# Merrill v. Abbott (In Re Independent Clearing House Co.)

> District Court, D. Utah · July 23, 1987 · 77 B.R. 843

URL: https://www.frixlaw.com/law-library/cases/2021041

## Case

- **Full name:** In Re INDEPENDENT CLEARING HOUSE COMPANY, a Trust, Debtor. in Re UNIVERSAL CLEARING HOUSE COMPANY, a Trust, AKA National Clearing House Company, a Trust, Debtor. in Re ACCOUNTING SERVICES COMPANY, a Trust, Debtor. Robert D. MERRILL, Trustee, Plaintiff-Appellee and Cross-Appellant, v. David ABBOTT, Et Al., Defendants-Appellants and Cross-Appellees
- **Court:** District Court, D. Utah
- **Decided:** July 23, 1987
- **Citations:** 77 B.R. 843; 1987 U.S. Dist. LEXIS 9646
- **Precedential status:** Published
- **Opinion:** Opinion by Jenkins
- **Judges:** Jenkins, Winder, Greene
- **Cited by:** 199 later opinions in the Frix Law Library

## Citator (automated)

- No negative treatment found by the automated citator. That is not the same as a confirmation that the case is good law; read the citing cases.
- Full citator and citing cases: https://www.frixlaw.com/law-library/cases/2021041

## How later opinions describe it (automated extraction)

- explaining that "[a] transfer made for reasonably equivalent value can still be fraudulent and hence avoidable if it was made 'with actual intent to hinder, delay, or defraud' persons to whom the debtor was or later became indebted.”
- holding, in the context of a Ponzi scheme, that “when a debtor obtains money by fraud and mingles it with other money ... the money is ‘property’ of the debtor within the meaning of sections 547 and 548 of the Code”
- stating that "[o]ne can infer an intent to defraud future undertakers from the mere fact that a debtor was running a Ponzi scheme. Indeed, no other reasonable inference is possible.”
- noting that perpetrators of a ponzi scheme must know that their scheme will eventually collapse, causing later creditors to lose their money, and holding that such knowledge is sufficient to establish actual intent to defraud later investors/creditors
- holding that investors in a Ponzi scheme did not give “value” within the meaning of § 548 for profits they received from the debtor

## Opinion text

MEMORANDUM OPINION
JENKINS, Chief Judge.
On September 30,1985, this court, sitting en banc, heard cross-appeals from the decision and judgments of the United States Bankruptcy Court for the District of Utah in numerous adversary proceedings brought by the trustee in bankruptcy of the debtor entities against named defendants.
1
The appeals had been consolidated for purposes of briefing and oral argument. At oral argument William G. Fowler and Joel R. Dangerfield appeared on behalf of the bankruptcy trustee, plaintiff-appellee and cross-appellant Robert D. Merrill, who also appeared in his own behalf. Daniel W. Jackson and Jeffrey W. Wilkinson appeared on behalf of over 350 defendants-appellants; Edwin F. Guyon appeared on behalf of some 80 other defendants-appellants; Laura M. Harris and Garry R. Appel appeared on behalf of defendant-appellant Ruby Van Sant; and defendants-appellants Thomas D. Richards and Charles A. Schultz appeared pro se. After oral argument the court took all the matters under advisement. After reviewing the records of these appeals, the arguments of counsel and the pertinent authorities, the court now enters this memorandum opinion. Each appeal has been considered on its own merits. Most of the questions decided are common to all.
I.
BACKGROUND
These consolidated adversary proceedings arose, out of the collapse of an alleged Ponzi scheme.
2
The debtors are Independent Clearing House Company (ICH) and Universal Clearing House Company (UCH) (the clearinghouses) and Accounting Services Company (ASC). Each of the debtor entities is a “Massachusetts” or common-
*848
law trust,
3
domiciled in the Grand Cayman Islands, British West Indies. ASC’s stated business was to provide management consulting services and accounting and payable services to client companies, ICH and UCH were to provide clearinghouse services for ASC, its clients and associated entities. Bagley affidavit ex. A. The stated business purpose of the trusts was to solicit funds from private investors, called “undertakers,” and to use the funds received to assume and pay at a discount the accounts payable of ASC’s clients. The trusts were to make a profit by receiving repayment from the client companies in excess of the discounted sums paid.
The “undertakers” signed contracts by which they committed to one of the clearinghouses a specified sum of cash, credit or other commodities for a period of nine months. The funds committed to the clearinghouse were to remain under the clearinghouse’s custody and control until the end of the nine months, at which time the principal amount was to be repaid to the undertaker. Under the terms of the contracts, undertakers assumed the debts of ASC’s clients, and ASC assigned to the undertakers the right to receive payment from its clients. Thus, in addition to the return of his principal, an undertaker was also to receive additional sums purportedly representing “revenues” from the client companies. An undertaker could elect to receive revenues or “earnings” in fixed monthly payments over the nine months or in a lump sum at the end of the nine-month period. If an undertaker chose to be paid monthly, he was to be paid at a rate of .0015 times his investment per business day for twenty business days each month. If he chose to be paid at the end of the nine months, he was to be paid at a rate of .004 times his investment per business day, which worked out to $84 per month per $1,000 invested.
See
41 B.R. at 994 (statement of undisputed facts); Bagley affidavit ¶19-12
&
ex. A. The clearinghouses were to retain full control of the right to revenues assigned to undertakers. Bagley affidavit ex. A.
The bankruptcy trustee has alleged, without contradiction, that ASC had no clients. Bagley affidavit 1115. Apparently, the money supplied by undertakers went into a common fund, from which “earnings” were paid and principal repaid. Later undertakers supplied the money to pay “earnings” and repay principal of earlier undertakers.
Id.
¶¶16-20.
4
On September 16, 1981, ICH and UCH filed petitions for relief under chapter 11 of the bankruptcy code.
5
ASC filed a chapter 11 petition on December 17, 1981.
6
On September 25, 1981, the bankruptcy court appointed Dr. Ron N. Bagley as bankruptcy trustee pursuant to section 1104 of the Code. On October 26, 1982, Dr. Bagley resigned as trustee, and the court appointed Robert D. Merrill to take his place. On September 15, 1983, within the limitations
*849
period of section 546(a), Mr. Merrill, as trustee, brought some two thousand adversary proceedings to recover funds that the debtors had paid to undertakers as “earnings” or as repayment of funds the undertakers supplied the trusts.
The defendants in these actions were all undertakers who received some payments from the debtor trusts within one year of the debtors’ filing their bankruptcy petitions, either as “earnings” or repayment of principal or both. The defendants for the most part fall into two categories: (1) those who advanced money early and received “earnings” and repayment of principal in excess of their initial advance, and (2) those who advanced money and received some payments of “earnings” or repayments of principal or both but no more than their initial advance.
7
The trustee’s complaint set out four claims for relief. The first claim sought to avoid as preferences under section 547 of the Code transfers of money that the debtors had made to a defendant within ninety days prior to the filing of the debtors’ bankruptcy petitions. The second claim sought to avoid as fraudulent conveyances under sections 548 and 544 transfers of money that the debtors had made to a defendant in excess of his advance and within one year before filing their petitions. The third claim sought to avoid on the same grounds
all
transfers of money that the debtors had made to a defendant within one year of filing their petitions.
8
The fourth claim sought to disallow claims that a defendant had filed against the estate unless the defendant remitted to the estate the allegedly preferential and fraudulent transfers he had previously received.
On March 30,1984, the bankruptcy court entered default judgments against some of the defendants. It later denied the defendants’ motions to set aside those judgments.
9
On August 6, 1984, the bankruptcy court entered a memorandum opinion disposing of the remaining cases.
Merrill v. Abbott (In re Independent Clearing House Company),
41 B.R. 985 (Bankr.D.Utah 1984). The bankruptcy court granted the trustee’s motion for summary judgment on his first and second claims for relief. It also granted summary judgment to each of the non-defaulting defendants on the trustee’s third claim for relief and dismissed those claims with prejudice. The court also awarded the trustee prejudgment interest on his successful claims, from September 15, 1983, the date he filed his complaint.
The trustee appealed from the bankruptcy court’s dismissal of his third claim for relief, and many of the defendants appealed from the court’s grant of summary judgment to the trustee on his first and second claims for relief.
On June 5, 1985, this court ordered all pending appeals from these proceedings— including the appeals from the bankruptcy court’s entry of summary judgment and the appeals from the orders denying motions to set aside default judgments — consolidated for purposes of briefing and oral argument.
II.
JURISDICTION
Some of the defendants argue that the bankruptcy court lacks subject matter jurisdiction in this case because the debtor entities cannot qualify as “debtors” under the bankruptcy code. A motion to dismiss for lack of subject matter jurisdiction can be made at any time in a proceeding, including for the first time on appeal. Generally, an appellate court will not reverse a lower court’s findings of jurisdictional facts unless “clearly erroneous.”
See Eaton v. Dorchester Development, Inc.,
692 F.2d 727, 732 (11th Cir.1982);
Williamson v. Tucker,
645 F.2d 404, 413 (5th Cir.),
cert. denied,
454 U.S. 897 , 102 S.Ct.
*850
396, 70 L.Ed.2d 212 (1981).
See also
Bankruptcy Rule 8013.
Some defendants argue that the debtors in this case do not qualify for relief under title 11. Section 301 of the Code provides that only an entity that can qualify as a “debtor” under a chapter of title 11 can file a voluntary case under that chapter. The Code further provides that only “persons” can be debtors under chapter 11.
See
11 U.S.C. § 109 (a), (b) & (d). It defines a “person” to include an “individual, partnership, and corporation,”
id.
§ 101(30), and further defines a “corporation” to include a “business trust,”
id.
§ 101(8)(A)(v). The defendants argue that the debtor enterprises (Massachusetts trusts) are not “business trusts” and are therefore not eligible for relief under the Code. If the debtors are not eligible for relief under the Code, then the statutory source of the bankruptcy court’s exercise of jurisdiction in these adversary proceedings is lacking, and they must be dismissed.
This court has previously considered this argument in a related case.
Merrill v. Allen (In re Universal Clearing House Co.),
60 B.R. 985, 990-93 (D.Utah 1986). For the reasons stated in that opinion, we conclude that the debtor trusts qualify as business trusts under the Code. The defendants’ motions to dismiss for lack of subject matter jurisdiction based on the trusts’ alleged lack of status as debtors are denied.
Several defendants argue that the bankruptcy court also lacks subject matter jurisdiction because the debtors filed their bankruptcy petitions in “bad faith.” The defendants raise this issue for the first time on appeal in the mistaken belief that good faith in filing is a prerequisite to the existence of subject matter jurisdiction in the bankruptcy court. This court has previously considered that argument and rejected it.
See id.
at 993-94 . For the reasons stated in
Allen,
we reaffirm that position.
Although a good faith standard continues to exist under the Code, as
Alien
demonstrates, dismissal of a bad-faith filing is a matter of court discretion under 11 U.S.C. § 1112 (b) — not a matter of jurisdiction.
10
60 B.R. at 993 -94 and cases cited therein. Dismissal (or conversion to chapter 7) is a determination that even though the court has jurisdiction over the case, proceeding with the case under chapter 11 would not be in the interests of justice or in the best interest of creditors. Otherwise, the bankruptcy court would have
no
discretion and would have to dismiss all bad-faith filings.
In short, the bad faith question requires a discretionary, equitable determination under section 1112(b) and must be considered in the first instance by the bankruptcy court. The question of jurisdiction is a separate question and has nothing to do with bad faith. Jurisdiction exists here as a matter of law, regardless of any bad faith on the part of the debtors. The defendants never raised the bad faith issue in the bankruptcy court, and, as a general rule, this court will consider on appeal only those issues raised before the bankruptcy court.
In re Pikes Peak Water Co.,
779 F.2d 1456, 1459 (10th Cir.1985). The bankruptcy court did not abuse its discretion by failing to dismiss the petitions sua sponte.
11
Indeed, in our opinion, dismissal would have been an abuse of discretion under the facts of this case. Because the bankruptcy court did not abuse its discretion in failing to dismiss the actions as bad-faith filings, the motion to dismiss the filings must be denied.
*851
III.
MOTION FOR PERMANENT INJUNCTION
Before reaching the merits of the trustee’s claims, we must address one other issue. On March 19, 1986, after oral argument on these appeals but before this court had rendered its decision, Daniel W. Jackson, on behalf of the defendants he represents,
see
appendix A, filed a motion for an order permanently enjoining the trustee from attempting to recover any property or the value of any property that the debtors had transferred to the defendants. The defendants argue that the adversary proceedings in the bankruptcy court, from which these appeals were taken, merely avoided certain transfers to the defendants as fraudulent or preferential— they did not authorize the trustee to “recover” the avoided transfers. Because more than a year has passed from the time the bankruptcy court avoided the transfers, the defendants argue, the trustee is barred from now recovering them.
