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Nature of Suit Code: 422
Nature of Suit: Bankruptcy Appeals Rule 28 USC 158
Cause of Action: 

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PUBLISH 

UNITED STATES COURT OF APPEALS 

TENTH CIRCUIT 

In re: M & L BUSINESS MACillNE ) 

COMPANY, INC., ) 

) 

Debtor, ) 

----------------- ) CHRISTINE J. JOBIN, Trustee of the ) 

Estate of M & L Business Machine ) 

Company, Inc., ) 

) 

Plaintiff-Appellee/ ) 

Cross-Appellant, ) 

) 

v. ) 

) 

PERRY S. McKAY, ) 

) 

Defendant-Appellant/ ) 

Cross-Appellee. ) 

No. 94-1087 

94-1097 

. FILED 

t.Jmted States Court or Appeals Tenth Circuit 

MAY 2 9 1996 

PATRICK FISHER 

Clerk 

APPEAL FROM THE UNITED STATES DISTRICT COURT 

FOR THE DISTRICT OF COLORADO 

(D.C. No. 93-K-1321) 

Craig A. Weinberg (Andrew C. Littman, with him on the briefs), Stevens, Littman & 

Biddinson, Boulder, Colorado for Defendant-Appellant. 

Christine J. Jobin (Dana M. Arvin and Charles F. McVay with her on the briefs), The 

Jobin Law Firm, Denver, Colorado for the Plaintiff-Appellee. 

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Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 1 
Before KELLY, SETH*, and HENRY, Circuit Judges. 

HENRY, Circuit Judge. 

· This appeal concerns the investments made by the appellant Perry S. McKay in a 

pyramid or "Ponzi" scheme run by the debtor in bankruptcy, M & L Business Machine 

Company, Inc. ("M & L"). The appellee Christine S. Jobin, the bankruptcy trustee forM 

& L, brought an adversary proceeding against Mr. McKay seeking to recover a total of 

$43,500 in payments made to him in the ninety day period preceding the filing of the 

bankruptcy petition. Ms. Jobin argued that, under the Bankruptcy Code, the $43,500 paid 

to Mr. McKay was avoidable for several reasons and that the money should be returned 

to the bankruptcy estate for distribution to all creditors. In response, Mr. McKay argued 

that the payments constituted returns of a good faith investment for which M & L 

obtained reasonably equivalent value, that the payments were made in the ordinary course 

of business, and that, as a result, the trustee was not entitled to recover them. 

After the resolution of cross-motions for summary judgment and a trial, the 

bankruptcy court concluded that the trustee was entitled to recover $22,000.00 from Mr. 

McKay under 11 U.S.C. § 547(b), which authorizes the avoidance of transfers through 

which a transferee obtains more than he or she would have received in a chapter 7 

·The late Honorable Oliver Seth, Senior Judge, United States Court of Appeals for the Tenth 

Circuit, heard oral argument in this case but did not participate in the final decision. 

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Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 2 
liquidation proceeding. The court also held that the trustee was entitled to recover the 

entire $43,500 from Mr. McKay under 11 U.S. C. § 548(a)(1) as transfers made with the 

intent to hinder or defraud creditors. However, the court rejected the trustee's claim 

under 11 U.S. C. § 548(a)(2), which concerns transfers for which the debtor receives less 

than reasonably equivalent value. The effect of the bankruptcy court's rulings was a 

$22,000 judgment in favor of the trustee on the§ 547(b) claim, and a judgment of 

$43,500 in favor of the trustee on the§ 548(a)(1) claim. The district court affirmed the 

bankruptcy court's decision in all respects. ~Jobin v. McKay (In reM & L Business 

Mach. Co., 164 B.R 657 (D. Colo. 1994). 

Mr. McKay now challenges the district court's affirmance of the bankruptcy court's 

entry of judgment in favor of the trustee on her§ 547(b) and§ 548(a)(1) claims. In her 

cross-appeal, the trustee contends that the bankruptcy and district courts erred in rejecting 

her claim under§ 548(a)(2). For the reasons set forth below, we affirm the decision of 

the district court. 

I. BACKGROUND 

In the mid-1980s, officers of the debtor M & L began running a Ponzi scheme. 1 

We have defined a Ponzi scheme as 

an investment scheme in which returns to investors are 

not financed through the success of the underlying 

business venture, but are taken from principal sums of 

newly attracted investments. Typically, investors are 

promised large returns for their investments. Initial 

investors are actually paid the promised returns, which 

attract additional investors. 

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Using the company's legitimate operations as a computer sales and leasing company as a 

front, the M & L officers solicited investments by promising extremely high rates of 

return. Upon receiving money from investors, M & L issued promissory notes and paid 

the promised sums with postdated checks drawn on company accounts. 

From June through September 1990, Mr. McKay invested a total of $207,500 in M 

& L on varying terms. He made an initial investment of $100,000 on June 19, 1990, 

receiving an unsecured promissory note offering a return of ten percent per month 

($10,000) over a two year period A week later, he invested an additional $7,500 on the 

same terms. Finally, on September 7, 1990, and again on September 10, 1990, Mr. 

McKay invested $50,000 in M & L. On the latter two investments, M & L promised Mr. 

McKay a return of nine percent per week ($4,000). At the time of each of his 

investments, Mr. McKay received postdated checks. He deposited nine of them, totaling 

$43,500. 

On October 1, 1990, M & L filed a petition under chapter 7 of the Bankruptcy 

Code. The bankruptcy court converted the case to chapter 11 and appointed Ms. Jobin as 

trustee. After the Ponzi scheme was discovered, the trustee converted the case back to 

chapter 7 and filed adversary proceedings against M & L investors in which she sought to 

recover payments made by M & L prior to the bankruptcy petition. She filed the instant 

Sender v. Heggland Family Trust (In re Hedged-Invs Assocs Inc), 48 F.3d 

470, 471 n.2 (lOth Cir. 1995) (citing Merrill v. Abbott (In re Ind Clearing 

House Co.), 41 B.R. 985, 994 n. 12 (Bankr. D. Utah 1984), aff'd in part and 

rev'd in part, 62 B.R. 118 (D. Utah 1986)). 

