National Realty Investment Advisors LLC
Honorable John K. Sherwood
United States Bankruptcy Court
INTRODUCTION
The Liquidation Trustee (“Trustee“) won a $4,605,112.16 judgment against Media Effective, LLC and its owner and sole employee, Javier Torres (collectively “Claimants“), based on amounts paid to Claimants for media services that were provided to National Reality Investment Advisors and its affiliates (“NRIA“). [Adv. Pro. 23-01335]. Though the Trustee‘s Amended Complaint alleged nine counts against Claimants, this Court‘s Decision and Final Judgment against Claimants only held them liable for actual fraudulent transfers under
Once the fraudulently transferred property is returned to the trustee,
“Section 502(h) is based upon the principle of fraudulent transfer law that the return of a fraudulent transfer restores the parties to the status quo.” In re Dreier LLP, 2012 Bankr. LEXIS 4799, *9 (Bankr. S.D.N.Y. 2012) (citing In re Best Prods. Co., 168 B.R. 35, 57-58 (Bankr. S.D.N.Y. 1994)). Therefore,
if the recipient of a fraudulent transfer paid $10 for property worth $1,000, the recovery of the property by the bankruptcy estate under § 550 would result in a claim under§ 502(h) of only $10.
In re Solidarity Contr., LLC, 2019 Bankr. LEXIS 3572, *8 (Bankr. S.D. Tex. 2019).
This is a good illustration of how
In the Trustee‘s claim objection, the first contention is that the claim is not valid because Claimants provided no value to NRIA in excess of the amounts already paid. Moreover, the services that were provided to NRIA had no purpose other than perpetuating NRIA‘s Ponzi scheme. [ECF No. 4093, p. 15 of 18]. In response, Claimants argue that the trial in the adversary proceeding already decided the value of the claim, and any attempt by the Trustee to dispute the value is barred by collateral estoppel. [ECF No. 4103-1, p. 16; ECF No. 4111, p. 2]. Claimants also assert that claims under
The Trustee‘s second argument is that the equities of the case favor disallowing the claim, and even if it is allowed, the claim should be equitably subordinated under
It is important to understand that if allowed, Claimants would have a Class 4 general unsecured claim, which would be unimpaired and paid in full under the Plan prior to defrauded investor claims in Class 5. [ECF No. 3599, p. 7 of 202]. The claims held by the defrauded investors are categorized in Class 5 which is an impaired class under the Plan and are unlikely to be paid in full. [Id. at p. 69]. Below investor claims are Class 6 JVA Claims and Class 7 Subordinated Claims which will probably receive no recovery under the Plan. [Id.]. JVA Claims are impaired claims arising from a Joint Venture Agreement executed between NRIA and another claimant. [Id. at p. 61]. A Subordinated Claim is a non-investor general unsecured claim or investor claim that is subordinated under
JURISDICTION
This Court has jurisdiction over this matter pursuant to
FACTS AND PROCEDURAL HISTORY
On October 11, 2024, this Court found that Claimants were liable to the Trust for $4,605,683.84—the profits that Claimants received from NRIA from April 2021 onward, when Claimants were on inquiry notice that NRIA was a Ponzi scheme. [Adv. Pro. ECF No. 91, p. 30]. The Court also found that profits after October 2021 were not warranted because “NRIA was paying Media Effective far more than what was being disclosed by Mr. Torres.” [Id. at 29]. On the
The Court addressed Claimants’ affirmative defense contained in
The Court also briefly addressed the Trustee‘s constructive fraud claim under
Claimants now allege that they are entitled to an unsecured claim of $3,147,629 under
LEGAL ANALYSIS
I. Whether Litigating the Value of the Claim is Collaterally Estopped
The Trustee argues that the Claimants did not provide $3.1 million of value to NRIA entitling them to a claim. Claimants say that the Trustee failed in the adversary proceeding to prove that Claimants were charging excessive rates for advertising before October 2021. Thus, its objection to the claim, to the extent it is based on value, is barred by collateral estoppel. “Issue preclusion, or collateral estoppel, bars re-litigation of issues previously adjudicated in a separate action. Issue preclusion applies when four conditions are satisfied: ‘(1) the issue sought to be precluded is the same as that involved in the prior action; (2) that issue was actually litigated; (3) it was determined by a final and valid judgment; and (4) the determination was essential to the prior judgment.‘” Brown v. Nash, 247 Fed. Appx. 406, 408 (3d Cir. 2007) (quoting Burlington N. R.R. v. Hyundai Merchant Marine Co., 63 F.3d 1227, 1231-32 (3d Cir. 1995)).