Sections 544, 547 and 548 of the Code state that the trustee “may avoid” any transfer of an interest of the debtor in property that meets certain conditions. Section 550 states that, to the extent a transfer is avoided under one of those sections, “the trustee may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property, from,” among others, “the initial transferee of such transfer or the entity for whose benefit such transfer was made.” However, section 550 includes a limitations provision: “An action or proceeding under this section may not be commenced after the earlier of—
“(1) one year after the avoidance of the transfer on account of which recovery under this section is sought; and
“(2) the time the case is closed or dismissed.” 11 U.S.C. § 550 (e).
12
The defendants argue that the trustee’s complaint in these adversary proceedings did not contain any cause of action brought under section 550 and that to date he has not commenced any action or proceeding under section 550. Because more than a year has passed since the bankruptcy court avoided the transfers, the defendants argue, the trustee is now barred from recovering the transfers under section 550.
The complaint filed in each of these adversary proceedings states the “general nature of the trustee’s claims” as follows:
In this adversary proceeding, plaintiff seeks to avoid transfers
and recover funds
paid to creditors of the above-named debtors within 90 days preceding the filing of the bankruptcy petition herein, which funds were paid for and on account of an antecedent debt, and which transfers constitute voidable preferences pursuant to 11 U.S.C. § 547 . Plaintiff also seeks to avoid transfers
and recover all funds
paid to creditors upon the ground that such transfers were without fair consideration and constitute fraudulent conveyances within the meaning of 11 U.S.C. § 548 and § 25-1-1,
et seq.,
Utah Code Annotated (1953, as amended).
Complaint 11 5 (emphasis added).
13
Each of the trustee’s first three claims ended with the same prayer for relief:
WHEREFORE, plaintiff demands judgment against defendants, severally, that such transfers be set aside,
and, that plaintiff have and recover from defendants the amount thereof,
together with interest as provided by law and his costs incurred herein, and for such other and further relief as the court deems just and proper.
Complaint at 8, 12
&
16 (emphasis added). Moreover, the judgments entered against the defendants read: “[I]t is hereby ORDERED, ADJUDGED AND DECREED that plaintiff, Robert D. Merrill, as trustee of the estates of the above-named debtors,
recover from defendant
[name] the sum of [amount].” (Emphasis added.)
As the parties recognize, avoiding a transfer and recovering the property transferred (or its value) are separate concepts.
See
H.R.Rep. No. 595, 95th Cong., 1st Sess. 375 (1977),
reprinted in
1978 U.S.Code Cong. & Admin.News 5787, 5963, 6331. However, we believe the allegations of
*852
paragraph 5 and the prayers for relief sufficiently state a claim for relief under section 550.
True, the complaint does not include a separate claim based solely on section 550, nor does the complaint even mention section 550. But in this day of notice pleading, such technical deficiencies (if they are indeed deficiencies) should not be fatal. The defendants have pointed to nothing in the Code requiring a trustee to file separate actions or even to state separate claims for avoiding and recovering transfers, and this court has found no such requirement.
Cf. Beneficial Fin. Co. v. Lazrovitch,
47 B.R. 358, 361 (E.D.Va.1983) (“§ 550 does not set up any procedural method for recovery of the debtor’s property interest” but merely tells from whom the trustee can recover a transfer); 4
Collier on Bankruptcy
¶¶ 550.02 at 550-5 n. 5 (L. King 15th ed. 1987) (“Normally the trustee’s action to avoid a transfer will be coupled with an action for recovery of the property transferred or its value”) & 550.-03[3] (the trustee “usually will file a consolidated action to avoid the transfer and recover the property transferred or its value”). Nor is this court inclined to read such a requirement into the Code or the rules of procedure.
When, as here, the action is against the initial transferee of an avoidable transfer, we believe that it is enough if the complaint, read as a whole and construed so as to do “substantial justice,”
see
Fed.R.Civ.P. 8(f); Bankr.R. 7008, gives the defendant fair notice that the trustee seeks not only to avoid a particular transfer but also to “recover” the property transferred or its value. We find that the complaint in these adversary proceedings meets that requirement. Therefore, the defendants’ motion for a permanent injunction is denied.
The trustee, as he is wont to do,
see infra
part VI, has moved for sanctions against the defendants for filing their motion. Specifically, he has asked for his court costs and attorney’s fees incurred in responding to the motion. Although this court finds for the trustee on the merits of the defendants’ motion, the law in this area — and the trustee’s complaint — are not so clear as to make the defendants’ motion frivolous, nor does that motion multiply these proceedings “unreasonably and vexatiously.”
See
28 U.S.C. § 1927 (1982). Therefore, the trustee’s request for sanctions is also denied.
IV.
THE TRUSTEE’S CLAIMS
Our conclusion that the bankruptcy court had subject matter jurisdiction over the bankruptcy cases and hence these adversary proceedings and that the debtor entities were “persons” within the meaning of the Code and hence entitled to bankruptcy relief brings us to the question of whether the trustee in bankruptcy could properly recover prepetition payments to undertakers through the exercise of his statutory avoiding powers.
The trustee asserted three principal claims. The bankruptcy court allowed him to recover, under his first claim, all transfers to undertakers made within ninety days of the debtors’ filing of their petitions in bankruptcy, on the grounds that the payments constituted preferences voidable under section 547(b) of the Code. The trustee was also allowed to recover, under his second claim, all transfers the debtors made to a defendant within one year of the debtors’ filing of their petitions to the extent the transfers exceeded an amount equal to the original principal the defendant advanced.
14
The basis for the bankr
*853
uptcy court’s order was that such payments constituted fraudulent conveyances voidable under section 548(a)(2) of the Code. The defendants against whom judgments were entered appeal from these rulings, claiming that the bankruptcy court misconstrued sections 547(b) and 548(a)(2) of the Code. The trustee, on the other hand, appeals the bankruptcy court’s conclusion that he could not recover, under his third claim,
all
transfers to each defendant made within one year of filing,
15
even those transfers that did not exceed the principal amount the defendant advanced to ICH or UCH. Before addressing the trustee’s specific claims we shall consider a preliminary question of statutory construction that cuts across all three claims.
A. “Property” of the Debtor
A trustee’s powers to avoid prepetition transfers by the debtor are statutory. As with any case of statutory interpreta-tion, our starting point must be the language of the statute itself.
See Blue Chip Stamps v. Manor Drug Stores,
421 U.S. 723, 756 , 95 S.Ct. 1917, 1935 , 44 L.Ed.2d 539 (1975) (Powell, J., concurring). Section 547(b) empowers the trustee to avoid “any transfer of property of the debtor,” and section 548(a) empowers the trustee to avoid “any transfer of an interest of the debtor in property” if the transfers meet certain conditions.
16
The defendants claim that the transfers at issue here were not transfers of the debtors’ “property” and thus could not be avoided under sections 547 and 548.
17
This court has previously considered and rejected the defendants’ argument that the money the debtors transferred to others was not “property” of the debtors.
Merrill v. Allen (In re Universal Clearing House Co.),
60 B.R. 985, 994-97 (D.Utah 1986);
Merrill v. Dietz (In re Universal Clearing House Co.),
62 B.R. 118 , 122-24
*854
(D.Utah 1986). For the reasons stated in those opinions, we conclude that, when a debtor obtains money by fraud and mingles it with other money so as to preclude any tracing and when the defrauded party does not timely avoid the transaction but accepts benefits under his contract with the debtor, the money is “property” of the debtor within the meaning of sections 547 and 548 of the Code.
See also DuVoisin v. Anderson (In re Southern Indus. Banking Corp.),
66 B.R. 349, 363-64 (Bankr.E.D.Tenn.1986) (if creditors are all victims of the debtor’s fraud and their money has been commingled with other investors’ money, they cannot claim that money they received from the debtor before bankruptcy was not the debtor’s money).
Having concluded that we are dealing with “property” of the debtors, we shall now address the trustee’s arguments for why he should be allowed to avoid each transfer and recover the property. The trustee asserted three principal claims. As did the bankruptcy court, we shall consider them in reverse order.
B. The Trustee’s Third Claim
Under his third claim the trustee sought to recover
all
payments made to undertakers within one year before the filing of the bankruptcy petitions.
18
He asserted three different legal theories. First, the trustee argued that the bankruptcy court, as a court of equity, had the inherent equitable power to avoid all transfers to undertakers. Second, he argued that the transfers were avoidable under section 548 of the Code as fraudulent conveyances. Third, he argued that they were avoidable under section 544(b), which gives the trustee essentially the same power to avoid transfers that an unsecured creditor has under state law. In support of this third argument, the trustee claimed that the transfers were avoidable under two distinct provisions of state law— under the corporate trust fund doctrine, and under the Utah Fraudulent Conveyance Act, Utah Code Ann. §§ 25-1-1 through -16 (1984).
We conclude that the bankruptcy court correctly denied the trustee’s motion for summary judgment on his third claim because genuine issues of material fact existed. Those same factual issues made it error, however, for the bankruptcy court to grant, as it did, summary judgment to the defendants on the trustee’s third claim. We therefore reverse the bankruptcy court’s judgment as to those claims and remand them as more fully explained below.
*855
1. The Trustee’s General Equitable Theory
The trustee first argued that the bankruptcy court has the inherent equitable power to avoid all transfers to undertakers in a Ponzi scheme. The bankruptcy court summarily rejected this argument, and properly so. The bankruptcy court concluded that “[t]o undo all of these transactions would cause incalculable harm to hundreds of people, at a staggering cost, for which no commensurate benefit would lie.” 41 B.R. at 1005 -06 n. 20. But the trustee’s first theory must fail for an even more basic reason: The bankruptcy law does not sanction the relief sought.
Although in theory the most equitable resolution of these cases may well be for each undertaker to return all the money he received from the debtors so that the money could be redistributed pro rata,
see Eby v. Ashley,
1 F.2d 971, 973 (4th Cir.1924),
cert. denied,
266 U.S. 631 , 45 S.Ct. 197 , 69 L.Ed. 478 (1925), the bankruptcy court is a court of limited jurisdiction. As the bankruptcy court stated:
The equitable powers of the bankruptcy court are limited by the express terms of the Code. A court of equity may not create totally new substantive rights under the guise of doing equity.... [I]n the absence of any statutory or judicial precedent, ... the court may not invoke its equitable powers to substantively enlarge the trustee’s avoiding powers as urged in this case.
41 B.R. at 1005 (citations omitted).
See also Johnson v. First Nat’l Bank of Montevideo, Minn.,
719 F.2d 270, 273 (8th Cir.1983), ce
rt. denied,
465 U.S. 1012 , 104 S.Ct. 1015 , 79 L.Ed.2d 245 (1984), and cases cited therein.
The trustee has failed to direct us to any statutory or judicial precedent expressly authorizing the result he seeks.
19
Rather, he has cited two cases in which courts refused to allow investors in fraudulent investment schemes to recover more from the bankrupts’ estates than they had invested.
Official Cattle Contract Holders Comm. v. Commons (In re Tedlock Cattle Co.),
552 F.2d 1351 (9th Cir.1977);
Abrams v. Eby (In re Young),
294 F. 1 (4th Cir.1923).
Abrams
arose out of the collapse of Young’s fraudulent investment program. Abrams had invested a total of $4,000 in the program but had withdrawn $2,000 of his principal and had received fictitious profits of some $2,797 before the case arose. When Young went into bankruptcy, Abrams asserted a claim against the bankrupt estate for $2,000, the remainder of his original investment. The court disallowed the claim on equitable grounds, noting that Abrams had already received some $797 in excess of his original investment while other investors had received nothing.
Tedlock Cattle
merely relied on
Abrams
in holding that the bankruptcy trustee could measure the claims of investors in a Ponzi scheme by their out-of-pocket loss rather than by the lost benefit of their bargain. The court concluded that the trustee could properly deny recovery for anticipated or “paper” profits investors had lost. In neither case was the trustee trying to recover money that the investors had already received.
It is one thing to say that the trustee can object to claims for more than one’s original investment; in such a case, he is merely protecting the property of the estate. It is quite another thing to say that he can avoid what the investors might justifiably have believed was a legitimate transaction and recover the payments; in such a case, the trustee is exercising extraordinary powers to enlarge the bankruptcy estate. Those powers are conferred only by statute. Without such a statute, the trustee has no avoiding powers. The trustee’s exercise of those powers is circumscribed by the very statute that creates them, and the statute in this case does not allow the trustee to recover
all
transfers made within a year of filing the bankruptcy petition, fraudulent or otherwise.
If the cited cases support the trustee’s theory, they do so only to the extent that
*856
he seeks to recover fictitious
profits
(or “earnings”) a defendant received. The court in
Abrams
said, “Equity ... requires that he [the investor] should account for all sums paid to him
as profit
before he can share with others in the application of the funds on hand to the debts due for sums actually paid in.” 294 F. at 4 (emphasis added). It did not say that the investor would have to account for
everything
he had received, including any portion of his initial investment.
Thus, at best,
Abrams
and
Tedlock Cattle
support the trustee’s second cause of action, not his third. In fact, in neither case were investors even required to give back fictitious profits they had received, let alone any part of their original investment.
