Court Raises Bar for Pleading by Trustee in Ponzi Scheme Case

Posted by Kathy Bazoian Phelps

   Trustees frequently sue to recover fraudulent transfers in Ponzi scheme cases. Most trustees include allegations in their complaints that are general but that they hope are sufficient to meet the pleading requirements of Federal Rule of Civil Procedure 8(a)(2). The Supreme Court has held that "a complaint must contain sufficient factual matter, accepted as true, to 'state a claim to relief that is plausible on its face.'" Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S. Ct. 1937, 1949 (2009) (quoting Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 547, 127 S. Ct. 1955, 1960 (2007)). Meanwhile, Fed. R. Civ. P. 9(b) provides that "[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake."

   A trustee bringing a claim to avoid a fraudulent transfer under state law must use 11 U.S.C. § 544(b) to derive standing. To avoid a transfer under section 544(b)(1), a trustee must show that the transfer is avoidable under state law by at least one unsecured creditor of the bankruptcy estate with an allowable claim. Trustees commonly include a general statement that there existed one or more creditors who held allowable unsecured claims against the debtor and that the allegedly avoidable transfers are avoidable by a creditor holding an unsecured claim.

   One court recently considered whether such general language is sufficient. In re Petters Co., 2013 Bankr. LEXIS 2838 (Bankr. Minn. July 12, 2013).  “It goes beyond saying, that it is not to be taken for granted that such a creditor exists.” Id. at *28. The court then found that the trustee had not sufficiently alleged this element of his claim.

To plead his standing to sue to set aside a transfer to any defendant as fraudulent under Minnesota law, the Trustee must identify by name, in his complaint, at least one unsecured creditor with a claim allowable against the estate whose standing he uses to sue that defendant, which creditor would have had the right to sue to avoid that transfer on the date that that Debtor filed for bankruptcy relief. The Trustee's generic pleading as to the existence of a predicate creditor does not satisfy Rule 8(a). To maintain his claims against the defendants beyond the stage of these motions, he must remedy this defect.

   Id. at *31-2.

   In a further blow to the trustee on the form of pleading, the court also addressed the pleading requirements when the trustee seeks to extend the applicable look-back period:

To the extent that the Trustee seeks to have the statute of limitations of Minn. Stat. § 541.05, Subd. 1(6) eased by the application of the discovery allowance, he must plead that his predicate creditor did not know of or discover the fraud of the Petters Ponzi scheme, at any time within the six years before the date on which the bankruptcy petition was filed for the relevant Debtor. He must also plead the specific facts that prevented the predicate creditor from obtaining such knowledge and from discovering the fraud. The defects in the Trustee's original pleading must be remedied, at the appropriate time.

   Id. at 41-2.

   This decision should serve as a reminder for bankruptcy trustees to make sure they have fully thought through each of the elements of their claims before filing their complaints, including identifying by name the predicate creditor upon which the trustee’s standing is based and the facts necessary to extend the applicable look-back period.