www.loubar.org 10 Louisville Bar Briefs PROFESSIONAL EXCELLENCE Ponzi Schemes in Bankruptcy J. Gabriel Dennery and Keith J. Larson A Ponzi scheme is a basic grift. It “involves a business obtaining money from investors through the promise of a high rate of return on an investment.” Aliera LT, LLC v. Health Reform Team, Inc. (In re Aliera Cos.), 665 B.R. 468, *489 n. 15 (Bankr. N.D. Ga. 2024). The business then obtains money from a second set of investors and uses those funds to pay the initial investors. So on and so forth. In many such schemes, this process continues until the business can no longer convince more investors to put money in, so it can’t deliver on the promise to the most recent class of investors, resulting in insolvency. These sham businesses often end up in bankruptcy. In doing so, a Ponzi scheme can open a Pandora’s Box of bankruptcy litigation. Bankruptcy trustees in particular may seek to avoid (aka recover) pre-petition transfers in Ponzi scheme chapter 7 bankruptcy cases. A trustee can usually proceed under two distinct theories of recovery: (1) actual fraud, and (2) constructive fraud. 11 U.S.C. § 548; see, e.g., Kirkland v. Rund (In re EPD Inv. Co., LLC), 114 F.4th 1148, 1157 (9th Cir. 2024). Actual fraud claims ad- dress the debtor’s fraudulent intent, whereas constructive fraud focuses on the lack of reasonably equivalent value exchanged. Id. Actual Fraud To establish intent for actual fraud, trustees routinely rely on the judicially created and “long-standing Ponzi-scheme presumption, which recognizes that a debtor’s actual intent to hinder, delay, or defraud its creditors may be inferred by the mere existence of a Ponzi scheme.” Kirkland, 114 F.4th at 1152. Some courts have found that if the trustee proves that the debtor operated a Ponzi scheme, the trustee is entitled to a presumption that the transfers were made with actual fraudulent intent. For example, where a bankruptcy court previously determined that debtors operated a Ponzi scheme, commission payments made to an outside broker recruiting new investors were held avoidable as actual fraudulent transfers under 11 U.S.C. § 548(a)(1)(A), re- gardless of whether the broker knew she was participating in a fraudulent scheme. In re Woodbridge Grp. of Cos., LLC, Nos. 17-12560 (JKS), 19-51069 (JKS), 2025 LX 465326, at *43 (Bankr. D. Del. Oct. 20, 2025). If there is no Ponzi scheme presumption, the trustee may attempt to establish fraudulent intent through alternative means. This can be done by alleging the traditional “badges of fraud,” which include: (1) lack or inadequacy of con- sideration; (2) close relationships between the parties; (3) retention of possession, benefit or use of the property; (4) the financial condition of the debtor before and after the transaction; (5) a cumulative pattern of transactions follow- ing financial difficulties or threat of suits; and (6) the general chronology of the events. See, e.g., Sec. Inv’r Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, Nos. 08-01789 (CGM), 12-01576 (CGM), 2024 Bankr. LEXIS 1299, at *29 (Bankr. S.D.N.Y. June 4, 2024); Terry v. Frost Bank (In re Chris Pettit & Assocs., P.C.), Nos. 22-50591-CAG, 22-50592-CAG, 24- 05034-CAG, 2024 LX 73637, at *4 (Bankr. W.D. Tex. Dec. 16, 2024). The trustee, however, must plead these badges with sufficient particularity to satisfy the heightened plead- ing standard of Federal Rule of Civil Procedure 9(b). Id. Constructive Fraud Under 11 U.S.C. § 548(a)(1)(B), a trustee may attempt to avoid a pre-petition transfer as constructively fraudulent if the debtor received “less than a reasonably equivalent value in exchange” and was insolvent at the time of the transfer derbycitylitho.com • duplicatorsales.net 1-800-633-8921 • 831 E. Broadway, Louisville, KY 40204 PRINT, CONNECT, SUCCEED Tailoring your Office Technology Solutions since 1959. Network Printers and Copiers Fleet and Managed Print Solutions Corporate Mailing Systems Computer Systems and Managed IT Document Management Professional Print (Continued on next page) “ Ponzi scheme bankruptcies have required courts to develop specific doctrines to protect victims while also prohibiting trustees from overreaching against good faith investors. 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