2. Section 548
Our conclusion that the trustee’s power to recover transfers is defined and circumscribed by statute brings us to the plaintiff’s second theory, namely, that the transfers were avoidable under section 548 of the Code as fraudulent conveyances. Section 548 authorizes the trustee to avoid certain transfers “of an interest of the debtor in property” if they fall within two broad categories.
20
A conveyance may be “fraudulent” within the meaning of section 548 either (1) if it was made with an actual intent to hinder, delay, or defraud creditors — regardless of whether the transferor was insolvent at the time — or (2) if the transferor was insolvent (or likely to become insolvent) and received “less than a reasonably equivalent value” in exchange for the transfer — regardless of the trans-feror’s intent.
See
11 U.S.C. § 548 (a).
21
The trustee argues that the transfers he seeks to recover were fraudulent in both respects.
a. Section 548(a)(2)
The trustee first argues that payments to the defendants were fraudulent under section 548(a)(2) because the debtors were insolvent when the transfers were made and “received less than a reasonably equivalent value in exchange for” the transfers. It is undisputed that the debtors were insolvent when they made the transfers, so the only question under section 548(a)(2) is whether the debtors received a reasonably equivalent value for the transfers.
Section 548 defines “value” as “property, or satisfaction or securing of a present or antecedent debt of the debtor.” 11 U.S.C. § 548 (d)(2)(A). The Code defines a “debt” as “liability on a claim,” 11 U.S.C. § 101 (11), and a “claim” includes any “right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured,”
id.
§ 101(4)(A).
The bankruptcy court concluded that all transfers to defendants “were payments on contractual debts” and hence “value” within the meaning of section 548. 41 B.R. 1007 .
22
*857
The trustee argues on appeal that each contract between a defendant and a debtor did not create a debt on the part of the debtor but rather gave the defendant an ownership interest in the debtor’s business.
Cf. Payable Accounting Corp. v. McKinley,
667 P.2d 15 (Utah 1983) (the contracts were “investment contracts” and hence securities within the meaning of Utah’s securities law). Thus, he argues, any transfer to a defendant that came from other undertakers’ money and not from actual profits could not have satisfied an antecedent debt and was therefore “fraudulent” within the meaning of section 548(a)(2) because not made for a “reasonably equivalent value.” And since the debtors had no actual profits, all transfers to all defendants were fraudulent within the meaning of section 548(a)(2).
23
.
We conclude 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.
From the time a defendant entrusted his money to the debtors, he had a claim against the debtors for the return of his money. We believe that the Code’s definition of “debt” and its related terms is broad enough to cover the debtors’ obligation to return a defendant’s principal undertaking, whether that obligation was based on the contract between the debtors and the defendant or was based on the defendant’s right to restitution.
24
Cf. Cunningham v. Brown,
265 U.S. 1, 13 , 44 S.Ct. 424, 427 , 68 L.Ed. 873 (1924) (investors in the original Ponzi scheme who could not trace their money were creditors of the debtor);
Rosenberg v. Collins,
624 F.2d 659, 664 (5th Cir.1980) (investors in a Ponzi scheme whose total cash withdrawals were less than their total cash deposits were creditors of the bankrupt);
Eby v. Ashley,
1 F.2d 971, 973 (4th Cir.1924) (an investor in a fraudulent scheme had a right to recover his principal “from the moment that he was deceived into paying it”),
cert. denied,
266 U.S. 631 , 45 S.Ct. 197 , 69 L.Ed. 478 (1925);
Lawless v. Anderson (In re Moore),
39 B.R. 571, 574 (Bankr.M.D.Fla.1984) (investors in a Ponzi scheme “are general unsecured creditors to the extent of their losses”). Thus, to the extent the debtors’ payments to a defendant merely repaid his principal undertaking, the payments satisfied an antecedent “debt” of the debtors, and the debtors received “value” in exchange for the transfers. Moreover, to the extent a transfer merely repaid a defendant’s undertaking, the debtor received not only a “reasonably equivalent value” but the exact same value — dollar for dollar. We therefore hold that such transfers are not avoidable under section 548(a)(2).
Transfers in excess of a defendant’s undertaking are another matter. The defendants argue that such transfers also satisfied an antecedent debt of the debtors. The only liability the debtors had for payments of so-called earnings was their contractual liability. Thus, whether the debtors were indebted to a defendant for amounts in excess of his undertaking depends on whether or not the defendant had a valid, enforceable right under his contract with the debtors to receive payments of so-called earnings.
The trustee has not argued that the contract between each defendant and the debtors was illegal or otherwise unenforceable on its face. Courts’ refusals to enforce an illegal bargain generally rest on “the elementary principle that one who has himself participated in a violation of law cannot be permitted to assert in a court of justice any right founded upon or growing out of the illegal transaction.”
Gibbs & Sterrett Mfg. Co. v. Brucker,
111 U.S. 597 ,
*858
601, 4 S.Ct. 572, 574 , 28 L.Ed. 534 (1884). “The rule was conceived for the purposes of protecting the public and the courts from imposition.”
Norwood v. Judd,
93 Cal.App.2d 276 , 209 P.2d 24, 31 (1949). For a court to lend its aid to a wrongdoing plaintiff is to lend its sanction to the wrong. However, if the party seeking enforcement is innocent of any violation, that reason for refusing to enforce the bargain does not apply. Thus, if a party enters into an illegal bargain and is justifiably ignorant of the facts creating the illegality or if he enters into a facially valid contract and is justifiably ignorant of the other party’s illegal purpose, the innocent party may generally enforce the contract.
See
J. Calamari & J. Perillo,
The Law of Contracts
§ 22-4 at 782-83 (2d ed. 1977); Restatement of Contracts § 599 (1932);
Oakes v. Guarantee Ins. Co.,
573 S.W.2d 899, 902 (Tex.Civ.App.1978) (quoting
Graham v. Dean,
144 Tex. 61 , 188 S.W.2d 372 (1945)).
However, in some cases “the interest of the public, rather than the equitable standing of individual parties, is of determining importance.” 14 S. Williston & W. Jaeger,
A Treatise on the Law of Contracts
§ 1630A at 22-23 (3d ed. 1972) (quoting
Parish v. Schwartz,
344 Ill. 563 , 176 N.E. 757, 761 (1931)). We believe that this is such a case. To allow an undertaker to enforce his contract to recover promised returns in excess of his undertaking would be to further the debtors’ fraudulent scheme at the expense of other undertakers.
In determining whether a contract is unenforceable because it is against public policy, the court may look beyond the terms of the contract itself to the underlying facts.
Tri-Q, Inc. v. Sta-Hi Corp.,
63 Cal.2d 199 , 404 P.2d 486, 497 , 45 CaLRptr. 878 (1965). It is undisputed that the debtors here had no legitimate source of earnings but were operating a Ponzi scheme. Therefore, any money that a defendant might recover in excess of his undertaking in an action on the contract could not come from the debtors but would have to come from money that rightfully belonged to other, defrauded undertakers. Enforcement of a contract such as those involved here would therefore hurt the debtors’ other creditors by depleting the pool of assets to which they could look for payment.
Cf. J.M. Deutsch Co. v. Robert Paper Co.,
13 A.D.2d 768 , 215 N.Y.S.2d 939 (contract to secretly prefer one creditor over others was contrary to public policy),
reargument and appeal denied,
14 A.D.2d 531 , 218 N.Y.S.2d 938 (1961).
Moreover, enforcement would further none of the policies generally favoring enforcement by an innocent party to an illegal bargain. It would not deter the debtors’ fraudulent conduct because it would not hurt the debtors at all. Any recovery would not come from the debtors’ own assets because they had no assets they could legitimately call their own. Rather, any award of damages would have to be paid out of money rightfully belonging to other victims of the Ponzi scheme.
One could argue that denying enforcement would unjustly enrich the debtors, but if they are enriched unjustly, it is because they are allowed to keep money that rightfully belongs to other creditors — not to the party seeking to enforce the contract. If the contract were enforced, the party who received the benefits of his contract would be unjustly enriched at the expense of other defrauded undertakers. In short, to enforce the contract as to fictitious profits would only further the debtors’ fraudulent scheme.
We therefore conclude that, as a matter of public policy, the contracts involved in this case were unenforceable to the extent they purported to give the defendants a right to payments in excess of their undertaking.
25
Consequently, transfers by the debtors to a defendant in excess of his undertaking did not satisfy an antecedent debt of the debtors.
*859
The transfers could still have been made for “value,” however, if the debtors received “property” in exchange for the transfers. The consideration for the transfers was the use of the defendants’ money over a period of time. The use of money may be “property” in some contexts.
See, e.g., Dickman v. Commissioner,
465 U.S. 330, 336 , 104 S.Ct. 1086, 1090 , 79 L.Ed.2d 343 (1984) (for federal gift tax purposes the use of money “is itself a legally protectible property interest”).
See also Larrimer v. Feeney,
411 Pa. 604 , 192 A.2d 351, 354 (1963) (implying that transfers were not fraudulent to the extent they did not exceed the legal rate of interest). We conclude, however, that the use of investors’ money to perpetuate a Ponzi scheme is not the type of “property” and hence “value” Congress had in mind when it passed section 548(a)(2).
“Value” must be determined by an objective standard.
See Pereira v. Checkmate Communications Co. (In re Checkmate Stereo & Elecs., Ltd.),
9 B.R. 585, 591 (Bankr.E.D.N.Y.1981). If the use of the defendants’ money was of value to the debtors, it was only because it allowed them to defraud more people of more money. Judged from any but the subjective viewpoint of the perpetrators of the scheme, the “value” of using others’ money for such a purpose is negative.
See also Lawless v. Anderson (In re Moore),
39 B.R. 571, 573 (Bankr.M.D.Fla.1984) (the court “would be hard pressed to determine what would constitute reasonably equivalent value” for transfers in furtherance of a Ponzi scheme).
But see Larrimer v. Feeney,
192 A.2d at 354 (implying that transfers were not fraudulent to the extent they did not exceed the legal rate of interest).
In theory, the trustee is not allowed to avoid transfers made for reasonably equivalent value because creditors are not hurt by such transfers.
See
5
Debtor-Creditor Law
1122.03[D][1][b] (T. Eisenberg ed. 1986). If the debtor no longer has the thing transferred, either he has its equivalent, in which case his creditors can reach the equivalent to satisfy their claims, or his liabilities have been proportionately reduced. In either case, creditors have not been prejudiced. But if all the debtor receives in return for a transfer is the use of the defendant’s money to run a Ponzi scheme, there is nothing in the bankruptcy estate for creditors to share. In fact, by helping the debtor perpetuate his scheme, the transfers exacerbate the harm to creditors by increasing the amount of claims while diminishing the debtor’s estate. In such a situation, the use of the defendant’s money cannot objectively be called “reasonably equivalent value.”
Cf. Consove v. Cohen (In re Roco Corp.),
701 F.2d 978 (1st Cir.1983) (the debtor corporation received less than a reasonably equivalent value for redemption of its stock where redemption significantly increased its liabilities without adding to its assets);
Glosband v. Watts Detective Agency, Inc.,
21 B.R. 963, 971 (D.Mass.1981) (“property” for purposes of the fraudulent conveyance statute incorporates “anything of value which but for the transfer might have been preserved for the trustee to the ultimate benefit of the bankrupt’s creditors”).
We therefore conclude that the debtors did not receive “value” in exchange for transfers to a given defendant to the extent the transfers exceeded the amount the defendant had advanced to the debtors. A fortiori, the debtors did not receive a “reasonably equivalent value” in exchange for those transfers.
Accord Eby v. Ashley,
1 F.2d 971, 973 (4th Cir.1924),
cert. denied,
266 U.S. 631 , 45 S.Ct. 197 , 69 L.Ed. 478 (1925);
Lawless v. Anderson (In re Moore),
39 B.R. 571, 573 (Bankr.M.D.Fla.1984). Such transfers may therefore be avoided under section 548(a)(2) unless the transferee has a good defense to the trustee’s claim.
See infra
part IV-B-2-c.
b. Section 548(a)(1)
Our conclusion that transfers to a defendant that merely repaid his principal undertaking were made for a reasonably equivalent value and hence are not avoidable under section 548(a)(2) brings us to the trustee’s next argument, namely, that such transfers are avoidable under section 548(a)(1). A transfer made for reasonably equivalent value can still be fraudulent and hence avoidable if it was made “with actual intent to hinder, delay, or defraud” persons to whom the debtor was or later became indebted. 11 U.S.C. § 548 (a)(1). The bankruptcy court gave little attention to the trustee’s claim that the payments to undertakers were fraudulent under section 548(a)(1), holding simply that “the trustee has not carried his burden of proof to show that the monthly payments to defendants
*860
were made with such actual intent.” 41 B.R. at 1007 . We disagree.
26
We conclude] that the debtors’ intent to hinder, delay or defraud was established as a matter of law.
Our role in an appeal from the grant or denial of summary judgment is to determine whether there was a genuine issue of material fact and, if not, whether the moving party was entitled to a judgment as a matter of law. 10 C. Wright, A. Miller & M. Kane,
Federal Practice and Procedure
§ 2716 at 643 (2d ed. 1983). Although intent is often a disputed factual question, we conclude that in this case there was no genuine issue of material fact concerning the debtors’ intent to hinder, delay or defraud creditors.
