Opinion
Case No. 1:03CV54DAK
November 7, 2003
MEMORANDUM DECISION AND ORDER
This matter is before the court on Defendant's Motion to Dismiss, A hearing on the motion was held on November 3, 2003. At the hearing, Defendant was represented by Kenneth B. Black and Plaintiff was represented by David Eckersley. The court took the matter under advisement. The court has considered carefully the memoranda submitted by the parties as well as the law and facts relating to the motion. Now being fully advised, the court renders the following Memorandum Decision and Order.
Defendant Jeffrey S. Yager moves to dismiss the Plaintiff's Complaint, which alleges claims for fraudulent conveyance, unjust enrichment, and disgorgement. Plaintiff Robert Wing brings this action in his capacity as Receiver for 4NExchange. Wing was appointed by this court as the Receiver for 4NExchange in another pending action before this court, SEC v. 4NExchange, et al., civil no. 2:02CV431 DAK. Yager was an investor in 4NExchange who made a profit of approximately $103,000. The Receiver seeks a return of these profits. The Complaint makes no allegation nor does the Receiver suggest that Yager knew that 4NExchange was a Ponzi scheme or that he knew of or committed any wrongdoing.
1) Fraudulent transfer claim
The parties agree that the Receiver's claims are governed by Utah state law. Therefore, in order to determine whether the transfer of profits from 4NExchange to Yager was a fraudulent transfer, this court must apply Utah's Fraudulent Transfer Act. Under Utah's fraudulent transfer statute, the elements of a claim are as follows:
(1) a transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor's claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation:
(a) with actual intent to hinder, delay, or defraud any creditor of the debtor; or
(b) without receiving a reasonably equivalent value in exchange for the transfer or obligation; and the debtor:
(i) was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or
(ii) intended to incur, or believed or reasonably should have believed that he would incur, debts beyond his ability to pay as they became due.
Utah Code Ann. $ 25-6-5 (2002).
Neither party claims that there is controlling Utah case law applying this statute. Yager argues that there is another federal district court case directly on point, Johnson v. Studholme, 619 F. Supp. 1347 (D. Colo. 1985), aff'd sub nom, 833 F.2d 908 (10th Cir. 1987), in which the court ruled that an appointed receiver for a "Ponzi" scheme cannot recover amounts paid to fund investors where there is no allegation that such investors committed fraud or participated in the scheme.
In Johnson, the court determined that the Receiver stands in the shoes of the company and is subject to all the defenses that could be asserted against it. Id. at 1349. The Johnson court found that the company did not overpay investors to defraud creditors, but instead to maintain and perpetuate the fund. Id. Even if the scheme was illegal, the court determined that "there is no doubt that the innocent investors gave value." Id. Because the Receiver represented the company and not the individual investors, the court held that the Receiver could not advance equitable theories or any claim against an investor who received a profit and dismissed the case. Id. 1349-50.
The Receiver, however, argues that Johnson is not on point because the court was applying Colorado state law which, at that time, did not have a fraudulent transfer statute. The Receiver argues that federal bankruptcy decisions construing Section 548 of the Bankruptcy Code are more instructive in this case because of that sections's similarity to Utah's Fraudulent Transfer Act. To the extent that the court looks to these cases for guidance, the Receiver argues that the more analogous case is a Ponzi scheme case in which the trustee in bankruptcy sued a defendant for insider preferences and constructive fraudulent transfers under the Bankruptcy Code, Sender v. Buchanan, 84 F.3d 1286 (10th Cir. 1996). In Sender, the Tenth Circuit found that the defendant had no claim against the Ponzi scheme for damages in excess of her original investment and that the Ponzi scheme did not receive reasonably equivalent value for its payments to her. Id. at 1290. The Sender court concluded that the transfers to the defendant for the year prior to bankruptcy were fraudulent transfers under Section 548(a) of the Bankruptcy Code. Id.
The Johnson court distinguished bankruptcy cases because "[i]ts specific provisions function within the context of an intricate legislative system of laws designed carefully to meet the policy objectives of the Congress." 619 F. Supp. at 1349. In Sender, the Tenth Circuit reiterated that there is a distinction between a case brought pursuant to a receivership and one brought by a trustee in bankruptcy. The Sender court stated that "[t]he case sub judice does not implicate the law of receivership, and nothing we say herein should be construed as applicable to that area of law."
This court agrees that bankruptcy cases are not directly on point because much of the regulatory framework and policy considerations contained in the Bankruptcy Code may not be applicable in an equitable receivership context. Nonetheless, some of the reasoning in these cases is instructive to a determination of what constitutes reasonably equivalent value and whether a transfer was made with an intent to defraud.
Under the Utah Fraudulent Transfer Act, which the parties agree governs this claim, the Receiver argues that the payments to Yager in excess of his investments were made with the actual intent to hinder, delay or defraud and 4NExchange did not receive reasonably equivalent value. Yager argues that the transfer was not made with an intent to defraud but, under the reasoning of Johnson, was made to perpetuate and maintain the fund.