The Court disagrees with Claimants’ argument that the value of the services provided to NRIA was determined by a final and valid judgment and that it was essential to the prior decision. As stated above, value was discussed in two contexts within the Decision, (1) Claimants’ good faith and for value defense under
Similarly, when discussing the value component of the Trustee‘s constructive fraud claim (the Trustee‘s burden), the Court found that the evidence suggested “NRIA was being overcharged by a lot.” [Adv. Pro. ECF No. 91, p. 32]. The Court did not make a finding of value for the constructive fraud claim because it believed that the damages it awarded under the actual fraud count were sufficient. Thus, while the issue of value was actually litigated, it was not decided by the Court, and it was not essential to the prior judgment. The Court is therefore not precluded by collateral estoppel from determining the value of Claimants’ services to NRIA.
A subsequent hearing to determine the value of the claim may be necessary. The Court notes that there is divergent authority discussing whether a party can ever provide value to a Ponzi scheme.2 But a
II. Whether the Trustee Can Equitably Subordinate the Claim
The Trustee also asserts that even if the Court denies its objection to Claimants’ claim, it should be equitably subordinated. In opposition to the Trustee‘s equitable subordination arguments, Claimants directed the Court‘s attention to In re Bernard L. Madoff Inv. Sec. LLC, 515 B.R. 117, 160-61 (Bankr. S.D.N.Y. 2014). This case involved a liquidation trustee‘s complaint against defendants that were feeder funds that invested in a Ponzi scheme. Id. at 124. The liquidation trustee‘s complaint sought to recover fraudulent transfers to the funds and to disallow and/or subordinate defendants’ claims. In response to the liquidation trustee‘s equitable subordination claims, the defendants argued that if the trustee recovered on the fraudulent transfer claims, they would be entitled to assert a claim under
Madoff is distinguishable due to the unique facts of this case. The New York Bankruptcy Court dealt with equitable subordination in the hypothetical. At that point in the litigation, the fraudulent transfer claims had not been decided and the transfer had not been returned. Here, the Court is presented with an actual
In re DVI, Inc., 326 B.R. 301, 310 (Bankr. D. Del. 2005) supports the idea that an estate representative can pursue fraudulent conveyance/preference actions together with equitable subordination. Though this case did not involve a
There is no Bankruptcy Code provision or binding case law that would preclude the Committee from pursuing equitable subordination of the defendants’ claims in order to obtain complete relief on its
preference and fraudulent transfer claims. . . . “If a complete remedy is to be provided for creditors harmed (beyond the loss resulting from the preference) by the preferred creditor‘s fraudulent or inequitable conduct, the guilty creditor‘s remaining unsecured claim also must be subject to subordination under section 510(c).”
Id. at 310-311 (emphasis added); (quoting Ponoroff & Snyder, Commercial Bankruptcy Litigation, § 10:46 (2004) (noting that “equitable subordination may operate in tandem with the trustee‘s power to set aside fraudulent transfers in situations where the court determines that the creditor should be deprived of any remedy against the estate“); then citing In re Missionary Baptist Found. of Am., 818 F.2d 1135, 1147 (5th Cir. 1987) (finding that some courts have ordered subordination even though a claim was voidable as a preference or a fraudulent conveyance); see In re Clark Pipe & Supply Co., 870 F.2d 1022, 1031 (5th Cir. 1989) (holding that setting aside a preference and equitably subordinating a claim are not duplicative remedies and can be used in concert to achieve a complete remedy for fraudulent or inequitable conduct).3 The Court agrees that nothing in the Code precludes it from considering equitable subordination with respect to a claim under
Equitable subordination requires the Court to consider three elements: “(1) the claimant must have engaged in some type of inequitable conduct, (2) the misconduct must have resulted in injury to the creditors or conferred an unfair advantage on the claimant, and (3) equitable subordination of the claim must not be inconsistent with the provisions of the bankruptcy code.” Citicorp Venture Capital v. Committee of Creditors Holding Unsecured Claims, 160 F.3d 982, 986-987 (3d Cir. 1998).
