When a federal court appoints a receiver, it initiates a complex process that sits at the intersection of litigation, forensic accounting, and equitable justice. Receivers are tasked not only with recovering misappropriated assets but also with distributing them fairly among creditors and defrauded investors.

The Art of the Hunt: Chasing Down Hidden Assets

Receiverships often follow large-scale frauds like Ponzi schemes. In these cases, the receiver must locate and recover every last asset that can be tied to the fraudulent enterprise. According to Greg Hays of Hays Financial Consulting, this often turns into a ‘treasure hunt’ that can turn up anything from real estate and luxury vehicles to jewelry, racehorses, and even livestock.

Every case is different, of course.

“We once even traced funds into property located in Venezuela, where foreign ownership was technically illegal,” notes Melanie Damian, partner with Damian & Valori, LLP, underlining the jurisdictional and legal challenges that receivers can face when assets cross borders.

Leveraging the Ponzi Presumption

In Ponzi scheme cases, courts may apply what is known as the ‘Ponzi scheme presumption,’ a doctrine that eases the burden of proving intent to defraud. Kelly Crawford, partner at Scheef & Stone, explains that if a scheme is classified as a Ponzi operation, the court can infer that all payments made within the scheme were done with fraudulent intent.

According to Crawford, “Once you establish the existence of a Ponzi scheme, you don’t have to prove the debtor’s intent for each transfer. It’s assumed that they were all fraudulent.”

This presumption is grounded in the idea that Ponzi schemes are inherently unsustainable and destined to collapse, thus every transaction within them is designed to deceive. As noted in In re 1031 Tax Group, LLC, this doctrine saves time and litigation costs. However, not all jurisdictions accept the presumption (for example, see Finn v. Alliance Bank).

Fraudulent Transfer Claims

Central to most receivership recoveries are fraudulent transfer claims, which are legal actions that seek to unwind transactions made to hinder, delay, or defraud creditors. Under Section 548 of the US Bankruptcy Code and parallel provisions in the Uniform Fraudulent Transfer Act (UFTA), courts recognize two primary types of fraudulent transfers: actual and constructive.

• Actual fraudulent transfers occur when a debtor intentionally defrauds creditors, and the court looks for circumstantial evidence known as the ‘badges of fraud.’ These include:
  1. Transfers to insiders (e.g., family or close associates)
  2. Transfers made when the debtor was insolvent or facing lawsuits
  3. The concealment of assets or transfer details
  4. Retention of control over transferred assets
• Constructive fraudulent transfers do not require intent. They occur when a debtor:
  1. Receives less than reasonably equivalent value in return for the transfer, and
  2. Is insolvent at the time of or because of the transfer.

The term ‘reasonably equivalent value’ is not defined in the Bankruptcy Code, and its definition is debated in the courts. Some circuits apply an objective standard based on market value, while others use a subjective standard, i.e., whether the value economically benefited the debtor.

Net Winners and the ‘Good Faith’ Defense

Melanie Damian emphasizes that receivers often pursue ‘net winners’ — investors who withdrew more than they originally invested. This ‘clawback’ strategy varies depending on whether the transfer is deemed actual or constructive fraud.

In actual fraud cases, both profits and principal are subject to recovery unless the investor proves they received the funds in good faith and for value. The so-called ‘good faith’ defense, codified in Section 548(c) of the Bankruptcy Code, allows transferees to retain the transferred property to the extent they can prove they received the funds in good faith and for value. It should be noted, however, that this strategy can open new legal questions. For example, courts have debated whether raising a good faith defense waives attorney-client privilege.

In constructive fraud cases, receivers can only recover fictitious profits, which are returns beyond what the investor initially put in.

Recovering Assets from Charities and Professionals

Kathy Phelps, partner at Raines Feldman Littrell LLP, explains that even seemingly innocent recipients like churches or charities might be subject to clawbacks if they received fraudulent transfers. Though these cases are legally valid (charities typically give no value in return), they are often politically and emotionally sensitive.

Receivers can also sue professionals, such as lawyers and accountants, for aiding and abetting the debtor’s misconduct. These actions require proving that the advisor knew of the client’s fiduciary duty, participated in breaching that duty, and caused damages as a result. Damian points out that these claims are essential when professionals fail to detect or report clear red flags, especially in massive frauds or financial schemes.

Distribution Plans: Balancing Fairness and Practicality

Once assets are collected, receivers face the equally challenging task of distributing them. Kathy Phelps stresses the importance of developing a court-approved distribution plan that takes into account the status of claims, the traceability of funds, prior distributions, and equitable treatment of similarly situated claimants.

Some common distribution methods include those listed below. Courts generally weigh fairness and administrative simplicity when choosing the methodology.

• Net Investment: Distributes funds based on the original investment minus withdrawals.
• Rising Tide: Adjusts for prior withdrawals before calculating what investors are owed.
• Last Statement: Bases distributions on the final account statement (which may be inflated).

Final Takeaways

Federal receivership is a powerful tool in the legal arsenal, blending equity and litigation. Each case unfolds uniquely based on the type of fraud committed, the assets involved, and the stakeholders impacted. Receivers must be creative, persistent, and deeply versed in both statutory and case law. Their work ensures that fraud doesn’t just stop, but that it gets unraveled and redressed, one asset at a time.

To learn more about this topic, view Federal Equity Receiverships / Federal Receiverships: Digging Deeper in Asset Recovery and Distribution. The quoted remarks referenced in this article were made either during this webinar or shortly thereafter during post-webinar interviews with the panelists. Readers may also be interested to read other articles about federal receiverships.

This article was originally published here.

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