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Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 4 
adversary proceeding against Mr. McKay in September 1992 and asserted claims to 

recover the $43,500 under the preference, fraudulent transfer, and post-petition 

transaction provisions of the Bankruptcy Code. ~ 11 U.S. C. § § 54 7, 548, and 549. 

Mr. McKay and the trustee filed motions for summary judgment, which the 

bankruptcy court granted in part and denied in part. The court ruled that the trustee was 

entitled to recover $22,000 from Mr. McKay as an avoidable preference under 11 U.S. C. 

547(b). 2 The court rejected Mr. McKay's argument that the transfers from M & L had 

been made "in the ordinary course of business" and therefore were not subject to 

avoidance in light of§ 547(c)(2). Additionally, the court found that although the trustee 

had established the elements of an avoidable transfer "to hinder, delay, or defraud" 

creditors under§ 548(a)(1), there were controverted issues of material fact as to whether 

Mr. McKay had received the payments from M & L "in good faith," as that term is used 

in§ 548(c), such that he could defeat the§ 548(a)(1) claim. Finally, the court concluded 

that there were unresolved factual issues as to whether M & L had received "reasonably 

equivalent value" for the transfers to Mr. McKay and that, as a result, summary judgment 

2 As to the other $21,500 in payments from M & L, the court observed that, after he 

received them, Mr. McKay invested an additional $100,000 (i.e. the two $50,000 investments that 

he made in September 1990). Noting that, under 11 U.S. C.§ 547(c)(4), the "new value" 

exception, the trustee may not avoid an otherwise preferential transfer if the transferee gives "new 

value" to the debtor after the transfer, the court ruled that the trustee could not recover the first 

four payments from M & L (totaling$ 21,500) under§ 547. The trustee did not challenge this 

conclusion regarding the§ 547(c)(4) exception in the appeal to the district court, and she has not 

done so in this appeal. However, because of our ultimate conclusion that the trustee may recover 

the entire $43,500 (including the $21,500 covered by the "new value" exception) under§ 

548(a)(1), the applicability of the exception is oflittle practical benefit to Mr. McKay. 

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Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 5 
was also not warranted on the trustee's claim to avoid the transfers under§ 548(a)(2). 

After denying summary judgment on the§ 548(a)(l) and 548(a)(2) claims, the 

bankruptcy court heard evidence concerning the circumstances surrounding Mr. McKay's 

investments in M & L. The evidence established that Mr. McKay had substantial 

experience in financial matters. In particular, he studied business administration in 

college and operated a profitable construction business in California. At the time of the 

bankruptcy proceedings, Mr. McKay was the co-trustee of a family trust holding over 

$3,000,000 in assets. He operated an industrial park in Golden, Colorado, a commercial 

real estate business, and a farming and ranching business. When he began investing in M 

& L, Mr. McKay's portfolio included stocks and bonds--which he traded through several 

brokers--mutual funds, land, and promissory notes. He subscribed to several investment 

publications. 

Mr. McKay testified that he learned ofM & L though Dr. Alec Tsoucatos, an 

economics professor and former college president who informed him of the extremely 

high rates of return that M & L was offering and reported that he had profitably invested 

in M & L over the last five years. Mr. McKay acknowledged that shortly after his first 

payment toM & L, he learned that Dr. Tsoucatos, although not representing himself to be 

a broker, had received a commission for convincing him to invest. 

After speaking with Dr. Tsoucatos, Mr. McKay visited M & L's corporate offices 

and spoke with two of its officers. In response to his inquiries about M & L's offering 

such high rates of return, the M & L officers stated that investors' cash payments allowed 

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Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 6 
the company to obtain computer equipment at very low prices and then negotiate extremely profitable contracts with its customers. The officers reported that M & L had 

obtained contracts to provide equipment to a California school district and to several 

Fortune 500 companies. However, they said, concerns about confidentiality precluded 

them from disclosing the terms of specific contracts. The M & L officers also informed 

Mr. McKay that the company's use of private investors to provide financing allowed them 

to negotiate contracts more quickly, without the constraints imposed by conventional 

lenders. However, the officers also stated that the majority of their financing was 

obtained through conventional lenders. 

Mr. McKay also testified to the bankruptcy court that, before investing in M & L, 

he reviewed audited financial statements (for 1988, 1989, and part of 1990) that M & L 

officers provided. He also reviewed sales projections for 1990 and biographical sketches 

of two ofM & L's officers. The sketches indicated that neither officer had significant 

financial experience. Additionally, Mr. McKay did not attempt to verify any of the 

information in the financial statements. He neither examined any of the purported 

contracts with M & L customers nor attempted to contact any of the conventional lenders 

that the M & L officers had reported to be the source of most of the company's financing. 

In his testimony before the bankruptcy court, Mr. McKay acknowledged that the 

first check that he received from M & L was returned for uncollected funds. After 

receiving notice of the returned check, Mr. McKay contacted a bank officer, who 

informed him that the matter would be discussed with M & L's president. Subsequently, 

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Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 7 
Mr. McKay spoke to M & L's president, who assured him that the problem had been 

corrected. The check cleared after it was deposited a second time. Dr. Tsoucatos then 

advised Mr. McKay not to deposit M & L's checks until five days after the date on each 

check Mr. McKay followed this advice and had no further difficulty in depositing M & 

L's checks. 

During the bankruptcy proceedings, the trustee also introduced testimony from Mr. 

