Kelley v. KaniosKelley v. Kanios
I. BACKGROUND
A. Factual History
1. Defendants Lend Millions of Dollars to Petters Company, Inc., Between 1997 and 2006, and Receive Millions of Dollars of Interest in Return
Steve Papadimos and Chris Kanios (collectively, "Defendants") are a married
Before investing with Petters, though, Papadimos did some due diligence. Among other things, he (a) had a short meeting with Petters in Minneapolis, and, while there, observed that Petters owned actual warehouses and retail stores that had "thousands of boxes" inside of them (see Papadimos Dep. II. at 13-14), (b) spoke with Thomas Hays (a well-regarded lawyer who worked with Petters) on multiple occasions, and learned that Hays was confident about Petters's business acumen (id. at 15-19), (c) talked to at least one business that Petters had purportedly conducted a merchandise transaction with, Montgomery Ward, and confirmed that a business relationship existed between the two companies (id. at 34, 76), and (d) read articles in the Minneapolis Star-Tribune newspaper about Petters's businesses (thus again confirming the fact that the businesses did exist) (id. at 31, 76, 132).
Consequently, in July 1997, Papadimos decided to begin lending to Petters's wholly-owned company, Petters Company, Inc. ("PCI").
The couple continued to lend money to PCI until 2005, when PCI told them that it only wanted to work with larger-scale investors, like hedge funds, from then on out. (See Papadimos Dep. II at 13, 17.) Shortly thereafter, PCI re-paid Defendants their principal investment(s) in full. (See Papadimos Dep. I at 107.)
In sum, between July 1997 and March 2006, Papadimos lent $ 3,297,300 to PCI, arising out of at least 87 promissory notes and 115 related "transactions." (See Martens - Papadimos Tracing Report ¶¶ 9, 12; see also id. at n.2 (noting that "the difference between the 115 transactions and the 87 promissory notes" arose for "one of the following reasons": "(1) rolling of principal and/or interest on certain notes; (2) multiple interest and/or principal payments on the same note; or (3) reversals due to insufficient funds, uncollected checks, or missing endorsements").) In return, PCI paid Papadimos $ 3,126,524.37 in interest. (See id. ¶ 9.)
Similarly, between March 2000 and March 2006, Kanios lent $ 690,000 to PCI, arising out of at least 13 promissory notes and 21 related transactions. (See Martens - Kanios Tracing Report ¶¶ 9, 12.) In return, PCI paid Kanios $ 572,500.22 in interest. (See id. ¶ 9; accord Kanios Dep. at 14-15 (admitting that she received this amount in interest income).)
Notably, during this entire time period, it is undisputed that Defendants believed they were investing in PCI's "diverting" business, and in the merchandise purchases and re-sales undergirding that business; they did not believe they were providing general business loans to PCI. (See supra at 858-59.) In fact, the vast majority of the promissory notes Defendants signed with PCI included a security interest in a specific order of merchandise that PCI had purportedly bought with Defendants' money, as well as in any proceeds from sales of that merchandise. (See Matens - Papadimos Tracing Report ¶ 33 (stating that 74 of Papadimos's promissory notes referenced a security agreement and accompanying "purchase order" underlying that agreement); Martens - Kanios Tracing Report ¶ 28 (same, with respect to nine of Kanio's promissory notes).) What's more, these security agreements contained language confirming that the express purpose of Defendants' loans was to allow PCI to purchase, and then re-sell, merchandise, i.e. , "[t]his Security Interest is granted to secure payment of funds loaned to [PCI]
2. In 2008, the Public Learns that PCI Was Actually a Massive, Years-Long Ponzi Scheme, In Which Funds from Investors Like Defendants Were Primarily Used to Re-Pay Other Investors, Rather Than to Finance Legitimate Commercial Transactions
In reality, however, Defendants were not investing in a diverting business, much less in specific merchandise transactions. Rather, Defendants were investing in a Ponzi scheme that maintained only a superficial veneer of a diverting business. See, e.g. , United States v. Petters ,
With respect to Papadimos in particular, Coleman testified as follows:
Q: Do you recall ever speaking to [Papadimos]?
...
A: Yeah, I talked to [him].
Q: Do you remember what you talked about?
A: If [PCI] needed money I might have called him up and asked for two, three million dollars to do a certain deal.
Q: And at the time you called him to ask him to do a certain deal, were you providing false or misleading invoices at that time?
A: Yes.
Q: And I think you testified that there was not one legitimate invoice ever used with the small investors,5 is that correct?
A: There was no real purchase order ever given to an investor, correct.
(Coleman Dep. I at 193-94.)
At a subsequent deposition, Ms. Coleman further noted that the "Montgomery Ward" deal that Papadimos had relied on as part of his due diligence had, in fact, been one of PCI's signature "Potemkin deals," in which Petters (and Coleman) vastly overstated the amount of merchandise PCI had purchased from Montgomery Ward, and then lied about the millions of dollars in "accounts receivable" it was "owed" from purported "re-sales" of that inventory. (See Pl.'s Ex. 1 [Doc. No. 115-1] ("Coleman Dep. II") at 370-76.)
On a more general level, Coleman also testified that she, Petters, and White had been intentionally committing this fraud since 1994. (See Coleman Dep. I at 21, 24, 208-09; accord Boosalis Civil Trial Tr. at 228 (Coleman); Petters Crim. Trial Tr. at 567, 773-74 (Coleman).) Indeed, shortly after the FBI discovered this scheme, Coleman pled guilty to conspiracy to commit mail fraud. (See Pl.'s Ex. 10 [Doc. No. 110-1] ("Coleman Criminal Judgment").) White similarly pled guilty to two criminal charges - aiding and abetting mail fraud, and illegal monetary transactions - and testified as such at Petters's criminal trial. (See Pl.'s Ex. 11 [Doc. No. 110-1] ("White Criminal Judgment"); Petters Crim. Trial Tr. at 1271 (White) (admitting that he forged "hundreds of millions of dollars" of merchandise sales to wholesalers that did not in fact occur).) And, perhaps most notably, after a month-long trial, a jury found Petters guilty of 20 criminal charges, including 13 counts of wire fraud and mail fraud, and four counts of money laundering. (See Pl.'s Ex. 9 [Doc. No. 110-1] ("Petters Criminal Judgment").)
