Kathy Bazoian Phelps
Senior Counsel in Ponzi Scheme Litigation
and Bankruptcy Matters

Kathy is a senior business trial attorney with more than 30 years experience prosecuting and defending claims for high net worth clients involved in Ponzi scheme matters and in bankruptcy proceedings. Kathy’s practice includes recovering assets for clients in complex fraud cases under standard fee and alternative fee arrangements. She also handles SEC and CFTC whistleblower claims. Kathy also serves as a mediator in bankruptcy matters, in complex business disputes, and in matters requiring detailed knowledge about fraud or Ponzi schemes.

Kathy’s Clients in Ponzi Scheme Cases and Bankruptcy Matters
Equity Receivers
Bankruptcy Trustees
High Net Worth Investors
Debtors in Bankruptcy
Secured and Unsecured Creditors

Tuesday, January 28, 2014

Jumping Through Hoops to Get Trustee Standing in Ponzi Scheme Cases

Posted by Kathy Bazoian Phelps

   In Ponzi scheme cases, the issue of trustee standing to bring third party claims can be very challenging. The Supreme Court has made clear that a trustee may pursue the debtor’s claims against third party defendants, but may not pursue creditors’ claims. Caplin v. Marine Midland Grace Trust Co. of N.Y., 406 U.S. 416 (1972). What makes the issue so challenging in Ponzi scheme cases is determining which claims belong to creditors and which belong to the debtor. Does the defrauded victim hold a claim for a particularized injury, or does the trustee hold the claim belonging to the debtor for generalized injury to the debtor as claims are filed against a debtor for victims’ losses in a Ponzi scheme?

   To avoid being thrown out of court on standing issues, trustees and their attorneys often employ a belt and suspenders approach to litigation. Trustees obtain assignments from creditors of their claims so the trustee then owns all possible claims and will be covered under either scenario. The theory is that, after the assignment, Caplin no longer applies because the trustee is pursuing claims that the estate owns, not the creditors’ claims. Pursuant to 11 U.S.C. § 541(a)(7), the estate includes, “Any interest in property that the estate acquires after the commencement of the case.”

   This strategy, however, has had mixed success depending on how and when the assignment is documented, as is fully discussed in § 13[2][d] of The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes (LexisNexis® 2012). At the circuit level, the cases have gone different ways, but a close look at these cases reveals differences in material facts that led to the different results:

  • The Ninth Circuit appeared to reject the assignment strategy in Williams v. Cal. 1st Bank, 859 F.2d 664 (9th Cir. 1988), where the court held that the creditors remained the “real parties in interest” because “the bulk of any recovery” had been reserved specifically for them. 
  • But then the Fourth Circuit approved it in Logan v. JKV Real Estate Servs. (In re Bogdan), 414 F.3d 507 (4th Cir. 2005), where the assignment was an unconditional assignment of all claims, making the trustee the real party in interest in that case. 
  • More recently in Grede v. Bank of NY Mellon, 598 F.3d 899 (7th Cir. 2010), the Seventh Circuit also approved the trustee’s standing based on an assignment of the creditors’ claims, where the trustee was a liquidating trustee and the claims were assigned pursuant to a plan of reorganization. 

   A recent decision from the United States District Court for the District of Idaho nicely reconciles the differing outcomes in these cases and lays out a possible roadmap for trustees. Zazzali v. Eide Bailey LLP, 2013 U.S. Dist. LEXIS 163282 (N.D. Idaho Nov. 14, 2012). In that case, the confirmed chapter 11 plan created a litigation trust called the Private Actions Trust (“PAT”), to which the creditors had assigned their personal claims against the Ponzi schemer’s accountants. When the PAT sued the accountants, the accountants responded with a motion to dismiss, arguing that under Caplin and Williams, the trustee lacked standing to pursue creditors’ claims.

   The court rejected this argument, concluding that Caplin and Williams apply only to bankruptcy trustees, and that the plaintiff was the trustee of a post-confirmation trust and not a bankruptcy trustee. The court instead relied on the Seventh Circuit’s decision in Grede, which specifically approved the standing of a post-confirmation trustee that resulted from creditors’ assignments of their litigation claims. The court also relied on two bankruptcy court decisions that had come to this same conclusion. In Calvert v. Zions Bancorporation (In re Consolidated Meridian Funds) 485 B.R. 604 (Bankr. W.D. Wash. 2013), the court held that under confirmed plan, the liquidating trustee is bound by the terms of the new contract and contract principles apply. Reaching the same result was Zazzali v. Hirschler Fleischer, P.C., 482 B.R. 495 (Bankr. D. Del. 2012), a decision that arose out of the same case and the same PAT that was before it.

   Grede, Calvert and the Zazzaili decisions clarify that in chapter 11, the assignment strategy may well succeed in creating standing for the trustee if it is executed in the context of a confirmed chapter 11 plan that creates a post-confirmation litigation trust.

   But what if the case is in chapter 7? Can a chapter 7 trustee ever establish standing through assignments of creditors’ claims? Based on the case law, a trustee could certainly try to solicit assignments from creditors, but those assignments would have to be unconditional assignments for the benefit of all creditors, as in Bogdan, to have any hope of success. Conditional assignments based on a promise to return some or all of the proceeds of the claims to the assigning creditors, as in Williams, are problematic for the purposes of establishing standing under the confines of Caplin.

   In the alternative, the chapter 7 trustee could, under 11 U.S.C. § 706(b), move to convert the case to chapter 11. That section states, “On request of a party in interest and after notice and a hearing, the court may convert a case under this chapter to a case under chapter 11 of this title at any time.” Upon conversion, the trustee, with the US Trustee’s consent, could become the chapter 11 trustee and then seek confirmation of a plan that creates a post-confirmation trust and accomplishes the necessary assignments. This strategy is more costly and time-consuming, though, so the claims would have to be of sufficient size and merit to justify this strategy. And, of course, the court deciding the issues would have to agree to follow the rationale in Grede and the Zazalli decisions that distinguish a liquidating trustee from a chapter 7 trustee.

   Is all of this jockeying and strategizing over the issue of trustee standing necessary? Is there a significant enough distinction between a trustee and a post-liquidation trustee to justify polar opposite results for creditors? Shouldn’t a fiduciary appointed to administer assets for the benefit of creditors (e.g., a chapter 7 trustee, liquidating trustee, or equity receiver) be permitted to bring claims that those very creditors are asking the fiduciary to pursue on their behalf? The developing case law requires trustees and creditors to consider all of the moving parts in strategizing over the pursuit of litigation claims, including the character of the fiduciary bringing the claims and the character of the assignments made by the creditors. Would it be easier to amend the bankruptcy code to clarify that the trustee has full standing to pursue creditors’ claims when those claims can be brought by each creditor in a group of similarly situated creditors?

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