Ken Wester, a goldsmith and gemologist who had been solicited to invest in M & L but 

had declined. Mr. Wester had considerably less financial experience than Mr. McKay, 

but he explained that he refused to invest because he was suspicious of the extremely 

high rates of return. 

After hearing the evidence, the bankruptcy court issued findings of fact and 

conclusions of law. The court ruled that Mr. McKay had failed to demonstrate that the 

transfers from M & L were taken in good faith under§ 548(c). As a result, it found that 

the trustee was entitled to avoid all of the challenged transfers under§ 548(a)(1), but not 

under § 548(a)(2). With regard to the § 548(a)(2) claim, the court reasoned that because 

M & L had received reasonably equivalent value for its payments to Mr. McKay, 

judgment should be entered in favor of Mr. McKay. 

The district court affirmed the bankruptcy court's summary judgment rulings, 

findings of fact, and conclusions of law in all respects. ~ JQ.bin, 164 B.R. at 661-668. 

On appeal to this court, Mr. McKay advances the following arguments: (1) that the 

bankruptcy and district courts erred in applying an objective standard of good faith under 

8 

Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 8 
§ 548(c); (2) that even under an objective standard, the evidence presented to the 

bankruptcy court established that he received the payments from M & L in good faith; 

and (3) that the courts erred in concluding that the transfers from M & L were not made 

in the ordinary course of business under § 54 7( c )(2). In her cross appeal, the trustee 

argues that the courts erred in rejecting her claim to avoid the transfers under§ 548(a)(2). 

II. DISCUSSION 

A. The objective standard for determining good faith is proper under 11 U.S. C. § 548(c). 

Mr. McKay first argues that the bankruptcy and district courts erred in concluding 

that he did not receive the transfers from M & Lin good faith and in thereby rejecting his 

defense to the trustee's § 548 claims. He maintains that both courts erroneously applied 

an objective standard of good faith, under which 11 ifthe circumstances would place a 

reasonable person on inquiry of a debtor's fraudulent purpose, and a diligent inquiry 

would have discovered the fraudulent purpose, then the transfer is fraudulent. 11 !Qbin, 

164 B.R. at 661 (quoting Hayes v. Palm Seedling Partners~A Qri re Agric Research & 

Technology Group, Inc.), 916 F.2d 528, 536 (9th Cir. 1990)). According to Mr. McKay, 

the proper measure of good faith under§ 548(c) is subjective--11 a transferee does not lack 

'good faith' unless he has some actual knowledge of the fraud. 11 Aplt. Brief at 26. This 

argument raises a legal question regarding the proper interpretation of the Bankruptcy 

Code and is therefore subject to de novo review. ~ Dalton Dev. Project v. Unsecured 

9 

Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 9 
Creditors Comm. (In re Unioil), 948 F.2d 678, 681 (lOth Cir. 1991) (Although "[a] 

bankruptcy court's factual determinations will not be disturbed on appeal absent the most 

cogent reasons appearing in the record," conclusions of law may be reviewed de novo. 

(internal quotation and citation omitted)). 

We begin our analysis with the language of the Bankruptcy Code. Section 

548(a)(l) provides that the trustee may avoid transfers of the debtor's property made 

within one year before the filing of the bankruptcy petition if the debtor "made such 

transfer or incurred such obligation with actual intent to hinder, delay, or defraud any 

entity to which the debtor was or became ... indebted." Section 548(a)(2) authorizes the 

trustee to avoid transfers on somewhat different grounds. If the debtor "received less than 

reasonably equivalent value" in exchange for a transfer of the debtor's property, the 

trustee may avoid the transfer if several additional elements are established. 11 U.S. C. § 

548(a)(2). 3 

3 

11 U.S.C. § 548(a) (2) states that the trustee may avoid transfers made 

within a year of the filing of the bankruptcy petition if she establishes that 

the debtor: 

(A) received less than a reasonably equivalent value in 

exchange for such transfer or obligation; and 

(B) (I) was insolvent on the date that such transfer 

was made or such obligation was incurred, or became 

insolvent as a result of such transfer or obligation; 

(ii) was engaged in business or a transaction, or 

was about to engage in business or a transaction, for which 

any property remaining with the debtor was an unreasonably 

small capital; or 

(iii) intended to incur, or believed that the 

debtor would incur, debts that would be beyond the debtor's 

ability to pay as such debts matured. 

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Section 548( c) provides a defense for individuals to whom the debtor's property is 

transferred: 

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 

or may retain any interest transferred or may enforce any obligation incurred, as the case may be, to the extent that such 

transferee or obligee gave value to the debtor in exchange for 

such transfer or obligation. 

11 U.S. C. § 548( c) (emphasis supplied). 

As the parties note, the Bankruptcy Code does not define "good faith." "Likewise, 

the legislative history related to section 548( c) never defines, and scarcely addresses, 

good faith." In re Telesphere Communications, Inc., 179 B.R 544, 557 n.20. (Bankr. 

N.D. TIL 1994) (citing S. Rep. No. 989, 95th Cong., 2d Sess. 89-90 (1978), H.R. Rep. No. 

595, 95th Cong,. 1st Sess. 375 (1977)). As a result, courts applying§ 548(c) have 

generally refused to formulate precise definitions. See, e.g., In re Agric. Research & 

Technology Group, 916 F.2d at 536 ("Courts have been candid in acknowledging that 

good faith 'is not susceptible of precise definition."') (quoting Consove v. Cohen (In re 

Roco Corp), 701 F.2d 978, 984 (1st Cir. 1983); In re Telesphere, 179 B.R. at 557 (noting 

that "there is no clear source of interpretive guidance" in construing the term). In 

analyzing§ 548(c), one leading commentator has concluded that "[t]he unpredictable 

circumstances in which the courts may find its presence or absence render any definition 

of' good faith' inadequate, if not unwise." 4 Collier on Bankruptcy 1 548. 07[2] at 548-72 

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Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 11 
(Lawrence P. King ed., 15th ed 1996). 