Coleman similarly testified that she, Petters, and White took substantial steps to keep this scheme secret from both investors and other PCI employees, such as by falsifying bank account, profit and loss, and insurance statements. (See Pl.'s Ex. 14 [Doc. No. 110-1] ("Coleman Dep. II") at 389-90, 409-10; Petters Crim. Trial Tr. at 1140-41, 1163-66 (White).) PCI's tax accountant, James Wehmhoff, also testified that, in 2007, he discovered that PCI had been "maintain[ing] two different sets of
Moreover, in an exhaustive forensic accounting investigation conducted after the Petters Ponzi Scheme became public knowledge, the Trustee's expert forensic accountant (the aforementioned Theodore Martens) discovered that PCI had effectively been insolvent from December 31, 1996 until its collapse in 2008. (See Pl.'s Ex. 19 [Doc. No. 110-2] ("Martens Solvency Report") ¶ 9.) In other words, at the end of 1996, PCI's liabilities exceeded its assets by at least $ 6.5 million, and that gap only increased until it had reached $ 3.25 billion by June 2008, when PCI went out of business as a result of the criminal prosecutions. (Id. ¶ 20; cf. Wehmhoff Dep. at 69-72 (noting that the tax returns he prepared for PCI in 2000, 2001, and 2002 all showed losses in the tens of millions of dollars).) This insolvency occurred largely because "the assets reported on the PCI Balance Sheets included fictitious accounts receivable and inventory balances that resulted from falsified purchases of goods." (Id. ¶ 15.) Indeed, Martens added, "PCI ... did not engage in actual inventory and accounts receivable financing, with the exception of some limited transactions involving the purchase of small amount of goods." (Id. ) Petters also did not contribute much of his own capital to PCI, which, in Martens's opinion, further "evidence[d] ... that [PCI] served no functional purpose from [its] inception other than to perpetuate the fraud." (Id. ¶ 24.)
Importantly, Martens and his forensic accounting team also built upon Coleman and White's generalized "Ponzi scheme testimony" by conducting an ex-post, individualized "tracing" investigation with respect to each PCI investor (including both Defendants here). As part of this investigation, Martens scoured PCI's bank account records (and any other available evidence) to glean whether any individual loan was used to fund a real merchandise order, as well as whether that loan was re-paid from revenue earned from the re-sale of a real merchandise order. With respect to both Papadimos and Kanios, Martens found "no evidence" "to indicate that any of the transactions to/from [Defendants] were related to potentially real PCI purchases and/or sales transactions," but that, "rather," "the funds received from/sent to [Defendants] were part of the rolling churn of the Petters Ponzi Scheme." (Martens - Papadimos Tracing Report ¶ 35; Martens - Kanios Tracing Report ¶ 30.)
Martens concluded that Defendants' funds were "part of the rolling churn of the Petters Ponzi Scheme," based largely upon the (highly suspect) timing between incoming loans and outgoing loan payments. (See Martens - Papadimos Tracing Report ¶ 15.c ("[W]e observed that the typical churn of the Ponzi scheme was such that cash received on one day was disbursed to other investors the same or the day after."); accord Coleman Dep. II at
Martens also conducted a "cash tracing analysis" to determine if any of Defendants' money flowed to one of Petters's more "legitimate" companies (see supra n.8), and was then used for real diverting activity. (See, e.g. , Martens - Papadimos Tracing Report ¶ 30; see also Defs.' Ex. J [Doc. No. 113-2] ("Martens Intercompany Analysis") (showing that, between December 1999 and September 2008, approximately three percent of PCI's $ 50 billion cash flow either went to, or came from, other Petters entities).) However, after a thorough investigation of available records, Martens likewise concluded that no evidence showed that "transfers to/from [these] other entities ... relate[d] directly to any of Defendants' PCI Note Transactions and/or indicate[d] that Defendants either (1) [were] potentially involved in the funding of any potentially real purchases, or (2) received the proceeds of potentially real sales made by those entities." (Martens - Papadimos Tracing Report ¶ 30; Martens - Kanios Tracing Report ¶ 26.) Martens specifically re-affirmed this conclusion at his deposition. (See Defs.' Ex. G [Doc. No. 113-2] ("Martens Dep.") (stating that Defendants' funds were not even used "indirectly," "through another Petters entity," to "acquire" "real goods, real inventory, for subsequent resale").)
