The Fifth Circuit Court of Appeals recently issued a decision that should make defendants in Ponzi cases shiver in their boots. The court said that the defendant, the Golf Channel, had to return nearly $6 million and that it could not take advantage of a commonly-invoked “reasonably equivalent value” defense. Even though the Golf Channel had aired advertisements promoting the business, which would normally have been “reasonably equivalent value,” the Fifth Circuit held that by airing advertisements promoting the Ponzi scheme, the Golf Channel did nothing to help the Ponzi scheme’s creditors. But how was the Golf Channel supposed to know that it was dealing with a Ponzi scheme? For more on the case, and what it means for merchants, read on.
For nearly two decades Allen Stanford’s Stanford International Bank, Limited (“Stanford”) operated a multi-billion dollar Ponzi scheme, offering unusually high rates of return on certificates of deposit and using the money deposited by initial investors to pay subsequent investors. The SEC eventually uncovered the scheme and sued Stanford in February 2009 in the U.S. District Court for the Northern District of Texas. The court appointed a receiver who took custody of Stanford’s assets and sought to void the transfers that had been made by Stanford before it went into receivership. Among these allegedly fraudulent transfers were at least $5.9 million in payments to the Golf Channel, made by Stanford for sponsorships and advertisements that ran on the Golf Channel.
The receiver in the Stanford case, Ralph S. Janvey, sued the Golf Channel under the Texas Uniform Fraudulent Transfer Act (“TUFTA”), which allows creditors to void fraudulent transfers made by a debtor and force the transferee to return the transfer to the debtor’s estate. The full citation for the case is Janvey v. Golf Channel, 780 F.3d 641 (5th Cir. 2015).
Under TUFTA, a transfer is fraudulent if made “with actual intent to hinder, delay, or defraud any creditor of the debtor.” In the Fifth Circuit, as in many other circuits, proof that a debtor/transferor operated as a Ponzi scheme is, itself, sufficient to establish the fraudulent intent behind the transfers that were made. However, a transferee may prevent the voiding of fraudulent transfers where the transferee can show (1) that it took the transfer in good faith and (2) that, in return for the transfer, it gave the debtor/transferor something of “reasonably equivalent value.”
In Janvey, it was undisputed that Stanford had engaged in a Ponzi scheme, and the parties stipulated that the $5.9 million transfer to the Golf Channel was fraudulent. The Golf Channel asserted as an affirmative defense that it had taken the transfer in good faith and that it had given reasonably equivalent value. The district court held, and the receiver did not challenge on appeal, that the Golf Channel had taken the transfer in good faith, thus satisfying the first element of the defense. What remained at issue was whether the Golf Channel could prove the second element of its defense—that its advertising services provided reasonably equivalent value to Stanford.
In the Fifth Circuit, courts use a two-step process to determine reasonably equivalent value, examining, first, whether the property or service exchanged categorically had any value under TUFTA, and, second, whether the value exchanged is reasonably equivalent to the value of the transfer.
The Golf Channel stumbled on the first step by failing to prove that it exchanged something of value, so the court did not address the second step.
The Fifth Circuit held that value is measured from the standpoint of creditors, rather than from that of a buyer in the marketplace. “While Golf Channel’s services may have been quite valuable to the creditors of a legitimate business, they have no value to the creditors of a Ponzi scheme,” the Fifth Circuit held. The Fifth Circuit reasoned that Ponzi schemes create greater liabilities than assets with each subsequent transaction. Put another way, each time someone invested with Stanford, that investment created a liability on the part of Stanford that Stanford could never repay. The Fifth Circuit held that a Ponzi scheme is, as a matter of law, insolvent from its inception, and each investment in Stanford put Stanford further into debt. Accordingly, services such as advertising that encourage investment in a Ponzi scheme do not provide value to creditors.
The Golf Channel argued that it was merely an innocent “trade creditor” generally promoting a business’s brand. However, the Fifth Circuit declined to carve out an exception for trade creditors, holding that “TUFTA makes no distinction between different types of services or different types of transfers, but requires us to look at the value of any services from the creditors’ perspective.”
The Fifth Circuit did take care to distinguish this Ponzi scheme case from cases involving legitimate businesses that ultimately fail. The Fifth Circuit noted that a legitimate business may receive reasonably equivalent value even where that value is speculative or potential. The Fifth Circuit pointed to a case of a debtor airline that purchased jet fuel in order to stay in business long enough to attempt a sale as a situation where there could be a transfer for “reasonably equivalent value.”
So, a lesson from Janvey might be that merchants, such as the Golf Channel, should be extra-vigilant when dealing with an entity that may in fact be a Ponzi scheme. The reason for such additional caution is that those merchants may not be able to assert a “reasonably equivalent value” defense if a receiver or bankruptcy trustee seeks to void fraudulent transfers made to the merchant. In practice, however, this may be difficult, since it is often not obvious when a Ponzi scheme is being perpetrated. Whether courts will extend the Janvey holding beyond the realm of Ponzi scheme cases remains to be seen.