Nevertheless, contrary to Mr. McKay's contention, "good faith" has frequently 

been construed to include an objective component. After noting that "[g]ood faith is an 

intangible and abstract quantity with no technical meaning," Black's Law Dictionruy 

states that the term includes not only "honest belief, the absence of malice and the 

absence of design to defraud or to seek an unconscionable advantage" but also "freedom 

from knowledge of circumstances which ou&}tt to put the holder on inquiry." Black's Law 

Dictionruy at 693 (6th ed. 1990) (emphasis supplied). Prominent bankruptcy scholars 

agree: "[T]he 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, SYiml, ~ 548.07 at 548-73. 

The Eighth Circuit has recently followed this objective approach in determining 

good faith under§ 548(c), holding that "a transferee does not act in good faith when he 

has sufficient knowledge to place him on inquiry notice of the debtor's possible 

insolvency." ~Brown v. Third Nat. Bank (In re Sherman), 67 F.3d 1348, 1355 (8th 

Cir. 1995) (citing Armstrong v. Ketterling On re Anchorage Marina. Inc.), 93 B.R 686, 

693 (Bankr. D. N.D. 1988); 4 Collier on Bankruptcy, ,Slijliil, ~ 548.07 at 548-72 to 73). 

The Sherman court concluded that the transferee's knowledge of the debtors' substantial 

debts, of their delinquent mortgage payments, of a bank's plan to file foreclosure proceedings against them, and of a pending lawsuit placed the transferee on inquiry notice 

12 

Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 12 
that the transfer of the debtors' property was not made in good faith under § 548( c). 67 

F.3d at 1355-56. Similarly, in In re Agric. Research & Technology Group, the Ninth 

Circuit relied on several Supreme Court decisions construing "good faith" in other contexts to conclude that "courts look to what the transferee objectively 'knew or should 

have known' in questions of good faith, rather than examining what the transferee actually 

knew from a subjective standpoint. "4 Significantly, the majority of bankruptcy courts 

construing "good faith," as it is used in § 548( c), have followed the Eighth and Ninth 

Circuits, holding that a transferee who reasonably should have known of a debtor's 

insolvency or of the fraudulent intent underlying the transfer is not entitled to the § 

548( c) good faith defense. See, e. g., In re Anchorage Marina, 93 B.R. at 693; Walker v. 

Littleton (In re Littleton), 82 B.R 640, 644 (Bankr. S.D. Ga. 1988), rev'd on other 

grounds, 888 F.2d 90 (11th Cir. 1989); Williams v. Kidder Skis Int'l (In re Fitzpatrick), 

73 B.R. 655, 658 (Bankr. W.D. Mo.), affd in part and rev'd in part, 60 B.R. 808 (W.D. 

Mo. 1985); In re Polar Chips Int'l, 18 B.R. at 484. 

In arguing that these decisions should not be followed and that good faith should 

4 

Although the question before the Ninth Circuit was the proper 

interpretation of "good faith" under a section of Hawaii's Fraudulent 

Conveyance Act, Haw. Rev. Stat. § 651C-8(d), the court referred to 11 U.S.C. § 

548(c) as "the equivalent" of the Hawaii statute. ~In re Agric Research & 

Technology Group, 916 F.2d at 535. Moreover, in adopting the objective 

standard for determining good faith, the Ninth Circuit relied on bankruptcy 

court decisions construing§ 548(c). See id. at 535-36 (citing McColley v 

Rosenberg {In re Candor Diamond CokP ), 76 B.R. 342, 351 (Bankr. S.D.N.Y. 

1987); Consumers Credit Union v. Widett (In re Health Gourmet. Inc), 29 B.R. 

673, 677 (Bankr. D. Mass. 1983); Sanitary Ice Vending Co . Inc v Harris {In 

re Polar Chips Int'l. Inc), 18 B.R. 480, 484 (Bankr. S.D. Fla. 1982)). 

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be measured subjectively, Mr. McKay invokes this circuit's decision in Richards v. Platte 

Valley Bank, 866 F.2d 1576 (lOth Cir. 1989), two Fourth Circuit decisions, the analysis 

of several bankruptcy courts, and the definitions of good faith under the Uniform 

Commercial Code and various state laws concerning fraudulent conveyances. However, 

none of these authorities establishes that the objective measure of good faith applied by 

the bankruptcy and district courts is improper. 

In Richards, we construed a provision of Colorado's version of the Uniform 

Fiduciaries Act, Colo. Rev. Stat. § 15-1-109, that imposed liability on banks paying 

checks written by fiduciaries when "paying the check amounts to bad faith." Richards, 

866 F.2d at 1579 n.2 (quoting Colo. Rev. Stat. § 15-1-109). We observed that although 

the statute did not define "bad faith," it defined good faith as "a thing done 'honestly, 

whether it be done negligently or not."' Id. at 1582 (quoting Uniform Fiduciaries Act,§ 

1(2), 7A U.L.A 396 (1985)). We considered that definition in concluding that, under the 

Colorado statute, the mere failure to make inquiry, even though there are suspicious 

circumstances, does not constitute bad faith--"unless the facts and circumstances are so 

cogent and obvious that to remain passive would amount to deliberate desire to evade 

knowledge because of a belief or fear that inquiry would disclose a defect in the 

transaction." Id. at 1583 (citations omitted). 