B. Procedural History
1. Petters Company Inc., Declares Bankruptcy and the Liquidating Trustee Commences Dozens of Adversary Proceedings to Claw Back Interest Payments Made to "Early" Investors Like Defendants
In October 2008, after Petters was arrested and indicted, the District Court appointed Douglas A. Kelley, Esq., as a "receiver," "to take control of the assets of Tom Petters." In re Petters Co. Inc. ,
What is important, though, is the Trustee's "theory of the case," particularly as it relates to smaller, private investors like Defendants. Put simply, the Bankruptcy Code allows a Trustee to "avoid," or, "claw back," payments made to creditors prior to the bankruptcy filing, for the benefit of the estate, if the transfers were "fraudulent" within the meaning of applicable state "fraudulent transfers" law, here, the Minnesota Uniform Fraudulent Transfers Act ("MUFTA"). See In re Petters Co., Inc. ,
Although fraudulent transfer law usually applies to "suspicious midnight hour transfers," such as the Debtor who "sells" his friend his beach house on the eve of his bankruptcy filing, for virtually nothing in return, courts across the country have broadly applied fraudulent transfer law for the benefit of Ponzi Scheme victims, too. See, e.g. , In re Petters Co., Inc. ,
2. The Bankruptcy Court Denies the Trustee's Summary Judgment Motions En Masse, and Many "Petters Claw Back" Cases, Including This One, Are Transferred to the District Court for Trial
Following a lengthy and complicated discovery process, which resulted in numerous published decisions from the Bankruptcy Court, this Court, and the Eighth Circuit Court of Appeals, the Trustee brought summary judgment motions against many private investors, including Defendants, based on the fraudulent transfer theory outlined above. The Bankruptcy Court
As best this Court can tell, the Bankruptcy Court reached this decision for two reasons. First, the Bankruptcy Court found that material disputes of fact existed as to whether PCI acted with fraudulent intent with respect to each individual transfer the Trustee sought to claw back (which, again, collectively totaled in the thousands). (See, e.g. , Mar. 5, 2018 Bankr. Hr'g Tr. at 75-76.) Although the Bankruptcy Court acknowledged the testimony of Ms. Coleman that "all of" the security agreements and purchase orders at issue were fabricated or exaggerated, the Court found that, at least in the case of Charap, the defendant-investor had rebutted that presumption of fraud by testifying that "he [was] not told that the loans were tied to specific deals, [and] did not rely on specific statements that tied the loans to specific deals." (Id. at 76; see also id. at 67 (noting that Charap had "testified that he would give [PCI] the money and it could be used for any purpose").) "There [were] no security agreements [with Charap]," the Bankruptcy Court added. (Id. )
Second, the Bankruptcy Court found that Martens's expert testimony did not sufficiently detail whether Defendants' money was used to finance legitimate merchandise transactions (as opposed to whether it was simply part of the "Ponzi churn"). (See id. at 77-78.) On this point, the Bankruptcy Court emphasized that, per Martens's own analysis, other Petters' companies "had legitimate business," and that PCI transferred "over a billion dollars" to those companies during the relevant time period. (Id. ; but cf. supra at 863-64 (noting that this activity amounted to only three percent of PCI's total cash flow, and that Martens conducted an analysis with respect to these "intercompany" transfers).) Accordingly, the Bankruptcy Court reasoned, a reasonable juror could find that at least some of any individual investor's funds may have flowed to legitimate, non-PCI transactions, and thus provided "reasonably equivalent value" to PCI.
3. The Court Holds the First "Petters Claw Back" Jury Trial in Late 2018, in the Case of Kelley v. Boosalis ; the Jury Rules for the Trustee
Between November 26 and December 4, 2018, the undersigned presided over the first (and, to date, only) Petters claw back trial, in the case of Kelley v. Boosalis . See No. 18-cv-868 (SRN/TNL). Although the facts in that case differed in some ways from the facts here, the Trustee put on an affirmative case that largely mirrored what the Court set forth supra (albeit in a vastly more detailed fashion). For instance, Coleman provided factual testimony about PCI's fraudulent intent, and Martens provided expert testimony about how each one of the at-issue transfers directly played into the "Ponzi churn." The Trustee also put on four other witnesses, including an IRS agent, a PCI secretary, and a PCI tax accountant (the aforementioned James Wehmhoff). In his defense, Boosalis offered solely his own testimony.
Most importantly for present purposes, though, in the days before closing arguments, the Court had to resolve a legal dispute as to what the jury instruction defining "reasonably equivalent value" should say. The Trustee offered the following instruction, which the Court found to be an accurate statement of Minnesota law:
Reasonably equivalent value may be found if the value Petters Company, Inc. received from Mr. Boosalis in exchange for a payment was reasonably equivalent to the value of the payment.
Value may be reasonably equivalent where the payment made to the investor satisfies a valid antecedent debt. Any payment above the amount of the principal investment is not in satisfaction of a valid antecedent debt if it was made in furtherance of a fraud, enabled by a fraud, or paid on dishonestly-incurred debt. If you find that an interest payment made by Petters Company, Inc. to Mr. Boosalis was made in furtherance of a fraud, enabled by a fraud, or paid on dishonestly-incurred debt, then that payment does not satisfy a valid antecedentdebt, and is not for reasonably equivalent value.
(See Boosalis Doc. No. 111 at 14.)
Boosalis's counsel objected to this instruction, on grounds that it both conflicted with a recent Minnesota Supreme Court decision called Finn v. Alliance Bank ,
The Court overruled Boosalis's objection and maintained its original instruction. See Kelley v. Boosalis ,
The jury returned a verdict in favor of the Trustee. (See Boosalis Doc. No. 116 (verdict form).) Specifically, the jury found that the Trustee had proven by a preponderance of the evidence that PCI made interest payments to Boosalis with an "intent to defraud" its other creditors, and that Boosalis had not proven by a preponderance of the evidence that he had accepted any of his interest payments in "good faith" or "in exchange for a reasonably equivalent value." (Id. (the "actual fraud" claim under MUFTA).) The jury also found that the Trustee had proven its "constructive fraud" claim by a preponderance of the evidence. (See supra at 865 (listing elements).)
The jury accordingly awarded the Trustee $ 3,502,455 in damages, i.e. , the interest that Boosalis had earned from his PCI loans. The Court later increased the Trustee's award to $ 6,382,144.71, in accordance with Minnesota's prejudgment interest statute. See Kelley v. Boosalis ,
Boosalis appealed this judgment to the Eighth Circuit Court of Appeals. (See Boosalis Doc. No. 128.) In his appeal, Boosalis primarily focuses on the "reasonably equivalent value" controversy noted above. (See Boosalis App. Br. at 26-43, App. Docket No. 19-1079 (filed Apr. 9, 2019).)
