Ponzi schemes and withdrawn funds: can these be clawed back?

In light of the recent spate of significant cases of investment fraud that have been uncovered, and in particular, the discovery of various high profile “Ponzi” schemes (the Madoff fraud being the most high profile), there has been speculation as to the ability of those investment vehicles (through the trustee in bankruptcy) to recover in the US sums paid out to investors prior to any bankruptcy petition being filed.

This issue was brought into focus in the decision of the US Bankruptcy Court Southern District of New York in a case called In Re Bayou Group LLC et al in 2007 (motion to dismiss) and 2008 (summary judgment).

In that case, the court considered the US States’ Code Bankruptcy Code (a federal statute and as such applicable in each of the 94 federal judicial districts in the US). Section 548(a)(1)(A) of that Code provides, amongst other things, that the trustee in bankruptcy may avoid any transfer of an interest or obligation of the debtor (the fraudulent investment vehicle in these cases) made up to 2 years before the filing of the petition if the debtor voluntarily or involuntarily made the transfer with an actual intention to hinder, delay or defraud any entity to which the debtor was or became indebted.

Amongst other things, the New York court held that:

1. if the investor is repaid by the debtor investment vehicle with an actual intention on the part of the debtor company to hinder, delay or defraud any entity to whom the debtor company was or became indebted, then the entire transfer must be reimbursed back to the debtor company. This includes not only any profit paid to the investor by the fraudulent debtor, but the principal sum invested as well;
2. where a Ponzi scheme is pleaded, there is a presumption that the debtor company actually intended to hinder, delay or defraud another entity to whom the debtor company was or became indebted;
3. the investor who receives the reimbursement has a “good faith” defence under Section 548(c) of the Code. The investor needs to show that it received the transferred sums for value and in good faith. The burden of proving this rests with the investor not the debtor company; and that
4. in that particular case, the debtor company had pleaded a valid prima facie case against the investors.

Further reading: In re Bayou GroupLLCIn re Bayou Group LLC

362 B.R. 624 and 396 B.R. 810