Richards clearly does not address the circumstances now before us in this 

adversary proceeding under the Bankruptcy Code. As noted above, unlike the Uniform 

Fiduciaries Act, § 548 (c) of the Bankruptcy Code does not define good faith in terms of 

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Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 14 
knowledge and does not expressly exclude consideration of negligence. Moreover, the 

Richards decision is based in part on consideration of the purpose of the Uniform 

Fiduciary Act--the need for uniform rules "to take the place of diverse and conflicting 

rules that had grown up concerning constructive notice of breach of fiduciary obligations 

in order that commerce might proceed with as little hindrance as possible." Id. (quoting 

Union Bank & Trust Co. v. Girard Trust Co., 161 A. 865, 870 (Pa. 1932)). In the instant 

case--in which a bankruptcy trustee seeks to recover assets for the benefit of all creditors 

of a Ponzi scheme--the need for a good faith standard that removes hindrances to 

commerce is not the paramount concern that it was in Richards. ~ Gill v. Winn (In re 

Penna Pac. Properties, Inc.), 983 F.2d 964, 968 (lOth Cir. 1992) ("It is the ultimate aim 

of the preference law in the Bankruptcy Code to insure that all creditors receive an equal 

distribution from the available assets of the debtor."). 

As to the other authorities on which Mr. McKay relies, we agree with the district 

court that none of them expressly addresses the issue of whether the determination of 

good faith under§ 548(c) has an objective component. ~ !Qbin, 164 B.R. at 661-62. 

Smith v. Mixon, 788 F.2d 229 (4th Cir. 1986), the more recent of the Fourth Circuit cases 

that Mr. McKay cites, interprets a provision of the Bankruptcy Code, 11 U.S. C. § 

550(b)(l), which establishes a defense to a trustee's avoidance actions under 11 U.s.c: § 

550(a)(2) for "any immediate or mediate transferee of such initial transferee." Section 

550(b)(l) provides that the trustee may not recover from these transferees if they "take for 

value ... in good faith, and without knowledge of the voidability of the transfer avoided." 

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11 U.S. C. § 550(b)(1) (emphasis supplied). In construing this section, the Smith court 

focused on the use of the term "knowledge" and concluded that that term referred to 

actual notice and not constructive notice. Smith, 788 F.2d at 232. In this case, because 

Mr. McKay received the disputed funds directly from the debtor, M & L, he was not an 

"immediate or mediate transferee of [an] initial transferee," 11 U.S. C. § 550(b)(1). The 

reasoning of Smith is therefore inapplicable. 

The earlier Fourth Circuit decision on which Mr. McKay relies, Gilmer v. 

Woodson, 332 F.2d 541 (4th Cir.), cert. denied, 379 U.S. 834 (1964), is also based on a 

statute not at issue here--section 67( d)(2) of the Bankruptcy Act. Construing that section, 

the Gilmer court stated that "good faith cannot be said to be 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" Gilmer, 332 F.2d at 547. 

However, the court did not expressly hold that good faith must always be subjectively 

measured under section 67(d) of the Bankruptcy Act. Moreover, in reversing the district 

court's finding of a lack of good faith, the Gilmer court considered several objective 

factors--the value of the antecedent debt and the value of the security received. ~ id. 

Therefore, Gilmer also does not establish that good faith under § 548( c) must be measured subjectively. 

As to the decisions of bankruptcy courts, Mr. McKay relies primarily on Merrill v. 

Abbott (In re Indep. Clearing House Co.), 77 B.R. 843 (D. Utah 1987), and Practical Inv. 

Corp. v. Rellen (In re Practical Inv. Corp.), 95 B.R. 935 (Banlcr. E.D. Va. 1989). 

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However, as the district court noted, neither case held that good faith under§ 548(c) must 

always be measured subjectively. In particular, although at one point the Independent 

Clearini House court referred to good faith as "a subjective question," 77 B.R. at 862, the 

court also noted that the presence of circumstances placing the transferee on inquiry as to 

the debtor's insolvency may deprive him of the good faith defense, i.d. (citing 4 Collier on 

Bankruptcy, .5YIIDl, , 548. 07[2] at 548-[72]). Moreover, the Independent Clearing House 

court explained (albeit in a mixed anatomical metaphor) the determination of good faith 

in a manner that emphasized objective factors: "The test is whether the transaction in 

question bears the earmarks of an arm's length bargain." Id. Similarly, in In re Practical 

Investment, the court focused on the particular facts before it in concluding that a 

transferee was entitled to the good faith defense and did not expressly hold that a 

subjective test was required. 95 B.R. at 942-45. 

Finally, we are not persuaded by Mr. McKay's argument that the definitions of 

good faith under the Uniform Commercial Code and state fraudulent conveyance laws 

should be adopted in interpreting § 548( c). Many of these provisions contain language 

different than the language used in § 548( c) and, like the Uniform Fiduciaries Act, which 

we considered in Richards, 866 F.2d at 1583, involve policy concerns not applicable 

here. See, e.g., Territorial Sav. & Loan Ass'n y Baird, 781 P.2d 452, 461 (Utah App. 

1989) (referring to the definition of" good faith" set forth in Utah Code Ann. § 70A-1-

201 (19) (1989)--"honesty in fact in the conduct or transaction concerned"); Money Mart 

Check Cashing Ctr .. Inc. v. Epicycle Corp. 667 P.2d 1372, 1373 (Colo. 1983) (noting that 

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Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 17 
"[t]he drafters of the Uniform Commercial Code intended that this standard [of good 

faith] be a subjective one"). Significantly, none of the decisions cited by Mr. McKay 

concern an investor in a Ponzi scheme who had notice of the kind of suspicious 

circumstances that surrounded M & L. In construing the term "good faith," as it is used 

in § 548( c), we find the decisions of the Eighth and Ninth Circuits and the majority of 

bankruptcy courts more persuasive than the authorities on which Mr. McKay relies. 