Defendants' trial was scheduled to occur shortly after the conclusion of the Boosalis trial. (See Doc. No. 97.) However, in a mutually-agreed-upon attempt to resolve certain threshold legal questions that might render a trial unnecessary, and thereby save all sides time and money, the parties requested the opportunity to file dueling summary judgment motions in lieu of an immediate trial. (See Doc. No. 99.) The Court granted the parties' request, and subsequently scheduled a summary judgment hearing. (See Doc. No. 101.)
The parties submitted full briefing on the matter shortly thereafter. (See Pl.'s Br. in Support of Summ. J. [Doc. No. 109] ("Pl.'s Summ. J. Br."); Defs.' Br. in Opp. to Pl.'s Summ. J. Mot. [Doc. No. 112] ("Defs.' Opp. Br."); Pl.'s Reply Br. [Doc. No. 116]; Defs.' Summ. J. Br.; Pl.'s Opp. Br.; Defs.' Reply Br. [Doc. No. 119].) The Court carefully considered the parties' briefing, and then entertained a lengthy oral argument on March 8, 2019. (See Doc. No. 123.)
II. DISCUSSION
Summary judgment is proper if there are no disputed issues of material fact and the moving party is entitled to judgment as a matter of law. See Fed. R. Civ. P. 56(a). In considering whether to grant summary judgment, a court must not "weigh the evidence, make credibility determinations, or attempt to discern the truth of any factual issue." Thomas v. Corwin ,
Here, the parties dispute three key issues: first , whether the Trustee is entitled to summary judgment as to "actual fraud" under MUFTA, second , whether either party is entitled to summary judgment on Defendants' "reasonably equivalent value" defense to "actual fraud," and, third , whether Defendants' proposed questions about the meaning of "reasonably equivalent value" under MUFTA should be certified to the Minnesota Supreme Court. The Court will address each issue in turn.
A. Actual Fraud
1. The Law
Under MUFTA and federal bankruptcy law, a debtor's pre-bankruptcy transfer is "fraudulent," and, hence, subject to "claw back," if , at the time of the transfer, the debtor "made the transfer ... with actual intent to hinder, delay, or defraud any creditor of the debtor."
First, it can be shown through "direct proof" of fraudulent intent. Citizens State Bank Norwood Young Am. v. Brown ,
Second, it can be shown through "badges of fraud" that provide circumstantial evidence of fraudulent intent.
When "no genuine issue of material fact exists" with respect to fraudulent intent, a court may grant a party summary judgment on the issue. Citizens State Bank ,
Importantly, until 2015, Minnesota courts would "conclusively" presume fraudulent intent with respect to any pre-bankruptcy transfer made "in furtherance of a Ponzi scheme," so long as there was no dispute that a Ponzi scheme, in fact, existed. Finn ,
However, the Finn court took care to note that "a court could make a rational inference from the existence of a Ponzi scheme that a particular transfer was made with fraudulent intent," and that its ruling only precluded a party from being "relieved ... of its burden of proving-or for preventing the transferee from attempting to disprove-fraudulent intent."
2. Analysis
The Trustee is entitled to summary judgment on this issue. This is so for three reasons. First , the Trustee has provided substantial "direct proof" of PCI's intent to defraud, on a transfer-by-transfer basis, and in the manner contemplated by Judge Kishel. Second , under a "badges of fraud" analysis, the Trustee has also proven its entitlement to an inference of fraudulent intent. Third , Defendants have not set forth any evidence, beyond the speculative, from which a reasonable juror could rebut the Trustee's proof of actual fraud.
First , the testimony of Deanna Coleman directly shows that PCI intended to defraud its future (and current) creditors when it made the at-issue interest payments to Defendants. That is, Coleman's testimony shows that, from 1994 through 2008, PCI intentionally lured investors to lend it money by promising "security interests" in merchandise that did not, in fact, exist, and then intentionally kept those investors coming back by paying them interest with other investors' money (who similarly believed they were investing in "securitized" merchandise orders). (See supra at 861-62.) Because PCI applied this fraud scheme through thousands of promissory notes and security agreements, Coleman (understandably) could not testify as to PCI's intent at the exact moment of each of the 100-some transfers at issue here. However, Coleman has testified (repeatedly and consistently) that she was responsible for drafting the promissory notes, security agreements, and purchase orders that undergirded each of the at-issue transfers, and that, from 1994 onwards, "every purchase order that [an] investor received or invested in was fake." (Coleman Dep. I at 88 (emphasis added).) Indeed, all of the security agreements in the record, from 1997 onwards, contain the same fraudulent misrepresentation that Coleman would make to Papadimos when she "called him up and asked for" a loan (id. at 193-94), namely, that PCI needed Papadimos's (or his wife's) money so that PCI could "acquire rights in or use of certain merchandise," and then "resell [that merchandise] as part of [PCI's] business." (Supra at 860-61; see also Papadimos Dep. I at 84 (noting that these purchase orders and security agreements constituted an "important factor" in encouraging him to invest with PCI).)
