JurisdictionUtah,United States
Publication year2022
CitationVol. 35 No. 5 Pg. 16
Date01 October 2022
Vol. 35 No. 5 Pg. 16
Utah Bar Journal
October, 2022


Reflections on Independent Clearing House Part Two: The Clawback Cases

by Ronald W. Goss

The collapse of a Ponzi scheme is usually followed by bankruptcy. Trustees are given statutory powers to avoid or “clawback” certain pre-bankruptcy transfers to augment the pool of assets available for distribution to creditors. The primary avoiding powers are the fraudulent transfer and preference provisions of the Bankruptcy Code. Prior to Independent Clearing House, Utah’s largest Ponzi scheme of the 1980s, these powers had rarely been used against innocent investors. The Clearing House case changed all that.

A Short History Of Clawbacks

There are two types of fraudulent transfers, actual and constructive. Actual fraudulent transfers are transfers made with subjective intent to “hinder, delay or defraud” creditors. The law dates from the Statute of 13 Elizabeth (1571). Constructive fraudulent transfers are a more recent development. The statutes replace subjective intent with an objective measurement test. Under current law the test is whether an insolvent debtor receives something of “reasonably equivalent value” in exchange for a transfer.

The modern era of fraudulent transfer law began in 1918 when the Commissioners on Uniform State Laws promulgated the Uniform Fraudulent Conveyance Act (UFCA). The UFCA codified the “better” decisions based on the Statute of 13 Elizabeth. The UFCA also introduced a constructive fraudulent transfer provision, which allowed a creditor to avoid a conveyance by an insolvent debtor unless the debtor received “fair consideration” and the transferee took the conveyance in “good faith.” The good faith concept sought to prevent transferees from knowingly participating in the transferor’s fraud, or, at a minimum, engaging in willful blindness. Twenty-five jurisdictions, including Utah, enacted the UFCA.

In 1938, Congress passed the Chandler Act, which amended the 1898 Bankruptcy Act to, among other things, add a constructive fraudulent transfer provision patterned after the UFCA. See 11 U.S.C. § 107(d) (repealed 1978).

The next important development in fraudulent transfer law was the Bankruptcy Reform Act of 1978, commonly known as the Bankruptcy Code (the Code). Like the UFCA and the Chandler Act, the Code contains both actual and constructive fraudulent transfer provisions. Congress substituted “reasonably equivalent value” for “fair consideration” as the measurement test, without significant change in meaning, and shifted the burden of proof of transferee good faith. Trustees are no longer required to prove that a transferee lacked good faith; instead transferees must prove their own good faith as an affirmative defense. See 11 U.S.C. § 548(c).

In 1984, the Commission on Uniform State Laws adopted the Uniform Fraudulent Transfer Act (UFTA), designed to conform state law to the Code in most respects. The UFTA provisions parallel those of the Code, often using identical language. Many states, including Utah, replaced the UFCA with the UFTA.

In 2014, the Commission on Uniform State Laws modified UFTA slightly and renamed it the Uniform Voidable Transactions Act (UVTA) to emphasize that the law regulates non-fraudulent actions. In 2017, Utah enacted the UVTA. See Utah Code Ann. §§ 25-6-101 to -502.

Bankruptcy trustees have two means to avoid fraudulent transfers. Section 548 of the Code is a true avoiding power. As originally enacted section 548(a) allowed trustees to clawback fraudulent transfers made within one year of the bankruptcy filing. In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act extended the reachback period to two years. See 11 U.S.C. § 548(a)(1). Section 544(b) is a borrowing statute that allows a trustee to step into the shoes of an actual creditor who could have avoided the transfer under nonbankruptcy law. Id. § 544(b). To utilize this derivative power trustees must identify a “triggering creditor.” Trustees use section 544(b) in conjunction with the UFTA or UVTA because these statutes provide a longer, four-year reachback. If the triggering creditor is the IRS, trustees can extend reachback to ten years utilizing the collection period under IRC Section 6502(a). See Mukamal v. Citibank N.A. (In re Kipnis), 555 B.R. 877, 878, 880–81 (Bankr. S.D. Fla. 2016).

Another clawback power is the power to avoid preferences, a unique bankruptcy concept introduced in the 1898 Bankruptcy Act. Under the Bankruptcy Act, trustees had to show that the preferred creditor had reasonable cause to believe the debtor was insolvent at the time of payment. The 1978 Bankruptcy Code substantially rewrote preference law. Under the 1978 Code, a preference is a transfer by an insolvent debtor to a creditor within ninety days of bankruptcy (or one year if the creditor is an insider) that enables the creditor to receive a greater percentage of its claim than it would receive if the transfer had not been made and the creditor participated in a Chapter 7 distribution of the debtor’s assets. 11 U.S.C. § 547(b).

The preference statute serves two broad purposes. It discourages creditors from racing to the courthouse to dismember a failing business instead of working with debtors and, to some extent, promotes equal distribution of the debtor’s estate among unsecured creditors. The statute strikes a balance between the nonbankruptcy policy of rewarding diligent creditors and the bankruptcy policy of creditor equality by limiting the reachback period to ninety days before bankruptcy for transfers to general creditors and one year for transfers to insiders.

The Road to Independent Clearing House

In the early 1980s Ponzi clawback law essentially consisted of four decisions. The first was a 1924 preference case under the 1898 Bankruptcy Act against seven investors in Charles Ponzi’s scheme. Cunningham v. Brown, 265 U.S. 1, 7–8 (1924). The investors argued that they received their own money. Id. at 9. The Supreme Court refused to apply tracing fictions and established the principle that money fraudulently obtained from investors is property of the debtor thus susceptible to preferential disposition. See id. at 11–13.

The first profits case was Eby v. Ashley, 1 F.2d 971 (4th Cir. 1924), an actual fraudulent transfer action under the 1898 Bankruptcy Act. The defendant invested $3,000 and received payments totaling $4,576. Id. at 972. The statute allowed trustees to clawback fraudulent transfers made within four months of bankruptcy if the bankrupt did not receive a “present fair consideration.” The Fourth Circuit, with virtually no analysis, held that the investor had not given a present fair consideration for his $1,576 profit. See id. at 973.

More than forty years elapsed between Eby and the next profits case, Conroy v. Shott, 363 F.2d 90 (6th Cir. 1966), an action by a trustee under an Ohio actual fraudulent conveyance statute. The defendant had made loans to a Ponzi operator and received back all his principal plus a return of $342,900. Id. at 91. Under the Ohio law, transferees were required to have knowledge of the transferor’s fraudulent intent. Id. The court found that the defendant had constructive knowledge, which satisfied the statute. Id. at 93.

The only profits case under a constructive fraudulent transfer statute was Rosenberg v. Collins, 624 F.2d 659 (5th Cir. 1980), where the trustee sued...

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