Accordingly, we conclude that the bankruptcy court and the district court properly 

held that good faith under § 548( c) should be measured objectively and that "if the 

circumstances would place a reasonable person on inquiry of a debtor's fraudulent 

purpose, and a diligent inquiry would have discovered the fraudulent purpose, then the 

transfer is fraudulent." JQ.bin, 164 B.R. at 661 (quoting Agric. Research & Technology 

Group, 916 F.2d at 536). 

B. Evidence of a Lack of Good Faith 

Mr. McKay also argues that, even under an objective standard, the bankruptcy and 

district courts erred in concluding that his receipt of the $43,500 was not "in good faith" 

under § 548( c). Resolution of this issue requires a determination of whether the facts 

satisfy the proper legal standard, a mixed question of law and fact. ~ Clark y. Security 

Pac. Business Credit, Inc. (In re Wes Dor, Inc.), 996 F.2d 237, 241 (lOth Cir. 1993). In 

these circumstances, because the question of good faith is primarily factual, we will 

review the findings of the bankruptcy court for clear error. ~ i.d. at 242 (applying the 

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clearly erroneous standard to the district court's determination of value under § 548( c)); 

see also Acequia, Inc. v. Clinton (In re Acequia. Inc.), 34 F.3d 800, 805 (9th Cir. 1994); 

In re Roco, 701 F. 2d at 981-82. 

In arguing that he received the $43,500 from M & Lin good faith, Mr. McKay 

notes that he invested in M & L on the recommendation of Dr. Tsoucatos, a former 

economics professor, and that he received assurances about the financial soundness of the 

company from M & L's president after the first check was returned. As further indicators 

of good faith, Mr. McKay also points to his visit to M & L's offices, the explanations of 

the high rates of return provided by M & L officials, and his review of company financial 

statements. 

Under § 548( c), Mr. McKay has the burden of establishing good faith. ~ Agric. 

Research & Technology Group, 916 F.2d at 535; In re Candor Diamond Corp., 76 B.R. at 

351; 4 Collier on Bankruptcy, supra,, 548.10 at 548-129. Upon review of the record, 

we agree with the district court that the bankruptcy court's finding that Mr. McKay failed 

to establish good faith under the objective standard of§ 548( c) was not clearly erroneous. 

The factors supporting this conclusion have been persuasively outlined by the district 

court: Mr. McKay's experience as an investor; promised rates of return greatly exceeding 

the market rate (120% per year on two investments and 468% on the two other 

investments); an implausible explanation by M & L officials as to how the company 

could pay these extremely high rates; M & L's use of postdated checks to pay investors; 

Dr. Tsoucatos's disclosure that he received a commission for finding investors forM & L; 

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and the fact that the company's first check to Mr. McKay was returned. ~ !Qbin, 164 

B.R at 662-63. In light of all of these circumstances, it was not clearly erroneous for the 

bankruptcy court to conclude that a reasonably prudent investor in Mr. McKay's position 

should have known of M & L's fraudulent intent and impending insolvency and that he 

was therefore not entitled to the good faith defense established by § 548( c). 

C. The "Ordinary Course of Business" Defense under§ 547(c)(2) 

Mr. McKay also challenges the conclusion of the bankruptcy and district courts 

that the transfers from M & L were not made "in the ordinary course of ... business or 

financial affairs," 11 U.S. C. § 547(c)(2), and that, as a result, the trustee was entitled to 

avoid the transfers under§ 547(b). On this factual question, we must accept the conclusions of the bankruptcy court unless they are clearly erroneous. Clark v Balcor Real 

Estate Fin .. Inc. (In re Meridith Hoffman Partners), 12 F.3d 1549, 1553 (lOth Cir. 1993), 

cert. denied, 114 S. Ct. 2677 (1994). 

Under§ 547(b), the trustee may avoid transfers of property of the debtor made 

within ninety days of the filing of the bankruptcy petition if she proves that the transfer 

was made: (1) for the benefit of a creditor; (2) in satisfaction of an antecedent debt; (3) 

while the debtor was insolvent; and (4) such that it enabled the creditor to receive more 

than he would have received in a chapter 7liquidation proceeding. 11 U.S. C. § 

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Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 20 
547(b)(1)-(5). 5 Section 547(c)(2) establishes a defense as to transfers made in the 

ordinary course of business: 

(c) The trustee may not avoid under this section a transfer--

(2) to the extent that such transfer was--

( A) in payment of a debt incurred by the debtor 

in the ordinary course of business or financial 

affairs of the debtor and the transferee; 

(B) made in the ordinary course of business or 

financial affairs of the debtor and the transferee; 

and 

(C) made according to ordinary business 

terms[.] 

11 U.S. C. § 547(c)(2). The transferee has the burden of proving this defense. In re 

Meridith Hoffman Partners, 12 F.3d at 1553. Additionally, the defense should be 

narrowly construed. J. P. Fyfe, Inc. v. Bradco Supply Corp., 96 B.R 474, 476 (D. N.J. 

1988), .affd, 891 F.2d 66 (3d Cir. 1989); First Software Corp. y. Curtis Mf~. Co. (In re 

First Software Corp ), 81 B.R. 211, 213 (Bankr. D. Mass. 1988); Waldschmidt v. Ranier 

(In re Fulghum Constr. Corp.), 78 B.R. 146, 150 (M.D. Tenn. 1987), rey'd on other 

grounds, 872 F.2d 739 (6th Cir. 1989). 

5 Under§ 547(b), the trustee may also avoid transfers made within a year of 

the filing of the bankruptcy petition if she also establishes that the transferee 

was an "insider." ~ 11 U.S.C. § 547 (b) (4) (B). 