The evidence before the bankruptcy court on the question of the debtors’ intent consisted of the affidavit of Ron N. Bagley, the original trustee and trustee Merrill’s accountant. That evidence shows that the debtors conducted no business operations, never generated any profits or earnings, paid all monthly disbursements to undertakers solely from other undertakers’ investments, were insolvent from the moment the first investment contract was executed, became more insolvent with each successive contract, and ran their business as a Ponzi scheme. In addition, the Bagley affidavit sets out fourteen material representations — many of them allegedly false— that the debtors made regarding the nature of their business and the nature of the investments to induce undertakers to invest in the program. None of the defendants introduced any evidence to dispute the assertions in the Bagley affidavit. Thus, it was undisputed that the debtors’ business “was conducted as a ‘Ponzi’ scheme....” 41 B.R. at 994 .
To be fraudulent under section 548(a)(1) a transfer need not be made with the intent to hinder, delay or defraud the transferee. The trustee need only show that the transfers were made with the intent to hinder, delay or defraud “any entity to which the debtor was
or became
[indebted], on or
after the date that such transfer occurred.”
11 U.S.C. § 548 (a)(1) (emphasis added). Those persons who invest on the eve of a Ponzi scheme’s collapse are entities to whom the debtor becomes indebted when they entrust their money to the debtors. Therefore, if at the time the debtors made transfers to earlier undertakers they had the actual intent to hinder, delay or defraud later undertakers, transfers to earlier undertakers may be fraudulent within the meaning of section 548(a)(1).
One can infer an intent to defraud future undertakers from the mere fact that a debtor was running a Ponzi scheme. Indeed, no other reasonable inference is possible. A Ponzi scheme cannot work forever. The investor pool is a limited resource and will eventually run dry. The perpetrator must know that the scheme will eventually collapse as a result of the inability to attract new investors. The perpetrator nevertheless makes payments to present investors, which, by definition, are meant to attract new investors. He must know all along, from the very nature of his activities, that investors at the end of the line will lose their money. Knowledge to a substantial certainty constitutes intent in the eyes of the law,
cf.
Restatement (Second) of Torts § 8A (1963 & 1964), and a debtor’s knowledge that future investors will not be paid is sufficient to establish his actual intent to defraud them.
Cf. Coleman Am. Moving Servs., Inc. v. First Nat’l Bank & Trust Co. (In re American Properties, Inc.),
14 B.R. 637, 643 (Bankr.D.Kan.1981) (intentionally carrying out a transaction with full knowledge that its effect will be detrimental to creditors is sufficient for actual intent to hinder, delay or defraud within the meaning of § 548(a)(1)).
Although the question of the debtors’ intent would ordinarily present a factual question, we conclude that, from the undisputed evidence in the record, only one inference is possible — namely, that the debtors had the intent to hinder, delay or defraud creditors. The trustee’s undisputed evidence is that the debtors were engaged in a Ponzi scheme and therefore must have known that undertakers at the end of the line would lose their money. That is the only evidence there is. We conclude that it was sufficient to establish, as a matter of law, the debtors' actual
*861
intent to hinder, delay or defraud creditors within the meaning of section 548(a)(1).
Cf. Conroy v. Shott
363 F.2d 90, 91-92 (6th Cir.) (quoting with approval from the opinion of the district court, which granted the trustee’s motion for summary judgment and concluded that “the question of intent to defraud is not debatable” given the fact that the debtor was carrying on a Ponzi scheme),
cert. denied,
385 U.S. 969 , 87 S.Ct. 501 , 17 L.Ed.2d 433 (1966).
c. Section 548(c)
The bankruptcy court concluded that, even if the debtors had the actual intent to hinder, delay or defraud, section 548(c) made the defendants “immune” from the trustee’s power to avoid fraudulent conveyances under section 548. 41 B.R. at 1007 .
Section 548(c) provided:
Except to the extent that a transfer or obligation voidable under this section is voidable under section 544, 545, or 547 of this title, a transferee or obligee of such a transfer or obligation that takes for value and in good faith has a lien on any interest transferred, may retain any lien transferred, or may enforce any obligation incurred, as the case may be, to the extent that such transferee or obli-gee gave value to the debtor in exchange for such transfer or obligation.
27
In other words, even if the payments to the defendants were fraudulent conveyances, the defendants are protected, to the extent they gave the debtors “value” in exchange for the transfers, if they took the money in “good faith.”
28
The extent to which a defendant “gave value” for a particular transfer is essentially the flip side of the question we have already discussed under section 548(a)(2), namely, whether the debtor received a “reasonably equivalent value” in exchange for the transfer. What the defendants gave the debtors in exchange for transfers in excess of their undertaking was the use of their money to further a Ponzi scheme. For the reasons previously stated, we conclude that what the defendants gave the debtors in exchange for such transfers was not “value” within the meaning of section 548. Therefore, to the extent the trustee seeks to recover transfers in excess of a defendant’s undertaking, section 548(c) provides no defense.
On the other hand, we have also concluded that, to the extent transfers to a defendant did not exceed the amount of the defendant’s undertaking, the debtor received a “reasonably equivalent value” for the transfer. The converse is also true: To the extent that a defendant received amounts less than or equal to his undertaking, he “gave value” to the debtor in exchange for the transfers. The consideration for the transfers was satisfaction of the debt created when the defendant advanced the debtor money or other property, and, under section 548(d), satisfaction of an antecedent debt is “value.”
Our conclusion that the defendants “gave value” for transfers that merely repaid their undertaking brings us to the question of whether they also took the transfers in good faith. If they did, section 548(c) protects them from the trustee’s power to avoid those transfers under section 548.
This court is troubled with the bankruptcy court’s blanket finding, unsupported by the record, that all defendants took in good faith.
The Code does not define “good faith.” Courts, however, have defined it in various ways.
Compare, e.g., Gilmer v. Woodson (In re Decker),
332 F.2d 541, 547 (4th Cir.1964) (good faith not lacking “unless the transferee knowingly participated in the debtor-transferor’s purpose to defeat other creditors or lacked good faith in valuing the property exchanged”),
with In re Windor Indus., Inc.,
459 F.Supp. 270, 279 (N.D.Tex.1978) (good faith under former 11 U.S.C. § 107 “is not present where the transferee at the time of the transaction had knowledge of facts sufficient to put him on inquiry as to the insolvency or possible insolvency of the debtor”).
See generally
4
Collier on Bankruptcy
¶ 548.-07[2] at 548-68 & nn. 10-13 (L. King 15th ed. 1987) and cases cited therein.
The construction to be put on the phrase “in good faith” may depend in large part on the facts as they develop.
See Boatman v. McMillan Mach. Co. (In re Bristol Indus. Corp.),
45 B.R. 606, 609 (Bankr.D.Conn.1985). Certainly, if a defendant knew that the debtor was running a Ponzi scheme when he advanced money to the debtor or knew of the debtor’s insolvency at the time of the allegedly fraudulent
*862
transfer, that knowledge might indicate a lack of good faith.
See
4
Collier on Bankruptcy, supra,
at ¶548.07[2];
see also Seligson v. New York Produce Exch.,
394 F.Supp. 125, 133 (S.D.N.Y.1975) (“if the transferee had knowledge of the unfavorable financial condition of the transferor at the time of the transfer, it could not meet the good faith requirement” of former 11 U.S.C. § 107 (d)(2));
Consumers Credit Union v. Widett (In re Health Gourmet, Inc.),
29 B.R. 673, 677 (Bankr.D.Mass.1983) (transferee’s knowledge of the debtor’s insolvency “is equivalent to lack of good faith” under § 548(c)). “Indeed, the presence of any circumstance placing the transferee on inquiry as to the financial condition of the transferor may be a contributing factor in depriving the former of any claim to good faith unless investigation actually disclosed no reason to suspect financial embarrassment.” 4
Collier on Bankruptcy, supra,
at 548-68.
The test is whether the transaction in question bears the earmarks of an arm’s length bargain.
Bergquist v. First Nat’l Bank (In re American Lumber Co.),
5 B.R. 470, 477 (D.Minn.1980). The mere fact that the debtors promised exorbitant returns on a defendant’s investment, however, does not, without more, mean that the defendant lacked good faith. If a legitimate accounts payable factoring program could have supported the promised rate of return, the promised rate of return may not have put the defendant on notice of the debtors’ fraud. Moreover, because the debtors paid the promised returns, at least initially, a defendant may have had no reason to suspect that the debtors were insolvent.
Cf. Cunningham v. Merchants’ Nat’l Bank (In re Ponzi),
4 F.2d 25, 29 (1st Cir.) (the fact that Ponzi “had, so far, kept his agreements with the bank” belied any knowledge by the bank that Ponzi was insolvent or was running an illegitimate business),
cert. denied,
268 U.S. 691 , 45 S.Ct. 511 , 69 L.Ed. 1160 (1925).
The bankruptcy court itself noted, on the issue of the debtors’ intent to defraud, that “[a]s a general proposition ... summary judgment is inappropriate when issues of motive, intent, and other subjective feelings are material.” 41 B.R. at 1007 . We feel that the same approach should be taken on the subjective question of whether the defendants took in good faith. From the record it appears that no evidence was taken on this particular question. Thus, this court is unable to determine the basis for the bankruptcy court’s finding.
29
We conclude that a defendant’s good faith (or lack thereof) was a genuine issue of material fact. Because the bankruptcy court took no evidence on the issue, it erred in granting summary judgment for the defendants on the trustee’s third claim. We therefore remand to the bankruptcy court for factual findings on the question of whether the defendants took payments that did not exceed their principal undertaking in good faith.
3. Section 544(b)
The last theory by which the trustee sought to recover all payments that the debtors had made within a year of filing for bankruptcy was that the transfers were avoidable under state law and hence were avoidable under section 544(b) of the Code.
Section 544(b) authorizes the trustee to avoid “any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an
*863
unsecured claim_”
30
The “applicable-law” for determining the rights of an unsecured creditor to avoid a transfer is state law.
31
See, e.g., Hunts Point Tomato Co. v. Roman Crest Fruit, Inc. (In re Roman Crest Fruit, Inc.),
35 B.R. 939, 947 (Bankr. S.D.N.Y.1983). The trustee argues that, under the applicable Utah law, an unsecured creditor could have avoided all transfers made to investors within a year of filing. He suggests two different grounds: First, he argues, the transfers were avoidable under the corporate trust fund doctrine. Second, he argues, they were avoidable under the Utah Fraudulent Conveyance Act, Utah Code Ann. §§ 25-1-1 through -16 (1984).
a. The corporate trust fund doctrine
The corporate trust fund doctrine is a judicially created doctrine that allows a corporation to recover disbursements to equity holders made when there were no profits out of which a dividend could lawfully be declared. Restitution may be enforced by the corporation, by stockholders, by creditors of the corporation and by a trustee in bankruptcy. 12 W. Fletcher,
Cyclopedia of the Law of Private Corporations
§ 5422 at 91 (rev. perm. ed. 1985) (citations omitted). The rationale for the doctrine is that the corporation’s
capital is a fund held by the corporation in trust for the payment of its debts, and that the money received for dividends, being in fact capital, is impressed with this trust, and that “he who has received moneys impressed with a trust, without consideration, ought to and must restore them.”
Id.
at 91-92 (quoting
Hayden v. Thompson,
71 F. 60, 66 (8th Cir.1895)). The doctrine is premised on the idea that a corporation’s creditors should have recourse to the corporation’s capital for repayment of their claims “since it [was] upon the faith of the corporation’s capital stock and assets which the law presumes that credit was given....” 15A
id.
§ 7371 at 52 (rev. perm. ed. 1981).
The doctrine — or at least its rationale— has been widely repudiated.
See, e.g., McDonald v. Williams,
174 U.S. 397, 401-05 , 19 S.Ct. 743, 744-46 , 43 L.Ed. 1022 (1899) (no trust fund at least where corporation is solvent);
Central Hanover Bank & Trust Co. v. United Traction Co.,
95 F.2d 50, 55 (2d Cir.1938);
Hospes v. Northwestern Mfg. & Car Co.,
48 Minn. 174 , 50 N.W. 1117, 1119-20 (1892).
See generally
15A
*864
W. Fletcher,
supra,
§ 7369 at 43 & 47 n. 2, § 7385 at 74 & 75 n. 1. The defendants argue that Utah does not recognize the doctrine, at least absent its codification,
see Passow & Sons v. Wetherbee,
50 Utah 243 , 167 P. 350, 351 (1917), and imply that the Utah Business Corporation Act is not such a codification,
see, e.g.,
Utah Code Ann. § 16-10-93 (1973) (procedure in liquidation of corporation by court).
Regardless of whether Utah law would recognize the doctrine, the plaintiffs argument must fail. We simply find the doctrine inapplicable under the facts of this case.
