A "Ponzi scheme," made famous by Charles Ponzi and his fraudulent postage speculation in the 1920s, is little more than an arrangement in which a fraudster pays returns to investors from monies obtained from later investors rather than from any real "profits" of an underlying business venture. Eventually these purported profits dry up, the Ponzi scheme is exposed, and more often than not the perpetrator and its business entities find themselves in bankruptcy or receivership proceedings.
Unravelling a Ponzi scheme once it has come to an end is a complicated affair that gives rise to a myriad of legal issues and considerations as bankruptcy trustees or receivers attempt to recover assets for the benefit of the victims of the scheme. The best means of maximizing asset recovery in a Ponzi scheme is for the trustee or receiver to try to "claw back" as much money as possible from "net winners" (those investors that have profited from the scheme) for the benefit of "net losers" (those investors that received less than their original investment).
Although clawback proceedings have received significant judicial consideration in the United States, there is surprisingly little Canadian jurisprudence on this topic. In Canada, trustees and receivers have utilized provincial fraudulent preference legislation for the return of funds given by the Ponzi debtor to net winners. Although preference legislation varies from province to province, in general four elements must be established to void a transaction: (1) a transfer of property must have been made; (2) by an insolvent person or a person who is on the eve of insolvency; (3) to a creditor; (4) with the intent of giving that creditor a preference. Titan Investments Ltd. Partnership (Re)  A.J. No. 1041 is the most comprehensive Canadian case to date concerning clawback proceedings. In Titan, the court found that the receiver appointed over a Ponzi debtor's estate had met the requisite elements of the Alberta Fraudulent Preferences Act to set aside transactions made to net winners. With regard to the insolvency requirement, the court adopted the American principle that Ponzi schemes are inherently insolvent from their inception. In addition, the court considered and found that investors fell within the statutory definition of "creditor" and that the fraudster intended to prefer those investors that he paid out. Accordingly, the net winners were ordered to return all distributions received from the Ponzi scheme.
Trustees in bankruptcy can also consider utilizing the legislative framework of sections 95 and 96 of the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, to challenge transactions that are preferences or transfers at undervalue that diminish the money available for distribution to creditors of the estate. Although these sections have not been applied in Canadian Ponzi cases, similar sections of the U.S. Bankruptcy Code, 11 U.S.C. have been utilized successfully in clawback proceedings in the United States.
Trustees and receivers can also consider bringing a claim in unjust enrichment against net winners. In Den Haag Capital, LLC v. Correia  O.J. No. 4316, the court set aside the impugned transactions as fraudulent preferences pursuant to the Ontario Assignment and Preferences Act, but noted in obiter that an unjust enrichment claim could succeed (although the court did not set out an analysis on each element of the claim).
While litigation is underway, bankruptcy trustees and receivers should consider utilizing prejudgment remedies such as certificates of pending litigation and injunctions to preserve assets pending the final outcome of the litigation.
At the end of a Ponzi proceeding, the trustee or receiver will be tasked with distributing the assets recovered. The claims allowance and distribution process gives rise to various issues, such as how to value the amount of a net loser's loss, trust claims, taxes paid on fictitious return and the appropriate distribution scheme to use at the end.
A bankruptcy trustee or receiver's asset-recovery efforts may also be impacted by parallel proceedings such as criminal proceedings, securities commission hearings, class action suits and independent civil actions. In such situations, it is important for the trustee or receiver to work co-operatively with the parties in these parallel proceedings to maximize value to creditors. For example, a trustee may consider working with class action counsel to run a single claims process to avoid duplication of effort and wasted resources.
Ponzi schemes unfortunately continue to flourish, and ultimately the goal of utilizing insolvency proceedings to administer a Ponzi estate is to compensate victims of the fraud. As the law in Canada continues to develop in this area, professionals involved with unravelling these schemes should consider use of clawback proceedings to maximize asset recovery to net losers.
Originally published by Lawyers Weekly.
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