Moreover, what Coleman asserts on a general basis, Martens (the forensic accountant) confirms on a transfer-by-transfer basis. That is, as contemplated by Judge Kishel, Martens analyzed each transfer at issue here, and, in so doing, found that PCI did exactly what Coleman claimed it did: (a) used fraudulent security agreements and promissory notes to "induce" Defendants to lend money; (b) "misdirected" Defendants' "cash infusions toward the payment of earlier investments," rather than to investments in real merchandise; and (c) paid Defendants' interest with funds provided by "the successive misdirection" of subsequent investors' cash, rather than from revenue realized as a result of real merchandise re-sales. (See supra at 863-65; accord In re Petters Co. Inc. ,
Second , to the extent PCI's intent with respect to any particular interest payment
First , in light of Coleman and White's guilty pleas, and Petters's conviction following a month-long trial, there can be no serious dispute that PCI was, in fact, conducting a Ponzi scheme at the time of the transfers, with the goal of defrauding investors. (See supra at 862; accord Finn ,
Second , in light of Martens's thorough insolvency report, there can also be no serious dispute that PCI was insolvent at least six months before Papadimos first lent PCI money in 1997, and that PCI fell deeper and deeper into insolvency as Defendants lent more and more money to the company. (See supra at 862-63; accord
Third , the undisputed evidence shows that, at the time of the interest payments, PCI's leaders were actively working to conceal critical information about the payments, and about PCI's finances more generally, from their outside creditors. (See supra at 862-63; accord In re Bayou Grp. LLC ,
Third , and finally, Defendants have provided no evidence, much less "clear evidence," that PCI had a "legitimate," non-fraudulent "purpose" in making any of the at-issue interest payments to them. Citizens State Bank ,
The Court emphasizes that it reaches this conclusion without considering the credibility of either Coleman or Martens, see Thomas ,
For these reasons, the Court finds that, with respect to each at-issue, pre-bankruptcy transfer from PCI to Defendants,
B. Reasonably Equivalent Value Defense
In light of this ruling on "actual fraud," the question now becomes whether a reasonable juror could find that Defendants have met their burden of proving that any of their loans provided PCI with a "value" "reasonably equivalent" to the interest payments they received in exchange for the loan. See
1. The Law
Before analyzing what evidence Defendants have offered in support of their burden, the Court must first address the threshold legal question of what constitutes "reasonably equivalent value" under MUFTA. As in Boosalis , this question lies at the heart of the parties' dispute.
The Court begins by noting four principles that all parties agree upon.
First , under Minnesota law, "[v]alue is given for a transfer or an obligation if, in exchange for the transfer or obligation ... an antecedent debt is ... satisfied."
Second , in the usual course of business, repaying a loan, or "antecedent debt," at a reasonable interest rate, prior to a bankruptcy, provides value to the payee because it eliminates a debt for which the payee (or their successors) otherwise would have been liable. See, e.g. , In re Duke & King Acquisition Corp. ,
Third , however, in the specific context of a Ponzi scheme, there is a long line of federal bankruptcy cases (most of which interpret materially identical state fraudulent transfer statutes) holding that the "interest," or "profits," received by a party directly investing into a Ponzi scheme are not in exchange for "value," much less "reasonably equivalent value." See, e.g. , Perkins v. Haines ,
Fourth , prior principle notwithstanding, under MUFTA, a Ponzi scheme operator's repayment of a loan (with interest) "can constitute reasonably equivalent value," if that "antecedent debt" was repaid pursuant to a "legally enforceable " contract against the scheme's operator. Finn ,
Disagreement arises, however, as to how one should interpret these four principles. In the Trustee's view (which this Court
Defendants disagree with this interpretation. In their view, Finn did reject the prior case law concerning the unenforceability of Ponzi scheme "profits," and that this Court was wrong to assume otherwise in Boosalis . (See, e.g. , Defs.' Summ. J. Br. at 11, 14.) Instead, Defendants argue, Finn stands for the proposition that any interest payments received from a Ponzi scheme operator are in exchange for "reasonably equivalent value," so long as the payments are pursuant to reasonable interest rates and in accordance with a facially legitimate promissory note, just as the payments would be in the non-Ponzi scheme context. (Id. ; see also In re Carrozzella & Richardson ,
After careful consideration of Defendants' arguments and cited legal authority, the Court re-affirms its position, and declines to reconsider its Order (and accompanying jury instruction) from Boosalis . See generally Kelley v. Boosalis ,
First , the Court cannot agree that Finn "rejected" the logic of the prior federal bankruptcy case law in toto . (See, e.g. , Defs' Reply Br. at 3-4 (arguing that Finn "rejected" the Seventh Circuit's decision in Scholes v. Lehmann ).) It is true, of course, that the Finn court found that some of those decisions went too far in "presuming" the key elements of a fraudulent transfer claim based solely on the fact that a party gave money to a Ponzi scheme operator, and in holding that "equality of distribution" constituted the sine qua non of state fraudulent transfer statutes. See, e.g. , Finn ,
However, as Judge Kishel observed, following an exhaustive examination of Finn and all of the case law upon which Finn relied, " Finn ... gives no reason to deny the continuing vitality of Scholes v. Lehmann ," and the other, equity-driven federal bankruptcy case law cited above, especially with respect to payments made "in the thick of a Ponzi scheme." In re Petters Co., Inc. ,
The Court concurs in this assessment, as it implicitly did in Boosalis , and therefore finds that the federal bankruptcy law cited above remains persuasive in the present
Second , the Court also disagrees that, as a matter of black letter contract law, a lender has a "legally enforceable" right to receive interest paid out of a Ponzi scheme, simply because they did not knowingly participate in the Ponzi scheme themselves. Finn ,
Applying these broad principles, then, and in light of the longstanding federal bankruptcy case law discussed above, the Court can only conclude that an investor who profits from a Ponzi scheme, even if an "unwitting accomplice" to fraud against a third party, does not have a contractual right to keep interest payments made as a direct result of that illegal scheme. See Scholes ,
Admittedly, the Court is reluctant to find promissory notes void, even partially, on this "public policy" basis, as "a court's power to declare a contract void for being in contravention of public policy is a very delicate and unrefined power," and "should only be exercised in cases free from doubt." Katun Corp. v. Clarke ,
Defendants' cited cases do not convince the Court that it must conclude otherwise. All of Defendants' cases involved fact patterns in which the at-issue contract was only tangentially connected to illegal or fraudulent behavior, or where a party's claim to payment could be asserted without any reference to illegal activity. See, e.g. , Booshard v. Steele Cty. ,
In a "Ponzi churn" case, by contrast, the Ponzi scheme operator's "performance" of their end of a "lending contract" only occurs because they steal money from other investors, by way of fraudulent inducement, which, in turn, encourages the counterparty to the contract (and others) to continue contributing money to the illegal scheme. Such a "lending contract" does not "merely ... tend to promote illegal or immoral purposes," it is what makes a Ponzi scheme "illegal" and 'immoral" in the first place.