For the trust fund doctrine to apply here, the debtors (Massachusetts trusts) must be deemed “corporations,” the defendants “shareholders” in those corporations, and their undertakings “capital” of the corporation. Even if the debtor enterprises could be considered “corporations” for purposes of applying the corporate trust fund doctrine, a question we do not reach, their relationship to the defendants was that of debtor to creditor, not that of corporation to shareholder.
32
Cf. Cunningham v. Brown,
265 U.S. 1, 13 , 44 S.Ct. 424, 427 , 68 L.Ed. 873 (1924) (investors in the original Ponzi scheme were only creditors of the debtor);
Rosenberg v. Collins,
624 F.2d 659, 664 (5th Cir.1980) (defrauded investors were creditors of the debtor);
Lawless v. Anderson (In re Moore),
39 B.R. 571, 573 (Bankr.M.D.Fla.1984) (investors in a fraudulent scheme were creditors to the extent of their losses).
Although as a general rule certificate holders in a common-law or Massachusetts trust “stand in their relation to the trust as stockholders in a corporation” (that is, they are “equitable owners of the trust property”),
Bryan v. Welsh,
72 F.2d 618, 620 (10th Cir.1934), there is no evidence that the defendants in this case were even certificate holders in the debtor trusts. Their relationship was defined by their individual contracts with the debtors and not by any ownership interest in the debtors. The contracts between the defendants and the debtor enterprises state:
It is understood and agreed that First Party [the defendant] is not lending or investing the funds herein commited [sic] but ... is assuming the debt of ASC’s clients to the extent of this commitment ... and that ASC assigns to First Party, through ICH, the right to the revenues to be paid by ASC’s clients....
Bagley affidavit exhibit A ¶18. Thus, the objective intent of the parties, as expressed in the contract, was that the defendants would assume the debts of the debtors’ clients in exchange for the right to receive revenues paid by the clients. In other words, the defendants were ostensibly buying accounts receivable, albeit indirectly, through the debtors. The holder of an account receivable is a creditor, not an owner of the debtor business.
Even assuming, however, that the defendants’ relationship to the debtors in this case was analogous to that of a certificate holder to a common-law trust, we find that that relationship was a creditor-debtor relationship.
The nature of the relationship between certificate holders in a common-law trust
*865
and the trust depends on the facts of each case.
Selected Investments Corporation v. Duncan,
260 F.2d 918 (10th Cir.1958),
cert. denied,
359 U.S. 914 , 79 S.Ct. 584 , 3 L.Ed.2d 576 (1959).
Duncan
involved the reorganization of a corporation and a related common-law trust, known as Selected Investments Trust Fund. The corporation and trust fund filed a joint petition for reorganization under chapter X of the old bankruptcy act. Certain holders of certificates issued by the corporation and countersigned by the trustee of the trust fund intervened, asserting that they were creditors of the debtor entities. Other creditors sought to have the petition for reorganization dismissed on the grounds that the debtors were not insolvent. The insolvency of the trust fund turned on whether the certificate holders w;ere creditors of the trust fund or beneficial owners of shares in the fund.
The relationship of the certificate holders to the trust fund appeared at first glance to be that of equity holders to a corporation. The trust indenture authorized the corporation to issue and sell certificates in multiples of $100. The certificates were labeled “Certificate-Bond,” and near the top were the words “No. Shares-.” The holders of the certificates received annual payments, which were called “dividends.” The certificates could be redeemed in cash at any time after three years from the date they were issued, at the election of either the holder or the corporation. The corporation did not have to redeem the certificates at their face value. Rather, on redemption the holder was entitled to receive only his fractional share of the total value of the fund. 260 F.2d at 921-22 .
Nevertheless, the Tenth Circuit rejected the argument that the certificate holders were “merely beneficial owners” of the fund and instead held that a creditor-debtor relationship existed between the certificate holders and the trust. Among the “characteristic earmarks” that distinguished the relationship from that of shareholders to a corporation were the sales practices and distribution policies of the debtors. The debtors’ general practice in selling certificates was to tell investors that they were lending money, that they were receiving bonds with a fixed rate of return and that after three years they could cash in the certificates at face value. The corporation treated the annual payments to investors as interest payments. The payments were consistently made, at a fixed rate and without regard to fluctuations in earnings or losses. Some were made out of capital. Despite the terms of the trust indenture, matured certificates were redeemed in cash at face value, without any attempt to determine the holder’s distributive share of the trust’s assets.
Id:
at 922. All of these facts
had the effect of creating the relationship of debtor and creditor between the Corporation and the Trust Fund on one hand, and the holders of certificates on the other hand, rather than that of the holder of certificates merely owning interests in or shares of the assets of the Trust Fund.
Id.
at 923 .
The facts here present even a stronger case for finding that the undertakers are creditors of the debtors and not shareholders. Here the relationship between the debtors and defendants has none of the indicia of a shareholder-corporation relationship. It does not appear from the record that the defendants had any right to vote for the officers or trustees of the trusts, any right to compel the calling of stockholders’ meetings, any voice in adopting by-laws or making fundamental changes in the trusts, any right to examine the books and records of the trusts or any right to sue as a representative of the trusts. According to the express terms of their contracts, the defendants were not even investing money in the trusts and thus could not be expected to share in the trusts’ gains and losses.
As in
Duncan ,
the debtors represented that the defendants would be paid regularly at a fixed rate, and until the enterprises collapsed the payments were consistently made at that rate, without regard to any earnings. The defendants could cancel their commitment at any time on thirty-days’ written notice and receive payments at seventy-five percent of the contract rate. The defendants’ relationship to the debtors was a contractual one — essentially that of a creditor and not that of an owner. Thus,
*866
the defendants were not shareholders of the debtors, the payments they received were not “dividends,”
33
and the corporate trust fund doctrine does not apply.
34
Because the trust fund doctrine does not apply under the facts of this case, it cannot provide a basis for the exercise of the trustee’s avoiding powers under section 544(b).
b. The Utah Fraudulent Conveyance Act
The plaintiffs second argument for avoiding the transfers under section 544(b) is that an unsecured creditor could avoid them under the Utah Fraudulent Conveyance Act, Utah Code Ann. §§ 25-1-1 through -16 (1984), which is based on the Uniform Fraudulent Conveyance Act and parallels in many respects section 548 of the bankruptcy code.
Sections 25-1-15 and -16 of the Utah Code allow an unsecured creditor to have a conveyance set aside to the extent necessary to satisfy his claim if the conveyance was fraudulent as to him.
See also
Utah Code Ann. § 25-1-1 (“creditor” defined). Sections 25-1-4 through -7 define the circumstances under which a conveyance is “fraudulent” as to creditors. The party seeking to set aside a conveyance as fraudulent has the burden of proving each element of a fraudulent conveyance by clear and convincing evidence.
Furniture Mfrs. Sales, Inc. v. Deamer,
680 P.2d 398 , 399 & 400 n. 10 (Utah 1984).
The first type of conveyance that is fraudulent under the Utah Fraudulent Conveyance Act is one made “with actual intent, as distinguished from intent presumed in law, to hinder, delay or defraud either present or future
creditors....” Id.
§ 25-1-7.
The trustee argues that the transfers to investors were made with actual intent to defraud at least later investors and hence were fraudulent conveyances under section 25-1-7. The bankruptcy court concluded that the trustee had not met his burden of proving actual intent to defraud, despite the admittedly fraudulent nature of the scheme. For the reasons discussed above in connection with section 548(a)(1) of the Code, we hold that the debtors’ fraudulent intent is established as a matter of law, notwithstanding the trustee’s higher burden of proof under the Utah statute.
The defendants argue that, even if the debtors made the transfers with an actual intent to defraud, the defendants come within the bona fide purchaser exception of section 25-1-13. That section states:
The provisions of this chapter [the Utah Fraudulent Conveyance Act] shall not be construed to affect or impair the title of a purchaser for a valuable consideration, unless it appears that such purchaser had previous notice of the fraudulent intent of his immediate grantor, or of the fraud rendering void the title of such grantor.
Section 25-1-13 provides an exception similar to that of section 548(c) of the bankruptcy code. To avail himself of it, each defendant must show (1) that he was “a purchaser for a valuable consideration” and (2) that he did not have “previous notice of the fraudulent intent” of the debtors “or of the fraud rendering void” the debtors’ title to the property conveyed.
*867
The threshold question under section 25-1-13 is whether the defendants were “purchasers” of the allegedly fraudulent transfers. We hold that they were. The Utah Supreme Court has never construed the term “purchaser” as used in section 25-1-13, but this court believes that, consistent with the definition of “purchaser” in similar contexts, the Utah Supreme Court would read the term broadly to include anyone who acquires title to property through a voluntary transfer.
See, e.g.,
11 U.S.C. § 101 (35) (Supp. III 1985) (a “purchaser” within the meaning of the Code is any “transferee of a voluntary transfer”); U.C.C. § 1-201(32)
&
(33) (1972) (a “purchaser” is any person who takes by “any ... voluntary transaction creating an interest in property”).
Compare Wright v. Sampter,
152 F. 196, 199 (S.D.N.Y.1907) (the defendant was a “purchaser” within the old Bankruptcy Act’s good-faith purchaser provision “because she acquired the payment to her otherwise than by descent”),
with Giustina v. United States,
190 F.Supp. 303, 309 (D.Or.1960) (the legal meaning of “purchaser” is “one who, for a valuable consideration, acquires property or an interest in property”),
aff’d,
313 F.2d 710 (9th Cir.1962). The defendants acquired their interest in the money the trustee seeks to recover by voluntary transfer from the debtors. We therefore hold that each defendant who received a transfer from the debtors was a “purchaser” within the meaning of section 25-1-13 of the Utah Code.
The next question is whether the defendants were purchasers “for a valuable consideration.” Although the phrase “valuable consideration” is not expressly defined in the statute, the concept is similar to the concept of “value” in section 548 of the Code. We conclude that the term “consideration” includes both a conveyance of “property” and satisfaction of an antecedent debt.
Cf
Utah Code Ann. § 25-1-3 (“fair consideration” includes both a conveyance of property and satisfaction of an antecedent debt); 11 U.S.C. § 548 (d)(2)(A) (“value” means “property” or satisfaction of a present or antecedent debt). For the reasons previously discussed in part IVB-2 of this opinion, we conclude that a defendant gave “valuable consideration” for the transfers he received to the extent the transfers did not exceed his undertaking. Such transfers satisfied the debtor’s obligation to repay the undertaking. However, for the reasons previously discussed we also conclude that a defendant did not give valuable consideration for a transfer to the extent the transfer exceeded the amount of his undertaking. Therefore, for such transfers, section 25-1-13 is no defense.
The final issue under section 25-1-13 is whether the defendants had notice of the debtors’ fraud or fraudulent intent. The bankruptcy court held that, as a matter of law, the defendants “took their payments for value and in good faith,” 41 B.R. at 1007 .
As previously discussed, the bankruptcy court’s finding on the defendants’ good faith was not supported by the record. These adversary proceedings must therefore be remanded for a factual determination on the question of whether a given defendant had “previous notice” of the debtors’ fraud or fraudulent intent at the time he received each transfer the trustee seeks to avoid.
35
Under the Utah Fraudulent Conveyance Act, a conveyance can also be fraudulent-regardless of the actual intent of the person making the conveyance—if the following conditions are met:
1. The conveyance must have been made without fair consideration, and
*868
2. The person making the conveyance must have — *
a. been insolvent at the time he made the conveyance or was rendered insolvent by the conveyance, Utah Code Ann. § 25-1-4 , or
b. been engaged in or been about to engage in a business for which his remaining property would be an unreasonably small capital,
id.
§ 25-1-5, or
c. intended to or believed that he would incur debts beyond his ability to pay as they matured,
id.
§ 25-1-6.
It is undisputed that the debtors were insolvent when they made the conveyances to the defendants. However, the defendants argue that the payments to them were not constructively fraudulent and hence do not come within sections 25-1-4 through -6 because they were made for “fair consideration.”
Under Utah law, “[f]air consideration is given for property” when, among other things, “in exchange for such property ... as a fair equivalent therefor, and in good faith, property is conveyed or an antecedent debt is satisfied_”
Id.
§ 25-1-3. We have already concluded that, to the extent the transfers to a defendant exceeded a defendant’s earnings, the consideration for the transfer was not “a fair equivalent.” Thus, such transfers were not made for “fair consideration.” On the other hand, we have also held that transfers to a defendant that merely repaid the defendant’s undertaking satisfied an antecedent debt of the debtor. Such transfers were also a “fair equivalent” for the debt satisfied.
If that were all that the statute required, we would hold that conveyances to a defendant that merely repaid his principal undertaking were made for “fair consideration.” But, unlike the fraudulent convey-anee provision of the federal bankruptcy code, the Utah statute also requires “good faith.”
36
A conveyance will fail for lack of “fair consideration” if the party seeking to avoid the conveyance can show that the transferee did not take “in good faith.”