Assessing the three factors, the Court finds that Claimants did engage in inequitable conduct by turning a blind eye to NRIA‘s fraud and receiving millions of dollars in fees for services that ultimately perpetuated the Ponzi scheme by securing additional investors. The Court found “no evidence in the record that Mr. Torres ever confronted Mr. Salzano (NRIA‘s principal) on the guaranteed return rates or did his own investigation on how NRIA could guarantee a rate of return when he knew that no one does that,” and that it was Mr. Torres’ duty “to do more than bury his head in the sand when legitimate concerns were raised about the content of NRIA‘s ads” by the media outlets. [Adv. Pro. ECF No. 91, p. 15]. As early as November 2019, the Court found that when media outlets expressed concern during their screening process over the content of NRIA‘s ads, Mr. Torres reassured Mr. Salzano that “there [wa]s a way to go around th[e] screening and it[ was] to buy by markets instead of nationally.” [Adv. Pro. ECF No. 91, p. 11 of 39]. The Court provided other examples where Mr. Torres was suggesting workarounds to media outlet concerns about NRIA‘s guaranteed returns in its ads so that they could be aired to induce additional investors. [Id.]. Moreover, in finding that Claimants were on inquiry notice of NRIA‘s fraud, the Court observed that “[h]ad Mr. Torres
As for the services provided by Claimants, their role was “simply that of a middleman” [Id. at 3], for which they received an average of 36% commission between 2016 and 2022. [Id. at 19]. Claimants’ conduct and large profits undoubtably resulted in injury to other creditors because Claimants were being paid with money that, because of the nature of the Ponzi scheme, was investor money, and which plunged NRIA deeper into insolvency. Further, Claimants’ services helped to perpetuate the Ponzi scheme by attracting additional investors with the advertising space that Claimants secured for NRIA. NRIA was Media Effective‘s only client from 2012 to 2022 and transferred approximately $36 million to Claimants for media services. [Adv. Pro. ECF No. 91, p. 7]. The profits retained by Claimants on account of these transfers were substantial, as indicated by Claimants’ own statement that when Javier Torres paid the $4,985,820.95 judgment, it was equal to nearly half of Mr. Torres’ entire net worth. [ECF No. 4103, p. 12]. This means that Mr. Torres’ current net worth is approximately $5 million, substantially all of which is due to his dealings with NRIA. Equitable subordination is not inconsistent with any provision of the Code because as stated above, equitable subordination can be used in conjunction with recovery in a fraudulent transfer action to provide a “complete remedy.” See In re DVI, Inc., 326 B.R. at 310-11.
While some cases hold that a hearing on equitable subordination must proceed in the form of an adversary proceeding, the Court does not believe that anything in the Code or the Rules prohibits the Court from deciding equitable subordination, as long as the parties are given notice, a hearing, and adequate procedural protections. In re French Quarter, Inc., No. 3:11-CV-00560-ECR, 2012 WL 1079564, at *8 (D. Nev. Mar. 30, 2012) (citing In re Graves, 279 B.R. 266, 274 (B.A.P. 9th Cir. 2002)). Given the extensive record here, the Court stated at the March 4, 2025 hearing that it might decide equitable subordination based on the supplemental briefs that the parties submitted and neither party objected. [ECF No. 4118, p. 27 of 29]. The Court is satisfied that the requirement for notice and a hearing in
The Court finds it appropriate to subordinate Claimants to Class 7 under the Plan, as intended by the Trustee. [ECF No. 4093, p. 16, n. 6]. As stated previously, allowing Claimants the full value of their claim under Class 4 would mean that Claimants would be paid in full prior to the defrauded investors. Also important to these considerations is the fact that the Court‘s decision in the adversary proceeding attempted to effectuate justice by stripping Claimants of $4,605,683.84, equal to the profits that Claimants received from NRIA from April 2021 onward, at which point Claimants were on inquiry notice that NRIA was a Ponzi scheme. [Adv. Pro. ECF No. 91, p. 30]. Allowing Claimants to be paid these profits in full prior to the investors receiving a return of the principal invested in the Ponzi scheme under
CONCLUSION
For the reasons set forth above, the Court will equitably subordinate Claimants’ claim to Class 7 under NRIA‘s Plan. Claimants’ right to a hearing on the value of their claim in Class 7 and the Trustee‘s objections are preserved based on the Court‘s determination that this issue is not barred by collateral estoppel.