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In affirming the conclusion of the bankruptcy court that Mr. McKay had failed to 

establish the ordinary course of business defense, the district court focused on 

§ 547(c)(2)(C)'s requirement that the transfer be made according to ordinary business 

terms. ~ JQbin, 164 B.R. at 664-65. In applying§ 547(c)(2), we have taken the same 

approach. ~In re Meridith Hoffman Partners, 12 F.3d at 1553 ("Because we conclude 

that the payments were not made according to ordinary business terms, we do not discuss 

whether they meet the other two requirements."). Accordingly, we will address the 

"ordinary business terms" element of the§ 547(c)(2) defense. 

In In re Meridith Hoffman Partners, we concluded that "ordinary business terms" 

under§ 547(c)(2) "are those used in 'normal financing relations,': the kinds of terms that 

creditors and debtors use in ordinary circumstances, when debtors are healthy." 12 F.3d 

at 1553. We arrived at this definition by considering the general purpose of the§ 

547(c)(2) defense--"to leave undisturbed normal financial relations, because it does 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." Id. (quoting, 

S. Rep. No. 989, 95th Cong., 2d Sess. 88 (1978), 1978 U.S.C.C.A.N. 5787, 5874). 

Although several courts have concluded that transfers by a debtor engaged in a 

Ponzi scheme do not, as a matter of law, involve ordinary business terms, see, e.g., 

Henderson v. Buchanan, 985 F.2d 1021, 1025 (9th Cir. 1993); In re Taubman, 160 B.R. 

964, 971 (Bankr. S.D. Ohio 1993), we have chosen a middle ground In Sender v. 

Heggland Family Trust (In re Hedged-Inys. Assocs., Inc.), 48 F.3d 470, 476 (lOth Cir. 

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Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 22 
1995), we rejected "the sweeping rule that§ 547(c)(2) has absolutely no application in 

the context of a Ponzi scheme." Instead, we stated that because investment companies 

do not ordinarily pay fraudulent profits to early investors, the§ 547(c)(2) defense is 

inapplicable to payments to investors in a Ponzi scheme. ld. However, we also noted 

that payments to non-investment creditors could be made according to ordinary business 

terms and in the ordinary course of business such that these investors are entitled to the§ 

547(c)(2) defense. ld. ("If, for instance, a Ponzi scheme uses telephone services, is billed 

for that service, and pays the phone company, disallowing the avoidance of that payment 

following a bankruptcy petition is consistent with the purposes of§ 54 7. "). 

In the instant case, it is undisputed that Mr. McKay is an investment creditor of a 

Ponzi scheme. The rule we formulated in In re Hedged-Investments is directly 

applicable, and the bankruptcy court did not clearly err in concluding that payments from 

M & L to Mr. McKay were not made according to ordinary business terms under § 

547(c)(2)(C). The bankruptcy court and the district court properly rejected Mr. McKay's 

ordinary course of business defense to the trustee's § 547 claim. 

D. Reasonably Equivalent Value Under § 548(a)(2) 

In her cross-appeal, the trustee argues that the bankruptcy court and the district 

court erred in concluding that she was not entitled to avoid the transfers from M & L to 

Mr. McKay under§ 548(a)(2). We find no error in the analysis of the bankruptcy and 

district courts. 

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Section 548(a)(2) provides that the trustee may avoid transfers of the debtor's 

property made within one year of the bankruptcy petition if the debtor: 

(A) received less than a reasonably equivalent value in 

exchange for such transfer or obligation; and 

(B)(i) was insolvent on the date that such transfer was made 

or such obligation was incurred, or became insolvent as a 

result of such transfer or obligation; 

(ii) was engaged in business or a transaction, or was about 

to engage in business or a transaction, for which any property 

remaining with the debtor was an unreasonably small capital; 

or 

(iii) intended to incur, or believed that the debtor would 

incur, debts that would be beyond the debtor's ability to pay 

as such debts matured 

11 U.S. C. § 548(a)(2). Section 548(d)(2)(A) defines "value" as "property, or satisfaction 

or securing of a present or antecedent debt of the debtor." As the district court noted, the 

Bankruptcy Code does not define the term "antecedent debt," but it does define "debt" as 

"liability on a claim." ~ JQbin, 164 B.R at 666 (citing 11 U.S. C. § 101(12)). "Claim" 

is defined broadly as the "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," and as the "right to an equitable 

remedy for a breach of performance." 11 U.S. C. § 101(5). 

Both the bankruptcy court and the district court rejected the trustee's § 548(a)(2) 

claim on the grounds that Mr. McKay had given "reasonably equivalent value" to M & L. 

According to both courts, the value given toM & L was the reduction of Mr. McKay's 

claim for restitution against M & L. As the bankruptcy court explained, "[I]t is not 

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Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 24 
disputed that [Mr. McKay] invested the total sum of $207,500 into M & Land was only 

able to cash checks totaling $43,500.00. That is[,] [Mr. McKay] lost, on an out-ofpocket basis, the sum of$164,000.00 and still has a restitution right to same." Aplt. App. 

vol. II at 542. Thus, according to the bankruptcy and district courts, in paying $43,500 

to Mr. McKay, M & L received "reasonably equivalent value" in that Mr. McKay's claim 

for restitution as a defrauded investor was reduced by this amount. 

The courts based their reasoning on two decisions: Wyle v. Rider (In re United 

Energy Corp.), 944 F.2d 589, 596 (9th Cir. 1991) and In re Independent Clearing House, 

77 B.R at 857. Both decisions concluded that investors in fraudulent schemes had 

claims for restitution and rescission against the debtor and that, by reducing the amount 

of these claims, the debtors' payments provided reasonably equivalent value. ~ In re 

United Energy 944 F.2d at 596 (noting that investors in a fraudulent scheme "clearly had 

claims for rescission and restitution ... regardless of whether there existed a contractual 

right to the return of principal); In re Independent Clearing House, 77 B.R. at 857 ("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."). 