Meyer v. General Am. Corp.,
569 P.2d 1094, 1096 (Utah 1977).
Courts and commentators have not always agreed on the content of the good faith requirement under state fraudulent conveyance statutes. One court, for example, has found that a transferee does not take in good faith if he lacks an “honest belief in the propriety of the activities in question,” has an actual intent “to take unconscionable advantage of others,” or either intends to hinder, delay or defraud others or knows that the conveyance will have such an effect.
Sparkman & McLean Co.,
4 Wash.App. 341 , 481 P.2d 585, 591 (1971) (quoting
Tacoma Ass’n of Credit Men v. Lester,
72 Wash.2d 453, 458 , 433 P.2d 901, 904 (1967)).
See also Cady v. Johnson,
671 P.2d 149, 151 (Utah 1983) (quoting with approval this definition of “good faith” in another context). On the other hand, at least one commentator has argued for a “participation” test, which would attribute bad faith to a creditor only if he obtained the payment for reasons other than protecting the value of his claim. Note,
Good Faith and Fraudulent Conveyances,
97 Harv.L.Rev. 495 (1983).
Cf.
4
Collier on Bankruptcy
¶ 548.07[2] at 548-68 & nn. 10-13 (L. King 15th ed. 1987) (discussing “good faith” under § 548(c)). It is not for this court to decide in the first instance how the definition of good faith in section 25-1-3 differs from the good faith requirement of section 548(c) of the Code, if at all. We simply hold that the defendants’ good faith or lack thereof raises a genuine issue of material fact that the bankruptcy court may have to resolve on remand.
37
If a defendant did not receive payments in good faith, then he did not give “fair
*869
consideration” for the payments within the meaning of the Utah statutes. On the other hand, if he did receive the money in good faith, not only may the court find that he gave “fair consideration” for the payments he received, but it may also find that he comes within the bona fide purchaser exception of section 25-1-13 even though the debtors made the payments with the actual intent to hinder, delay or defraud other creditors.
For the reasons stated above, we must remand these cases to the bankruptcy court to determine each defendant’s good faith (or lack thereof) under section 25-1-3 and to determine his lack of notice under section 25-1-13. If the bankruptcy court finds that a defendant did not take in good faith, then the trustee may be able to recover all transfers to that defendant under section 544(b) of the Code and the applicable Utah law. On the other hand, if the bankruptcy court finds that a defendant received payments in good faith, the trustee may still be entitled to recover a portion of those payments, either as fraudulent conveyances or as preferential transfers. We will therefore discuss the trustee’s other claims to aid the bankruptcy court with its disposition of the case on remand.
C. The Trustee’s Second Claim
Under his second claim, the trustee sought to avoid as fraudulent conveyances all transfers to undertakers in excess of their undertaking, that is, all payments of fictitious profits. The bankruptcy court granted the trustee’s motion for summary judgment on his second claim, ruling that, as a matter of law, “the debtors received less than a reasonably equivalent value in exchange for these transfers.” 41 B.R. at 1009 .
We have already rejected the defendants’ argument that the transfers were not “of an interest of the debtor in property” and hence not avoidable under section 548.
See supra
part IV-A.
38
Moreover, we have also concluded, in part IV-B-2, that the debtors made the transfers with the actual intent to defraud creditors and that the debtors received less than a reasonably equivalent value in exchange for the transfers to the extent transfers to a given defendant exceeded his undertaking. The defendants do not dispute that the transfers occurred within one year before the debtors filed their petitions in bankruptcy at a time when the debtors were insolvent. Thus, we hold that the transfers are avoidable under section 548(a).
39
Furthermore, we have also held that, to the extent a defendant received more than he entrusted to the debtors, section 548(c) does not present a possible defense to the trustee’s actions. In short, the bankruptcy court correctly granted the trustee’s motion for summary judgment on his second claim.
Case law supports the bankruptcy court’s conclusion that payments of fictitious profits to investors in a Ponzi scheme are not made for a reasonably equivalent value and thus are avoidable as fraudulent conveyances.
See Eby v. Ashley,
1 F.2d 971 (4th Cir.1924),
cert. denied,
266 U.S. 631 , 45 S.Ct. 197 , 69 L.Ed. 478 (1925);
Lawless v. Anderson (In re Moore),
39 B.R. 571 (Bankr.M.D.Fla.1984).
See also Rosenberg v. Collins,
624 F.2d 659 (5th Cir.1980) (affirming the decision of the district court, which found that transfers in excess of a defendant’s total cash deposits were without “fair consideration” within the meaning of old 11 U.S.C. § 67 (d)(1)(c));
Larrimer v. Feeney,
411 Pa. 604 , 192 A.2d 351 (1963) (transfers in excess of a defendant’s invest
*870
ment plus the legal rate of interest were without fair consideration under the Pennsylvania fraudulent conveyance act). The defendants have cited no cases holding to the contrary.
The law allowing a trustee to avoid payments of fictitious Ponzi scheme profits as fraudulent conveyances embodies the principal that no one should profit from a fraudulent scheme at the expense of others. Were the defendants allowed to keep payments in excess of their undertakings, they would be profiting at the expense of those who entered the scheme late and received little or nothing. The fortuity that these defendants got into the scheme early enough to make a profit should not entitle them to a reward at the expense of equally innocent undertakers who entered the scheme later, perhaps as a result of misplaced faith borne of prior undertakers’ success. On the other hand, if the trustee is allowed to avoid transfers of fictitious profits the defendants are not hurt but will be in roughly the same position they were in before they entrusted their money to the debtors. They will still have all the funds that they invested (subject, of course, to the trustee’s third claim on remand). We therefore hold that, to the extent the defendants received more than their undertaking, the debtors did not receive a reasonably equivalent value in exchange for the transfers, the defendants did not give value in exchange for the transfers, and the trustee can avoid the transfers under section 548(a)(2), as well as under section 548(a)(1).
D. The Trustee’s First Claim,
Under his first claim the trustee sought to recover as preferential all transfers made within ninety days of the debtors’ petitions in bankruptcy under section 547 of the Code.
Section 547(b) provided:
Except as provided in subsection (c) of this section, the trustee may avoid any transfer of property of the debtor—
(1)to or for the benefit of a creditor;
(2) for or on account of an antecedent debt owed by the debtor before such transfer was made;
(3) made while the debtor was insolvent;
(4) made—
(A)on or within 90 days before the date of the filing of the petition; ... [and]
(5) that enables such creditor to receive more than such creditor would receive if—
(A) the case were a case under chapter 7 of this title;
(B) the transfer had not been made; and
(C) such creditor received payment of such debt to the extent provided by the provisions of this title.
11 U.S.C. § 547 (b) (1982).
40
The purpose of section 547 is twofold: It is meant to discourage creditors “from racing to the courthouse to dismember the debtor during his slide into bankruptcy” and to further the fundamental bankruptcy policy of treating creditors equally by preventing a debtor from preferring one creditor over others on the eve of bankruptcy. H.R.Rep. No. 595, 95th Cong., 1st Sess. 177-78 (1977),
reprinted in
1978 U.S.Code Cong. & Admin.News 5963, 6138.
Under the old preference statute, section 60b of the bankruptcy act, 11 U.S.C. § 96 (b) (repealed 1978), the trustee could avoid a preferential transfer only if the creditor for whose benefit the transfer was made had reasonable cause to believe, at the time the transfer was made, that the debtor was insolvent. The requirement that the trustee prove the creditor’s state of mind proved “nearly insurmountable” to a successful preference action. H.R.Rep. No. 595, 95th Cong., 1st Sess. 178 (1977),
reprinted in
1978 U.S.Code Cong. & Admin.News at 6139. Congress therefore
*871
dropped the requirement when it enacted the Code.
To make it easier for the trustee to recover preferential transfers and to further the twin goals of preference law, section 547 proceeds on the assumption that a debtor is “nearly always” insolvent during the three months before bankruptcy.
Id., reprinted in
1978 U.S.Code Cong. & Admin.News at 6138. Thus, the statute creates a presumption (rebuttable only by certain statutory “exceptions”) that transfers made on or within ninety days before the debtor files for bankruptcy are preferential. It generally leaves untouched transfers outside the ninety-day period.
41
One might seriously question whether section 547 should even apply to payments made to undertakers in a Ponzi scheme such as this. For a Ponzi scheme that lasts more than three months, the statute’s basic assumption does not go far enough. By definition, an enterprise engaged in a Ponzi scheme is insolvent from day one. Thus,
all
transfers to investors in a Ponzi scheme are preferential, not just those made within the three months before bankruptcy. Every transfer prefers the transferee to those investors at the end of the line.
The evil of a preferential transfer is that it “unfairly permit[s] a particular creditor to be treated more favorably than other creditors of the same class.” Recent Developments, 3 Bankr.DevJ. 365, 366 (1986). All investors in a Ponzi scheme are creditors of the same class, so in theory all should be treated equally. In effect, though, applying section 547 to a Ponzi scheme such as this favors some creditors over others. Under section 547 the creditors who are most preferred are allowed to keep their preferential payments because the transfers were made outside the statutory period,
42
while those the statute was meant to protect are hurt the most. Generally those investors paid within ninety days of bankruptcy will not have been paid in full. Were it not for the accident that they had the misfortune to invest in the scheme late, they would have just as good a claim to the money they received as those who joined early and were fully repaid. Yet later investors — those hurt most by the debtor’s demise — are required to return their payments, while earlier investors are not. The statute simply does not reach the early investors. Thus, applying the statute as written, the court is “compelled to take part in a farce whose result is ... to take away from those who have little, the little that they have.” Letter from Justice Samuel F. Miller to William P. Ballinger (Jan. 13, 1878),
quoted in
C. Fairman,
Reconstruction and Reunion, 1864-88, Part I
1069 (The Oliver Wendell Holmes Devise History of the Supreme Court of the United States vol. 6, 1971).
The equitable solution would be either to apply the statute to all transfers to investors in a Ponzi scheme — without regard to when the transfers were made — or to apply the statute to none of the transfers. Yet this court is no more free to rewrite the statute to bring the early undertakers into its net than it is to ignore the statute to treat later undertakers equally. Courts must apply the statute as written. The only question in these appeals is whether the bankruptcy court correctly applied the statute.
The bankruptcy court granted the trustee summary judgment on his first claim. The defendants appeal that ruling on three grounds. The defendants first argue that the property transferred was not property of the debtor and therefore not subject to avoidance under section 547. Second, the defendants contend that the trustee failed to prove all of the elements of a preferential transfer under section 547 and therefore the transfers may not be avoided. Finally, the defendants claim that all payments made within the preferential period fall within the “ordinary course of business” exception of section 547(c)(2) and thus may not be avoided. We have ad
*872
dressed the defendants’ first argument and have concluded that the property transferred was property of the debtors. We will now address the defendants’ second and third arguments.
Section 547(b) establishes five requirements for a preferential transfer. The parties agree that the transfers the trustee seeks to avoid under his first claim were to creditors, were made while the debtors were insolvent, and (with one exception discussed later) were made within ninety days of the debtors’ filing for bankruptcy relief. The defendants contend, however, that the trustee failed to carry his burden of proving that the transfers were “for or on account of an antecedent debt,” 11 U.S.C. § 547 (b)(2), and that the transfers enabled the defendants to receive more than they would have if “the case were a case under chapter 7,” 11 U.S.C. § 547 (b)(5). '
With regard to subparagraph (2) of section 547, the only issue the defendants have raised is whether payments of so-called earnings were for “antecedent” debts.
43
The court's conclusion in parts IV-B and -C of this opinion that the trustee can. avoid transfers in excess of a defendant’s undertaking as fraudulent conveyances makes that question academic. Obviously, the trustee cannot recover twice for the same transfer, so it is irrelevant whether he could also recover the transfers as unlawful preferences.
With regard to subparagraph (5), the defendants argue that the trustee has failed to meet his burden of showing that, because of an allegedly preferential transfer, the transferee received more than he would have received under a chapter 7 liquidation.
The bankruptcy court first set forth the applicable standard for such a determination: The court must construct a hypothetical liquidation of the debtor’s estate to determine whether the creditor received more as a result of the alleged preferential payment than he would have received at the time of the bankruptcy (as opposed to the time of the transfer) under a chapter 7 liquidation had the payment not been made. 41 B.R. at 1013 (citing
Palmer Clay Prods. Co. v. Brown,
297 U.S. 227, 229 , 56 S.Ct. 450, 451 , 80 L.Ed. 655 (1936)). The trustee need only show that the defendant received some payment on his claim within ninety days and that a chapter 7 liquidation would result in a distribution to creditors of less than 100 percent of their claims. Under such circumstances, the payment to the defendant enables him to receive more than he would have received under a liquidation had the transfer not been made.
44
See Palmer Clay,
297 U.S. at 229 , 56 S.Ct. at 450 .
See also Henderson v. Allred (In re Western World Funding, Inc.),
54 B.R. 470, 479 (Bankr.D.Nev.1985) (“If the dividend would be less than 100%, the defendants would ‘receive more’ if allowéd to retain the payments, and also share in a pro-rata distribution on any remaining claims”), and authorities cited therein.