For these reasons, the Court finds that the correct legal interpretation of "reasonably equivalent value" is the jury instruction it gave in Boosalis . And, there, it instructed the jury that "[v]alue may be reasonably equivalent where the payment made to the investor satisfies a valid antecedent debt," but that "any payment above the amount of the principal investment is not in satisfaction of a valid antecedent debt if it was made in furtherance of a fraud, enabled by a fraud, or paid on dishonestly-incurred debt." (Boosalis Doc. No. 111 at 14.)
2. Analysis
With the legal question settled, the application of law to fact in this case becomes relatively straightforward. That is, just as Defendants failed to adduce
Admittedly, Defendants did submit some expert testimony suggesting that the interest rates on their loans were "reasonable," given the "high risk" of "this type of financing." (Defs.' Summ. J. Br. at 6-7 (describing testimony of Matthew Polsky).) The Trustee did not address this evidence in its briefing in any substantial manner. However, the Court finds that, because Defendants failed to show that their promissory notes were in exchange for non-fraudulent business purposes, the Court need not consider the reasonableness of the interest rate attached to the notes.
The Court also acknowledges that, were there evidence that Defendants' "promissory notes" were intended to function as "general business loans" to PCI, this case might present a closer call on "reasonably equivalent value." In that scenario, a lender could perhaps argue that interest payments on their loans were in exchange for "value," in the sense that the loans were intended to be spent on employee salaries and building rent and the like, and were therefore not "directly connected" to a Ponzi scheme operator's fraud. See Kelley v. Boosalis ,
Finally, the Court acknowledges that the Bankruptcy Court denied the Trustee summary judgment on the question of "reasonably equivalent value" earlier in this litigation. (See supra at 866-67.) Upon close examination of the Bankruptcy Court's reasoning, though, it appears that the Bankruptcy Court took this action because it found that the Trustee had failed to meet its burden on the issue, as is the case in the "constructive fraud" context. (See, e.g. , Mar. 5, 2018 Bankr. Hr'g Tr. at 78.) Because this Court, unlike the Bankruptcy Court, has found that the Trustee is entitled to summary judgment on "actual fraud," and that therefore it is Defendants' burden to prove "reasonably equivalent value," the Court finds this case distinguishable from that earlier decision. See Residential Funding Co. ,
C. Certification
Defendants next argue that, in the alternative, this Court should certify the following two "unsettled" legal questions to the Minnesota Supreme Court, in lieu of a definitive ruling on "reasonably equivalent value" here:
(1) Under MUFTA, is a promissory note given in exchange for a loan legally unenforceable because the borrower operated a Ponzi scheme and employed the borrowed funds in the operation of its Ponzi scheme?
(2) Under MUFTA, does the repayment of interest that an entity is contractually required to pay under the terms of an agreement whereunder funds were borrowed constitute the repayment of antecedent debt?
Because the Court has already rejected Defendants' arguments with respect to both questions, there is no "unsettled" question of state law that the Court need certify to the Minnesota Supreme Court. However, for the sake of thoroughness, the Court will briefly review the law of certification, and will explain why, prior ruling notwithstanding, certification is still unnecessary here.
1. The Law
The Minnesota Supreme Court "may answer a question of law certified to it by a" federal District Court like this one, "if the answer may be determinative of an issue in pending litigation in the certifying court and there is no controlling appellate decision, constitutional provision, or statute of this state."
The Court finds certification unnecessary here, for three primary reasons. First, and most importantly, the Court is not "genuinely uncertain" about its interpretation of Finn , as set forth in its Boosalis Order and now again in this Order. Johnson ,
Next, although the Court acknowledged above that other cases may present "closer calls" as to the application of Finn (id. at 879-80), the Court in no way believes that the legal portion of this Order constitutes a "conjectural" interpretation of Finn in particular, or of Minnesota state law in general. Smith ,
Finally, to the extent the Court erred in its analysis, the Eighth Circuit provides a forum by which to remedy that error. (Cf. supra at 868-69 (discussing the Boosalis appeal).)
Defendants make two additional arguments to the contrary, neither of which the Court finds availing. First, Defendants suggest that, because the Fifth Circuit Court of Appeals once certified an analogous legal question involving the interpretation of Texas's fraudulent transfer act, the Court should do likewise here. See Janvey v. Golf Channel ,
For these reasons, the Court denies Defendants' motion to certify questions of law to the Minnesota Supreme Court.
D. Remaining Issues
The Court will conclude by addressing a few remaining, ancillary disputes between the parties.
First, the parties dispute various issues with respect to the Trustee's "constructive fraud" claim, such as the appropriate statute of limitations. (See, e.g. , Defs.' Summ. J. Br. at 17; Pl.'s Opp. Br. at 18-23.) However, because the Court finds for the Trustee on its "actual fraud" claim, and because the relief sought under that theory is identical to the relief sought under its "constructive fraud" claim, the Court need not resolve these issues. (Accord Mar. 8, 2019 Hr'g Tr. at 4 (Trustee's counsel: emphasizing that the damages between the "actual fraud" claim and the "constructive fraud" claim are "duplicative").)