In challenging the rejection of her§ 548(a)(2) claim, the trustee relies on the 

bankruptcy court's finding that Mr. McKay lacked good faith under § 548( c). She argues 

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Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 25 
that, because Mr. McKay lacked good faith, he did not have a colorable restitution claim 

against M & L, and, as a result, M & L's payments to him did not provide M & L with 

"reasonably equivalent value" by reducing such a claim. She also argues that the 

bankruptcy and district courts improperly applied two standards of good faith--an 

objective one under§ 548(c) and a subjective one under§ 548(a)(2). She maintains that 

the objective standard should be applied under both subsections and that, under this 

objective standard, she is entitled to avoid the transfers under§ 548(a)(2). 

Contrary to the trustee's argument, the language of §548(a)(2) and §548(c) does 

not require application of the same standard Although § 548( c) uses the term "good 

faith," § 548(a)(2) does not. Instead, § 548(a)(2) refers to "value." Because the 

Bankruptcy Code's definition of "value" includes "satisfaction of an antecedent debt" and 

because the Code's definition of" debt" includes "liability on a claim," analysis of the 

trustees§ 548(a)(2) claim requires us to determine whether Mr. McKay has a claim 

against M & L and, if so, whether M & L's payments to him reduced that claim--thereby 

providing "reasonably equivalent value." 

In making these determinations, we apply Colorado law. ~ Lansing Diversified 

Properties-IT v. First Nat'l Bank & Trust Co. (In re W. Real Estate, Inc.), 922 F.2d 592, 

595 (lOth Cir. 1990), modified sub nom., Abel y. West, 932 F.2d 898 (1991); Flavor Dry, 

Inc. v. Lines On re James E. O'Connell Co.), 799 F.2d 1258, 1260 (9th Cir. 1986). 

Additionally, we must consider the following factual findings of the bankruptcy court 

regarding Mr. McKay's state of mind--which the trustee has not challenged in her cross26 

Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 26 
appeal: 

This conclusion regarding objective "bad faith," (more 

accurately lack of good faith) should not be construed as a 

determination by this Court of malicious intent, malevolence, 

or nefarious scheming by McKay--or of a lack of credibility. 

The Court does not find that he was malicious, malevolent, 

nefarious, or not credible. He simply did not invest in M & L 

and receive payments from M & L in a good faith manner as 

measured by an objective--not subjective standard. 

Aplt. App. vol. IT at 547. Accordingly, the question before us is whether an individual 

investor who should have known of a fraudulent scheme but did not have actual 

knowledge has a colorable restitution claim to recover his investment. 

Upon review of the applicable law, we conclude that Mr. McKay has such a claim. 

One who has been fraudulently induced to enter into a contract may rescind the contract 

and recover the benefits that he has conferred on the party who has defrauded him. See 

Western Cities Broadcasting y. Schueller, 849 P.2d 44, 48 (Colo. 1993) (en bane); 

Trimble v. City & County of Denver, 697 P.2d 716, 723-24 (Colo. 1985). Importantly: 

A suit in equity for rescission of a contract ... does not 

necessarily fail because the party seeking rescission was 

unreasonable in relying upon the misrepresentation made by 

the other party. Even negligence on the part of the party 

seeking rescission will not bar equitable relief when the 

misrepresentation was made intentionally by the other party. 

Pacific Maxon. Inc. v. Wilson, 619 P.2d 816, 817 (Nev. 1980). 

Colorado courts have applied this principle to allow a party fraudulently induced 

to enter into a contract to recover the full amounts paid even when the defrauded party 

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Appellate Case: 94-1087 Document: 01019279313 Date Filed: 05/29/1996 Page: 27 
acted negligently and had inquiry notice of the fraud For example, in Enerwest. Inc. v. 

Dyco Petroleum Corp., 716 P.2d 1130, 1132 (Colo. App. 1986), the court concluded that 

a company that had entered into a contract to acquire an easement was entitled to 

"restitution of the full amount paid under the contract" because the parties purporting to 

convey the easement had fraudulently concealed the fact that they had previously 

conveyed the easement to a third party. The court observed that the defrauded parties' 

right to recover restitution was unaffected by the fact that they had inquiry notice of the 

prior conveyance. Id; see also Loden y. Drake, 881 P.2d 467,469 (Colo. App. 1994) 

(noting that a party's failure to read certain provisions of a contract does not preclude 

restitution if the other party fraudulently concealed other contractual terms). 

In this case, the evidence in the record indicates that Mr. McKay was fraudulently 

induced to invest in M & L. As a result, in light of the bankruptcy court's factual finding 

that he did not have actual knowledge of the fraud, Mr. McKay has a colorable claim to 

recover the amounts that he invested in M & L. The bankruptcy and district courts thus 

properly concluded that M & L's payments to Mr. McKay reduced the amount of this 

restitution claim, that M & L thereby received reasonably equivalent value for its 

payments to him, and that the trustee was not entitled to avoid the transfers under§ 

548(a)(2). 6 

6 In her cross-appeal, the trustee has also argued that the fact that Mr. 

McKay filed a proof of claim in the bankruptcy court for the entire amount that 

he invested in M & L ($212,500.00) and the fact that he did not state that this 

claim was for restitution establish that he does not have a restitution claim 

against M & L. We agree with the district court that this argument is not 

persuasive. "[T]he issue is not what McKay stated that M & Lowed him but, 

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ill. CONCLUSION 

For the reasons set forth above, we therefore AFFIRM the decision of the district 

court in all respects. 

whether, at the time he made his investments, he had a right to restitution." 

~' 164 B.R. at 668. Moreover, Mr. McKay has filed an amended proof of claim 

for $164,000--the sum of his investments in M & L minus the payments that he 

received. ~~at 668 n.6. 

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