Applying that standard to the facts before it, the bankruptcy court stated:
[I]t appears that approximately 924 investors, who invested sums aggregating
*873
more than 4 million dollars, received no returns and lost all of their original investment. Affidavit of Ron N. Bagley in Support of Trustee’s Amended Motion for Summary Judgment at II 30 (Feb. 24, 1984). It is true that the trustee has not constructed a hypothetical distribution to demonstrate what percentage of their debts the investors will likely recover in this case. From a practical standpoint, it is doubtful whether this is possible in the situation, as here, where all of the assets of the estate consist of contingent recoveries from the trustee’s litigation. But it is perfectly clear on the evidence presented that there will not be a 100 percent dividend to creditors. In a summary judgment proceeding, the court is not precluded from taking judicial notice of the record in the case. When we consider that 924 investors have claims exceeding four million dollars, for which they received nothing, scheduled claims for principal and unpaid interest total more than 50 million dollars, most of the administrative expenses allowed by this Court, which exceed $600,000.00, have not been paid, the liquid assets of the debtors’ estate have never exceeded $150,000.00, and the United States claims substantially all of the assets sought to be recovered by the trustee under the criminal forfeiture provisions of the R.I. C.O. statute, it is perfectly clear that the [allegedly preferential] payments enabled defendants to receive more than they would under Chapter 7. Accordingly, I find that the requirements of Section 547(b)(5) have been met.
41 B.R. at 1013 (footnote omitted). We agree.
Finally, the defendants argue that, even if the requirements of section 547(b) have been met, the transfers to them cannot be avoided because they come within the “ordinary course of business” exception for preferential transfers, found in section 547(c). That section states:
The trustee may not avoid under this section a transfer—
[[Image here]]
(2) to the extent that such transfer was—
(A) in payment of a debt incurred in the ordinary course of business or financial affairs of the debtor and the transferee;
(B) made not later than 45 days after such debt was incurred;
(C) made in the ordinary course of business or financial affairs of the debtor and the transferee; and
(D) made according to ordinary business terms
[[Image here]]
11 U.S.C. § 547 (c)(2) (1982).
45
The bankruptcy court concluded that the defendants had not borne their burden of proving each of the four elements of section 547(c)(2).
46
Of course, that conclusion alone would not justify the court in granting the trustee’s motion for summary judgment. To oppose successfully a motion for summary judgment, a party need not prove its case. It is enough if it shows that, given the undisputed facts in the record, the moving party is not entitled to a judgment as a matter of law.
See
Fed.R.Civ.P. 56(e).
The trustee introduced no evidence that the transfers he sought to avoid were made other than in the ordinary course of the debtors’ financial affairs and according to the contract terms. Rather, he moved for
*874
summary judgment on the grounds that the ordinary course of business exception “was not intended to cover the type of transactions at issue in this proceeding.” Memorandum of Points and Authorities in Support of Trustee’s Motion for Summary Judgment at 39, Record on Appeal, No. C-84-0927W, at 87. He argued that there can be no ordinary course of business exception for payments in furtherance of a Ponzi scheme.
Id.
Apparently, the bankruptcy court agreed. The bankruptcy court concluded that transfers to defendants within the ninety-day preference period were not made “in the ordinary course of business of the debtors and the defendants and made according to ordinary business terms.” 41 B.R. at 1014 .
47
Rather, all the transactions “were unusual, extraordinary, and unrelated to any business enterprise whose protection was intended by the drafters of Section 547(c)(2).”
Id.
at 1015 .
48
We believe that the bankruptcy court read section 547(c)(2) too narrowly. Just because a debtor does not have a legitimate or “ordinary” business does not mean that transfers he makes in the course of that business may not be made in the “ordinary course of business.”
As the bankruptcy court noted, the Code does not define “ordinary course of business.” In construing the statute, we must be guided by its purpose.
See Chapman v. Houston Welfare Rights Org.,
441 U.S. 600, 608 , 99 S.Ct. 1905, 1911 , 60 L.Ed.2d 508 (1979). As we have noted, the purpose of section 547 is to discourage the race to the courthouse and to promote the equal treatment of creditors. Not all transfers by a debtor on the eve of bankruptcy, however, threaten to set off a race to the courthouse or to undermine the equal treatment of creditors. Transfers in the ordinary course of the debtor’s business are presumably of this kind. By section 547(c) Congress meant “to leave undisturbed normal financial relations [of the debtor], because [they do] not detract from the general policy of the preference section to discourage unusual action by either the debtor or his creditors during the debtor’s slide into bankruptcy.” H.R.Rep. No. 595, 95th Cong., 1st Sess. 373 (1977),
reprinted in
1978 U.S.Code Cong.
&
Admin.News 5963, 6329.
We believe that, viewed in light of the statute’s purpose, the transfers to defendants in this case may have been made in the “ordinary course” of the debtors’ business. The debtors’ business was to solicit “undertakings” from investors and to pay the undertakers according to the terms of their contracts, in order to attract new undertakers. There is nothing in the record to indicate that the payments in question were any different from any other payments on the clearinghouse contracts, that they were made according to other terms or that the underlying debts were incurred in other than the ordinary course of the debtors’ admittedly fraudulent business. There is nothing to indicate that the transfers were not in conformity with the prior dealings of the parties, with the prior practice of the debtors or with the practices of others engaged in the same type of fraudulent business. Moreover, the payments did not threaten to set off a race to the courthouse. In fact, they had just the opposite effect. The race to the courthouse would have started sooner if the debtors had
not
made the payments in question.
Of course, preventing the race to the courthouse is just one purpose of the preference statute. It is also meant to minimize the unequal treatment of creditors. The bankruptcy court concluded that, in passing section 547(c)(2), “Congress did not intend to protect one group of investors in a ‘Ponzi’ scheme over the rest.”
Id.
at 1014. Yet by refusing to recognize an ordinary course of business exception in this case, that is exactly what the bank
*875
ruptcy court did. It treated more favorably those defendants who received payments outside of the ninety-day preference period, at the expense of those defendants who entered the scheme late and lost all or most of their undertaking, without any showing that the later investors had any worse claim to the money than the earlier investors. Rather than protecting those defendants who received transfers on the eve of bankruptcy, the bankruptcy court’s interpretation of section 547(c)(2) hurt them. Congress may not have intended to protect one group of investors over the rest, but neither did it intend to make one group bear a disproportionate share of the loss.
Thus, avoiding the allegedly preferential transfers in this case would do little to further the twin goals of preference law. Moreover, avoiding the transfers would do little to deter similar transfers in the future, since in theory such transactions “would have taken place regardless of the debtor’s financial straits.” Nutovic,
The Bankruptcy Preference Laws: Interpreting Code Sections 547(c)(2), 550(a)(1), and 546(a)(1),
41 Bus.Law. 175, 181 (1985). This is especially true of transfers in furtherance of a Ponzi scheme.
This does not mean that the defendants all have a good defense to the trustee’s first claim. We do not hold that the ordinary course of business exception applies to every transfer the trustee seeks to avoid by that claim. If a defendant knew of a debtor’s financial woes and sought and obtained accelerated payments under the contract, for example, the transfer may not have been made in the “ordinary course” of even the debtors’ extraordinary business. Whether any of the transfers at issue here fit that classical preference situation is a matter for the bankruptcy court to determine on remand. We simply hold that the bankruptcy court erred in granting the trustee summary judgment on his first claim. On the state of the record before the bankruptcy court, the trustee was not entitled to a judgment as a matter of law. A transfer does not fall outside the scope of section 547(c)(2) simply because it was made in furtherance of a Ponzi scheme.
On remand the defendants will still have the burden of showing that the transfers in question meet all four requirements of section 547(c)(2), including the requirement that the transfer be made not later than forty-five days after the debt was incurred.
49
But by leaving open the possibility of an exception to the trustee’s preference actions, all creditors are put on a more equal footing.
E. Prejudgment Interest
The defendants contend that the bankruptcy court abused its discretion in granting prejudgment interest to the trustee. To the extent we have reversed the bankruptcy court’s grant of summary judgment to the trustee, we vacate any award of prejudgment interest. However, to the extent we affirm the bankruptcy court on the merits of the trustee’s claims, the propriety of awarding prejudgment interest on those claims is still at issue.
The defendants acknowledge that the court has broad discretion in determining when prejudgment interest should be
*876
granted to the prevailing party, but they argue that the court’s failure to consider the merit of their defenses constitutes error because such consideration was essential to the proper exercise of the court’s discretion. The defendants, however, cite no authority for their argument.
The same argument was made in a related case,
Merrill v. Allen (In re Universal Clearing House Co.),
60 B.R. 985, 1001-02 (D.Utah 1986). For the reasons stated in that decision, we reject the argument. The bankruptcy court did not abuse its discretion in awarding prejudgment interest from the date of commencement of the adversary proceeding. Thus, to the extent that the court affirms the bankruptcy court on the merits of the trustee’s claims, the bankruptcy court’s award of prejudgment interest in these adversary proceedings is also affirmed.
V.
DEFENSES UNIQUE TO PARTICULAR DEFENDANTS
A. Defendant Ruby Van Sant
Ruby Van Sant appeals from the bankruptcy court’s grant of summary judgment against her on the trustee’s first and second claims. As to the trustee’s second claim, she contends that the record does not support the summary judgment against her and that the bankruptcy court erred in failing to address the issue of recoupment. We find for defendant Van Sant on both issues. We cannot, however, agree with her contention, under the trustee’s first claim, that payments she received within the ninety days before the filing of the debtor’s petition in bankruptcy did not come within section 547(b) of the Code.
1. Appropriateness of Summary Judgment
Defendant Van Sant contends that the record does not support summary judgment on the trustee’s second claim and that the bankruptcy court erred in determining that there were no material factual issues. She argues that the Bagley affidavit, the only affidavit filed in support of the motion, presented facially inconsistent facts and that the affidavit itself thereby raised a material factual issue.
By his second claim the trustee sought to recover all transfers to a defendant that exceeded the defendant’s undertaking. The bankruptcy court granted summary judgment in favor of the trustee on his second claim but did not allow him to recover payments that did not exceed a defendant’s undertaking. Thus, a crucial factual issue in the bankruptcy court was whether Van Sant had suffered a net loss or received a net gain.
Taken together, the Bagley affidavit and its exhibits asserted that Van Sant (a) “withdrew from the ... program and thereby received from the debtors the full amount of [her] deposit, together with additional sums representing ostensible ‘profits’ or ‘earnings,’ ” and (b) “received payments representing ostensible ‘profits’ or ‘earnings’ from the debtors but realized net losses on [her] investments.”
50
Bagley affidavit at 9, ex. D at 7, ex. E at 80. In his brief, the trustee offers an explanation for the affidavit’s facial inconsistency.
51
The record, however, contains no such explana
*877
tion. The bankruptcy court’s opinion gives no indication that any such explanation was presented for its consideration. It appears rather that the bankruptcy court was unaware of the affidavit’s inconsistency. The trustee may not now supplement the record on appeal by means of the arguments presented in his brief. It is well settled that issues not presented to the trial court “need not be considered on appeal.”
Kenai Oil & Gas, Inc. v. Department of the Interior,
671 F.2d 383, 388 (10th Cir.1982). This general rule applies with equal force in bankruptcy appeals.
See, e.g., Beery v. Turner (In re Beery),
680 F.2d 705 (10th Cir.),
cert. denied,
459 U.S. 1037 , 103 S.Ct. 449 , 74 L.Ed.2d 604 (1982).
A material factual issue was presented not only by the apparent factual inconsistency of the only affidavit submitted in support of the trustee’s motion, but also by both the answer to the complaint and the answers to interrogatories. Defendant Van Sant consistently stated in both of those documents that she had not received payments from the debtors in excess of her investment but rather suffered a net loss. Record on Appeal in No. C-841225W at 46, 15-16.
Rule 56(c) of the Federal Rules of Civil Procedure, made applicable to the bankruptcy court by Bankruptcy Rule 7056, governs the granting of summary judgment. It requires the court to render judgment “forthwith if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law.” Under this standard, the record did not support the judgment.
52
We therefore reverse the bankruptcy court’s grant of summary judgment against defendant Yan Sant on the trustee’s second claim.
2. Recoupment
Defendant Van Sant’s second argument is that the bankruptcy court erred in failing to consider her recoupment defense to the trustee’s second claim.
53
She contends that the sixth defense in her
pro se
answer to the complaint set forth the defense of recoupment despite her failure to employ that term of art. The sixth defense reads as follows:
This Defendant has incurred substantial losses as a result of her investment with Universal Clearing House Company. Any relief sought by the Trustee for the alleged benefit of the creditors should be limited to recovery against the principals and agents of the debtors who profited from the investments by this Defendant and the other creditors.
It would be unfair, inequitable, and beyond the scope and intent of the bankruptcy law to impose further losses upon this Defendant by requiring her to pay back the amounts she received in partial repayment of the amounts she deposited with the debtors.
Record on Appeal in No. C-84-1225W at 46 (emphasis added). Although defendant Van Sant’s answer did not set forth the factual basis for her recoupment defense, her answers to the interrogatories did. Answer number 7 reads as follows: “All payments received by me were used to purchase new contracts except for the months of May, June and July.”