Second, the parties also dispute whether the Trustee has sufficiently set forth a case of "personal liability" against Kanios (as opposed to liability solely against her 401(k) retirement fund). Defendants contend that, under federal law, a lawsuit against an "employee benefit plan" (like a 401(k)) must separately "establish" "personal liability" with respect to a plan's beneficiary, and that the Trustee failed to do so here. (See Defs.' Opp. Br. at 18-19 (citing
Finally, the parties dispute what amount of prejudgment interest (if any) the Court should award the Trustee. The Trustee argues that the Court should simply adhere to its analysis from Boosalis , and apply Minnesota's statutory 10% per annum prejudgment interest rate from September 10, 2010 (when the Trustee commenced this lawsuit against Defendants) to the date of final judgment. (See Pl.'s Summ. J. Br. at 30-31 (citing Kelley v. Boosalis ,
For the reasons already explained in the Boosalis Order, Minnesota law, not federal law, provides the prejudgment interest rate for this action. See Kelley v. Boosalis ,
Moreover, as the Court also noted in its Boosalis Order, far from being an unusual occurrence, "[c]ourts regularly award prejudgment interest whenever damages lawfully due are withheld, unless there are exceptional circumstances to justify the refusal," so as to both "compensate prevailing parties for the true costs of money damages incurred, and ... promote settlement and deter attempts to benefit unfairly from the inherent delays of litigation." Kelley v. Boosalis ,
III. ORDER
Based on the foregoing, and all the files, records, and proceedings herein, IT IS HEREBY ORDERED that:
1. Plaintiff's Motion for Summary Judgment [Doc. No. 108] is GRANTED ;
2. Defendants' Motion for Summary Judgment, or in the Alternative, for an Order Certifying Questions of Law to the Minnesota Supreme Court [Doc. No. 102] is DENIED ;
3. Plaintiff is accordingly entitled to recover prejudgment interest from Defendant Papadimos on the amount of $ 3,126,524.37, and from Defendant Kanios on the amount of $ 572,500.22, at the rate of 10% per annum from September 10, 2010 until final judgment is entered; and
4. Within seven days of this Order, the parties shall jointly file a calculation of the appropriate award of prejudgment interest pursuant to this Order so that the Court can enter final judgment in this matter.
5. The pending motions in limine [Doc. Nos. 48, 53, 60, 61, 62, 63, 67, 70, 73, and 76] are DENIED as moot.
Notes
In describing the background of this case, the Court will occasionally cite to testimony that certain key witnesses have given (under oath) in other Petters-related trials. Although Defendants argue that citing this testimony constitutes hearsay or is precluded by collateral estoppel (see Defs.' Br. in Opp. to Pl.'s Mot. for Summ. J. [Doc. No. 112] ("Defs.' Opp. Br.") at 14-17), the Court disagrees. The Trustee has amply demonstrated that all of the testimony cited herein could be produced "in a form that would be admissible in evidence" at trial. Target Corp. v. All Jersey Janitorial Serv., Inc. ,
Petters was, at all relevant times, PCI's sole shareholder and President. (See Pl.'s Ex. 2 [Doc. No. 110-1] ("Petters Crim. Trial Tr.") at 646-48 (Coleman).)
Defendants argue that Papadimos only received $ 2,756,054 in interest income. (See Defs.' Br. in Support of Summ. J. [Doc. No. 104] ("Defs.' Summ. J. Br.") at 6.) In support of this argument, Defendants contend that a "corrected 2006 Form 1099-INT," showed that Papadimos only received $ 63,436.83 in interest income in 2006, as opposed to the $ 370,697.87 originally reported. (See Defs.' Ex. H [Doc. No. 105-2] ("April 2008 Letter in Connection with Corrected 2006 Form 1099-INT").) However, as the Trustee pointed out at oral argument, its expert forensic account, Mr. Theodore Martens, took this corrected 1099 form into account when calculating the amount of interest Papadimos received from PCI. Defendants' counsel did not attempt to rebut this interpretation of Mr. Martens's accounting at any point during the hearing, and the Court cannot find any evidence in the record that would have allowed them to do so. As such, there is no genuine dispute as to the amount of interest Papadimos earned as a result of his transactions with PCI.
As mentioned above, a few of the promissory notes Defendants signed with PCI did not contain a security agreement making any kind of representation as to how Defendants' loan would be spent. However, not only did these few non-securitized loans exclusively occur near the tail end of Defendants' business relationship with PCI (see, e.g. , Defs.' Ex. N [Doc. No. 105-2] ("2005 Loan Documentation")), but there is no evidence that either Defendant changed their interpretation of what they were investing in because of this slight change in documentation. (See, e.g. , Papadimos Dep. II at 91 (admitting that he did not even recall that "at some point ... no security agreements were provided with the promissory note").)
For context, from 1996 to 2008, PCI entered into 3,800 promissory note transactions with 153 "private," or "small," investors, many of whom were similarly situated to Defendants. (See Pl.'s Ex. 17 [Doc. No. 110-2] ("2010 PriceWaterhouseCoopers Interim Global Report") ¶ 124.) Although PCI moved away from these private investors and toward "large investment funds" in the early 2000s (id. ¶ 134), Ms. Coleman nonetheless testified that private investors like Defendants were essential to PCI's scheme because traditional banking was "very hard" for PCI. (See Coleman Dep. I at 233.)
Although Petters steadfastly maintained his innocence during both his trial and direct appeal (neither of which succeeded), at a subsequent habeas proceeding in 2013, Petters admitted that he had "help[ed] orchestrate a fraud" with PCI since the early 1990s, that he "knew" PCI had been "robbing Peter to pay Paul," and that he committed all of this misconduct "intentionally." (Pl.'s Ex. 8 [Doc. No. 110-1] ("Petters 2013 Habeas Hr'g Tr.") at 31, 38, 76.)
In October 2010, Wehmhoff also pled guilty to two criminal charges: "conspiracy to defraud the United States," and "aiding and assisting in filing of false tax returns." (See Pl.'s Ex. 12 [Doc. No. 110-1] ("Wehmhoff Criminal Judgment").)
By contrast, Martens separately analyzed Petters Group Worldwide ("PGW"), a different Petters entity that owned companies such as "Fingerhut," "RedTag," and "Polaroid," all of which conducted some modicum of "real business." (Id. ¶¶ 28, 32, 35.) Although Martens found that the "vast majority of [these PGW] businesses lost money and accumulated significant deficit balances" (id. ¶ 28), he acknowledged that, unlike PCI, PGW was not a complete fraud from the outset, and accordingly did not become irreparably insolvent until December 31, 2002. (See id. ¶ 9.)
