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Utah Court Did Not Allow a Creditor to Retain the Funds He Invested With a Non-Debtor in a Ponzi Scheme, Even When the Non-Debtor was Operating the Debtor’s Ponzi Scheme

Gillman v. Russell (In re Twin Peaks Fin. Servs.) No. 2:15-cv-00167-DN, 2016 U.S. Dist. LEXIS 73550 (D. Utah June 6, 2016)

Debtor Twin Peaks Financial Services, Inc. and MNK Investments, a real estate development company was allegedly operated by Kenneth C. Tebbs. Defendant Christopher Russell was introduced to Tebbs who represented himself as the owner and principal of the Debtor. In reality, Tebbs operated the Debtor as a Ponzi scheme. In reliance on Tebbs’ representations and assurances, Russell provided a significant amount of short term financing to the Debtor and/or Tebb and also received returns from the Debtor later on. The Defendant provided transfers to the Debtor totaling $520,000.00.

In return for the $520,000.00 total investment, Russell was paid a total of $961,008.97 by the Debtor, thus allowing him to receive $441,008.97 more than he had invested with the Debtor. A year later, involuntary Chapter 11 petitions were filed and the Court entered an order for substantively consolidation all of the Debtor’s cases. However, Tebbs case was not consolidated with the Debtor’s other cases. The Trustee brought an adversary proceeding against Russell alleging that the funds Russell received were fraudulent transfers pursuant to Sec. 548. The Bankruptcy Court ruled that the excess of funds specifically deposited directly into the Debtor’s account (totaling $441,008.97) constituted Ponzi scheme profits and were therefore avoidable as fraudulent transfers.

Russell argued that the transfers were not made with the subjective intent to hinder, delay, and defraud creditors; that the Debtor was part of Tebb’s fraudulent scheme and that Russell had a fraud claim against the Debtor and all payments that he received from the Debtor was received for value under §548(c); that the bankruptcy court erred in only considering what he invested with the Debtor and disregarded his investments with Tebbs which totaled $1,725,635.48; and finally by separating and isolating the Debtor from the broader Ponzi scheme, the bankruptcy court ignored the underlying public policy that allows for clawbacks.

The District Court concluded that the bankruptcy court did not err when it found that Russell received funds in excess of his undertaking. The Court pointed out that Section 548(c) specifically limits the affirmative defense to the value given to the debtor. In the present case, the Debtor was Twin Peaks Financial Services, Inc. and MNK Investments. Although Russell invested with Tebbs in amount of $1,725,635.48 (apart from the amount he gave to the Debtor), this amount cannot be considered as principal investment with the Debtor as Tebbs had his own bankruptcy case which was not substantially consolidated into the Debtor’s bankruptcy case. The fact that Tebb’s fraudulent scheme may have extended beyond the Debtor’s business operations did not automatically permit the Court to ignore Tebbs’s and the Debtor’s separateness. The District Court also affirmed the determination of the lower court that the transfers were not given in exchange for satisfaction of the Defendant’s alleged fraud claim. The Court said that the transfers were made pursuant to certain investment contracts promoted by the Debtor and not in exchange for satisfaction of his alleged fraud claim.

The Court concluded that although Russell lost a significant amount of money through his investments with the Debtor and non-Debtor parties, Russell cannot be given credit for the value that he provided to the third parties, because if he is allowed to keep the money he received from the Debtor in excess of his investments with the Debtor, then the money invested by other investors in the Debtor’s Ponzi scheme will be used to compensate Russell for investment losses that he suffered with investments which he made with other entities that never benefitted the Debtor. This will be against the public policy behind clawback. The District Court affirmed the ruling of the Bankruptcy Court in its entirety and ordered Russell to remit $441,008.97 as those were fraudulent transfers pursuant to 11 U.S.C. § 548.