmers themselves, who technically propagated the scheme by cultivating the ants to formulate the elixir? (13)

There is a significant amount of scholarship on whether an unknowing investor can retain his or her investment in the Ponzi scheme based on an affirmative good faith defense. (14) One aspect of Ponzi schemes that is frequently overlooked is the unknowing employee, who likely left his or her original job to come work for someone they viewed as channing, brilliant, and business savvy. If legitimately unaware of the nature of their boss's work, should their labor entitle them to keep the wages they earned while working for the scheme?

This Note will explore the contested definitions of "reasonably equivalent value" and "good faith" in the context of the worker, rather than the investor. Part II will discuss background terms and definitions surrounding the good faith affirmative defense. (15) Part III will explore the different approaches various courts have taken regarding whether an employee or a service provider can contribute value at all to a Ponzi scheme. (16) Part IV will delve into the various schemas in existence for determining the "good faith" of an employee or a service provider in the Ponzi scheme context. (17) Because neither the Bankruptcy Code nor the parallel state law defines good faith, (18) there is significant room for growth in delineating a test that consistently evaluates good faith and deters participation in Ponzi schemes. After examining these varying definitions and standards, this Note proposes a standard to which courts should look in evaluating the affirmative good faith defense for employees. (19) First, transfers in Ponzi schemes should not be per se valueless. Second, a three-category evaluation should be implemented to gauge the employee's level of involvement in the Ponzi scheme in order to determine what level of good faith analysis scrutiny should be applied. Part VI will evaluate the policy arguments implicated by implementation of this two-part proposal. (20) Not only will this new standard promote much-needed consistency in Ponzi scheme clawback actions, but it will also adhere to the principles of equity, strike a compromise between protecting unknowing employees and investors, and encourage vigilance in accepting employment, especially within the higher levels of the company.

1. BACKGROUND

   In the United States, Ponzi schemes surged in 2019. (21) Sixty Ponzi schemes were uncovered, revealing a collective $3,245 billion in misappropriated investor funds. (22) "Ponzi schemes are based on fraudulent investment management services ...," (23) Usually, an unknowing investor will "contribute money to [a] 'portfolio manager,'" (24) who lures the investor in by promising them unreasonably high returns. The name Ponzi scheme originated from Charles Ponzi, "who promised investors [fifty percent] returns on investments in" just ninety days. (25) When an investor wants their money back, they are bought out with money from other later investors, creating a cyclical cash flow that can only sustain itself as long as investors continue to buy into the scheme. (26) After a Ponzi scheme inevitably collapses like a house of cards, (27) the consequences leave the leaders facing criminal charges. (28) However, the civil lawsuits that usually ensue--with every participant trying to claw back his or her investment, unknowing family members making ancillary claims, and employees battling avoidance actions after losing everything themselves--are usually very complicated, lose-lose situations. (29)

   Beyond the litany of lawsuits that may ensue upon the collapse of a Ponzi scheme, the end result of such a collapse is often bankruptcy. (30) In bankruptcy, a trustee (31) steps in to administer the case and liquidate the debtor's nonexempt assets. (32) The trustee has "avoiding" powers that can be utilized to "undo a transfer of money or property made during a certain period of time before the filing of the bankruptcy petition." (33) "By avoiding a particular transfer of property," the trustee can force the return of the property to the creditors--the victims/investors--of the Ponzi scheme. (34) The statutory framework guiding these actions to recover money lost in a Ponzi scheme is contained in the Bankruptcy Code and the Uniform Fraudulent Transfer Act (UFTA). (35) The Bankruptcy Code governs fraudulent transfer law at the federal level, while the UFTA governs fraudulent transfer law for states. (36)

   The Bankruptcy Code section 548 gives the trustee in bankruptcy this power to avoid, as fraudulent conveyances, certain transactions in which the debtor transferred property or incurred an obligation. (37) Section 548(a)(1)(A) empowers the trustee to avoid transfers made or obligations "incurred with actual intent to hinder, delay, or defraud" creditors to whom the debtor was then or thereafter became obligated. (38) Section 548(a)(1)(B) empowers the trustee to avoid constructively fraudulent transfers or obligations. (39) Although frequently challenged in bankruptcy scholarship, there exists a presumption that Ponzi schemes operate with actual fraud, or intent to hinder, delay, or defraud a Ponzi debtor's creditors. (40) Therefore, operating under the presumption that actual intent to defraud exists, the affirmative defense that creditors must utilize is dubbed the "Good Faith Defense":

   Except to the extent that a transfer or obligation voidable under this section is voidable under section 544, 545, or 547 of this title, a transferee or obligee of such a transfer or obligation that takes for value and in good faith has a lien on or may retain any interest transferred or may enforce any obligation incurred, as the case may be, to the extent that such transferee or obligee gave value to the debtor in exchange for such transfer or obligation. (41) This provision allows a transferee that has stepped into the place of a creditor to recover a "transfer" (money invested) if the transfer was given to the Ponzi scheme operator (1) for value, and (2) in good faith. (42)

   Section 4 of the UFTA is fashioned similarly to the Bankruptcy Code. There is a section empowering the trustee to avoid fraudulent transfers made with actual intent to defraud, (43) and there is a section empowering the trustee to avoid fraudulent transfers with constructive intent. (44) Unlike the Bankruptcy Code, the UFTA delineates eleven "badges of fraud" (45) that courts can look to in interpreting the intent of a debtor. (46) These badges of fraud operate similarly to the Ponzi scheme presumption because a majority of the factors tend to illustrate the Ponzi scheme mastermind operated with actual intent. (47) For example, "the relationship among the parties and the secrecy, haste, [and] unusualness of the transaction" will often be sufficient to tip the badges of fraud in favor of inferring actual intent. (48) Similarly to the Bankruptcy Code, section 8 of the UFTA also establishes a good faith defense: "[a] transfer or obligation is not voidable under Section 4(a)(1) against a person who took in good faith and for a reasonably equivalent value [given the debtor] or against any subsequent transferee or obligee." (49) Therefore, the parallel touchstones for a creditor's ability to retain their transfer are (1) reasonably equivalent value, and (2) good faith. (50)

2. "REASONABLY EQUIVALENT VALUE"

   There is little consensus about whether, and under what circumstances, consideration provided to a Ponzi scheme can constitute "reasonably equivalent value." (51) One line of cases holds that the reasonably equivalent value element is lacking when someone is paid for aiding a scheme. (52) Even if the employee is completely oblivious to the illegal nature of the scheme, these cases hold the employee did not give anything of value for the payment they received. (53) The Ponzi scheme leader or its creditors/victims did not...