Id.
at 15.
Recoupment
is defined as “the setting up of a demand [or defense] arising from
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the
same transaction
as the plaintiff’s claim or cause of action, strictly for the purpose of abatement or reduction of such claim.” 4
Collier on Bankruptcy
¶ 553.03 at 553-13 (L. King 15th ed. 1987). A typical scenario giving rise to the recoupment defense is a suit for payment under a construction contract that the defendant claims was not fully performed. If the defendant can prove his claim, he is entitled to a reduction in the amount of damages awarded the plaintiff.
See Ashland Petroleum Co. v. Appel (In re B & L Oil Co.),
782 F.2d 155, 157 (10th Cir.1986). The underlying policy is that “the defendant should be entitled to show that because of matters arising out of the transaction sued on, he is not liable in full for the plaintiffs claim.” 4
Collier on Bankruptcy, supra,
¶ 553.03 at 553-14.
Although this case may not be the typical recoupment case, the same underlying policy applies. If Van Sant can prove that her total investment with the debtors was one transaction and that she did not retain payments made to her by the debtors but rather reinvested those funds with the debtors, she is entitled to either a reduction in or an abatement of the damages. In other words, Van Sant should not have to return more than she actually received from the debtors. For example, if she ostensibly received $100,000 but $50,000 of that amount went to purchase other investment contracts from which she received nothing, she should only be liable for at most the $50,000 she received and not the whole $100,000.
The documents Van Sant submitted with her answers to interrogatories indicate that she may be able to prove the elements of the recoupment defense. Several of the contracts do not bear her signature but were apparently prepared and signed on her behalf by an agent of the debtors. Record on Appeal in No. C-84-1225W at 19, 23, 25, 27, 29, 31, 35, 38 & 40. This implies that payments the debtors purportedly made to Van Sant may never have reached her but rather may have been applied by the sales agent directly to the purchase of new investment contracts on her behalf.
The trustee maintains that Van Sant’s sixth defense did not specifically raise the recoupment defense. He argues that it was nothing more than an empty lamentation of the unfairness of the debtors’ scheme. We cannot agree. Rule 8(f) of the Federal Rules of Civil Procedure, made applicable to adversary proceedings by Bankruptcy Rule 7008(a), provides that “[a]ll pleadings shall be so construed as to do substantial justice.” This court has long been bound by the rule that justice requires especially liberal construction of the pleadings of
pro se
litigants.
Conley v. Gibson,
355 U.S. 41, 47-48 , 78 S.Ct. 99, 102-03 , 2 L.Ed.2d 80 (1957). Under these rules of construction, we must find that Van Sant raised the recoupment defense despite the inartfulness of her pleading.
The trustee further argues that the doctrine of recoupment does not apply to defendant Van Sant’s case because her claim does not arise from the same transaction as does the trustee’s claim. Although the trustee cites cases in which the recoupment defense did not prevail because a series of transactions were involved and also maintains in another section of his brief that Van Sant’s investment with the debtors consisted of several separate and distinct investment contracts,
see supra
note 51, this is not the basis of his argument. Rather, he argues that
[t]he trustee’s action arose from the fraudulent Ponzi scheme while the defendant bases her claim on the fictitious investment contracts. The subject matter of [both claims] may be similar yet one transaction involves purported investments in an accounts payable program while the other involved defrauding investors through an elaborate corporate facade and Ponzi scheme. The program in which the defendant believed she was investing was very ... different from the ... operation in which she actually invested. The transaction conducted under the guise of the debtor’s investment program was not the same transaction whereby the defendant received “profits” from the debtors under the Ponzi scheme.
Reply Brief of Appellee and Cross-Appellant, Robert D. Merrill, Trustee, at 17-18. We find this argument to be without merit.
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The trustee urges us to adopt a rule of law that would deny all victims of fraudulent transactions the right of recoupment. Even if equity did not counsel against so incongruous a result, we cannot deny victims of fraud the rights enjoyed by parties to legitimate transactions simply because we know of no legal theory supporting such a result.
The trustee further maintains that the policy of equality of distribution embodied in the bankruptcy code precludes the assertion of the recoupment defense in a case involving a Ponzi scheme. The trustee bases his argument on the assumption that Van Sant’s recoupment claim is based on nothing more than having suffered a net loss on her investment. Such an assumption is incorrect in this case. Defendant Van Sant’s recoupment defense arises from the reinvestment of funds she received from the debtors. Under such circumstances, the equitable principles of the bankruptcy code do not preclude but rather support Van Sant’s assertion of the recoupment defense. She must be allowed the opportunity to prove, if she can, that payments purportedly made to her by the debtors actually remained part of or were reintroduced into the debtors’ estate. They were simply “rolled over.” The debtors have them. She does not.
The factual basis for Van Sant’s recoupment defense also makes the trustee’s argument concerning preferential payments unnecessary. Van Sant’s answer to interrogatory number 7 indicates that she ceased reinvestment prior to the preference period. She stated, “All payments received by me were used to purchase new contracts except for the months of May, June and July.” Record on Appeal in No. C-841225W at 15. As indicated above, the date of filing in this case was September 16, 1981. 41 B.R. at 991 . Therefore, the ninety-day preference period began on approximately June 18, 1981. There is no indication in the record that Van Sant reinvested any payments that she may have received during the preference period. In fact, she indicates in her brief that she received no payments after July 1981. Opening Brief of Appellant at 16. The recoupment defense is therefore inapplicable to any payments she may have received during the preference period.
54
In light of the Tenth Circuit Court of Appeal’s recent decision that the recoupment doctrine applied to a contract for the sale of petroleum,
Ashland Petroleum Co. v. Appel (In re B & L Oil Co.),
782 F.2d 155 (10th Cir.1986), we believe that the bankruptcy court is required to consider Van Sant’s recoupment defense.
3. Section 547(b)
Finally, Van Sant claims that payments she received from the debtors within the ninety days before Universal Clearing House (UCH) filed its petition in bankruptcy were not preferential transfers avoidable under section 547(b) of the Code. We have already considered the defendants’ common arguments for why transfers within the ninety-day preference period should not be avoided. The only argument we need address here is Van Sant’s argument that the payments to her were made outside the preference period because an order for relief was not granted against Payable Accounting Company (PAC) until August 16, 1982.
This argument is based on the premise that Van Sant dealt with PAC, not UCH. Our review of the record leads us to conclude that this claim borders on the frivolous. Van Sant entered into at least fourteen contracts that very clearly establish her contractual relationship with both PAC and UCH.
See
Record on Appeal in No. C-84-1225W at 17-43. Van Sant’s answers to the complaint and to interrogatories also indicate that she dealt with UCH.
Id.
at 14-15, 44-46.
See also
Van Sant’s sixth defense as set forth above. On the record before us, we must conclude that Van Sant dealt with UCH and that payments she received within the ninety days before UCH filed its petition were made within the preference period. However, for the reasons stated in part IV-D of this opinion, we reverse the summary judgment entered
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against Van Sant on the trustee’s first cause of action.
B. Defendant Thomas Richards
Thomas Richards appeals from the bankruptcy court’s grant of summary judgment against him and in favor of the trustee. Defendant Richards’s sole contention is that the amount of damages awarded was erroneous. Richards argues that the judgment against him should order recovery not of $8,633.60 but of no more than $1,533.60.
55
The record on appeal supports his argument.
Considering that approximately two thousand adversary proceedings were filed in this case, 41 B.R. at 990-91 , and that most if not all of them were disposed of summarily, it is unfortunately all too probable that error concerning the amount of damages might occur in one of those proceedings. Our review of the record, as outlined below, indicates that just such an error did occur in Richards’s case.
The judgment against Richards, for $8,633.60, was entered on March 22, 1985, pursuant to the Order Respecting Summary Judgment.
See
Record on Appeal in No. C-85-0437W at 241-42, 236-40. The order granted the trustee’s motion for summary judgment on his second claim.
56
Id.
at 238. The trustee’s second claim was to recover as fraudulent conveyances cash payments made to the defendants by the debtors in amounts exceeding the defendants’ undertakings. Exhibit A to the amended complaint lists the defendants to whom the second claim applies and the amount of the claim against each defendant, under the heading “Claim II.”
See id.
at 47, 56-66. According to exhibit A, the trustee sought to recover $8,634.00 from defendant Richards on his second claim.
Id.
at 63A.
Richards stated in his answer to the complaint that “$8,634.00 ... is not the amount received by Thomas D. Richards in excess of deposits made to Independent Clearing House.”
Id.
at 156. In his answers to the trustee’s first set of interrogatories, Richards spelled out his dealings with the clearinghouse:
9. The amount received from ICH was as follows:
amount invested by defendant $7100. dividends or returnes [sic] from this amount were
January 9th $ 340.80
February 6th 596.40
March 10th 596.40
Total received $1533.60
Id.
at 32. All six documents submitted with his answers support Richards’s accounting. The contract, the statement of the contract account and the document entitled “Commitment to Assume Debt” show that the amount invested was $7,100.00.
Id.
at 33A-35. The statements accompanying the payments that ICH made to Richards, dated January 9, 1981, February 6, 1981, and March 10, 1981, indicate that Richards received payments of “earnings” of $340.80, $596.40 and $596.40 respectively and that his “undertaking” was $7,100.00.
Id.
at 36-38. That undertaking was repaid on March 10, 1981. The repayment conforms with the terms of the contract, which specified that the investment was for a period of not less than two nor more than nine months,
id.
at 35, and with the notice at the bottom of each statement that the “contract expires February 29, 1981 [sic],”
id.
at 36-38.
From the bankruptcy court’s decision, it is clear that the trustee sought and the court intended to grant recovery on the trustee’s second claim only for an amount equal to what a defendant received in excess of his undertaking. Richards’s answer to the complaint, answers to interrogatories and accompanying documents not only disputed the amount of damages the trustee sought but in fact demonstrated that the correct amount was $1,533.60 rather than $8,633.60. For that reason, the amount of the judgment entered against defendant Richards should be reduced to $1,533.60.
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VI.
MOTIONS TO VACATE DEFAULT JUDGMENTS
We next address the appeals from the bankruptcy court’s order denying motions to vacate default judgments. These particular appeals raise the issue of whether the bankruptcy court abused its discretion by denying certain defendants’ motions to vacate default judgments earlier entered against them. This issue is complicated by the unique circumstances underlying the entry of the default judgments.
A. Background
As has been made evident above, the collapse of the clearinghouses, the filing of the bankruptcy petitions, the bringing of some two thousand adversary proceedings against investors, many of whom had already lost substantial sums, and the substantial confusion that followed — all overshadowed by a major criminal investigation against the clearinghouse principals — distinguish this case from the ordinary bankruptcy proceeding. Many of the undertakers were unsophisticated in investment matters and had invested a substantial portion of their savings on the strength of advice from friends. When the scheme was uncovered and the clearinghouses collapsed, the investors understandably felt betrayed, confused and anxious about their money. The initial appointment and subsequent reorganizations of a creditors’ committee did nothing to clear up the confusion. The sheer number of adversary proceedings and the unorganized way in which many were handled made it virtually impossible for the investors to know who was doing what to whom.
57
During this time of uncertainty and strong feelings, the defendants, many of whom had lost most of their initial investments, learned that they stood to lose the little they had received. Yet, judging from the large number who appeared pro se, they either could not afford an attorney or did not recognize the need for one.
Against this backdrop, shortly after the filing of the adversary proceedings some of those investors against whom adversary proceedings had been filed composed a letter and mailed it to “all creditors of Universal Clearing House and Independent Clearing House.” Pertinent portions of the letter are as follows:
Most of you by this time have undoubtedly been served a summons and complaint in an “Adversary Proceeding” by the Trustee, Robert Merrill and his Attorney, William Fowler. We have been informed that when Mr. Goss an attorney in Mr. Fowler’s office was asked if he thought that the undertakers had the money to make the payment if judgment were entered for the Trustee and against the undertakers, he reported “They all have cars, houses and other assets”. Make no mistake, the Trustee and his counsel WILL COLLECT IF THEY GET JUDGEMENT, and they will do so unless we act together. We therefore hope you will read the rest of this letter and get in touch with us.
We as creditors of the above companies are very concerned with the developments in the bankruptcy proceedings of the above companies, and feel it is imperative that all creditors be informed of the same.
We have researched the affairs of the companies and reviewed the bankruptcy proceedings. As a result we have concluded that the creditor’s interests have not been the concern of the Trustee, his attorneys and the former Trustee now acting as accountant. [A synopsis of their findings and conclusions followed.]
[[Image here]]
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WE HAVE BEEN INFORMED THAT IF CREDITORS DO NOT ANSWER THE COMPLAINT, A DEFAULT JUDGMENT WILL BE TAKEN AGAINST THEM. If an answer is filed, we are advised that the Trustee will probably send interrogatories (requests for answers to legal questions regarding your account), which when answered, will result in the Trustee’s counsel filing motions for summary judgments again

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/2021041. Public record. Not legal advice.