One of the entities Petters owned, Polaroid, entered bankruptcy in a separate proceeding and with a separate Trustee (John R. Stoebner). See In re Petters Co., Inc. ,
At this point, Chief Bankruptcy Judge Kathleen H. Sanberg.
Based on the Bankruptcy Court's questioning, it also appears that, in divining the meaning of "value" in the Ponzi scheme context, the Court relied on a Colorado Court of Appeals decision holding that an (otherwise reasonable) loan to a firm engaged in a Ponzi Scheme could provide "reasonably equivalent value" to the firm based solely on the "time value of money." (See, e.g. , Bankr. Hr'g Tr. at 29.) However, a few months after the hearing, the Colorado Supreme Court overruled the Court of Appeals, and noted that the lower court's understanding of "reasonably equivalent value" conflicted with "the majority view in the federal courts," which focuses on whether an investor's "profits" stemmed "from an actual business venture," or whether they "merely" "deplet[ed] the debtor's assets under the guise of a profitable business." Lewis v. Taylor ,
As of May 20, 2019, it appears that five Petters claw back proceedings remain pending before the District Court (excluding this case and the Boosalis case discussed infra ). Two of these cases, Kelley v. Charap and Kelley v. Johnson , are set for trial later this year. (See Kelley v. Charap , No. 18-cv-687 (DSD/DTS) (trial set for Sept. 17, 2019); Kelley v. Johnson , No. 18-cv-895 (DSD/DTS) (trial set for June 3, 2019).) The remaining three cases are not currently set for trial. (See Kelley v. Dovolis , No. 19-cv-501 (DSD/SER); Kelley v. Westford Special Situations Master Fund, LP , No. 19-cv-1073 (ECT); Kelley v. Hofer , No. 18-cv-853 (NEB/DTS).)
Moreover, based on the parties' briefing and the Court's review of the docket, it appears that at least ten other Petters claw back proceedings remain pending before the Bankruptcy Court, and may ultimately be transferred to the District Court, too. (Compare Defs.' Summ. J. Br. at 24 with Pl.'s Br. in Opp. to Summ. J. [Doc. No. 114] ("Pl.'s Opp. Br.") at 16 n.7.)
Boosalis also appealed this Court's rulings as to the existence of a predicate creditor, the meaning of "good faith" under MUFTA, and the proprietary of awarding prejudgment interest.
This conclusion appeared to flow from the Supreme Court's observation that Ponzi schemes can take "a multitude of different forms," and that, consequently, "not every Ponzi scheme lacks a legitimate source of earnings." Id. at 646, 652 ; see also id. at 649 (noting that "it is not hard to imagine a debtor that begins as a legitimate business and eventually turns to fraud," or who has "assets or legitimate business operations aside from the Ponzi scheme"). For instance, in Finn , the at-issue debtor arguably lacked fraudulent intent when making at least one of the pre-bankruptcy interest payments sought to be clawed back, because the payments indisputably came from a legitimate business transaction, not from the "Ponzi churn." See id. at 643, 655.
In fact, in neither their opposition brief nor at oral argument did Defendants attempt to rebut any of this direct evidence, other than to cursorily suggest that a jury might not believe Coleman or Martens's testimony. (See, e.g. , Mar. 8, 2019 Hr'g Tr. at 47 (noting that Coleman is a "convicted" "fraudster").) Under the circumstances, this kind of vague credibility argument is not enough to create a "genuine" dispute of material fact. Ingrassia ,
Martens's analysis accords with Finn 's holding that insolvency cannot be presumed merely by the existence of a Ponzi scheme. See Finn ,
The Court acknowledges that, in the standard issue fraudulent conveyance action, the transfer itself is being "concealed" from other creditors, and that that was not the case here. (See Defs.' Opp. Br. at 6-7 (noting that "many of the transfers were recorded with the Secretary of State of Minnesota by way of UCC filings").) However, given the flexibility of the "badges of fraud" analysis, the Court nonetheless finds that PCI's widespread concealment of important financial information constitutes a compelling "badge of fraud."
It is undisputed that the Trustee has identified a "predicate creditor" under
The Trustee has stipulated, for purposes of this motion, that Defendants transacted with PCI "in good faith," and could thus prove the other element of the statutory defense to "actual fraud." (See Pl.'s Summ. J. Br. at 27.)
Although not relevant here, the Court notes that this theory of liability focuses on individuals who invest into the Ponzi churn itself; it may not apply to parties who provide "consumable goods or services" to a Ponzi scheme operator prior to their bankruptcy. See, e.g. , Janvey v. Golf Channel, Inc. ,
What's more, Finn in no way suggested that it was adopting the minority federal court view, in which interest payments made pursuant to a Ponzi scheme are enforceable, and hence not subject to claw back, so long as the payments were made pursuant to a facially legitimate promissory note, and at a reasonable interest rate. (See supra at 876 (citing In re Carrozzella & Richardson and In re Unified Commercial Capital ).) Not only are these cases clear "outliers" among judicial authorities, see, e.g. , Silverman v. Cullin ,
Although Defendants repeatedly imply that this Court's decision and the Judge Kishel "effect of Finn " decision are at odds (see, e.g. , Defs.' Reply Br. at 12), that is not the case. True, Judge Kishel declined "to reach the theory of unenforceability as a matter of public policy" (which the Court relied on above), on grounds that "unenforceability" could be determined solely by reference to law holding that contracts "fraudulently induced" are "voidable." See In re Petters Co., Inc. ,
What's more, the Court finds that any differences between its analysis and Judge Kishel's analysis are largely semantic, and that, at root, the decisions reach virtually identical conclusions regarding how best to interpret Finn in the context of a Ponzi scheme like the one at bar.