Courts have found that an intent to hinder, delay, or defraud is established by the mere existence of the Ponzi scheme. Merrill v. Abbott, 77 B.R. 843, 860 (D. Utah 1987) (en banc). Innocent investors, whose money is being used to pay earlier investors rather than being invested, must be considered creditors of the company. "Because a Ponzi scheme is, by definition, unable to repay all its creditors, any transfer from the scheme to a creditor is necessarily made with the intent to hinder the rights of some other creditor." Missal v. Washington, 1998 U.S. Dist. LEXIS 6016, *7 (D. D.C. 1998) (quoting In re Agricultural Research Technology Group, Inc., 916 F.2d 528, 535 (9th Cir. 1990)). Whether this determination is made in the context of a bankruptcy or receivership case, the court sees no distinction.
The Johnson court's determination that the transfer of profits was made in order to perpetuate the fund does not persuade this court that such transfer was not fraudulent. In the case of 4NExchange, a perpetuation of the fund was impossible because it was a classic Ponzi scheme. Therefore, the transfer merely perpetuated the fraud. This court concludes that 4NExchange's transfer of profits to Yager was with an intent to defraud, hinder or delay other investors in the company.
Second, the Receiver argues that for the amount of profits paid to Yager, 4NExchange did not receive reasonably equivalent value. Courts have held that investors in a Ponzi scheme do not give value, but merely provide "grist for the fraud." Missal, 1998 U.S. Dist. LEXIS 6016, at *10. Also, Independent Clearing House, 41 B.R. 985 (Bankr. D. Utah 1984), cites several cases for the proposition that an investor who receives more than he put into a Ponzi scheme has not given equivalent value for the amount exceeding his investment. Id. at 1008-09. The court stated, "It is apparent that the few courts which have considered the question are unanimous in requiring the transferee to disgorge his `Ponzi' scheme profits, These opinions are well grounded in reason, clear and persuasive." Id. at 1009.
In the appeal of Independent Clearing House, the district court concluded that "the debtors received a `reasonably equivalent value' in exchange for all transfers to a defendant that did not exceed the defendant's principal undertaking but, to the extent a defendant received more than he gave the debtors, the debtors did not receive a reasonably equivalent value." Merrill v. Abbott, 77 B.R. 843, 857 (D. Utah 1987) (en banc).
Yager argues that he gave value to 4NExchange in that by making the investment he, like the other investors, took the risk that all or part of his investments would be lost. Although this risk could be consideration for the amount of profits Yager received, the court cannot conclude that such risk constituted reasonably equivalent value as a matter of law. Therefore, the court concludes that Defendant's motion to dismiss the fraudulent transfer claim is denied.
2) Unjust Enrichment and Disgorgement
Yager also asserts that the Receiver for 4NExchange is not in a position to assert equitable claims. The parties dispute whether Utah law allows the Receiver to recover profits made by other innocent investors for distribution to other investors who lost all or most of their investments. There is conflicting law regarding whether a Receiver stands in the same position as the entity. Compare Scholes v. Lehman, 56 F.3d 750, 754 (7th Cir. 1995) with Johnson, 619 F. Supp. at 1349.
However, unlike the receiver in Johnson, the Receiver in this case has been appointed by the court to marshal and preserve assets for the benefit of 4NExchange's creditors and investors. The court does not believe that its appointment of a Receiver for the benefit of investors defrauded by the company is at odds with Utah law on receivership. Because the Receiver was appointed for the benefit of any creditors or defrauded investors, he is in a position to assert equitable claims. The fact that investors have initiated a class action against Donald Storms in state court does not preclude the Receiver from representation of the defrauded investors interests in the federal action.
Under Utah law, there are three elements necessary to state a claim for unjust enrichment: (1) there must be a benefit conferred on one person by another; (2) the conferee must appreciate or have knowledge of the benefit; and (3) there must be the acceptance or retention by the conferee of the benefit under such circumstances as to make it inequitable for the conferee to retain the benefit without payment of its value. Groberg v. Housing Opportunities, Inc., 68 F.3d 1015, 1020 (Utah Ct.App. 2003).
To prevail on a claim for unjust enrichment, the Receiver must show that it is inequitable for Yager to retain a benefit without payment of its value. In this case, Yager contends that he gave value for the payments he received. However, the court has concluded that it cannot determine as a matter of law that the risk of obtaining a profit was sufficient to constitute reasonably equivalent value for the profits Yager received. Yager also argues that 4NExchange has no justifiable claim to the money it paid to investors. However, this court has appointed the Receiver to represent the investors who lost money and can properly maintain equitable claims.
Similarly, Yager argues that the Receiver's request for damages in the form of disgorgement of improper profits is one based on equity and there is no justification for the disgorgement of profits by Yager to 4NExchange's receivership estate. However, for the same reasons as discussed above, Yager's motion to dismiss this claim is denied.